The Daily Item, Sunbury, PA

March 11, 2013

Bucknell professor: Wall Street is resilient

By Rick Dandes
The Daily Item

— LEWISBURG — Maybe Wall Street traders had it figured out all along.

They have learned to ignore Washington and simply don’t care what the political system does. That was undeniably the message Washington received last week from Wall Street, as the Dow Jones Industrial Average gained 67.58 points, or 0.5 percent, to reach 14,397.07. The increase was driven by strong corporate earnings, a compliant Federal Reserve and a belief that even Congress’ budget wars can’t blow up a recovering U.S. economy.

This comes as welcome news to corporate America and workers checking their 401(k) statements.

But it complicates President Barack Obama’s message that the $85 billion in sequester spending cuts, which took effect March 1, could hurt the U.S. economy, which grew at just a 0.1 percent rate in the fourth quarter of last year.

No one on Wall Street liked the idea of across-the-board sequester cuts, but it already was priced into the market when the cuts took effect.

On that day, suggested Janice Traflet, associate professor of management at Bucknell University, the stock market showed incredible resiliency and an ability to earn profits in an uncertain market.

Companies like Hewlett Packard, Bank of America and Microsoft have found ways to prosper, despite the sluggish economy and despite the sequestration.

“Consumer confidence is better these days,” Traflet said. The economy has been recovering, slowly, for the past few years, but it’s only recently that consumers have started to feel it in their pocketbooks.

“Is the recession over?,” asked Michael Morssey, a young Lewisburg man with a background in financial services. “Well, unemployment fell to 7.7 percent, and that’s good news, although there are still too many people out of work. And the sequester isn’t helping with young families in financial straits. Meanwhile, most individual investors are starting to put money into the market, and that’s why it’s rising so fast. I mean, where else is someone going to park their money?”

Stocks also have been boosted by continuing economic stimulus from the Federal Reserve.

Morssey is seeing many people taking money out of bonds and buying stocks.

Which begs the question, at these heights, are stocks safe?

Traflet was noncommittal. “Going forward,” she said, “it will be interesting to see whether some of the Dow’s strongest gainers in the past year (like Bank of America, Home Depot and JP Morgan Chase) will be able to sustain or even extend their runs. Who knows, perhaps some relative laggards in the Dow might eventually wind up being a source of added momentum.”

“If — and this is a big if — the Dow continues to hit new highs, how will mom and pop investors react?” Traflet asked. “Will they continue to merely tiptoe back into the market or will we start to see some exuberance reminiscent of the euphoria accompanying earlier Dow highs?

“So far, while getting some confidence back, the typical retail investor remains quite cautious, having witnessed the calamitous crisis of a few years back, and remembering that frightening volatility.”

Two fundamental determinants of stock prices, added Gregory Krohn, a Bucknell University economist, “are the growth rate of corporate earnings and the level of interest rates.”

The faster the growth in corporate earnings and the lower the interest rates, the higher the prices of stocks, all else being equal. Corporate profits have been high relative to national income in the economic recovery, a recovery which is expected to continue at a sluggish pace. The recent rebounds in house prices and home sales contribute to forecasts of a continuing economic expansion.

The Federal Reserve has been buying long-term bonds to keep interest rates low and has signaled that it will keep short-term interest rates low for two more years or so if economic conditions do not change drastically. Low interest rates will encourage borrowing and spending and support the modest recovery. Relatively high profits, the ongoing economic recovery and low interest rates help to explain the rise in stock prices over the past few years.