Streetwise for July 4,  2010

Streetwise for Sunday July 4, 2010

 

 

Streetwise

 

Lauren Rudd

 

Sunday, July 4, 2010

 

 

It's the 4th of July - Will Wall Street Offer Up a Summer Rally

 

  

 

It is summertime once again and the living is easy...or at least it used to be. The Fourth of July is the unofficial start of the beach and barbecue season. It is also when everyone asks the same question...is a summer rally in store for the stock market?

 

Somehow I believe just escaping the jaws of the bear would have you grinning and waving flags, especially since the S&P 500 index recently chalked up a second quarter decline of about 12 percent.

 

So what is the likelihood of a summer rally? Statistically, July is the best month for stock prices in terms of percentage gain. Furthermore, the Dow Jones industrial average has rallied during 58 of the past 65 summers. And the preponderance of data indicates that there are seasonal quirks within the markets.

 

Of greater significance is the consensus that the financial markets portend potentially difficult times ahead. One quandary is the high level of unemployment and its symbiotic sister, consumer demand.

 

Adding to the severity of the problem is the apparent disdain Congress has for the plight of the unemployed, as evidenced by the short duration of extensions, while the approval process is both arduous and contentious. One repeatedly voiced undercurrent of concern is that providing extensions restrains incentive and therefore magnifies and sustains the level of unemployment.

 

Not true. An April 2010 study by the Federal Reserve Bank of San Francisco showed clearly that the absence of extended benefits would have reduced unemployment by miniscule 0.4 percent in 2009. Therefore, Congress merely adds additional pain and suffering to those already facing economic hardship, while at the same time postponing a much needed shot of fiscal stimulus.

 

So what about that nettlesome inflation issue? Ever since the late economist Milton Friedman wrote in 1963 that "inflation is always and everywhere a monetary phenomenon," central bankers have been on notice that excess printing of money jeopardizes their guardian legacies.

 

No argument. However, despite the degree to which the Fed has added to its balance sheet, the net result has merely been a dramatic increase in excess bank reserves. As Richard Koo so carefully elucidates in his book, “The Holy Grail of Macro Economics,” we are facing a balance sheet recession. Specifically, the private sector is immersed in balance sheet repair by decreasing leverage, meaning reducing debt.

 

With the demand for borrowing diminished, low interest rates become immaterial. Therefore, to stimulate economic activity the government must continue to borrow unused funds and put those funds to productive use (military conflict does not qualify). To do otherwise would mean a reoccurrence of the same trap that Roosevelt fell into in 1937 and Japanese Prime Minister Ryutaro Hashimoto in 1997.

 

Those who worry about inflation and excess government spending do not fully grasp the ramifications of the problem. Deleveraging is good for the long-term health of the economy. In the short-run it impairs consumer spending, which accounts for about two-thirds of our gross domestic product.

 

Despite comments from a certain members of Congress, the European Union, not to mention the International Bank of Settlements, a dramatic reduction in government expenditures at this time will not extricate anyone from their current malaise. Instead, it will likely only aggravate the situation. There will come a time for fiscal restraint but now is not that time.

 

Barring any idiotic replays by Congress of the failed economic policies of the late 1930s in the U.S., or late 1990s in Japan, I continue to remain cautiously optimistic as we move into the second half of 2010. At the same time remember that the market’s overall trend does not determine your portfolio’s performance. Asset allocation and corporate fundamentals are the means by which you enhance your portfolio and your wealth.