If the market continues as it appears today, we may be poised to enjoy a highly favorable situation where bad news is good news and good news is good news—based on a few big “ifs.” This is the opinion of noted economist Arthur B. Laffer, a valued adviser to Caldwell Trust Company for many years. We’d like to follow up on Laffer’s thoughts in this newsletter.

We’ll begin by referring to our investment letter in the preceding (August 2013) issue, “To taper or not to taper: That is the question.” At that time we discussed whether, when and if the Federal Reserve Bank would begin slowing its program of Quantitative Easing (QE), which means tapering its policy of buying bonds. We also presented a chart of the positive and negative aspects of QE.

Predictions about the Fed’s upcoming actions have been based mostly on rumors and speculation, built in part around who will replace departing Fed chair Ben Bernanke in January after he completes his seven years of service. For example, various reportshave stated that the Fed will:

• begin a policy of gradual tapering in September 2013, continuing until mid-2014; 
  
  
• elevate the Fed’s vice chair, Janet Yellen, to the top slot where she, as a Bernanke supporter, will maintain low interest rates until unemployment drops to 6.5 percent;
  
  
• choose Lawrence Summers, Treasury Secretary under President Bill Clinton (1999-2001) and former economic adviser to President Barack Obama, to chair the Fed, resulting in an interest rate increase at some undetermined level;
  
  
• select Timothy Geithner, Treasury Secretary under President Obama (2009-2013) for the top slot.

According to a Bloomberg survey of 63 economists polled from August 9-13, economists see a 65 percent likelihood that President Obama will choose Yellen to head the Fed and a 53 percent opinion that she would do the best job, vs. a 25 percent likelihood for Summers and a 10 percent opinion that he would do the best job.

Regardless of who is chosen, the reality is that existing Fed commitments make any quick change in policy unlikely, although some measured responses to economic conditions are possible.

With that in mind, it seems appropriate to offer our own opinions and highlight a potential outcome that isn’t getting much traction in the media. That outcome could be a sweet spot economically, one where bad news is good and good news is good.

When bad news is good news

IF  the economy continues to present low employment growth and weak underlying economic fundamentals, not only here in the U.S. but globally, the Federal Reserve Bank will likely continue its easy money policies: low interest rates and continued purchase of bonds. This is good news because the easy money policies that have been in effect for the last several years will continue to provide support to housing and stock markets, potentially extending the recovery that we have experienced. It may also contribute to consumers repairing their own balance sheets and setting the stage for growth in consumption going forward.

When good news is good news

IF  underlying economic fundamentals are truly improving—more than they have in the recent past—as evidenced by a strengthening labor market and a continued revival in housing prices, the Fed could begin reversing its easy money policies. This, too, would be good news because the economy would be displaying attributes that we have been awaiting for years. These attributes would include and highlight a self-perpetuating loop of investment and hiring, allowing the economy to free itself of the support that the Fed has provided. In that case the economy should again be able to stand on its own.

Outside threats

The biggest concerns on a global basis are in two areas, the economies of China and Europe. China recently has been in the news due to difficulties in its banking sector, its waning growth and accusations that central planners are creating fraudulent economic reports. Europe is being criticized for not being “allin” in terms of its monetary policy responses, especially with respect to the structural issues of too-high debt and no/slow growth plaguing Greece, Italy, Portugal and Spain. Unfortunately, the European Economic Community is not dealing with the underlying problems of too much debt and too little growth. Although some EEC nations have instituted austerity (policies used by governments to reduce budget deficits during adverse economic conditions), they are simply putting a band-aid on a festering wound. Without growth, austerity won’t work.

CONCLUSION

IF outside nations will move to correct or at least begin to control their precarious economic situations, markets within the U.S. could be headed for a win-win situation, where bad news is good news (the Fed continues its easy money policies) and good news is good news (the Fed begins to taper its easy money policies because underlying fundamentals have actually strengthened). At Caldwell, as we remain vigilant about the changing U.S. political situation as well as economic conditions globally and domestically, we see current conditions providing reasons for longer-term optimism.

About Caldwell Trust 

Caldwell Trust Company is an independent trust company with offices in Venice and Sarasota, Florida. The company offers a full range of fiduciary services to individuals, including services as trustee, custodian, investment adviser, financial manager and personal representative. Additionally, Caldwell manages 401(k) and 403(b) qualified retirement plans for employers.