The
preoccupation in the stock and bond markets at this time is with what is happening in
Washington. The mixed economic reports that came out last week indicate that
the Federal Reserve will likely make no changes to their bond and mortgage
buying program until very late this year or early next year. This has sent bond
prices up as yields have fallen. At the same time, the equity markets are
justifiably worried about what Congress is going to do to resolve the budget
and Federal debt ceiling issues. If the debt ceiling issue is not resolved, the
government will run out of funds by the latter part of October. Currently, the
concern is with a budget resolution by October 1st, the beginning of
the next fiscal year. The lack of a resolution will result in closure of
non-essential government services and the inability to pay Social Security and
Military Pension benefits. The repercussions of this inaction would have a
detrimental effect on the entire economy. This concern has lead to a downturn in
the stock market. The short-term outlook is cloudy. In the long term, I believe
the stock markets in the U.S. will do well if the economy continues to grow.
Stocks trade at a multiple of earnings. On a trailing 12 month basis, the
market’s current price-to-earnings ratio of about 19 is a third above its
long-term average. This has occurred because earnings growth has been tepid
while stock prices have gone up significantly. The expectation is that we will
see greater earnings growth in the future. Shutting down the government could
change this assessment. Bond markets will have to adapt to increasing interest
rates over the next year or so, but should subsequently be fine.
Ed
