The Fed's latest policy actions should lead to an improving economy over time. The economy is likely to remain weak near-term and the turnaround will likely be fairly slow when it does come, much like turning a supertanker. Even so, the Fed's actions are bearing fruit. In this environment, patience will be required and the best investments will be those that do not require a quick pick up in economic activity. It is also a good environment for stocks, since gradual gains in profitability discounted at low interest rates are very good for stock valuations.
Industrial economies respond sharply to surges implied by an inventory cycle. Liquidation requires sharp job losses and major reductions in production, while the end of that process requires recalling furloughed workers and resumed production. That makes for large, sharp swings in GDP. Service economies display great inertia. Repairing impaired balance sheets requires time. Firings, not layoffs, are the result of declines in demand for services and new hiring is implemented only slowly when demand picks up again, so as to not recreate the problem solved by the earlier firings. Thus, a service economy weakens more gradually than a manufacturing economy and also rebounds more slowly. We're already seen this type of behavior before and after the past few recessions.
The Fed's response to the sub-prime problems initially unfolded with great caution, but policy action intensified markedly once the threat to the broader economy emerged. Then, the Fed cut rates substantially and quickly and it implemented creative new methods to improve the functioning of the credit markets. These actions have already begun to narrow credit spreads and financial firms have been able to raise capital in vast sums. No doubt, more steps will be taken if the improvement does not continue. But the steps taken will take some time to fully turn the economy.
Investors are clearly already looking ahead to better times, as reflected in the stock market rebound since mid-March. Even from current levels, higher risk assets should outperform safe assets. While default rates will likely remain on the high side for some quarters, the high yields and wide risk spreads on junk bonds should more than compensate for these losses. Corporate profit growth may be fairly moderate, but such an environment, with its low interest rates, have been very good ones for stocks historically. The safest investments, cash and Treasuries, will perform worst, providing little return. Long-term Treasuries may pay somewhat higher yields, but will also suffer from some capital loss, as interest rates gradually return to more normal levels.
About Advisors Capital Management, LLC
Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
©2005 Advisors Capital Management, LLC 
