The Big Choice: Combat Inflation or Stimulate Growth?

Ashley Page, Senior Vice President, Wealth Consulant04/23/12: We hope that you had a great weekend and that the “tax man” didn’t hit you too hard! As we always do at the beginning of the market week, we wanted to give you a “look ahead” at a few items that we will be tracking carefully during the next few days. These are just a few opinions that we have, and as with life, nothing is certain about them.

1. First, here is a “week-at-a-glance” view of several key market drivers for the next five business days. Beginning today, there will be more “take away” analysis from Saturday’s first round of the French presidential elections that saw incumbent Nicolas Sarkozy finishing second behind Socialist candidate Francois Hollande. Tuesday is highlighted by a combination of domestic economics and politics, as the S&P/Case-Shiller home-price index on new home sales is released and The Conference Board reports on consumer confidence. Connecticut, Delaware, New York, Pennsylvania and Rhode Island hold presidential primaries. Wednesday is an important Federal Reserve day, as that body wraps up a two-day meeting followed by a Ben Bernanke news conference. March data on durable goods orders is also released. On Thursday, the National Association of Realtors reports on pending home sales for March. Friday ends the market week with officials of the Bank of Japan holding a policy meeting, The Commerce Department issues its initial estimate for first-quarter GDP and The University of Michigan publishes its consumer sentiment index.

What does this mean for investors? Market participants should be watching the unfolding political situation in France very closely. The May 6th runoff elections have significant implications for whether or not France will continue to stand “shoulder to shoulder” with Germany in leading through the European financial crisis. Simply put, Sarkozy wants to follow Germany’s austerity example and keep purse strings tight while Hollande is urging his countrymen to spend more in order to spur economic growth. The key political question is whether Sarkozy can capture the 18.3% of voters who chose far right leader Marine Le Pen. Will these voters abstain in the May 6th runoff in order to ensure a Sarkozy defeat?

Financial Market Outlook

2. What economic direction will the Federal Reserve take at its two-day policy meeting this week? More than likely, nothing will change from its January policy stance. Because of doubts about the durability of the current recovery, Fed officials seem likely to “stick to the plan” of keeping rates low until 2014. From the beginning of the year, we have a little less unemployment (as the jobless rate has dropped slightly) and a little more inflation (due to the recent rise in gasoline prices). Other than that, there seems to be no other economic variations that would cause any change in Fed policy to emerge from this week’s meeting.

What does this mean for investors? At the moment, market participants will find it extremely difficult to “handicap” the Federal Reserve’s two main choices: (1) raising short-term interest rates sooner than planned to combat inflation, or (2) initiating a new bond buying program to stimulate growth and reduce long-term borrowing costs. Overall growth projections for 2012 seem to have changed very little, which probably means that projections for 2013 and 2014 won’t either until more data is gathered in the next couple of quarters.

3. Euro-zone finance ministers are hoping expanded reserve funds will be enough to “stave off” some significant upcoming financial tests. After concluding meetings in Washington on Sunday, finance ministers from around the world are hopeful that two expanded reserve funds will improve market confidence in the Euro-zone. Both IMF lending capacity and the European rescue fund were expanded, the former to $700 billion and the later to $925 billion. The objective is to reassure markets that governments won’t default on their debts. The next battle is a “political” one in trying to decide how to deploy the new funds if needed. The increase in funds appears just in time, as borrowing costs for Spain and Italy have increased in recent weeks and European banks are facing ratings downgrades in May. All of this is against a backdrop of the French elections mentioned above which will begin to shed light on whether Europeans will truly brace more austerity.

What does this mean for investors? We are watching upcoming developments in Spain and Italy quite closely, as many analysts doubt whether the increases in reserve funding just approved would be enough if either of those significant economies needed a bailout. Further, many international officials also feel the funds are too small if Europeans do not undertake economic reforms that will cut budgets and “re-tool” their economies for improved long-term growth. For now, the reserve fund increases are yet another effort at crisis “containment.”

4. In a move that could help employment and increase owner-managed business lending, the federal government has made it easier for community banks to raise capital. The JOBS Act signed into law this month includes a provision that allows small banks to register with the SEC at the 2,000 shareholder level rather than the previous 500 shareholder mark. The change means that small banks are free to raise significantly more capital without the regulatory costs that existed before. In addition to making bank balance sheets healthier and encouraging more lending, employment within this industry sector could increase nationwide as it is easier to acquire expansion funding. The new rule could not be better timed, as community banks have really struggled to stay profitable in the past four years with higher charge-offs, stagnant loan growth and low interest rates.

What does this mean for investors? Having a way for community banks across the country to access more capital is a “win-win” in many ways for our economy, particularly in the small business lending arena. As an aside, we feel that it could also reinvigorate the M&A market among banks, which in 2011 stood at its second-lowest level since 1980.

Should you have any questions or concerns, please call or email me here and I would be delighted to talk with you.

Ashley Page
Senior Vice President
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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