I think what we had today was a disconnect between the stock market and the economy. The U.S. economy looks great...corporate profits [are] good...inflation and interest rates will be friendly for longer.
The basic conclusion is that 1999-2000 will bring further gains in corporate profits, mild-mannered inflation and a generally favorable outcome for equity prices. Increasing confidence that the economic expansion will continue through our newly-extended forecast horizon encourages a modest upward revision in stock price targets.
After September 11, 2001, we assumed that the equity risk premium demanded by investors would be above the historical average, but did not anticipate the current extreme reading which is near the highs of the past three decades.
It is too soon to know how the situation in Iraq will unfold in the coming months, and the extent to which the new government can indeed control the country. But, for the present, investors seem relieved that the direction is not toward an increased level of U.S. involvement.
Our economic outlook still calls for real GDP (gross domestic product) growth averaging 3-4 percent in coming quarters. We believe that economic and profit expansion can persist for longer at the moderate pace we project.
Equity prices can rise, despite decelerating profit growth and moderately rising interest rates, if investors expect economic expansion to continue. In previous such cases, stocks outperformed bonds, often notably.