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Analysts See Long Wait to Recovery

Worst of defaults, unemployment could stretch into next year.

Hold onto your hats — now there’s a chance the economic recovery could be delayed until well into 2010.

Participants at a New York Society of Security Analysts presentation on “Market Forecast: The Times They Have-a-Changed,” held at its offices last week, discussed the direction of the economy. The main conclusion: The U.S. isn’t heading back into a bull market any time soon.

The panelists included Martin Fridson, chief executive officer of Fridson Investment Advisors; Richard Bernstein, chief U.S. strategist and head of the investor strategy group at Merrill Lynch; Philip J. Roth, chief technical analyst at Miller Tabak + Co., and Donald J. Rissmiller, partner and chief economist at Strategas Research Partners. Vincent C. Catalano of Blue Marble Research moderated the program.

Fridson said there was a chance of a long recession, due in part to the elimination of many restrictive covenants in loan agreements, which had the effect of delaying defaults. Those delays, helped in part by payment-in-kind agreements where firms that can’t pay cash pay with goods or services instead, could push the peak of defaults into the first half of 2010.

Fridson also said the low cost of capital played a big role in the boom in private equity deals. However, with mergers and acquisition deals by private equity players waning, the door has been opened for strategic players to jump back into the deal-making process.

“The market is fairly valued. In our opinion, inflation is not a problem,” Bernstein told attendees.

He noted inflation is a lagging indicator and not a leading one, and so is pointing “more toward the end of something.” He added that global leadership, from a market performance perspective, has shifted “from a period of global growth to global slowdown. The U.S. is still good compared to other [markets].”

Roth said, “I don’t see conditions for a new bull market….If we don’t get going in the next two weeks, [it could be that] we’ll keel over to another leg down,” meaning another drop in the market.

One troublesome factor is that he doesn’t see investment demand, and that some big investment institutions such as Calpers think they have too much stock in their portfolios and are liquidating some holdings. “I need to see some change where insiders are buying,” he said.

He expects stocks to do well again in the next cycle, but noted that “this is the end of cheap energy. Next we’ll see the end of the era for cheap food.”

And in case the macroeconomic picture wasn’t already troubling, Rissmiller cautioned there could be a “double-dip” in the U.S. economy in terms of downturns. According to the economist, companies have shed workers, but have not cut wages. And the federal government’s tax rebate of 2008 didn’t do much to spur the economy.

“The problem is next year. They can’t keep doing rebates,” Roth said. While there’s been talk about another rebate early in the next administration, Rissmiller wondered aloud how those rebates would be paid for.

Beyond the NYSSA panel, there’s been a debate over what the Federal Reserve will do to interest rates, which were left unchanged last week. While the consensus among economists was that there wasn’t likely to be further interest rate movement this year, many, like Merrill Lynch’s Bernstein, are now concluding that inflation expectations are down, making a rate hike less likely as the Fed attempts to balance concerns about inflation and economic growth.

However, Richard D. Hastings, consumer strategist at Global Hunter Securities, thinks rate cuts could begin in October, noting that the ongoing credit crisis requires more cuts. He predicts a quarter-point cut, but feels that it could be a half-point cut if from now to October there is a greater weakening in consumer spending.

UBS chief economist Maury Harris foresees the unemployment rate at between 6 and 6.4 percent in 2009, with real gross domestic product growth at 1.1 percent. That was lowered from an earlier forecast of GDP growth of 1.9 percent.

Chief economist John Ryding at RDQ Economics expects the Fed policy to “remain on hold” for the rest of this year, noting the Federal Open Market Committee decision last week to keep interest rates unchanged “points to an expected moderation in inflation and implicitly notes the recent fall in energy and some commodity prices.”

Ryding concluded the “unchanged language on growth suggests the committee expects several quarters of below-trend economic activity, which translates to a further rise in unemployment into 2009.”

Stephen Gallagher, economist at Société Générale, said U.S. energy prices peaked just before the July 4th holiday, and continued falling after that. “The economic data is just beginning to capture the consumer reactions, but [the] markets may be moving ahead. Inflation expectations are subsiding [and the] Fed rate hike expectations are edging down,” he said.