"Kee" Points with Jim Kee, Ph.D.

Most of the broader market indices finished up for the week, and while fairly conventional, my view is that Friday’s sell-off (185 points on the Dow) was largely a reversal of the over 200 point gain on Wednesday that followed Bernanke’s remarks regarding Fed tapering (of their bond buying, that is). Since a postponement of tapering indicates a lack of strength in the economy, most analysts saw the market’s positive move as a short-lived overreaction (and short-covering -- buying stocks to cover or close short positions). I think Wednesday’s statements were consistent with prior Fed verbiage; that’s a straightforward conclusion if you manage to restrict your central bank readings to Fed statements only and avoid the biased press discussions.. I have found market commentary regarding Fed policy pretty worthless for the past five years.


International data was mostly encouraging from both China and Europe (including the U.K.) last week, and Angela Merkel handily won the German parliamentary elections on the 22nd (Sunday). That was expected – the big market shock would have been if any other outcome had ensued. In the U.S., capital spending expectations from various survey sources (e.g. Philly and New York Feds) indicate a pick-up going forward, and housing data pointed to continued, moderate recovery in that important sector.


But the impact of increased housing prices on consumer spending, i.e. “the wealth effect” shouldn’t be overestimated. Recent research at the University of Chicago shows conclusively that, during the housing boom, only those with poor access to credit, or the “credit constrained,” took out home equity loans for consumption. And during the bust, it was this same group that had to curtail spending the most. During this recovery, these “credit constrained” borrowers have been shut out of housing and mortgage markets, so few homeowners are borrowing against their homes (Capital Ideas). Thus the authors argue that the actual wealth effect of higher housing prices on spending for these households “may be close to zero.” That sounds a little overstated, but overall the research has merit and the conclusion, which seems to be “don’t overestimate the wealth effect,” is valid.


Of course, the big issue in the U.S. right now is our fiscal situation. The current budget that funds the federal government expires on September 30th, and the federal debt limit will have to be raised by mid-October in order for the government to continue functioning (WSJ). House Republicans have recently attempted to tie funding the government with defunding of the Patient Protection and Affordable Care Act (i.e. “Obamacare”), or approving funding for the government over the next 12 months in exchange for putting off funding of the healthcare bill (whose exchanges are slated to begin operating October 1st) for 12 months. None of that should happen and, as always, there will be a lot of political posturing. My sense is that this go-around will be more intense than the “fiscal cliff” episode at the end of 2012, but less intense than the debt-ceiling debates during the summer of 2011. That will certainly roil markets, but I suspect that market sensitivity to on-going fiscal wars is declining.