NYTimes -- Between a Paw and a Sharp Place

Looking at the same set of statistics, economists and strategists can plausibly argue that the United States will post solid growth next year, or fall back into recession. Though it increases the odds of business-friendly legislation, including limitations on lawsuits and jury awards, the Republican takeover of the Senate also raises the chances of a tax cut whose benefits would go mainly to the very wealthy, with uncertain economic benefits.

Wall Street cannot even agree on what corporate earnings are. Optimistic strategists look at the S.& P. 500's "operating earnings," which factor out one-time restructuring charges and other expenses that companies have persuaded analysts should not be counted against them. On that basis, the S.& P. 500 is expected to earn roughly $48 a share in 2003.

If that calculation is right, the price-to-earnings ratio of the S.& P. 500, based on expected future earnings, is about 19, and stocks are more reasonably valued than they have been since 1994. Stocks look especially attractive relative to 10-year government notes, which are paying 3.85 percent, the lowest rate in more than a generation.

But skeptics argue that investors need to look at reported earnings after charges; on that basis, earnings this year will be closer to $30 a share. By that measure, the S.& P. 500 is trading at a P/E ratio of 30, far above its historical average. By other measures, stocks are also quite expensive; the dividend yield on the S.& P. 500 is only 1.8 percent, well below its historical norm.

The Gloom and Doom Scenario

With economic growth anemic and a strong dollar keeping imports cheap, Mr. East expects the United States to avoid deflation only narrowly over the next few years. He and others predict that inflation will be only 1.25 percent in 2003.

But investors have not yet accepted that when inflation is low, corporate earnings tend to grow very slowly, Mr. East said. In the long run, profits grow about 7 percent a year, and inflation represents about half of that increase, he said. But with inflation so low, companies will struggle to generate that level of profit growth. So, relative to bonds, Mr. East said, stocks are not as cheap as they appear.

"A real challenge for the equity market is to come to grips with a lower rate of inflation and nominal earnings growth," Mr. East said. "You have very low Treasury yields mainly because inflation is very low, and because inflation is very low, you can't value earnings as you have in the past."

Mr. East would not offer a specific target for the S.& P. 500. But he said he did not believe the index should trade above its historical average of 16 times profits, even with interest rates so low. For the S.& P. 500 to reach that level, it would have to fall to 800, near the lows it set in July and early October.

Zachary Karabell, a senior economic analyst at Fred Alger Management in New York, is almost as pessimistic. He figures that economic growth in the United States and worldwide will probably sputter for at least the next year. "It wouldn't take much to have a double-dip" recession, he said. "What's going to lead companies to really think more aggressively about new spending?"

The Worst Is Over and the Don't Worry, Be Happy scenarios seem less plausible.