Wednesday, November 03, 2010

Less Bad Stuff Is Good

Momentous events this week — the Republican House sweep and the Fed’s QE2 — moved the stock market needle only a little over Tuesday and Wednesday, although the net impact was a gain of about 90 points.

Obamanomics was repudiated at the polls and the Republicans inflicted a crushing defeat on the Democrats in the House. However, tea partiers disappointed in several Senate elections, leaving Harry Reid & Co. in charge of the upper chamber.

The real meaning of the new Senate-House-Obama triangle is not yet clear. The bad stuff will be stopped. That’s good. But how much good stuff can be legislated remains to be seen. This might be what’s slowing down the stock market. (Though again, I note, a 90 point rise is not nothing.)

Two key Senate races produced supporters of extending all the Bush tax rates. This could be the key. Democrat Jim Manchin in West Virginia and Republican Mark Kirk in Illinois will be seated immediately to fill the Robert Byrd and Barack Obama vacancies. This raises the probability that a full extension of the Bush tax cuts will go through the Senate. I’m going to assume that the people have spoken, even to the lame ducks in the House. And a conciliatory and compromising Obama at his news conference today suggests that the president will sign a temporary full extension of the Bush tax rates. That’s a pro-growth development.

On the Fed side, the central bank is going to pump $600 billion of new money into the over $14 trillion economy in the next eight months. The Fed held back on a shock-an-awe program that could have been over $1 trillion. But it’s going ahead with the money stimulus.

This middle-ground action was already discounted by the market. The dollar did fall today, but so did gold. Of course, I would have preferred no QE2 at all. Similarly, to protect the dollar, I would replace the Fed altogether with an ounce of gold. But that’s my problem.

Here’s a question, though. Is the Fed stimulating into an improving economy? Today’s ISM for services came in above expectations. The same is true for Monday’s ISM manufacturing report. September factory orders rose 2.1 percent. And monthly car sales near 12.4 million at an annual rate are the best since September 2008.

It wouldn’t be the first time the central bank is a lagging indicator. Commodity indexes have been booming. Bond market inflation expectations have been rising. And now the economy seems to be improving in the early part of the fourth quarter.

To me, the Fed is at least doing minimal harm, although I continue to fret about the outlook for the dollar. But the possibility of a pro-growth fiscal policy coming out of the lame-duck Congress — a large budget continuing resolution that extends the Bush tax rates and is stingy on spending — is a good thing.

Regarding the future triangulation between Obama, Reid, and Boehner, we will all have to puzzle though this. But surely stopping the bad stuff is a plus.