December Economic Update
Cambridge Advisors
December 10, 2010
The stock market rally that began in early September ran through the first week of November then took a breather through the end of the month. Bonds also sold off after the first week of November through the end of the month pushing yields higher. These market moves coincided with a strengthening US dollar as more European countries struggled with debt problems and US economic data showed improvement.
We are encouraged by improving economic data on several fronts despite an unfavorable employment picture. Improvements in private sector wages, small business income and pent-up demand have provided a welcomed boost to retail sales which are up 7.3% over the past 12 months and have been particularly strong over the past 4 months. Manufacturing activity has continued at fairly robust levels over the past several months while strong demand has kept inventory levels in check. Third quarter real GDP growth was also revised to 2.5% from 2.0%.
The much anticipated Fed policy of additional Quantitative Easing was announced early in November. Ben Bernanke announced additional bond purchases of $600 billion by June 2011. Since the Fed telegraphed this action well in advance the market moved ahead of the announcement and reaction to the actual announcement was fairly subdued. The stated purpose of this action was to stimulate economic growth and create inflationary pressures to combat potential deflation. Critics say that the action is unnecessary and may contribute to undesirably high inflation in the years ahead.
The mid-term elections are over and most races have been decided. The results were widely expected as Republicans gained seats in both houses of Congress as well as Governorships and in most state legislatures. We now have a Republican majority in the US House of Representatives and continue to have a Democratic majority in the Senate. The Tea Party movement had significant influence in the elections as many of the candidates supported by the Movement won their respective elections. The outcome of the election is widely believed to reflect a desire among voters for less Federal Government spending and control.
Since Congress failed to address the expiration of the Bush era tax cuts prior to the election, the issue is now being debated during this lame-duck session. The debate primarily centers on whether to extend the tax cuts to everyone or only to those making less than $250,000 per couple annually. If an agreement is not reached before year-end the tax cuts would expire, including the so-called marriage tax penalty, reduced tax rates on dividends and capital gains and child tax credit among other provisions. If this occurs, it may be up to the new Congress to decide how to proceed. Even then, if the cuts were extended for everyone as Republicans desire, the President could veto the bill and it would be difficult for Congress to override it.
According to the Congressional Budget Office, expiration of the Bush Tax cuts would increase Federal tax revenues by about $370 billion annually with about $70 billion coming from taxpayers earning $250,000/yr. or more and $300 billion coming from those who make less than $250,000 annually. Economists estimate that the tax increase will create a 2.5% drag on economic activity. With current economic growth in a range of 2-3%, a 2.5% drag could lead to another recession and would certainly hamper employment growth.
As markets continue to heal, we are optimistic that the economic environment will become increasingly favorable for stocks. However, the healing process is far from over and shocks to the system remain a meaningful risk. We believe a well diversified portfolio combined with an emphasis on assets that benefit from a weaker dollar will be an effective strategy in the months ahead.
402-697-1166
17330 Wright Street, Suite 205
Omaha, Nebraska 68130
Lori L. Liffring, CFA
Michael L. Bridgman, ChFC
Gaylan C. Abood, CFA
Justin S. Anderson, MBA AAMS
Karen K. Benefiel, CPA AAMS
(c) Cambridge Advisors
