After the worst market selloff in three months a week ago Monday, ostensibly due to the chaos resulting from the fact that no political party in Italy was able to secure a governing majority, with the opposition led by an unemployed comedian and a 76-year-old disgraced former Prime Minister under indictment for tax fraud, the major averages were able to brush that one-day hiccup aside and continued to rally in subsequent days. As a result, the Dow Jones Industrial Average ended this past Monday at its second-highest close ever, only 37 points away from the record high close of 14,165 reached on October 9, 2007.
And even if the Dow does surpass its previous record in the coming days, I still maintain that most investment portfolios are not as healthy today as they were at that time, as for instance — is the value of a person’s home today as much as it was then? Do you get the same return on money market funds now as you did then — around four percent versus virtually nothing today? And did you live through the worst market decline since the Great Depression of the 1930s as investment portfolios were decimated during the late 2008–early 2009 market meltdown?
But never mind, as investors saw the glass as half-full in making its most recent recovery from that worst market shellacking in three months, despite issues that at other times would ostensibly have buyers more concerned than they seem to be now.
Helping to ease the worries about an eventual withdrawal of the $85 billion per month in stimulus that the Federal Reserve is providing through its purchases of Treasury and mortgage-backed securities to the tune of $2.5 trillion, last Wednesday Chairman Bernanke said that the U.S. jobless rate is unlikely to reach “more normal levels” for several years, meaning that the Fed is going to continue to keep its foot on the monetary easing pedal. In fact, he downplayed internal divisions at the central bank that had caused a market selloff two weeks ago by saying that the quantitative easing policy, better known as QE, has the support of a “significant majority” of top Fed officials. He mentioned that it was a “reasonable guess” for an unemployment rate of six percent to be attained by 2016, about three more years.
He also countered the notion that the Fed’s loose monetary stance could be responsible for asset bubbles, as what happened in both the stock and housing markets in the past decade and a half, by saying that “there is still a good bit of slack in the economy” and that he did not think that the economy was overheating.
The Chairman argued that this extraordinary policy easing deserved at least some credit for the ongoing economic recovery, even if growth remains somewhat fragile and vulnerable to the $85 billion in sequestration budget cuts that were scheduled to begin this week.
This line of thinking was reiterated on Monday when the Fed’s vice-chair repeated that the aggressive monetary stimulus was justified, considering how far below its maximum potential the economy was operating. She drove this point home with her assertion that “Insufficiently forceful action to achieve our dual mandate (steady economic growth and low inflation) also entails costs and risks and I believe that the balance of risks still calls for highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment.” She concluded by saying that the “large shortfall of employment relative to its maximum level has imposed huge burdens on all too many Americans and represents a substantial social cost” and that “prolonged economic weakness could harm the economy’s productive potential for years to come.” It was these remarks that caused the stock market to overcome early losses resulting from signs of further economic slowdown in China and additional weakness in Europe. This intraday turnaround put the Dow within striking distance of its record high as mentioned above.
The most recent market gains have been played out against the background of the latest political drama emanating from Washington, D.C. as last Thursday, the day before those sweeping budget cuts were about to begin, both the White House and Republicans blamed each other for failing to prevent another fiscal crisis which both the non-partisan Congressional Budget Office and the I.M.F. said could slow both the U.S. and world economies, and what else is new?
The full force of these automatic cuts will be felt over seven months and Congress can stop them at any time if the two parties can ever agree on how to do so. It will be difficult to predict how this belt tightening might affect ordinary Americans, as for instance the President has said that naval vessels could be idled and schoolchildren might not be able to get vaccinated.
The present cuts came about as the result of a law passed in 2011 as part of a bi-partisan solution to a prior financial crisis, and few thought at that time that these cuts would ever come into being, but the politicians so far have been unable to figure out a way to reduce the federal deficit. The White House accused Republicans of refusing to compromise by not agreeing to close tax loopholes on the wealthy and to end tax breaks for oil and gas companies, in addition to ending the lower “carried interest”tax schedules used by hedge funds to avoid paying regular tax rates.
Half the spending cuts will come from the defense budget and the other half from non-defense domestic programs, but Wall Street so far has shrugged them off, primarily because the feeling among investors is that the $85 billion in cuts represents only a tiny fraction in a $15 trillion economy and are not such a drag on an economy that appears on the road to recovery in any event.
Examples of signs of this recovering economy lately were January durable goods orders rising by the highest level in a year, with the industrial machinery, construction equipment and computer sector, which is the component used in G.D.P. calculations, doing very well, January pending home sales increasing by more than expected and the February ISM Manufacturing Survey showing its best expansion since June 2011.
Another reason that investors have shrugged off the sequestration so far is that this round of automatic spending reductions is only one of 10 years’ worth of cuts that will total the $1.2 trillion that was mandated by law as they will be worked in slowly.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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