Beginning this week, stock and bond markets will be bracing for a series of important announcements that have been previewed in the financial press for months. The significance and uncertainty surrounding these events has led to an exceptionally high level of confusion among investors as to the direction of the markets in coming months. A recent poll of individual investors revealed that the percentage of respondents who characterized their posture as neutral (i.e. undecided) is at a 10-year high! Fortunately, some of the haze will soon be lifted.
On Wednesday, the Federal Open Market Committee (FOMC) will announce its plans for continuing its aggressive bond buying program that began a year ago. Although it is a close call, most observers believe that the Fed will reduce the rate of monthly purchases by $10-15 billion from the current level of $85 billion. Since the Fed first telegraphed its intention back in May, interest rates have risen sharply and emerging markets have fallen. Our view is that much of the adjustment in the markets to this announcement has already occurred, and if the Fed delivers as expected, market reaction should be benign.
The next major announcement will be the new Fed Chairman to replace Ben Bernanke, expected within the next few weeks. After Sunday's surprise announcement that Lawrence Summers has withdrawn his name from consideration, the odds-on favorite now appears to be Janet Yellen, a current vice chairwoman of the Fed. However, Yellen's appointment is not assured, as a host of dark horses could now emerge, creating more anxiety over the Fed's future plans.
Politicians are facing two important deadlines in October: the funding of the government as we begin a new fiscal year on October 1, and the inexorable climb toward the government's debt ceiling limit, expected a few weeks later. The worst case scenario is a temporary government shutdown on October 1 followed by a far more troubling technical default on certain government obligations soon thereafter. The current standoff in Washington provides little comfort that either of these issues will be resolved easily. We expect a satisfactory resolution to each, but not before the usual last minute brinksmanship results in another band-aid solution that saves the day, at least for awhile.
With all this uncertainty (and we haven't even mentioned Syria), how is it that the U.S. stock market is up almost 20% this year, including a 3% rise just this month? In James Carville's infamous words, "it's the economy, stupid." While recent data has continued to reflect a mixed bag of economic activity, the cumulative effect of four years of steady job growth and a recent pickup in manufacturing augur well for improving momentum in the months ahead. Despite higher payroll taxes and reduced government spending, the U.S. economy has demonstrated surprising resilience. If markets can successfully navigate these near-term potholes, the longer-term outlook remains bright.
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