Monday, September 30, 2013

Budget, Debt, Fed

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