September 2012 Economic Outlook
This is a monthly newsletter by Greg Sweeney, CFA, Chief Investment Officer, at Bell State Bank & Trust. Sweeney holds a bachelor’s degree in business from the University of North Dakota, is a CFA charter holder, and is a 26-year veteran of the Investment Management team.
Federal Reserve Monetary Policy
- At the next Federal Reserve meeting on September 13, we expect the Fed to leave rates unchanged between zero and 0.25%. The Fed indicated rates would remain near these lows until late 2014.
- The year-over-year consumer price index (CPI) released in August shows inflation at 1.4%. It is beyond our ability to reconcile this low number with a consumer’s actual cost of living. If it weren’t so serious, it would be laughable.
- California proposed initiating a tax on caloric sweetened beverages. The argument legislators are making is that taxes can be used to influence people’s behavior away from drinking soda. Maybe we are too simple-minded, but what does this say about income taxes and their effect on encouraging people to earn money?
- Europe is in a “continuous feedback loop”: lots of talk and few workable solutions.
- There appears to be a limit to the effect Federal Reserve monetary policy can have on the economy. Unfortunately, people at the Fed are some of the few remaining who don’t realize it. There also appears to be a limit to fiscal policies, as trillion-dollar-plus deficits have failed to noticeably support economic growth or reduce unemployment. For the benefit of legislators, perhaps the Keynesian theory should be modified to add the following themes: (1) Stimulus spending works better when starting from a position of little or no debt. (2) Stimulus spending works better in the short run rather than as a consistent program. (3) Stimulus spending works better for a liquidity problem than it does for a solvency problem.
- We are concerned that the focus on the Fed’s plan for a new round of monetary policy is taking investors’ eyes off the prospect of gradual economic slowing, both here and in Europe. Investors are afraid of being out of the market when the next easing is launched, while at the same time, they are encouraged by the slowing economy that will facilitate the Fed’s next move. It seems perplexingly conflicting. This is one of the themes that makes it extremely difficult to forecast market direction.
- There is also some indication that continued easy monetary policies encourage imprudent government behavior in the form of deficit spending, as we see a continued string of debt ceiling increases, with another one expected in the first quarter of next year.
- With bond investors looking for additional yield anywhere they can get it, ownership of corporate and high yield bonds has increased. The biggest risk to this sector of the market is a rapid decrease in appetite for risk. A secondary risk is rising interest rates.
- We also remain concerned that bond investors fail to realize they are not collecting the double-digit returns being reported by popular bond funds and indexes. They are only collecting the coupon income.
- The stock market seems to have reached a temporary plateau. Will the prospect of more Fed stimulus shift the momentum higher, or will the prospect of diminishing growth push it lower?
- The U.S. fiscal cliff, European debt issues, slowing economies worldwide, and Middle East tensions are some of the themes that suggest the stock market could drift lower.
- The next Fed monetary bazooka, analysts’ continued projections for earnings growth, rising gold prices, and continued global bailouts all suggest that the stock market could drift higher.
- The psychology of investors will determine the outcome.
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