Bernanke and Buffett try the feel-better approach
Squeezed into a corner, Ben S. Bernanke tried a classic escape tactic: Create a diversion.
With financial markets hoping for something of substance in the Federal Reserve chairman’s speech on the economy Friday, Bernanke instead cooked up some comfort food. The near-term outlook is a struggle, he allowed, but over the long term the U.S. has the wherewithal to return to a healthy pace of growth.
Warren Buffett also tried to make America feel better this week, although unlike Bernanke, the country’s second-wealthiest man put up some real money to back his oft-stated optimism. Buffett on Thursday agreed to invest $5 billion in Bank of America Corp., which helped to douse fears that BofA’s latest troubles could lead to a replay of the 2008 financial-system crisis.
Buffett’s surprise move pulled the bank’s battered stock up more than 9% on Thursday. The shares added another 1.4% on Friday to $7.76, after slumping to a two-year low Tuesday.
The stock market overall posted its first weekly advance since late July. The Dow Jones industrials rallied 134.72 points, or 1.2%, to 11,284.54 on Friday and rose 4.3% for the five days.
Maybe the bears decided they’d done enough damage for the time being, with the Dow off 11.3% since July 21 and some broader market indexes down more than 17% in the same period. Or maybe the markets’ biggest pessimists cleared out of town early Friday, hoping to get to some mountaintop in the Adirondacks before Hurricane Irene hits New York.
Despite the feel-good efforts of Bernanke and Buffett, Wall Street enters the unofficial last week of summer with no resolution of the issue at the heart of the market turmoil of the last five weeks: the fragile state of the U.S. and European economies. Both are at risk of falling into new recessions at a time when their governments are focused on slashing spending instead of supplying new stimulus.
That has placed more pressure on central banks, including the Fed, to again ride to the rescue by pumping another massive amount of cash into the financial system.
Yet Bernanke on Friday promised nothing. Though most economists had warned that the Fed chief was unlikely to commit to a new stimulus plan just yet, the stock market appeared disappointed at first, with the Dow sinking as much as 218 points at the outset.
One explanation for the rebound later in the day was that Bernanke’s lack of urgency was a relief to investors — a sign that things may be a lot less dire than stocks’ slump may suggest.
But his speech made clear that the Fed can’t go it alone, and that he believes Congress and the White House must put politics aside and fashion policy moves that could bolster growth. “Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank,” Bernanke said.
Perhaps nodding to expectations that President Obama will announce new job-creation incentives next month, Bernanke specifically cited the need for government efforts to boost employment.
“In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow,” he said.
Although he offered no new help for the economy, Bernanke reiterated that the Fed could do more if needed. He also announced that the central bank’s meeting in late September would be a two-day affair instead of one day — conceivably to give policymakers more time to assess their options if the economy weakens further.
By far the Fed’s most powerful tool is its ability to create money with the press of a button. That’s what it did from last November through June, buying $600 billion of U.S. Treasury bonds from banks and other investors in the open market. The goal was to get that money into the economy.
Some investors hoped Bernanke would signal another such bond-buying spree Friday. One year ago this month, at the same annual bankers’ conference in Jackson Hole, Wyo., Bernanke discussed the relative merits of that kind of stimulus. Wall Street correctly saw that as laying the groundwork for the program launched in November.
The problem the Fed now faces is that it doesn’t have much to show for that big expenditure, at least in terms of the real economy. On Friday the government revised its estimate of second-quarter economic growth to a paltry annualized rate of 1% from an initial estimate of 1.3%.
Stock investors benefited from the Fed’s largesse: Even after this summer’s plunge, the Dow is up 13% from a year ago. The Treasury benefited as well as its borrowing costs have fallen. The yield on 10-year Treasury notes has fallen to 2.19% from 2.47% a year ago.
But one of the biggest winners of the last year is gold, which at $1,794 an ounce Friday was up 44% from a year ago. That couldn’t have been part of the Fed’s game plan, because soaring gold represents a repudiation of Bernanke’s policies. It says investors don’t trust the Fed or the dollar, which is devalued as the Fed prints more of them.
The metal gained $34.30 an ounce Friday, resuming its climb after profit-taking knocked almost $135 off the price Tuesday and Wednesday.
At a time when the primary fear in financial markets is that the economy could trip into recession, gold’s continued ascent may seem odd. After all, if the economy slumps, the world could be facing another deflation scare, meaning the risk of a broad-based decline in asset prices. Though gold is a haven in times of turmoil, it isn’t at all certain that the metal would benefit if other assets were to plummet.
Recall what happened in the fall of 2008, when gold slid with the rest of the markets.
With any investment, the question at any given moment is what’s already built into the price.
Buffett decided that Bank of America had gotten cheap enough to merit a $5-billion capital injection that includes warrants to buy 700 million shares of the bank over the next 10 years. His price: $7.14 a share. Meanwhile, he’ll earn 6% a year in dividends on the $5 billion in preferred stock he’s buying.
The rest of us can’t get the kind of sweet deals that Buffett can negotiate, but the same basic consideration applies if you’re looking at the stock market as a whole: Could share prices at these levels already be reflecting the worst that might happen in the economy, at least in the short term?
At its recent low reached Aug. 8, the Standard & Poor’s 500 index was down nearly 18% from its multiyear high set in April. Looking back to 1927, a study by Deutsche Bank Private Wealth Management found that the S&P’s average decline has been 16% during mild recessions. So investors who believe that the economy is at risk of only a modest contraction, before growth would resume, might figure that Buffett has the right idea.
If you think another deep recession is at hand, however, stocks’ pain may just be beginning: The S&P 500 has dropped an average of 44% during what Deutsche Bank categorized as severe recessions since 1927.
The Fed would surely react to a drop of that magnitude. But by then, how many investors would there be left to save?
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