Stock Market High: Cause for Alert?

Seeking balance among a host of variables, including unemployment, inflation, Europe

by Marisa D’Vari

Ms. D’Vari is Managing Director of corporate communications for New Oak Capital. Connect with her by e-mail:

“Stock market indexes are at record high but so are better-than expected corporate earnings driven by monetary stimulus and supporting evidence for improving housing and steady economic growth,” says Ron D’Vari, CEO and Co-Founder of NewOak.

While there is yet no clear case for economic acceleration that can be made, the U.S. economy ahead is less subject to derailment from its slow recovery than any time in the last five years. Europe is still struggling to deal with unemployment and recession, but threat of collapse is less likely. US budgetary issues remain but the system seems to be generally coping with it and making the necessary adjustments. U.S. consumers are also holding up despite the tax increases. A key issue remains unemployment, which must be corrected to support a robust fundamental growth. The U.S. housing sector continues to be the bright spot.

When analyzed in light of earnings and steady expected growth, the stock markets valuation is not out of line with the historical norm. The market’s expectation of growth are very much predicated on the central banks stimulus continuing as long as the unemployment picture in U.S. and Europe has not normalized and inflation remains benign.

Another reason for a lower probability of market crash is there is still plenty of investors with cash waiting in the wings for a potential dip to add to their equity exposures. It is hard to short U.S. consumer and housing sectors. Barring another global crisis many expect U.S. economy and hence the markets do generally well. While risks remain high in both the equities and debt markets, we recommend overweighting normal exposures to the equity markets and underweighting fixed income allocations or at least keeping the duration short.

Excited About an $850 Billion Deficit?

While there is yet no clear case for economic acceleration that can be made, the U.S. economy ahead is less subject to derailment from its slow recovery than any time in the last five years

“According to the Congressional Budget Office estimate, the government is expected to run a full-year deficit of $845 billion for fiscal 2013,” says James Frischling, President and Co-Founder of NewOak. “The large figure is worth noting because it represents the first time in five years that the national deficit is below $1 trillion.”

Addressing the country’s mounting deficit is not an issue that is heavily debated. However whether to meet the challenge by focusing primarily on spending or revenues has our politicians divided. Seven months into the fiscal year, while the forced spending cuts associated with the sequester have contributed to the expected drop in the deficit number, the key driver has been the increased revenues. Federal receipts reached $1.6 trillion, the highest level ever recorded for that period according to the Treasury. Higher taxes as a result of the payroll tax and tax rate increases for higher earning households have been the key drivers of the increased revenues. There have also been some extraordinary contributions coming from the GSEs. Both Fannie and Freddie have been paying billions in dividends as a result of the improvements in the housing market.

The need for deficit reduction is obviously critical for the country, but it may come at the expense of a more robust economic recovery. Despite the Federal Reserve’s aggressive efforts to stimulate the economy and reduce unemployment, the headwinds being caused by the government’s tax increases and spending cuts may result in a lackluster growth. As they say, you can’t have your cake and eat it too.