The economic news in the last several weeks has been almost uniformly positive. The commentary from our competitors has been even more so, tending to dismiss as laughable the possibility that the recovery may be only temporary, that a “double dip” recession may occur. Consequently one is driven to ask: Are we in a bear market for Bears? (Wherein bear analysts will be run out of town.)

The single most damaging statistic released last week from the Bear viewpoint is productivity growth, which according to the Bureau of Labor Statistics reached 5.1 percent at an annual rate in the fourth quarter of 2001.

If productivity growth continues anywhere near as high as this, then the implications for the economy are vast. After all, if productivity growth can average 4 percent per annum, then the real rate of growth inherent in the U.S. economy is not 3 percent per annum (allowing for 1 percent per annum population growth) but 5 percent per annum. In that case, the appropriate price-earnings ratio on Wall Street should be very much higher than had previously been thought.

For example, since P/E ratios on the Standard & Poor’s 500 Index averaged 14 times over the last 50 years for a 7 percent earnings yield, at a time of average real potential growth of 3 percent per annum, then the expected real rate of return on U.S. equities was 7 percent plus 3 percent, or 10 percent, fairly close to what we have actually seen over the period, a premium of about 6.5 percent over the yield on (theoretically risk free) government bonds, reflecting both the higher uncertainty of holding equities and a premium for their illiquidity compared with government bonds.

But if the average real potential U.S. economic growth rate is 5 percent, not 3 percent, and because of the higher rate of productivity growth and more stable inflation the risk premium for equities over government bonds is now not 6.5 percent but 5.5 percent, then the required return on equities is now 9 percent, not 10 percent. Then subtract the 5 percent potential growth rate, would give an expected price-earnings ratio on the S&P 500 of 25 times, fairly close to its present level. If we can expect the average rate of productivity growth for the U.S. to be 4 percent per annum, over the long term, then U.S. equities, assuming there are no factors tending to produce a secular drop in earnings, are now fairly valued.

This is the New Economy thesis, so beloved of Alan Greenspan, for whom a market that was “irrationally exuberant” at Dow 6,400 in December 1996 is now fairly valued and due for recovery at Dow 10,600. According to Greenspan, the invention of the Internet, and computer technology generally, has increased the potential growth rate of productivity in the U.S. economy, essentially raising the “speed limit” at which the economy can grow. It’s an attractive thesis, beloved of Wall Street analysts and others paid to justify the outrageous valuations sometimes attained by individual stocks or the stock market as a whole.

Its problem is that the evidence for a secular rise in the productivity rate is at best ambiguous. Gross domestic product and productivity figures are frequently revised substantially, a year or more after they are first announced and reacted to by the market. Thus 2000’s GDP growth, originally estimated at 5 percent, has now been revised down to around 4 percent, with a corresponding decrease in the Bureau of Labor Statistics estimate of 2000’s productivity increase, now estimated at 3.4 percent.

This is not the end of the story, for two reasons. First, as discussed in a previous column, the BLS changed its methodology in the mid-1990s, capitalizing business software investment and writing it off over five years. This tended to produce an increase in productivity growth of about 1 percent per annum in 1996-2000, because of the very rapid increase in business software investment during those years. However, as is well known to users of computers, in practice the average lifespan of business or any other software is nowhere near five years but at most three, and in periods of rapid obsolescence like 1997-2000 more like 18 months. Hence output and productivity were consistently overstated during those years, and in particular productivity growth was overstated, because the amount of business software investment was continually expanding.

In 2001, this effect lessened and may have gone into reverse, because the level of business software investment flattened in the early part of the year and began to decline in the latter part. Hence this effect is likely to be less critical for 2001 than for previous years.

But the BLS’s average productivity growth over 2001 was only 1.9 percent, since productivity growth in the first three quarters of the year was very low indeed. Analysts who claim that recession was responsible for the low productivity figure can’t have it both ways; if 2001 was a uniquely shallow recession, so shallow as to be more or less non-existent, then its depressing effect on productivity may have been correspondingly minor. In fact, since Japan in the 1990s managed to achieve labor productivity growth of 3.5 percent per annum, in an economy that was almost stagnant, the cyclical effect on productivity may be less than is commonly thought.

A further anomaly in the productivity figures is that they represent only labor productivity. Total factor productivity, including capital employed and other factors of production, is calculated only years in arrears, but is a much more significant figure. During the 1990s, because of the stock market and investment boom, the capital intensity of U.S. business greatly increased, so total factor productivity in the period 1992-99 increased at a rate of only 0.74 percent per annum, slightly lower than in the expansion of the 1980s.

Here the figure for 2000, to be announced later this month, will be of exceptional interest. In 2000, the capital devoted to the U.S. economy increased at a record pace, with over $100 billion of private equity financing being raised, more than double the previous highest level. It is thus my belief that total factor productivity in 2000, even given the 3.4 percent increase in labor productivity, will prove to have been much lower than expected, and will drag the average productivity growth of the 1990s boom well below that of the 1980s.

If that occurs, then the 1990s productivity miracle will indeed prove to have been a myth, and the likely trend of productivity growth going forward will be nearer 2 percent than 4 percent. After all, productivity must have been helped during the 1990s by the maturing of the “baby-boom” generation into its most productive, hard-working years. This effect will however go into reverse in the decade ahead, as the boomers begin to retire and produce, instead of a boost to the economy, an increasing drag against it.

If productivity growth in the next few years is indeed 2 percent, then the valuation arguments go into reverse, the appropriate price earnings ratio for the stock market is indeed 14 not 25, and stocks are currently trading at about twice their proper price. Arguments such as that presented in Sunday’s Washington Post, that add earnings yield to earnings growth to get investor return, are false ones; the investor never in fact receives the earnings yield, but instead is forced to reinvest it, thus producing (he/she hopes) much of the earnings growth.

The other arguments for regarding the economy as being in the early stages of recovery really don’t hold water. The U.S. balance of payments deficit is currently running at over $400 billion per annum, which is financed by foreign investment in U.S. stocks and real estate. But if stocks are due to decline, then that foreign investment will also dry up, the stock market will fall further, and the dollar also will drop sharply against its competitor currencies, in order to find a point at which the payments deficit can readily be financed.

As for the 1.4 percent GDP growth in the fourth quarter, isn’t that to be expected after a period of more than a year during which M3 money supply has been inflated at more than 12 percent per annum, and short-term interest rates have been forced down to their lowest level in nearly 50 years?

Of course, this period of loose money, and indeed the much longer period of relatively loose money since 1995, hasn’t produced consumer price inflation. But it has produced asset price inflation, in both stocks and real estate. Given that we are very near the bottom of the interest rate cycle, therefore, and indeed long term interest rates have trended upward in the last few months, it must be likely that the asset price inflation will go into reverse, while the money supply growth, if it continues, finally feeds into consumer prices.

The imbalances, in summary are still there, and short of a miracle must inevitably return to haunt us in all but the shortest term, producing a sharp and prolonged downturn in both stock and real estate prices, and a corresponding second “dip” in the economy that is likely to be considerably more severe than the first — a descending staircase, in other words.

Only a miracle, and the only one potentially available would appear to take the form of a magical increase in the long term potential rate of productivity growth, can save us from this fate.

Whether that miracle is in fact occurring will be shown by the multi-factor productivity figures for 2000, to be announced later this month and the first quarter labor productivity growth figure, the first estimate of which is to be announced in early May. One can only pray.

Or, if one is a Bear, gloat in anticipation.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.