| |
 September 2010 Stimulus Hangover Simply shifting the timing of economic activity doesn't really create new demand.
This year earnings have recovered in virtually all corners of the market, yet stocks have fallen back. Coming into 2010, the economic consensus predicted the economy would be building momentum as the year progressed, particularly in the second half. But now, with only four months left in 2010, the economy has weakened to the point that a double-dip recession is again a possibility. What's up with that?
Looking back with perfect hindsight, it's easy to see that last year really wasn't as good as it first appeared. In fact, a great deal of the economy's variation then and now has been self-inflicted or misinterpreted. Consider unemployment which appeared to have peaked in late 2009. In reality, the numbers have been distorted by both the government's temporary hiring and then firing of census workers as well as the departure of discouraged workers dropping out of the labor force. Last year's improvements in the the auto and housing markets were equally ephemeral. The "cash for clunkers" and first-time homebuyer's tax credits didn't really spur new demand, they simply shifted it from the future leaving today's void in both markets. And then there's the good-willed government's unintended consequences. These would include the passage of Obamacare and the threatened expiration of the Bush tax cuts. Even improved balance sheets can't entice banks to lend and businesses to borrow when they can't realistically estimate the costs from such sweeping (and anti-business) legislation.Taken together, these factors are keeping a lid on any prospective recovery. Politicians wonder why the economy isn't turning around by now when in reality, they've been more of the cause than the cure.
Little Interest in Rates
However, at the early August meeting of the Federal Open Market Committee, the central bankers decided to reverse course and restart the program by reinvesting the proceeds of maturing holdings. This was misinterpreted by the media as a further easing of monetary policy when it was actually just maintaining the current level. Not reinvesting would have effectively tightened monetary policy by removing cash from the financial system. Then again, that was the Fed's intent back in March. Now with the reversal, analysts concluded the Fed must now see a further weakening economy as the need to extend the easy money policy. This was confirmed in the post-meeting statement, "The pace of recovery in output and employment has slowed in recent months," and, "The pace of economic recovery is likely to be more modest in the near term than had been anticipated." It was this perceived softening of the economy that led to the decision to restart the government security purchases. According to the statement, "To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities" One thing is certain: As long s the Fed is actively purchasing government securities in the open market, interest rates will remain much lower than most market watchers had anticipated at the beginning of the year. The steady demand from the Fed will be enough to assure this. With the benchmark 10-Year Treasury Note approaching a generational low of 2.5%, 30-year mortgage rates (based on the 10-Year Treasury) will also fall to -- or through -- forty-year lows. As long as the Fed maintains the current policy, rates can be expected to remain at these remarkably low levels indefinitely.
"De" not "In"-flation Although the prospect of minimal interest rates and falling prices may sound like a good think, it's potentially more problematic than inflation. Japan's economy has been mired in deflation for over a decade now and growth still remains elusive. While the prospects of the U.S. following a similar path are rather minimal, the Fed is willing to pull out all stops to make doubly sure.
Fiscal policy is a different story. Much of the legislation of the past two years has been decidedly anti-business. The prospect of higher taxes and new mandates are keeping businesses -- especially small businesses -- from reinvesting in physical or human capital. The Gulf oil leak and the subsequent ban on drilling has cost thousands of jobs while overall unemployment remains stubbornly high.
Better Than Bad, But Worse Than Good But here's the good news: Just as things weren't as positive as they appeared last year, they aren't as dire as they seem this year. Companies are in much stronger position than they were last year, with less debt and more secure balance sheets. Corporate earnings have shown definite improvement in every broad sector of the market. Although the rate of their growth may slow in the coming quarters, the upward trend will continue. After the summer decline, stocks are now more fairly valued than they have been since early 2009. Values are no longer difficult to find. Blue chip shares of well capitalized companies now yield more than the 10-Year Treasury Note, not to mention offer price appreciation rather than declines like bonds. Over he short-term, as the November mid-term elections draw closer and their outcomes become clearer, stocks may be poised to rally. This, coupled with solid third quarter earnings, could fuel the traditional year-end rally. Over the longer term, lingering structural problems in the economy will temper the appreciation potential. Concerns remain regarding the weak housing market and persistently elevated levels of consumer debt. Businesses are faced with higher taxes and greater costs of doing business in 2011 and beyond. This all filters over to the equities market in various ways. For example, small cap stocks generally have greater appreciation potential in the early stages of a strong and sustained rally, however this year they're lagging. Chalk that up to the upcoming new taxes and legislative burdens which will fall more heavily on smaller companies. On the other hand, shares of large, more highly capitalized companies -- particularly those with safe, well-covered dividends -- offer better opportunities. Things are rarely as bad or as good as they appear at the time. In this case, investors need to realize it will take time to correct the structural damage incurred in the deep 2008 recession. The economy is slowing improving, but it's a slow process for the housing market, unemployment, and ultimately GDP growth. Once we emerge from the 2010 hangover of the 2009 stimulus, things will again look up. Just as there's no need to rush into the market to catch the upturn, there's no urgency in abandoning it, either. Short-term setbacks are just that, short-term setbacks. In essence, this is a good time to stick to a solid long-term investment policy to ride out the short-term ups and downs of a healing economy. Next year when we look back with perfect hindsight, we may realize this was actually a great buying opportunity. Search this site! Just enter you key word or words:
Get current quotes or follow your own custom portfolio,
courtesy of E-Line Financials:
|
||||||||||||||||||||||
WO-THIRDS THROUGH 2010 and this year has been as surprising as last -- but for dramatically different reasons. In 2009 investors were caught off guard when stocks bottomed and suddenly staged an unexpectedly strong and enduring rally. Most surprising was the fact this occurred while earnings and the financial markets were still languishing.
