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... and what about Wall Street?

Traditional price-earnings ratios, stocks are already richly priced, according to many analysts. But the incredibly strong productivity increases of the past year have meant some of the best profit growth in years. If that continues, stocks may well continue their run.
In 2003, Wall Street broke its string of three straight losing years as the economy began to pick up momentum and investors sought stock market bargains.Mike Segar / Reuters
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After three consecutive losing years, the stock market came back with a vengeance in 2004, with the broad Standard & Poor's index up more than 20 percent so far this year and the tech-heavy Nasdaq up 45 percent. The long bear market finally hit bottom in March, just before U.S. forces invaded Iraq.

By traditional price-earnings ratios, stocks are already richly priced, according to many analysts. But the incredibly strong productivity increases of the past year have meant some of the best profit growth in years. If that continues, stocks may well continue their run.

Here are some highlights from comments offered by's panel of economic forecasters. For comments on the general economic outlook, see Part 1 of this story.

Diane Swonk, chief economist, Bank One:
2004 will be an extremely strong year, with at least 20 percent gains in the broader indices of the S&P 500. This kind of environment is just a money-making machine for the equity market, for better or worse. With high productivity, top-line demand pushing profits up, and persistent, relatively low interest rates, you’ve got a big ride on equity markets. The question is, how long will that ride be sustained once the world has returned to a more normal place on interest rates? But for 2004 it looks to be another blowout year.

Sung Won Sohn, chief economist, Wells Fargo: I am looking for more modest gains in 2004. The market can go higher as long as the Federal Reserve keeps interest rates low. When the central bank decides to take the punch bowl away from the party, then watch out. In the meantime things are looking pretty good to me.

Gary Thayer, chief economist, A.G. Edwards: I don’t think we’re overpriced yet at all. If we get good growth and good earnings I think there is more upside to the market. We could have another double-digit year. It might not be quite as strong as this year, but a lot of that depends on confidence and P-E ratios.

Ethan Harris, chief U.S. economist, Lehman Bros.: Our base case is a 10 percent kind of return to stocks. You’re still in the fast-growth period for earnings, so you can continue to support solid stock market gains. Profit growth eventually will slow, but next year should be another good year on the profits front.

Ed Leamer, director, UCLA Anderson Business Forecast: (Stock prices are) at the upper end of the range of what I would consider to be reasonable valuation. It’s ultimately a question of productivity and profits. If we have another year like this last year with that incredible productivity, then the equities markets are seriously undervalued. A year ago who would have thought we would get the numbers that we got this year?

David Rosenberg, chief North American economist, Merrill Lynch: I don’t think next year will be a year when you can play the index and be happy like you were this year. I think it will be a much more discriminating market next year, very sector-specific. If there's one theme I feel strongly about it's to be in the areas of the market that will benefit from a continued weakening U.S. dollar environment.

I’m very concerned about budget deficits. That is one of the biggest concerns I have about the economy in the future. Budget deficits are going to be very high for years to come. Even excluding defense spending we have seen a feeding frenzy in Washington, which is building in high deficits indefinitely. We know what happened in the 1970s and 1980s. Uncle Sam got his share and we in the private sector got what was left in the credit markets. Inflation and interest rates went up sky high. Hopefully we will not repeat those mistakes, but certainly I think there is that risk.

David Lereah, chief economist, National Association of Realtors: With our defense expenditures in Iraq, for the military, against terrorism, there's a lot of government expenditures. We just had a tax relief package. If we continue to reduce tax rates, which I am all for on a personal level and even as an economist, I do worry about the budget deficit. If it swells and goes toward the $500 billion mark, then I think that will exert some upward pressure on interest rates.

Leamer: I think we should be very, very concerned. Not so much for the economy in the short run, but the problems that creates in the longer run are very, very substantial. The big problem for the U.S. economy is we have a very low savings rate, and we have an aging work force. We’re going to have a big retirement bulge starting in 2010. We need to prepare for the benefits that those retirees are going to be demanding and we’re not doing that.

Thayer: I’m not a pessimist. I tend to think that as the economy gets better there will be more budget restraint than what we’re seeing right now. I don’t think you want to have that kind of budget restraint when we’re having a weak economy. I think in the next year or two we will see more discipline on the budget.

Rosenberg: I wouldn’t say I’m overly concerned. It's one of the reasons economists would be so bullish about the outlook, because there’s so much stimulus in the pipeline. The danger is more in the out years.

The economy is going to be neutral to favorable for incumbents. With that said, even in the best of economic times trade issues clearly are major.  Both sides seem to be a little more lenient to protectionist policies at this stage of the game. My concern is that we go down some bad economic policy roads.

Sohn: The economy should be a positive for President Bush. I see the economy growing nicely, the jobless rate falling as low as 5.2 percent from 5.9 percent today. So the economic environment should be a good help for President Bush.

Harris: As long as we don’t have a Fed tightening or we don’t have some other kind of shock to interest rates you should be in pretty good shape going into the election if you’re an incumbent.

Leamer: (Bush) has got a couple more quarters of data before he can declare victory. He doesn’t want to say "mission accomplished" a little early yet again.

After the next few quarters you’ve got a pretty long list of risks. The immediate risk will be, how does the economy handle the Fed starting to hint at rate hikes? We’ll also have to watch the way the markets handle the continued collapse in the dollar. So far it's been a very orderly transition down. If we were to get a major crash in the dollar it could precipitate foreign investors pulling out from U.S. financial markets. That threat is more real than it’s been in about 10 years.

Lereah: I worry about foreign money leaving this country. There is a threat that foreign funds could leave.  Interest rates are still very low in the United States. There is some uncertainty in the United States in some areas, terrorism being one of them. So we do worry if we lose a percentage of foreign funds, that could exert upward pressure on rates.

Thayer: Outside of another shock to confidence our biggest concern would be some sort of collapse of the dollar that would cause capital markets to seize up. The decline of the dollar has been very orderly, and if the Fed starts to move to a more neutral policy rather than its current reflation policy I think the dollar will stabilize.

Swonk: I think the it the biggest risk factor in the longer term is whether or not we are overstimulating today.  The risk is that we get upside surprises on the economy, that we see inflation sooner than we expect and then have to deal with it, which gives us a very different end to the cycle than we saw in the 1990s. That is still many years away where we have these real problems, but you can certainly see this cycle being reminiscent of the 1990s.

Sohn: The only contingency I can think of is outside shocks -- it could be the price of oil, it could be the geopolitical situation in Iraq. I don’t really worry about the Fed tightening too soon. My worry is that they will wait too long.