Another Record, Another Round of Doubts for the Bull
The stock market stayed in overdrive last week, posting another record high, but views are mixed on whether stocks will keep climbing.
Right off the starting line, the Dow on Monday shattered its previous record of 7185, posting a 143 point gain to close at 7214. It pulled back during the week, but still ended with solid gains for both the week and the year.
Traders heard interest-rate czar Alan Greenspan give an ambiguous speech on inflation.
Some analysts saw it as a change of heart and now no longer expect the Federal Reserve chairman and his colleagues to raise interest rates later this month.
Wall Street also experienced a change of heart. Initial cheers for Washington's budget agreement turned to catcalls.
"It's all smoke and mirrors," says Michael Metz, chief investment strategist at Oppenheimer & Co., calling most of the deal's economic assumptions idealistic.
"They really didn't address the longer term problem of entitlements," Mr. Metz says, referring to programs such as Social Security and Medicare. "They just declared that there was no deficit problem and announced a deal. That's not the way grown-up statesmen should act."
In truth, the same robust economy that has fueled the stock market's meteoric rise also swelled the government's tax coffers, whittling down a once enormous deficit to manageable levels. That makes it easier for Republicans and Democrats to find common ground.
But a basic premise to the budget agreement is that the economy will keep rolling along, generating higher tax revenues.
The federal deficit, which stood at $290 billion when President Clinton first entered office, is now projected to shrink below $70 billion this fiscal year.
"The Clinton administration's official deficit forecast is still $127 billion. Needless to say, this extra $60 billion can go a long way toward making any balanced-budget deal more balanced," says Robert Froehlich, chief investment strategist for Kemper Funds in Chicago.
If the Federal Reserve, which could raise interest rates further to preempt inflationary pressures, slows the economy too much, the rosy forecasts behind the budget deal may start to wilt.
The politicians have figured out that "the way to balance the budget is to let the economy grow. That's a great plan unless we have a Fed that tries to slow things down," says Mr. Froehlich. "The Democratic and Republican leadership would lynch Alan Greenspan [if he keeps raising rates], so he has to act before people realize that the budget agreement is balanced on the back of the economy."
The moderating economic trends that could make deficit reduction more of a challenge may also slow profit growth, making it difficult to build on the stock market's sudden recovery.
"I'm guessing that based on current valuations, we are at the top end of the market's range" for the near-term, says Richard Cripps, chief market strategist for Legg Mason of Baltimore.