Don’s Outlook 3/20/09
While much of the country and political establishment was focused on just $165 million of a $170,000 million ($170 billion) bailout of AIG—and ignoring the billions that went out the backdoor to Goldman Sachs, Société Générale, Deutsche Bank, et al—Ben Bernanke was busily pumping cash into the banking system. On Wednesday, the Federal Reserve announced plans to purchase $300 billion of long-dated Treasuries and $750 billion in mortgages. Bonds, stocks, and commodities rallied on the announcement, with gold turning a $30 loss into a $40 gain over the course of a few hours.
More money in the economy should devalue the existing money…and debt. Prices will rise across the board if the Federal Reserve is successful, including real estate. The debt overhang in the housing and financial sectors will shrink relative to income, and the economy can resume its growth path, albeit in a weaker position due to high inflation. We can already see the effects through the eyes of a foreign investor. A European holding an S&P 500 Index fund may have enjoyed the 4.4 percent gain since last Thursday, but the nearly 5 percent drop in the U.S. dollar leaves this investor with a slight loss.
This week’s changes should bring a greater tolerance for risk, luring investors from the sidelines to buy stocks, real estate, and inflationary commodities. Bonds will hold up for a while longer, as the Fed’s action will push rates down even further. As this reduces borrowing costs for individuals and businesses, the pressure to reduce debt will lessen and the credit markets will improve.
Nevertheless, we must not forget that the weak economy is the impetus for the additional policy moves announced by the Federal Reserve. This is not a panacea, nor is it without its own implications. Until the de-leveraging of risk ceases on a longer-term basis and the unemployment picture improves, the headwinds to sustainable market advances persist. The stock market could have another major advance in the coming months, but I have yet to recognize the all-clear signal to know that much greater risk-taking is warranted for anything other than tactical purposes.
