Wall St. bulls bet the Fed got it right
You can’t please everyone, and the Federal Reserve didn’t bother to try this week. With its bold interest-rate cut Tuesday, the Fed clearly put economic growth -- and the stock market -- ahead of inflation concerns.
Too bad if you were planning a vacation to most anywhere outside the U.S. In slashing short-term interest rates, the central bank sacrificed the dollar’s value against other major and minor currencies by reducing the appeal of dollar-denominated debt.
Looks like a good time to revive the “See America First” ad campaign.
Though the Fed was roasted by its critics for, in their view, caving to Wall Street, policymakers’ half-point cut in their benchmark rate also must be playing well on much of Main Street.
For many average investors, what’s not to like? The Fed’s move had the effect of performing further repair work on 401(k) retirement accounts that had been battered in the late-summer credit crunch and related market turmoil.
The share price of the biggest stock mutual fund, the American Funds group’s Growth Fund of America, slumped 9% from July 19 to Aug. 16. That loss has been almost entirely recouped. At $37.29 on Friday, with a 3.1% gain for the week, the fund’s price was just a penny below the July 19 record high.
Strong interest in technology stocks has helped the market rebound. And if you’re betting on tech, you’re betting on a continuing economic expansion, which is what the Fed wants to see.
The Nasdaq 100 index, dominated by tech issues, closed Friday just 0.2% away from its midsummer peak. Google Inc., one of the big names in the index, rose $7.27 to a record $560.10. Software giant Oracle Corp. ended at a 6 1/2 -year high after reporting strong sales and earnings growth in the quarter ended Aug. 31.
Among other indexes, the Dow Jones industrial average added 53.49 points to 13,820.19 on Friday, up 2.8% for the week. It’s a mere 1.3% away from setting a new high.
The story has been much the same for foreign stock markets, many of which were hit harder than the U.S. market in the summer pullback.
And there’s a kicker for American investors, who, overall, have poured far more money into foreign stock mutual funds than domestic funds for the last two years. As the dollar weakens, investments denominated in stronger currencies are worth more when translated into dollars.
So although the falling dollar is lowering Americans’ purchasing power and, arguably, our standard of living in the long run, it’s a bonus if you own foreign assets.
Case in point: The Canadian dollar is at 1-for-1 parity with the U.S. dollar for the first time since 1976. That’s bad news if you’re dreaming of a Manitoba adventure. But if you own a stock fund indexed to the main Canadian market gauge, the 8% year-to-date rise in that index becomes a stunning 25.7% gain when translated into U.S. dollars.
That’s about as compelling an argument anyone can make for maintaining a well-diversified portfolio.
So is the performance of gold, and gold-mining stocks. The metal’s price hit a 27-year high of $732.40 an ounce this week. An index of 16 gold-mining stocks surged to an all-time high.
Whatever is driving gold -- inflation worries, doubts about the economy, demand from wealthier emerging-market consumers, or all of the above -- investors who own the metal or its proxies are thrilled that they have a piece of the action.
Who’s hurt by the drop in the Fed’s key rate to 4.75% from 5.25%, the first reduction since 2003? People with cash in the bank or in money market mutual funds will earn less because yields on those accounts will decline in the near term.
And, at least this week, owners of long-term Treasury bonds took a mild hit. Instead of falling with short-term rates, long-term Treasury yields rose for the week, with the 30-year T-bond ending Friday at 4.89%, up from 4.72% a week earlier.
The Fed’s critics say that’s the penalty for a rate cut that they believe wasn’t justified by the economic fundamentals. Their argument: With oil, wheat and other commodity prices at or near record highs, and with the weak dollar threatening to boost prices of imported goods, the Fed risks stoking inflation pressures by encouraging cheaper credit.
Buyers of long-term bonds are highly sensitive to inflation concerns, because fixed returns are eroded by rising inflation. With current T-bond yields under 5%, even an increase in annualized inflation to 3% from the current 2% range (as measured by the government’s price indexes) would be devastating for bond investors.
Still, it’s going to take more than a one-week rise in long-term yields to make a compelling case that the bond market senses a serious inflation problem out there.
The Fed’s supporters, the bulk of the Wall Street crowd (not surprisingly), say the central bank got it right. They believe that the disruption in credit markets stemming from worries about the housing sector’s woes raised the risk of recession and required intervention.
The Fed showed that it was “committed to doing whatever it can to avoid more significant economic weakness,” said Nick Raich, director of equity research for the private client group at National City Corp. in Cleveland. Bolstered by that assurance, stocks could soon climb to new highs, he said.
But what if the Fed is too late, or simply won’t be able to forestall an economic slump with lower interest rates? That happened in 2001, after all.
Brokerage Goldman Sachs this week cut its estimate of U.S. economic growth in the next three quarters to a range of 1% to 1.5%. If the forecast is right, any fresh shock to the economy may tip it into recession.
Global stock markets, zooming again, clearly don’t believe that a recession (and with it, a plunge in corporate earnings) is imminent. Obviously, that means share prices are vulnerable if the economy doesn’t follow the bulls’ script.
The markets’ fast comeback of recent weeks, however, shows that the appetite for equities remains robust. If the Fed rode to the rescue in time, that appetite may well get stronger.
