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Central Bankers Steal the Show
So far this year global equity markets have been on that proverbial roller coaster, posting sharp gains in the first quarter, losses in the second quarter and solid upward momentum in the recently concluded third quarter. Overall, 2012 has been a fruitful year for both equity and bond investors. During the summer the S&P 500 Index made up all of the second quarter losses, gaining 5.8% and ending the quarter at essentially its highest level since early 2008. The most notable thing about the market’s summer levitation is that it occurred despite worsening economic data out of Europe and China. The 10-year U.S. Treasury note yielded 1.637% at quarter’s end, essentially flat from three months ago.
Why, clients and friends ask me, have the U.S. equity markets done so well during a time of such economic and political uncertainty? I offer two answers to this question: 1) Accommodative central bankers and 2) the growing safe-haven status of U.S. markets.
Central bankers stole the show this summer. The actions and proclamations of the Federal Reserve and the European Central Bank persuaded investors that their biggest fears (e.g. euro zone implosion) were not going to be realized—at least not in the near-term. With a doomsday scenario temporarily removed from the range of potential outcomes, stocks were free to march higher. Here in the U.S., Federal Reserve Chairman Ben Bernanke announced a new round of monetary stimulus dubbed “QE3” (for quantitative easing, round three). The basic plan with QE3 is to buy $40 billion worth of mortgage-backed bonds on the open market each month until the economy improves to a point where such support is no longer deemed necessary. The program is designed to keep mortgage rates low, thus supporting housing, and to keep stocks up, thus supporting both consumer sentiment and spending.
In late July, European Central Bank President Mario Draghi announced he will do “whatever it takes” to keep the euro zone from imploding. So far, markets have taken him at his word and the beleaguered euro has gained 5% versus the dollar since the end of July. European stock markets have also responded. Germany’s DAX Index is now up 22% year-to-date while many other European bourses have reclaimed their losses from earlier in the year and are now positive or on the verge of going positive. There is no question that tough times remain ahead for much of the euro zone, but at least for the moment the ECB has brought stability to the situation.
It may seem trite, but one big reason that U.S. stocks are doing so well is that there are simply a lot of people out there buying U.S. stocks. Global investors, worried about the turmoil in Europe and the slowdown in Asia, are tilting their portfolios toward the U.S. Corporations here in the U.S., flush with cash from years of under-investment, are on track to repurchase more than $400 billion of their stock this year. Meanwhile, individual investors, unable to generate a decent income stream from bonds, have rediscovered the charms of dividend-paying stocks. And companies are indeed sweetening their payouts: in August they paid a record $34 billion in dividends. Finally, many hedge funds and traders, caught by surprise by both market resilience and central banker resilience, are back in a buying mood after having been too conservatively positioned coming out of the spring.
Of course much political uncertainly remains ahead, with the election in early November followed by the so-called “fiscal cliff” on January 1st, when many economic stimulus measures expire. In short, the fiscal cliff, if not navigated adroitly by politicians, could result in a sharp slowdown in economic growth as its measures seek to cut the budget deficit by $1.2 trillion, or about 8% of GDP. The deficit reduction would be achieved partly through increased taxes and partly through federally mandated spending reductions. In any case, for better of for worse investors’ attention is likely to shift back toward Washington, D.C. in the months ahead.
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