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By Alison Fitzgerald and Michael Forsythe

March 28 (Bloomberg) -- President George W. Bush, promoting his plan to set  up private Social Security accounts, is betting that stock returns will remain strong even as economic growth slows. Economists and equity strategists aren't so sure.

Bush is using forecasts from the Social Security Administration that say the economy will expand less than 2 percent a year -- the slowest sustained rate  since the 1930s --after 2020 as population growth eases. At the same time, the agency projects that stocks will return an annual average of 6.5 percent after inflation.

Thirty-nine of 58 economists and strategists surveyed by Bloomberg News say  that if the economy slows that much, Bush's stock outlook is too optimistic.
Over the last 50 years, as the U.S. economy grew 3.4 percent a year on average, almost twice as much as the agency is forecasting, the Standard & Poor's 500 Stock Index returned only 6.8 percent after dividends were reinvested.

``A 6.5 percent real equity return is not realistic'' at the growth rates being projected, says Thomas McManus, chief investment strategist in New York at  Banc of America Securities LLC. ``If it were, we will not have a Social Security problem in 2050 because shareholders will be so wealthy they could easily fund the shortfall.''

Neal Soss, managing director and chief economist at Credit Suisse First Boston Inc. in New York, says that ``real growth of 1.9% and real stock market returns of 6.5% can go together for a significant stretch of time, but not in perpetuity.  Among other things, that combination would suggest that eventually all of national income was being paid as profits with no wages at all, or alternatively that price-earnings multiples were rising without limit.''

`Way Too Low'

If the economy grows faster, the problems with Social Security won't require the overhaul Bush is proposing, several economists say.

``These GDP estimates are way too low, even with a slowing workforce due to  retirees,'' says Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi in New York. ``With GDP faster than their assumption, there will be more money in the trust fund, or we will have paid down some debt with potential budget surpluses so we can borrow again to get through the baby-boom retirement period.''

The possibility of low stock-market returns could undercut the main arguments that Bush, Vice President Dick Cheney and Treasury Secretary John Snow  are using as they try to convince the public that personal accounts invested in  equity and bond index funds can result in bigger benefits for future retirees.

Exhausted of Assets

The Social Security trustees said on March 23 that the 70-year-old program will be exhausted of assets by 2041. The White House is using such forecasts to bolster its case that workers should be allowed to divert payroll taxes into higher-yielding private accounts.

Under the current system, Social Security funds are invested in Treasury bonds. The Social Security trustees project a 3 percent long-term return for the  bonds, and Bush says the stock and bond markets will do better.

``The point is, the individual would get a higher rate of return than if they just send their money to Social Security,'' Cheney told an audience in Bakersfield, California, on March 21.

Economists such as Robert Shiller of Yale University say counting on averages from the past to predict returns decades from now is dangerous. ``These  historical returns are not, however, a good guide to future returns,'' Shiller said in a research paper released last week.

A Lucky Experience?

``The United States economy and stock market performed extremely well over the last century,'' he wrote. ``Many factors suggest this lucky experience is not likely to be repeated.''

He cited forecasts for lower economic growth and the current historically high stock values. The price-earnings ratio for the Standard & Poor's 500 index from 1936 through 1990 was 13.2 on average; it rose to an average 24.8 from 1991  through 2003, according to S&P data. The ratio was 19.6 as of March 24.

Shiller wrote the 2000 book ``Irrational Exuberance,'' which chronicles the  1990s stock boom and the phrase Federal Reserve Chairman Alan Greenspan made famous in a 1996 speech warning about a possible bubble in the equity market.

The White House Council of Economic Advisers said in a Feb. 4 statement that investment returns don't necessarily have any relation to economic growth.
Greenspan echoed that view in testimony before the Senate Committee on Aging on March 15, saying that stock prices are closely related to investors'
expectations of future earnings, reflected in price-earnings ratios, not just economic growth.

Slower Profit Growth

``It is the case if you have a slower economy that profits will grow at a slower rate,'' Greenspan said. ``But remember, a very significant part as far as  equities is concerned is the price-earnings ratio.''

He added, ``It's ambiguous as to what that will do over time. And I wish we  could forecast that better, but we don't seem to do that all that well.''

A Bloomberg analysis shows a strong correlation between investment returns and economic growth over the last 50 years. Gains and declines in the S&P 500 index preceded corresponding gains in gross domestic product and losses by about  a year. The correlation coefficient was 0.92, with 1 being a perfect correlation.

Greenspan said workers close to retirement shouldn't be exposed to risk and  should be largely invested in bonds. Bush and the Social Security Administration are also recommending that workers hedge their risk. They're touting a ``lifecycle portfolio,'' where older workers invest more in bonds than  stocks.

Lifecycle Returns

Lifecycle-account returns may be even less than the 3 percent annual yields  that the Social Security Administration forecasts for Treasury bonds over 75 years. Shiller analyzed 91 different scenarios for a worker born in 1990, and the median return was 2.6 percent.

McManus and 46 of the other 57 economists and strategists polled said the Social Security Administration's economic-growth forecast was too low, and that higher growth would yield better returns on stocks. Twenty of those surveyed said stock market returns would likely match or exceed the historic average.

If their prediction is true, it tempers the urgency to overhaul the federal  retirement program, as higher economic growth results in increased wages and more workers, with more tax revenue going into the pension system.

"This low estimate ignores the potentials for immigration growth, an increase in the retirement age and significant productivity growth stemming from  technology enhancements,'' says Ernest Goss, an economist at Creighton University in Omaha, Nebraska, and former scholar-in-residence at the Congressional Budget Office.


Treasury's Snow says high stock-market returns will be possible because gains in productivity -- or output per worker --will continue to be strong, offsetting slowing population growth.

GDP growth is a function of both growth in the workforce and productivity, he said in a March 23 interview. ``Productivity stays strong, and productivity per capita remains high,'' predicted Snow, who has a Ph.D. in economics. ``And it's productivity per capita that drives returns on assets.''

Yet the Social Security Administration expects productivity growth to plummet in the coming years, falling from last year's 4.1 percent gain to about
2.1 percent starting in 2010, according to the agency trustees' report released March 23.

Better Solution

Many economists who say Bush's forecast for investment returns is unrealistic still say private accounts are a better solution than the current system of paying for retirement as the baby boom generation -- those born between 1946 and 1964 --leaves the workforce.

``The money has to come from somewhere,'' says Stephen Stanley, chief economist at RBC Greenwich Capital in Greenwich, Connecticut, who was also included in the survey. ``Under the current system, we save nothing, which means  we are on the hook for all the necessary payments in the future. Under personal  accounts, people are saving a part of their eventual retirement income. Whether  investment returns and the economy are good or poor, the burden will be spread out over time.''

--With reporting by Alex Tanzi and Simon Kennedy in Washington and Michael McKee  and Tom Keene in New York. Editors: McQuillan, Jaroslovsky, Siler.

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For Immediate Release: 
March 28, 2005