Several days after a record winning streak for the Dow Jones Industrial Average, as the U.S. is witnessing budget bickering, and at the time of the Fed's meeting on the economy, where is the country's economy really standing?
Overall, investors' optimism has increased over the past few months, at every level. Mega deals are back, as indicated by the recent buyouts of H.J. Heinz (HNZ), the famous ketchup maker from Pittsburgh for $28 billion, and of Dell (DELL), the computer maker from Texas for $24 billion (even if this deal is currently contested by investor Carl Icahn). The Dow Jones closed at an all-time on March 5, at 14,253.77. It has roughly doubled since March 2009. Following the lead of institutional investors, retail investors are now jumping back into the stock market, fostering the "great rotation," the large-scale readjustment of portfolios from bonds to equities.
The housing market (defined by condos, co-ops, townhouses and single-family houses), which was at the heart of the Great Recession, has picked up and stabilized. The subprime and foreclosure crisis seems behind, and construction is bouncing back. That could assist in sharply lowering the unemployment rate nationwide, given the breadth of the housing sector in economic activity.
The banking industry is healing too, as have shown the recent 'stress tests' conducted by the Fed: 17 out of the 18 largest American banking institutions would have enough capital to survive a hypothetical severe economic shock in which unemployment would jump to 12%. Banks are better capitalized than before, and their capital is of higher quality (toxic assets are disappearing little by little), even if the Fed placed conditions on capital distributions for Goldman Sachs (GS) and J.P. Morgan Chase (JPM) after the stress tests. Citigroup (C), which had been bailed out by the government, has now a Tier 1 capital ratio of 9.35%. Credit is loosening, and it is now easier to borrow, whether for individuals, businesses small or large, even though the banking sector is still somewhat contracted. At investment banks, some exotic securities that had disappeared during the crisis are reappearing.
These days, many feel that the largest risk for the economy comes from the entity that is supposed to protect it: the federal government. For a long time now, the U.S. has gone from gridlock to fiscal cliff to sequester. Political paralysis on the budget issue has caused market anxiety, and even though the dialogue between Democrats and Republicans seems to have improved lately, a compromise is still far off.
The Fed has also kept investors in a cautious mood. It has promoted rates close to 0% since 2007, and at present injects $85 billion per month in the economy through its purchases of fixed-income securities. It has been a primary driver of the increase in stock and real estate prices. Some are beginning to use the word 'bubble' to refer to markets that they deem overheating, such as the junk bonds market. And in the medium run, volatility could be foreseen if the Fed does not handle adequately the decrease of its support to the economy.
Where are we going?
Even if public finances are preoccupying (public debt totals $17 trillion, more than the GDP), the U.S. is still doing much better than a few years ago. Cautious optimism seems appropriate to the current situation. As soon as budget talks are dealt with, and even if another confrontation over the debt ceiling can be expected for the summer, investments should accelerate since the private sector is sitting on $2 trillion in cash. Businesses are already spending a record amount on research and development, and the crisis has enabled companies to become more competitive. In the longer run, the U.S. should also benefit from the major technical progress that has been made in the energy sector. The nation's infrastructures, oftentimes outdated, should also offer profitable and necessary investment opportunities.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.