Headlines and rumors from Washington continue to drive the US equity market. Yesterday’s rally was driven by a hint of compromise over the debt limit debate. Republicans proposed a short-term extension to the deadline, conditional on negotiations over long term and entitlement spending and the President agreed to at least talk.
This is encouraging, but no agreement has yet been reached and the Government remains at least partially shut down. The market’s exaggerated response, with the Dow Jones Industrial Average closing up 323 points (2.18%) says a lot to me about the underlying situation. Traders are desperately looking for an excuse to buy.
As I have said before, retail traders and investors should see all this political turmoil as temporary and use the volatility it produces as an opportunity to buy stocks at a discount. There is, after all, still one influence lurking behind any drop that is more powerful than the uncertainty caused by Washington…the Federal Reserve.
As long as the Central Bank is pumping $85 Billion into the financial system each month, declines will be relatively limited and any good news will result in significant rallies. The Bernanke put is alive and well. The path of least resistance remains in an upward direction.
Given that, the news that President Obama is nominating Janet Yellen to the job of Federal Reserve Board chair, though expected, may well be more important to the overall mood of the market than any possible resolution to the bickering of politicians.
Dr. Yellen brings a wealth of experience, having served as the president of the Federal Reserve Bank of San Francisco and more recently as the Vice Chair of the Fed’s Board. She has been an ally and supporter of Bernanke, so little immediate policy change is expected, and is regarded as dovish on monetary policy. This view was confirmed when she said at her nomination, “The mandate of the Federal Reserve is to serve all the American people. And too many Americans still can't find a job and worry how they will pay their bills and provide for their families. The Federal Reserve can help if it does its job effectively. We can help ensure that everyone has the opportunity to work hard and build a better life.”
Her voting record and statements like this lead most to believe that she will continue with the Fed’s stimulus program, QE, and if anything reduce it at a slower rate than Chairman Bernanke might have.
This and the current hyper partisan atmosphere in Washington mean that her confirmation by the Senate won’t happen without a fight. She can expect the support of Democrats, but the threat of a filibuster by Republicans concerned about future inflation is a possibility.
Yellen’s testimony to the Senate Banking Committee will probably be on October 21st and, assuming that some short term fix to the debt limit issue is found, it is possible that her nomination will become embroiled in that controversy. If you think the 4-5% drop in the equity market as a result of the current debacle is bad, wait until traders feel that continued stimulus is threatened.
I do agree with the prevailing thoughts here, that Dr. Yellen’s appointment will come to a vote and her confirmation will be confirmed, but the process could, as we have come to expect, be messy.
So, what does this mean for traders and investors? If there is a fight, then it probably means more volatility, and volatility means more opportunity. I don’t want to sound like a broken record, but if it does pan out that way, then stocks could quickly get to good levels for buyers.
The fact is that despite all of the political drags the economy continues to recover slowly. This, combined with the likely continuation of QE in the event of a Yellen led Fed, leads me to conclude that the fundamental bull case for stocks is still intact. Don’t be fooled by any agreement on the debt ceiling, however, the fighting isn’t over yet.