Equities may prompt a third round of Fed stimulus

Things are shaping up for another hot summer on Wall Street, and there is a long, long way to go yet. Federal Reserve Chairman Ben Bernanke will be back on Capitol Hill on Thursday to testify before a congressional committee about the state of the US economy. He’s not going to get an easy ride. The blue-chip Dow average of stocks is now negative for the year. Employment appears to be slowing to a snail’s pace and Europe remains mired in crisis. “This puts the Fed firmly in play and they will likely feel compelled to respond,” Tom Porcelli, chief US economist at RBC Capital Markets in New York, said after data yesterday showed US job growth in May was the weakest in a year. “The missing ingredient preventing the Fed from action had been the equity market, but now we are seeing it softening,” he said. “Equities are falling and that was the last hurdle for Fed policy action because all the other criteria have been met.” For the week, the Dow Jones industrial average fell 2.7 per cent, the Standard & Poor’s 500 index was down 3 per cent and the Nasdaq composite index fell 3.2 per cent. The Fed’s next policy meeting occurs on June 19-20. A Reuters poll of 15 dealers gives a 35 per cent chance of the Fed extending its stimulative operating twist at that meeting. The poll showed that dealers expecting further quantitative easing, or QE3, rose to 50 per cent from 33 per cent in May. Stock market rallies in each of the past three years were fuelled by combinations of massive central bank and government stimulus spending. That maybe the only hope for equities this year, too. The world’s economic outlook darkened yesterday as reports showed slowing US employment growth, Chinese factory output barely grew, and European manufacturing fell deeper into malaise. “It certainly suggests that perhaps the softness in Europe is either influencing the US or that the US recovery may not be strong enough to overcome the softness in Europe,” Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said. “I underestimated the relationship or the alignment of the world markets to the European markets,” he said. “I felt that Europe could potentially proceed in their own little corner of the world. For right now anyway, it just doesn’t seem that way.” Nothing tells the story of the global economy at the moment better than the world’s equity markets. Bear markets are raging in Spain, Italy, Brazil and Russia. Asian stocks have been weak. Most of Europe’s other markets are negative for the year, and that is where US stocks are going — and fast. “I don’t see any compelling reason to think that we are going to have any sustained recovery absent new fiscal, monetary stimulus, not only here in the United States but perhaps even more importantly elsewhere around the world,” Clark Yingst, chief market analyst at Joseph Gunnar, said. Yingst said that signs of more stimulus may be a compelling reason to get bullish. We will be “watching very closely for new fiscal and monetary stimulus from a variety of countries. I think the source will be important, I think the magnitude, the scope will be important,” he said. Volume in the robust US investment-grade market has dwindled from $284.8 billion (Dh1.05 trillion) in the first quarter to just $118.7 billion in the first two months of the second quarter, according to data from IFR, a unit of Thomson Reuters. That number is expected to fall even more in the summer. But not everyone is hitting the sell button. Zahid Seddiqi, associate portfolio manager of the Gabelli Equity Trust, says his two to four-year time horizon and focus on value is allowing him to add to positions in sectors that are getting hit the hardest. “Companies that we liked before are becoming more attractive from a valuation perspective and we have been buying more of those,” he said. “We just buy on any dips and exit when valuations reach our assessment of value.” Seddiqi said he’d been adding to holdings in auto suppliers, aerospace and consumer sectors.