A thick cloud over Washington but sunny on Wall Street
At fleeting moments over the last 15 months or so, Americans might have dared to imagine a U.S. economic recovery in which the government’s influence would fade and the private sector’s animal spirits would take over.
Instead, we’re heading into the fourth quarter of 2010 with Washington’s power to make or break the recovery still paramount — and with enormous uncertainty about what to expect from those in charge or soon to be in charge.
It’s the kind of murk that typically vexes financial markets, which crave clarity. And yet the U.S. stock market just turned in its best quarterly performance in a year.
Huh?
The Standard & Poor’s 500 index surged 10.7% in the quarter that ended Thursday, and tacked on an additional 0.4% on Friday. Other major market indexes also scored double-digit returns in the quarter, recouping most of their spring losses and lifting them modestly into the black for the year.
Maybe someone needs to buy Wall Street a calendar. Look what’s coming:
The Nov. 2 congressional election will shape fiscal policy for the next two years and possibly beyond. “Stimulus” has become a four-letter word. Nearly everyone wants to cut massive deficit spending, but how, exactly?
One crucial fiscal decision is supposed to be made by Dec. 31: whether to extend the 2001 and 2003 personal tax cuts, which expire that day. Yet, with Democratic and Republican leaders polarized over what to do about tax rates for the highest-income Americans, it’s conceivable that Congress won’t act at all. That would mean higher taxes across the board, hardly a formula for boosting economic growth near term.
The Federal Reserve, meanwhile, is wrestling with whether to launch a huge new program of buying Treasury bonds or other debt securities to try to push longer-term interest rates even lower.
On Friday, Bill Dudley, the head of the Fed’s New York branch, said he believed that “further action is likely to be warranted” by the central bank to help the economy, given what he called an “unacceptable” outlook for job growth.
But as with Congress on fiscal matters, the Fed is conflicted on monetary policy. Charles Plosser, the Philadelphia Fed bank’s chief, said earlier this week that he was opposed to the central bank’s sharply boosting its bond purchases — in effect, printing money.
“It is difficult, in my view, to see how additional asset purchases by the Fed, even if they move interest rates on long-term bonds down by 10 or 20 basis points [0.10 or 0.20 percentage point] will have much impact on the near-term outlook for employment,” Plosser said in a speech.
A clear risk for the economy and markets this fall is that many businesses, investors and consumers could put their own decisions on hold, waiting for Washington’s agenda to emerge.
If you’re considering refinancing a 30-year mortgage at current record-low rates of about 4.3%, for example, you might be tempted to delay in the hope that the Fed decides to push ahead with a bond-buying program — and that its effect is far greater in driving down interest rates than Plosser suggests.
Individual investors, many of whom already have little appetite for U.S. stocks, understandably may see even less incentive to buy shares given the prospect of higher capital gains and dividend tax rates if the 2001 and 2003 cuts aren’t extended.
In fact, if you expect your capital gains rate to rise as scheduled on Jan. 1 to 20% from the current 15%, you’re more likely to think about selling in 2010 any long-held assets that you might have expected to sell in the next few years anyway.
Why, then, isn’t the stock market gripped by fear?
One explanation for stocks’ third-quarter bounce is that depressed share prices by late summer were anticipating another recession. As September economic data have mostly indicated that the U.S. recovery is alive, if not kicking, the market has repriced accordingly. Armageddon postponed yet again.
Another popular explanation is that the big-money players who move the markets are certain that the election will result in a Republican sweep, crippling the Obama administration’s policies, which the president’s opponents say are stridently anti-business. If you’re in that camp, what’s bad for Obama then must be good for businesses and shareholders.
Some on Wall Street think the markets are simply responding to the promise of easier credit from the Fed. What’s not to like about the idea of more nearly free money, at least for the people and companies that can get it? (The unemployed and other credit-challenged need not apply, of course.)
David Tepper, a hedge fund legend who heads Appaloosa Management, which holds $12 billion in assets, helped feed a stock market rally on Sept. 24 when he told CNBC viewers that he saw only two scenarios in the short run, both bullish for equities.
Said Tepper: “Either the economy is going to do well, and what assets [then] will do well? Stocks. Bonds won’t do so well, gold won’t do so well. Or, if the economy is not going to pick up and the Fed is going to come in with QE [quantitative easing, via bond purchases], then what is going to do well? Everything. Stocks, bonds in the near term, gold.”
One more way to explain stocks’ strength ahead of the fourth quarter’s great unknowns is that the markets no longer focus on fundamentals in any case, and are more than ever at the mercy of short-term traders and their computer algorithms — the culprit behind the May 6 market “flash crash.”
In other words, the stock market went up last quarter because it went up, but it had nothing to do with anything important to the real economy or actual human beings.
That’s an appealing theory to many small investors who have sworn off stocks, sick of the volatility and the sense that the game is rigged against them.
Let’s say the game is rigged. You don’t have to play it if you’re content to keep your money in bonds, bank savings, gold, real estate or other assets.
But consider this: What’s a rigged market to you is a market that huge numbers of institutional investors (pension funds, hedge funds, mutual funds, sovereign wealth funds, etc.) must continue to own. Most of them can’t be out of stocks entirely.
More important, if enough of them decide that stocks’ appeal is growing relative to low-yielding bonds in particular, they may shift money heavily enough toward equities to generate another advance for the bull market that began in March 2009.
If you have at least some money in stocks, you’ll benefit if the big players take them higher. If you’re out of the market altogether, the risk is that you’ll be sucked back in only after the next major rally.
The fourth quarter will come and go. Washington will make decisions that either will help or hurt the economy, or both. If things somehow work out for the better, it’s possible the stock market doesn’t yet fully reflect that.
tom.petruno@latimes.com
