The stock market is pushing to new highs and we are seeing some real improvement in the employment picture. Does this mean that the president’s economic plan is working ? Does it mean that the card check bill, Cap and Trade and the health care bill can be absorbed with little economic damage?
In the short run it may appear that the stock market is nodding approval. But as Benjamin Graham noted ” in the short run it is a voting machine, but in the long run it is a weighing machine.”
The stock market like any market is responding to competitive alternatives for capital and the supply of funds available. There are three trillion dollars sitting in money market funds paying very little interest. Real estate is still overbuilt and the credit available to buy real estate is still restricted or better said, it is returning to prudence and normalcy. Interest rates are expected to rise, so long term bonds are risky. Stocks just seem to be a good place to put cash.
The stock market is also very liquid and that is a great advantage in an economy where new broad political demands leave a large amount of uncertainty that retards long term thinking that a quality business environment needs.
It is also likely that earnings are shifting into 2010 from 2011 to avoid the higher taxes we know are coming. While this can cause some price pressure on equities it can also cause a very short term surge in earnings that could disappear in 2011.
The stimulus money, which is also only a temporary boost, was distributed to the states to be distributed to the communities. It got hung up in state bureaucracies, but that will soon change as the funds finally make its way through the state agencies. We should see a substantial pickup in employment as the funds finally reach their intended target.
This is a market where talented stock pickers will beat the indexes and the averages. Companies will do better more because of sound management than because of being in the right asset allocation group. Professional investors will have to start using their brains again.
The tough economy and the new regulatory atmosphere will weigh on small companies more than large companies. Smaller companies have a higher percent of variable costs to fixed costs and can thus exit their business quicker in an adverse economy. Bigger companies will have better access to credit. This leads to a consolidation that will give the bigger companies better pricing power from less competition. Access to better credit also gives the bigger companies better purchasing power.
But how much will the short term benefit from the stimulus be countered by the uncertainty of radical legislation and the higher costs placed on smaller businesses?
Higher taxes, higher regulation, and a weak currency will still have long term consequences that will be reflected in corporate earnings. Deficit spending is a short term solution with long term consequences. It is like borrowing from one credit card to pay off another credit card.
What could go wrong from here?
- The Fed could screw up the exit strategy. We are hoping they can avoid a resurgence in inflation from the liquidity pumped into the system. They expect to do this with a debt ten times larger than the last time they tried it.
- Higher oil prices can derail a recovery.
- Higher interest costs can derail a recovery.
- Financial shocks such as Greece or a final collapse of California.
- Political realities shift more workers to part time; drop in wages undoes the benefit of high employment.
The market was expecting a total collapse a year ago. The further we get from the epicenter of the crash the safer investors will feel about investing. We are in a recovery and the capitalist system is recovering along with employment .
Political adversaries are hesitant to credit the administration with the recovery, but they cannot deny its existence. They would be wiser to focus on what is needed to make this recovery last. We will soon see the market as a weighing machine.