"As depressing as thinking about Washington might be, the news about the economy and capital markets is actually encouraging."
Frustration with Washington is never far from investors’ minds. The litany of issues related to fiscal policy that remain unresolved, and which will soon once again be engaged, is long and difficult. Corporate tax reform, entitlement reform, extending the debt ceiling, passing a budget or even a continuing resolution, long-term deficit reduction, and personal income taxes for high income households all need to be addressed. And if you thought this last one has already been settled, the president has news for you.
The deadlines ahead promise more confrontation and more weariness for investors, who just want official Washington to do its job in a responsible manner, and get out of the way. Unfortunately, that is wishful thinking.
But, as depressing as thinking about Washington might be, the news about the economy and capital markets is actually encouraging. Housing continues to improve, although, even here, with Washington in the way nothing improves in a straight line. On Tuesday we learned that sales of existing homes fell in December from their pace in November, despite widespread expectations to the contrary. The pace of sales was still the second best since 2009. But with the uncertainty surrounding the fiscal cliff, including concerns that the mortgage interest deduction might somehow be restricted, it is not really surprising that home sales momentum slowed in December. Nevertheless, housing is improving. Housing starts were actually better than expected.
Retail sales were better than expected in December, as well. And consumer price inflation year-over-year fell to a 1.7 percent rate from 1.8. But not everything was positive. We also learned last week that consumer confidence declined for the second straight month in January, due to, you guessed it, Washington. The fiscal cliff, higher payroll and income taxes, and the prospect of more battles in a few weeks conspired to sour the mood.
Perhaps the best barometer of all, the stock market, continues to climb. Looking beyond the noise in Washington and seeing improving economic conditions, stocks reached a five-year high last week. Leading the way so far this year are energy, health care, and industrial stocks. Corporate bond prices are also rising, with lower quality debt outperforming high quality, while Treasuries have declined.
The news from overseas was positive last week as well. China reported improvement in its fourth quarter economic growth rate, arresting a decline that began two and a half years ago. It also reported solid industrial production and retail sales data for December. The Shanghai Composite Index rose 3.3 percent for the week, and has climbed 17 percent since the end of November. In Japan, the Nikkei Index rose 1.0 percent last week, for its tenth straight week of gains, during which it has risen 25 percent. Supporting the trend were expectations of fiscal and monetary stimulus and the export benefits of a weaker yen. Yet on Tuesday, some of that optimism receded after the Bank of Japan delayed an expected increase in quantitative easing.
In Europe, one has to look harder for real evidence of economic improvement, but so far this year European stock markets are up in similar fashion to stocks in the U.S. In local currency terms, the gains range from a low of 1.1 percent in Germany to a high of 8.9 percent in Italy. The U.K. is up 4.8 percent. And for dollar-based investors the gains are even greater, as the euro has appreciated against the dollar this year. Sovereign bond yields continue to fall as financial conditions improve. Just since the first of the year the yield on ten-year Greek debt has fallen 129 basis points to 10.16 percent. Twelve months ago, that yield was 27.8 percent. And Greece quietly received the next tranche of its bailout package last week, while few seemed to notice.
Emerging markets are also higher, but less than developed markets. Latin America has fared better than Asia so far this year.
The point is, in a number of regions there are positive signs and evidence of receding risk aversion. Of course, growth is still tentative and is still grateful for the massive support it receives from central banks. But there is improvement. Now, if we can only get through the next few months in Washington, we might be ok.
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