Are They Watching in Washington?

One of the benefits of being closely involved with the publishing of important business and economic news is that it is easy to stay in tune with the message from the headlines. And in short, the message we’ve been hearing lately is that the economy is not exactly hitting on all cylinders at the present time.

This week alone, we’ve seen the PMI’s (Purchasing Managers Index – designed to indicate the state of the manufacturing sector) from around the world come in below expectations. We’ve gotten word that business activity has slowed via reports from both the Richmond Fed Index and Chicago Fed National Activity Index. We’ve seen Orders for Durable Goods pull back and housing prices continue to fall. We’ve seen an uptick in jobless claims that is becoming difficult to ignore, and finally, a GDP report that failed to include the upside surprise that many analysts were hoping for.

While none of the above reports suggest that the economy is heading south, they all point out that the growth rate has clearly slowed a bit. But at this stage of the game, with the job market still in a bad state, a slowdown of almost any degree is not a desirable result.

The question at hand is if anybody in Washington is watching? And since the answer is obviously “Yes!” the next becomes one of whether or not the powers-that-be will take action.

The primary purpose of Ben Bernanke’s QE2 program was to get prices of “stuff” (think stocks and bonds) moving higher. The thinking was that if the John and Jane Q. Public could see their 401(k) plans move in the right direction for a change, they might begin to feel better about their future and return to the malls. And with the U.S. consumer accounting for something like 70% of the country’s GDP, the plan made some sense.

On this score, the QE2 program has clearly been a big success as the stock market has moved up handsomely since word of the program started to leak out late last summer. However, there have been some unintended consequences. The most glaring problem with the QE2 program has been the spike in commodity prices, which is putting pressure on inflationary expectations as well as profit margins.

Given the choice between a little inflation, which could easily be solved with a higher dollar, and a deflationary spiral, Bernanke made the right call. The idea was to keep get the economy up to “escape velocity” and worry about inflation later.

To be sure, the plan hasn’t worked perfectly. Real Estate is still dead in the water (this is likely due to the fact that banks are “managing” their release of foreclosed properties on the market) and the jobs market hasn’t improved much. But we should keep in mind that trying to game the actions of an economy the size of ours is not an exact science. But again, I liked Bernanke’s plan at the time.

Up until just recently, it looked as if Mr. Bernanke had effectively walked the tightrope and was almost ready to lift his foot from the economic accelerator. Up until recently, there was a great deal of talk about the Fed’s “exit strategy” and when interest rates would start to return to normal. And up until just recently, the economy looked like it had indeed reached “escape velocity” and was actually ready to move up on its own.

But then the trouble in the Middle East and Africa started, pushing gasoline prices up to uncomfortable levels. And then the triple tragedies hit Japan. In short, this double whammy caused the growth rate of the economy to slow and many to question whether or not the Fed needs to keep going with its accommodative policies.

The NY Times is thinking that Bernanke needs to keep on keepin’ on in his effort to help the economy. As written in the Times Friday morning, “The most sensible response for Washington would be to begin thinking more seriously about taking out an insurance policy on the recovery. The Fed could stop worrying so much about inflation, which remains historically low, and look at how else it might encourage spending. As Mr. Bernanke has said before, the Fed “retains considerable power” to lift growth.”

The problem however, and what has many analysts worried, is the idea that the entire world is currently on an austerity kick. Debt is suddenly a bad thing and politicians are clearly working this angle in their quest for office. Thus, the “political will” for any additional stimulative measures doesn’t appear to be there.

Given that, in our opinion, the game is on the line right now, we will continue to watch the economic data closely and will recommend that all serious investors do the same. We’re of the mind that the economy merely hit a speed bump in the March/April period. However, should that speed bump turn into a “soft patch” such as we saw last summer (or worse), the stock market could have a big problem on its hands. Therefore, this is no time to be asleep at the wheel.