Bernanke's boom yet to reach Main Street

Federal Reserve chairman Ben Bernanke has succeeded in returning the United States economy to growth after the longest contraction in more than six decades but so far Wall St, not Main Street, has been the primary beneficiary.

Bernanke, who spoke overnight at the Economic Club of New York, has helped spark a 62 per cent rally in the stock market since March 9 by pledging to keep borrowing costs "exceptionally low" for "an extended period". His efforts haven't stopped unemployment from reaching a 26-year high of 10.2 per cent in October.

The Fed's benchmark rate is near zero and its balance sheet is just below a record at US$2.14 trillion ($2.87 trillion), leaving Bernanke, 55, little room to manoeuvre. He may be faced with growth that doesn't generate many new jobs, while stocks keep rising because companies including Caterpillar and Home Depot are cutting costs and meeting demand by improving productivity.

"It's a good news, bad news story," says Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts. "The corporate sector is going to be in very good shape financially, and that's good for the stock market. The bad news is that we'll continue to see job losses through next spring."

The economy strengthened for the first time in more than a year during the third quarter, expanding 3.5 per cent. Much of the growth came from a surge in productivity that is helping employers meet demand without hiring. Worker output per hour rose at a 9.5 per cent annual rate for the period, the fastest in six years, according to Labour Department figures released November 5 in Washington.

The increased efficiency has boosted corporate earnings and stock prices. The Standard & Poor's 500 index has jumped 62 per cent in the past eight months. During the most recent quarter, more than 80 per cent of the companies in the index reported profits that exceeded the consensus analysts' estimates, Bloomberg data show.

Caterpillar, the world's largest maker of bulldozers and excavators, earned US$404 million, or 64c a share, in the third quarter, far surpassing the analysts' forecast of 5c a share.

The Peoria, Illinois-based company, which saw sales fall 44 per cent to $7.3 billion in the period, has slashed inventories and production and cut about 37,400 full-time and temporary workers since December 2008.

Its stock is up 165 per cent since hitting a low in March.

Net income at Home Depot, the largest home-improvement retailer, dropped 7.2 per cent in the second quarter to US$1.12 billion.

Overall expenses were US$20 million less than the company planned, and it earned 66c a share, 7c better than analysts had estimated. Shares of the Atlanta-based company, have risen 52 per cent since March.

Rising corporate profits will be the "seed corn" for a sustained economic recovery and future hiring, and will justify continued stock purchases, says James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis.

The Fed's promise to keep interest rates low is also helping to buttress stock prices. The central bank is likely to hold its benchmark rate at near zero per cent through all of next year, says Bruce Kasman, chief economist at JPMorgan Chase in New York.

Wall St's focus on quarterly profits may mean job growth will be slow because companies won't add workers who don't immediately contribute to the bottom line, says Edmund Phelps, who won the 2006 Nobel Prize in economics.

"There's a whiff of joblessness in the recovery, because as long as firms are only looking in front of their nose, they're not going to reconstitute forward-looking jobs," he says.

The credit crisis has also changed the dynamic of the recovery. Large companies that relied on commercial-paper borrowing to finance payrolls have to keep more cash on hand, while tighter bank-lending standards are crimping expansion plans for small companies, she says.

"It's hard to get a small-business loan; we're still talking about tightening credit conditions in the sector that creates the most jobs," Diane Swonk, chief economist at Mesirow Financial in Chicago says.

Commercial and industrial loans at US commercial banks dropped to US$1.37 trillion from $1.6 trillion at the end of 2008, according to Fed data. Consumer loans have fallen to US$842 billion from US$857 billion at the end of last year.

Many borrowers are being charged more than double on some loans relative to what banks pay for funds. A five-year car loan rate was 4.49 percentage points higher on November 13 than the rate on a similar-maturity certificate of deposit that a bank can sell to raise cash, according to Bankrate.com data. That is up from an average of 2.05 percentage points in the five years through 2007. Spreads between so-called jumbo 30-year mortgages and 10-year Treasuries averaged 2.49 percentage points, up from 1.58 percentage points in the same period.

Tight credit remains a threat to Bernanke's success at helping sustain expansion, partly because Fed officials don't see prospects for immediate improvement in unemployment, which was 4.9 per cent when the recession began in December 2007.

The dichotomy between the surging stock market and lagging jobs market may end up posing problems for the central bank, says Mohamed El-Erian, chief executive of the Newport Beach, California-based Pacific Investment Management, which runs the world's biggest bond fund.

"In seeking to avoid a depression occasioned by the financial crisis, the Federal Reserve now finds itself having inadvertently placed a large bet on a recovery driven by asset prices," he says.

The danger is that the Fed's accommodative policy will push stock prices further out of line with the economic fundamentals of modest growth and high unemployment, according to El-Erian. The Fed's strategy, coupled with the federal government's US$787 billion stimulus package, also "faces the risk of collateral damage, including dollar pressure", he adds. The dollar has fallen 15 per cent since March against a basket of the most-traded currencies.

Rising unemployment poses political perils for President Barack Obama and his fellow Democrats ahead of Congressional elections next November. Exit polls during state balloting earlier this month showed the economy was the chief concern of voters who elected Republicans to replace Democratic governors in New Jersey and Virginia.

Obama said that he will convene business executives and experts for a jobs forum next month at the White House.

"The economic growth that we have seen has not led to the job growth that we desperately need," he said.

"We have an obligation to consider every additional responsible step that we can to encourage and accelerate job creation in this country."

- BLOOMBERG