Upbeat investors are back in stocks, confident that Federal Reserve interest rate cuts will shelter the nation's economy from foreign ills.

The Fed almost surely will lower rates again by yearend-perhaps as soon as its policy meeting next week, economists say. Despite the big stock market rally, they say, economic signs point toward a business slowdown.

The cooling labor market added just 116,000 net new jobs in October, the slowest monthly growth rate in three years. Hourly wages rose at the slowest pace in 15 months.

The jobless rate was unchanged at 4.6% last month, but "we expect it to rise above 5% by next spring," asserted Bruce Steinberg, chief economist at Merrill Lynch & Co.

Mr. Steinberg and others point out that credit market spreads for nongovernment issues remain at recession levels despite two rate cuts since late September. "More Fed easing is needed," he said.

Though rate cuts help business conditions in the short term, some economists question whether they are the long-term answer to overproduction-the main problem afflicting the global economy.

"Lower rates could well have the perverse effect of stimulating oversupply more than demand for that supply," said Edward Yardeni, chief economist at Deutsche Bank Securities, New York.

Oversupply has resulted from an epic investment boom in emerging markets over the past decade, as businesses built multiple production facilities in lower-cost labor markets after the Cold War.

The economic distress in many Asian nations over the past year has highlighted a shortfall in consumer demand for the output of so many production points. That creates deflationary pressure on prices, corporate profits, and, eventually, wages.

"The world is awash with excess productive capacity and output. Business has little or no pricing power," said Philip Braverman, chief economist at DKB Securities (USA) Corp., New York.

"Easier credit will neither create more consumer demand than we already have in the U.S., nor revive demand in Asia over the next 12 to 24 months," Mr. Yardeni said, "but it may well keep in business many producers who really should be out of business.

"I am not saying central bankers shouldn't lower rates," he said, "but forces of deflation are a lot more powerful and deeply rooted than many people recognize."

The outlook for earnings may not be as good as recent gains in the stock market suggest.

"There is no reason to believe corporate earnings will be better in the fourth quarter than in the third, and probably they will be weaker," said economist Lacy H. Hunt, a partner in Hoisington Investment Management Co., Austin, Tex.

Businesses are under "tremendous margin pressure," as shown by the relationship between labor costs, up 3.6% through September, and prices, up 0.6% according to the consumption deflator index, he said. Labor costs account for roughly two-thirds of production costs.

"The stock market rally raises the question of timing of Fed easings, but if the Fed is concerned about the underlying economic fundamentals and the recession-level spreads in the bond market, they will ease" at the policy meeting on Nov. 17, Mr. Hunt said. "I have no doubt they are going to ease many times over the next two years."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.