What’s Driving This Stock Market Rally?

What a great couple of weeks it has been in the stock markets! We just had the mid-term elections, an important Federal Reserve Meeting and the October 2010 monthly jobs report.  Most were expecting this past week to be one where the markets took a breather and pulled back a bit. Instead, the markets powered higher to levels not seen since 2008 and better than our April 2010 highs.  The NASDAQ market is up by double digits for the year and the DJIA and S&P500 indexes are near double digits.  With the announced quantitative easing (QE2) by the Federal Reserve this week (simply translated, the government is going to print more money to avoid deflation), more funds will find their way to the stock markets.  Therefore I believe that the markets are headed higher over the next 6-12 months (obviously, my crystal ball may be broken, but Federal Reserve Chairman Ben Bernanke came out and said that higher stock markets is one of his main objectives to stimulate spending and the economy.) Please read more about that below.  If you read nothing else in this message, please at least read “The Bottom Line” below.

Quantitative Easing 2-It’s HUGE!

With inflation at historic lows and prices at risk of descending into deflation, Dr. Bernanke is determined to avoid Japan’s lost two decades due to inaction to stimulate inflation.  In an environment of deflation (falling prices), spending stagnates because no one buys anything because they expect prices to be lower in the future.  So yes, I said it: Dr. Bernanke wants to manufacture inflation, believe it or not. By printing greenbacks ($$$), we increase the money supply, cause the dollar to fall in value (and thereby increase exports), which in turn causes stocks and commodities to rise in price, which causes people to feel better about their investments and retirement plans, which in turn gives them the confidence to spend, which spurs more manufacturing and hiring and so on…you get the picture.  Or at least that’s what he’s expecting and hoping to happen.  This round of quantitative easing has been dubbed QE2 since it’s the second time since the great recession began that we’ve embarked on a similar stimulative program.  This program will add $600 billion of money into the system at the rate of $75 billion for eight months to try and jump start inflation. If this doesn’t work, some analysts think that we should expect QE3 or even QE4, and by then, we may have as much as $2 trillion of money printing when all is said and done.  A trillion here and a trillion there and soon you’re talking about some real money (remember when a billion used to be a huge sum of money?)

One impact of the new QE2 program hasn’t received much attention.  That is, it almost guarantees that short-term interest rates will remain near zero for quite some time, perhaps for the next couple of years.  Keep that in mind if you’re one of those people who collectively still have about $3 trillion invested in money-market funds.  Has the memory of 2008 (-37% on the S&P500) kept you from earning +26.5% in 2009 and possibly +15% or so in 2010?  Then Dr. Bernanke’s program is aimed squarely at you to get you to take some risk again.  If you are still scared of the markets, then maybe you should be talking to us.

As expected, the value of the U. S. dollar dropped with the announcement of the QE2 program.  Printing lots of money lowers the value of any currency, even the mighty greenback.  On cue with the decline in the dollar, the value of oil, gold, and other commodities increased. The weaker dollar should help to boost American exports, reduce imports, and lessen our trade deficit with the rest of the world.  Obviously, the rest of the world – our major trading partners – aren’t too happy about it.  The risk of a worldwide “currency war” is higher as a result.

October Jobs Report-Much Better than Expected

The October 2010 jobs report was very positive and showed growth in jobs of about 151,000 (story below), but an unemployment rate that is still stubbornly high at 9.6%.  This was far higher than the 60,000-90,000 jobs growth expected.  Of course, at this rate it will take several years to get back to where we were in 2007, but this is indeed positive for a recovery that is likely to be disappointingly slow and painful for those who are still unemployed or are at risk of losing their homes.  Nonetheless, I will repeat what I’ve said in the past: many of the 5M+ jobs lost over the past three years are gone and will never be coming back due to technology advances, outsourcing and higher productivity.  Although many would like to see a return to 5-6% unemployment, we may be stuck with 7-8% unemployment as the norm in the future.

There have been numerous positive economic reports over the past several weeks that have all but put speculation of a double-dip recession to rest.  As I’ve said several times since the spring and summer, every recovery from a recession as deep as the one we’ve experienced has felt like a jobless one and real estate prices take much longer than expected to recover.  There was one report on CNBC the other day that said that Florida had an 18-year supply of condos on the market, and if you hurry you just might get one, but only if you can pay cash since most lenders are not loaning money against them.  Obviously, the housing market is not coming back any time soon, and talks of 2020 as the soonest timeframe are abound. I personally believe that’s far too pessimistic, and that by 2013, the lower supply of homes (due to low current new home construction rates) will necessitate increased building and help boost prices once again.

Year-end Tax Planning & 2010 Roth IRA Conversions

I’ve delayed my year-end tax planning letter this year due to all the uncertainty about what will be happening with the expiration of the Bush-era tax cuts. My expectation is that with President Obama extending an olive branch to the newly Republican controlled House of Representatives, we will see a two-year extension for everyone, not just the poor and middle-class.  The president doesn’t want to be responsible for counter-acting the QE2 program with increased taxes, especially during such a feeble recovery.  Look for my year-end tax planning letter in a week to ten days. For all my financial planning clients, I am making appointments or encouraging you to send in your year-end pay stubs and financial estimates so we can get your tax planning underway before mid-December.  This is a complimentary and year-round service for all our financial planning and money management clients.

2010 is the only year that you can convert all or part of your traditional or rollover IRA and spread the resultant income over 2011 and 2012. If you decide to do so and the value of your converted assets goes down by October 15, 2011 (and you’ve extended your 2010 tax return), you can undo the conversion. Beginning in 2011 (and all years thereafter), you can convert your IRA but the two year spread of income is not available to you—you will have to report all conversion income in the year of conversion.  The decision to convert your assets is a very important and complicated one, and should only be undertaken with a detailed analysis of your taxes and finances. Anyone who tells you to convert or not convert without a full evaluation or knowledge of your individual finances and future tax rates is not giving you an informed decision. Please discuss with me or your tax advisor if a Roth conversion in 2010 makes sense for you.

The Bottom Line

You may hate what’s happening in Washington, what the Federal Reserve is doing, how high the unemployment rate is, how terrible the housing market is, how much Washington’s spending, how we are debasing our beloved greenback, how inflation is going to be hyperbolic, and how this country is going to heck in a hand-basket.  But if you focus on those things you will miss out on what is likely to be a continuation of the current stock market rally.  The government has told us that it wants the stock market to go higher and you may have heard the expression that “You can’t fight the Fed.”  For the next 6-12 months, perhaps longer, money will find its way into the stock market and surely push prices higher.  Sure there will be bumps along the way, periods of sideways movement, and some corrections, but I believe that the ultimate direction is upward.

We can debate whether the government will be successful in its objectives, but that won’t increase the value of your investments, IRA or 401(k).  If you are on the sidelines, or are considering investing money in the markets, I urge you to talk to a planner or advisor who can help you sooner rather than later.  It’s not often that the government tells you that it will help and actually does help you make money on your investments.  I believe that we’ll look back on this time period in hindsight and realize what an great investment opportunity it was.

Of course, my prognostication would not be complete without a proper disclaimer: my crystal ball is in the shop, so any forward looking statements I make should be discounted and evaluated in the context of your own financial plan and should be discussed with your financial planner.  As we all know, anything can happen and usually does to trip up the smart and dumb money in the markets.  But right now, the smart money tells me that the best place to be right now is in high quality equities, bonds and commodities.  If you have money on the sidelines waiting to be invested, you can put it to work now if it’s planned to be invested for the long term (five or more years) or wait for an inevitable short-term market correction to get in.  However, the thing about dips lately is that they’ve been quite shallow and are bought up quickly.  If you’re concerned, you can start slow, invest a little and invest a little more on inevitable corrections.

In my role as a fiduciary planner, I will also plainly disclose that encouraging you to invest (more) money in the stock or bond markets is a direct conflict-of-interest for me (at least for my clients and prospects) since I charge fees based on assets managed.  However, regardless of how or where you invest, I just want to see you participating and getting your share of the government’s current “asset re-inflation program.”

Market Update For Week Ending 11/5/2010
Index Close Net Change % Change YTD YTD %
DJIA 11,444.08 +325.59 2.93 +1,016.03 9.74
NASDAQ 2,578.98 +71.57 2.85 +309.83 13.65
S&P500 1,225.85 +42.59 3.60 +110.75 9.93
Russell 2000 736.59 +33.24 4.73 +111.20 17.78
International 1,671.56 +55.15 3.41 +90.77 5.74
10-year bond 2.53% -0.08% -1.28%
30-year T-bond 4.12% +0.12% -0.57%

About the author

Sam Fawaz, CPA, CFP®

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