Bear Market: The debate goes on whether we are in a bull market or have been in a bear-market rally. It is still our firm belief the bullish forces at work on the economic system outweigh the bearish ones. It will be three steps forward, two steps back on a regular basis until the bulls get a bigger policy feeding, and we think that is also more likely than not. The Wall Street rally has in itself emboldened administration officials and congressional Republicans about the efficacy of genuine supply-side tax cuts and there are possibilities of modest changes getting through this year in the one or more tax bills that are in the works to prevent some tax provisions from expiring. With everything else being equal, though, it may take several months for the bull to get to 10,000 on the DJIA. The NASDAQ and tech stocks are in a better position because the superior tax climate on capital formation marginally favors growth enterprise more than it helps mature corporations.
Bush Vulnerability on Iraq: I’m surprised to get so many queries about whether I think President Bush is vulnerable on Iraq, in the sense it might still threaten his re-election or even impeachment. Did he knowingly deceive the American people and the Congress about the rationale for war? It is the Watergate question about President Nixon: “What Did He Know and When Did He Know It?” I’m fairly certain that public hearings would show he himself was deceived, that the intelligence getting to his desk was crafted to persuade him that weapons of mass destruction would be found. If there are public hearings by the House or Senate, the level of deception might cause sufficient fireworks to force a few high-level resignations, the CIA’s George Tenet being the most obvious. Democratic presidential contenders who had been wary of criticizing the commander-in-chief thinking WMD might still turn up are now turning up the heat. In particular, Sen. John Kerry of Massachusetts is saying he feels he may have been deceived in his support of the resolution authorizing force to disarm Iraq. What is further emboldening the Democrats is the situation in Iraq, with Saddam Hussein and his two sons still at large and perhaps directing the guerrilla war Saddam may have planned in anticipation of the invasion. The longer this goes on, with daily American casualties, the more the Democrats will demand answers to why the President got the country into the war. I can at least imagine it getting as high as the Cabinet level, but not to the President or Vice President.
The Fed: The Washington Post's John Berry, the most senior Fed reporter in the press corps, reports today the Fed next week will definitely cut 50 basis points from the funds rate, to 0.75 from 1.25%. If the Fed only does 25 bps, we doubt it would have any effect on equities and might not make much difference on Treasury securities. In either case yields should rise a bit, our Michael Darda believes, because the market may believe the Fed is either at bottom or close to the bottom of where it can take fed funds. The risk of continued economic weakness would then suggest the Fed might be buying Treasuries to “fight deflation,” but over the next few months it should be apparent that the economy is growing fast enough to discourage that kind of play.
The Road Map: There is more here to worry about than I am comfortable with, given the possibilities a complete breakdown of peace talks in the Middle East could create new global geopolitical risks. The news has been all about how Israeli Prime Minister Ariel Sharon is sticking to his hard line that there will be no moves on the “road map” as far as he is concerned until all Palestinian violence stops. This wasn’t how the concept was conceived and Secretary of State Colin Powell will try to move things along the right direction when he meets with Sharon and his Palestinian counterpart, Mahmoud Abbas. The issue of “targeted assassinations” by Israelis will be the one most discussed, I’d suspect, as this is where President Bush drew the line. Members of the Israeli Knesset have been criticizing Sharon on this score and so have Jewish supporters of the “road map” in the United States. My guess is the tattered map will be patched up this time around, and maybe the next time around, but it will be too hard to predict one way or another given the other variables in the Middle East, including the continued strife in Iraq, and in American presidential politics.
The Trade Deficit: Yes, there are record deficits on the current account, but as usual that is primarily a function of the ability of the American economy to attract capital relative to the rest of the world. The hoary “twin deficit” theory which says a federal budget deficit causes a trade deficit has been a staple of financial commentators for decades, one that was ignored when the budget was running big surpluses a few years back. The climb in the stock market from the first of the year – temporarily interrupted by concerns related to Iraq and the administration’s seriousness about tax cuts on capital – is the magnet pulling in goods from abroad. The trade deficit will not cause “weakness in the dollar,” relative to the euro and the yen. Those exchange rates are the result of combinations in monetary and fiscal policies in each of the currency zones and how they intersect. The dollar would “weaken” against the other key currencies from this point only in the unlikely event the Fed this summer decides it must fight “deflation” to get the economy moving faster. The dollar/gold price would climb rapidly and the euro/gold and yen/gold prices would not, unless all the central bankers decided to inflate together. And that is most unlikely.
Political Notes: I agree with Pat Buchanan that at present the only two Democrats who might conceivably defeat George Bush in 2004 are former Vice President Al Gore and Hillary Clinton, neither of whom are running. It also seems Buchanan may be right that Governor Gray Davis will be recalled by California voters and the most likely Republican to successfully contest for the GOP nomination would be Arnold Schwartzenegger. Who would want to be governor of a state with a $38 billion deficit? Piffle. The national expansion underway will begin to produce state revenues at a higher rate. Schwartzenegger could get the economy – already the fifth largest in the world in GDP – moving faster by eliminating the state tax on capital gains. The deficit on current account then would really balloon.
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