Last Wednesday, Federal Reserve Chairman Bernanke delivered testimony to Congress, taking great pains to clarify Fed policy. His comments were well received because stocks moved higher and interest rates retreated. Our first article examines what the Chairman said and what he really meant. Though the economy still may need Fed support to reach “escape velocity” (i.e., where it can grow by its own momentum), our next article by Liz Ann Sonders of Schwab takes a look at the plunging Federal budget deficit and what it means. Finally, we summarize a recent poll by the Institute of Chartered Financial Analysts about expectations over the next 12 months.
Hilsenrath: What Bernanke Means. Federal Reserve Chairman Bernanke testified to Congress last Wednesday. This piece from The Wall Street Journal does a good job in explaining what the Chairman said and what he really meant. In summary, his prepared testimony tilted toward a policy stance of continued support of the economy through asset purchases and low interest rates. The Chairman emphasized downside risks to the economy more than in the June policy statement. He clarified conditions for the Fed to “taper” asset purchases and that low rates might stay in place, even after employment drops below 6.5%. He gave new emphasis of risk to the economy of persistently low inflation.
Arc of a Driver: The Budget Deficit’s Plunge. You probably wouldn’t know it by listening to television news shows, but the Federal budget deficit actually is declining. In fact, the government ran a surplus in June. The budget deficit has been cut by more than half, from over 10% of GDP to less than 5% today. Several reasons are noted, including “the economy has been steadily (albeit slowly) improving, generating seven million new jobs, almost $2 trillion increase in personal income, and about a one-third organic increase (i.e., unrelated to higher tax rates) in personal income tax receipts.” In addition, “corporate profits are up 65% from the low, while taxes paid have more than doubled from $122 billion in 2009 to $272 billion in the past 12 months.” She also notes the resilience of the private sector during the public sector’s (i.e., federal, state and local government) retrenchment.
CFA Institute Poll & Analysis:
Is the economy strong enough to grow on its own? If so, perhaps the markets could focus on more company-specific events as earnings, product development and acquisitions. If the economy is not strong enough, the removal of stimulus might send the economy back down again. The CFA Institute polled its membership and these were the results among respondents:
Question: Over the next 12 months, do you expect global equity markets to be driven more by macroeconomic news (e.g. GDP growth rate, monetary policy, fiscal policy) or company-specific news (revenues, earnings, mergers)?
Macroeconomic news will be the most important driver: 86.29%
Company-specific news will be the most important driver: 13.71%
Since the onset of the 2008 financial crisis, the markets have been driven by global macro events, particularly in the form of government support and stimulus. These events include the massive monetary stimulus from the U.S. Federal Reserve, large-scale asset purchases by the European Central Bank, and the introduction of Abenomics in Japan just seven months ago. On 26 June 2013, the Bureau of Economic Analysis revised U.S. GDP for Q1 2013 downward from 2.4% to 1.8%. Combined with the Fed’s recent talk of removing monetary stimulus from the markets (by tapering its $85 billion per month purchases of bonds), we thought it would be a good time to ask investors whether they thought the economy was strong enough to grow on its own. If so, perhaps the markets could focus more on such microeconomic (company-specific) events as earnings, product development and acquisitions. If the economy is not strong enough, the removal of stimulus might send the economy back down again. Of the 926 respondents, 86% expect the markets to continue to be driven by macroeconomic events during the next 12 months, with less than 14% of respondents expecting micro events to drive the markets. According to the poll results, any shift in focus toward microeconomic events would be a big surprise. — Ron Rimkus, CFA, Content Director, CFA Institute
And in case you missed it, click here to read last week’s blog post on financial repression.
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