Sorting through Wall Street's lowered expectations

Investors know that at some point the stock-market bear will retreat into the woods and a bull will come charging across the field.

But will that bull be more like a cow – docile, less vigorous?

The "irrational depression" mentioned by New York Stock Exchange Chairman Richard Grasso last week could be dissipating. A whiff of encouraging news Wednesday sent stock prices soaring.

But that doesn't necessarily mean a return of the "irrational exuberance" that Federal Reserve Chairman Alan Greenspan spoke of in 1996.

During the long bull market from 1982 to early 2000, the financial markets rewarded American investors generously. A portfolio of 60 percent stocks and 40 bonds generated an average annualized return of more than 15 percent per year.

"Glorious," note two Goldman Sachs & Co. economists.

But Bill Dudley and Jan Hatzius suspect the nation now faces "a very different era of diminished financial asset returns." Maybe the long-term return on corporate shares will be about 6 percent per year in current dollars, 4 percent after inflation, they say. That return would be the sum of the yield from dividends, about 1.5 percent now, and the long-term growth rate of real dividends and corporate earnings.

Nor are large returns from bonds likely, the two argue.

Robert Conlon, a Hong Kong-based manager of the Investec Asia Focus Fund, also sees "at best" a 6 percent average return for stock investors ahead, based on real growth in gross domestic product averaging 3 percent a year and 3 percent inflation.

The stock market, he says, is in a "post-bubble environment."

Much hangs on the performance of corporate profits and the economy.

Dean Baker, an economist at the Center for Economic and Policy Research (CEPR), has long held that with an aging population, economic growth in the United States is bound to slow in the years ahead and thus corporate earnings and stock-price gains will be much tamer.

That's relevant to proposals to put Social Security tax money into stocks.

A recent report by CEPR found that if 2 percentage points of Social Security payroll taxes had been diverted into private accounts invested in stocks in 1998, American workers would have lost $31 billion as of June 30, 2002 – and even more at the moment.

The flop in the stock market has badly damaged support for privatization of Social Security. Americans now know the market has big downs, not just ups.

At this time, Mr. Baker suspects the wealth effect of the stock-market boom, which swelled consumer purchases in the late 1990s and 2000, is being reversed.

"Very likely we will have a second dip" – back into recession, he says.

That is a minority view among economists. Most expect the recovery to continue, though at a relatively slow pace for the next several months.

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