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Stocks Fall after Italian Election; Bernanke defends Bond Buying Program

Market Digest – Week Ending 3/1

Stocks fell sharply Monday in a knee-jerk reaction to Italian elections, and spent the rest of the week clawing back to even. Enthusiasm was dampened by a congressional failure to find a compromise on automatic spending cuts (known as the Sequester) which begin to phase in today. Bonds rose as Bernanke indicated his stimulus exit strategy may include holding positions on the Fed balance sheet to maturity rather than selling them.

Weekly Returns:

S&P 500: 1,518 (+0.1%)

MSCI ACWI ex-US: (-0.5%)

US 10 Year Treasury Yield: 1.85% (-0.12%)

Gold: $1,576 (-0.2%)

USD/EUR: $1.302 (-1.2%)

Major Events:

  • Monday – An Italian national election provided no clear winner and could lead to gridlock in pursuing additional economic reform. Stocks fell.
  • Tuesday – Bernanke defended his bond buying program and said it should continue in testimony to Congress. He said they have helped spark a recovery in the housing market and have increased production of automobiles and other durable goods.
  • Wednesday – In further testimony to Congress, Bernanke said the Fed has not completed a review of the exit strategy from stimulus but suggested it may sell bond holdings more slowly than previously expected or hold them until maturity.
  • Thursday – Groupon fired its CEO after releasing disappointing earnings results.
  • Thursday – The Senate failed to pass a pair of largely symbolic bills designed to ease the impact of the Sequester.
  • Friday – Obama met with congressional leaders to discuss automatic spending cuts, but little progress was expected from the meetings.
  • Friday – January consumer spending rose despite a drop in income related to the payroll tax increase.

Our Take: 

This week’s choppy stock market featured a battle of bearish concern over Italian elections and the Sequester and bullish optimism about Bernanke’s seemingly limitless appetite for stimulus. It ended in a draw.

The Sequester is blunt legislation that cuts spending in an awkward and indiscriminate way. The cuts themselves may be appropriate, but it would be better to implement them more thoughtfully. Already, some people are being directly and inappropriately punished, particularly in the defense sector. There is some cause for optimism. The worst of the cuts won’t happen for another two months, which buys some time for Congress to figure something out. Meanwhile, individual programs facing cuts will act rationally and make the best of a bad situation.  Nevertheless, the unfortunate situation is another sign that child-like partisanship is a real problem with real impact.

For the last few years, Bernanke has never missed an opportunity to find new ways to be accommodative. The mere suggestion the Fed may hold its bonds to maturity propped up both equity and bond markets. It should also make our friends in Congress happy. The Fed holds trillions of dollars of government debt on which it refunds the interest to the Treasury. Good or bad, this ultimately allows for a lot more spending.

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