May 15, 2013
With a growing expectation that the Federal Reserve will take the training wheels off the economy, investors turned squeamish about stocks late last week.
But the fear of going it alone, without the Fed's indulgent support, didn't keep investors on the stock market's sidelines for long. The Standard & Poor's 500 index hit another high Tuesday, the eighth record in about two weeks.
Economists have been assuring investors this week that the Fed probably has no intention of yanking the wheels in a sudden aggressive move. Instead of depending on the economy to pedal on its own, economists say, the Fed is going to gradually withdraw bond-buying stimulus into late 2014 and reverse the strategy if the economy starts looking shaky.
The idea of slow change is considered less traumatic for investors than a dramatic shift. In addition, investors have been calmed by the latest economic data.
Monday's April retail sales report, in particular, was stronger than expected. Economists were impressed that even as higher payroll taxes ate away at paychecks, consumers in April were willing to increase spending on everything from restaurant meals to electronics and sporting goods.
The growth in sales of just 0.1 percent was "not exactly inspiring as a stand-alone," said Gluskin Sheff economist David Rosenberg. But economists had assumed retail sales would decline 0.3 percent, not increase. They think cheaper gasoline helped stretch paychecks and rising home prices may have given people comfort about the future.
"Maybe the wealth effect is starting to work after all, or maybe the employment data are masking a booming underground in the economy," in which people considered unemployed are making money, said Rosenberg.
There is an economic theory that when people feel wealthier because of their stocks or rising home values, they are inclined to buy more. That's been part of the Federal Reserve's low-interest-rate strategy. By buying bonds, the Fed has been driving interest rates to near zero, and that's enticed even risk-averse investors to pursue stocks and risky bonds instead of putting their money in low-yielding savings accounts, certificates of deposit and U.S. government bonds.
As a result, stocks have climbed about 15 percent this year.
"Many of this year's stock market investors are traditional bond buyers fed up with the yield on their fixed-income portfolio," said Jack Ablin, chief investment officer of Harris Private Bank. "Stocks became unglued to the economy earlier this year as investors clamored for alternatives to unappetizing bond yields."
Because of the Fed's tinkering, analysts are no longer sure what stocks and bonds should be worth. But they believe that if interest rates rise sharply, some investors will move money to higher-paying bonds and out of stocks — perhaps causing the stock market to drop.
Yet, IHS Global Insight economist Nariman Behravesh says that, with unemployment still high, the Federal Reserve isn't likely to increase interest rates until 2015. In addition, he expects a "soft patch" in the economy during the next couple of months as the federal government cuts spending and puts employees on furlough as part of the deficit-cutting sequester adopted a few months ago.
Still, after getting through that weak economic period, he presumes, the economy will strengthen and give the Fed signals that it's time for stimulus reduction late this year.
There is pent-up demand for vehicles and housing and young people are starting to move out of parents' homes to start households of their own, he said. Slow growth continues, "with consumer spending good but not great" and with "household debt burdens down but still high by historic standards." Household net worth has just about recovered from the recession, Behravesh adds, although higher-income households are in better shape than lower-income ones.
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