American economy: Proceed with caution
America’s economy looks set for a good year. But investors should beware the treacherous path beyond 2011
Dec 29th 2010 | from PRINT EDITION
THE American stockmarket enters 2011 in a jolly mood. In the past four months it has leapt by 20%, to heights last enjoyed when Lehman Brothers was a going concern. Investors are likely to cheer a second consecutive year of double-digit returns.
This partly reflects growth elsewhere: American companies make a third of their profits outside the United States. But the most recent spurt has been driven by a sharp change in the outlook at home. At the end of the summer Wall Street worried that growth was grinding to a halt. The Federal Reserve was running out of monetary ammunition. The incremental contribution of Barack Obama’s $814 billion stimulus had faded and a gridlocked Congress seemed incapable of supplying new support. Big business was rattled by Europe’s sovereign-debt crisis. Wall Street’s bears sniffed deflation.
What has changed? In part it is simply a case of the underlying American economy turning out to be stronger than pessimists imagined: consumer spending, business investment and job creation are all up lately. But policymakers have also done their bit. In November the Fed began a second round of “quantitative easing”—buying bonds with newly created money in order to push down long-term interest rates and stimulate lending. And in December Mr Obama and the Republicans agreed to extend George Bush’s tax cuts until the end of 2012 and to pump a further $300 billion into the economy in 2011 through a payroll-tax cut and other measures. The deal should spur growth; it also got rid of the (until then very real) danger of inadvertent fiscal tightening tipping the economy back into recession. That is the main reason why bond yields have risen with share prices. Bolder investors are less willing to accept rock-bottom yields in return for safety.
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Put these things together, and the American economy could grow by nearly 4% in 2011: so Wall Street is right to be cheery on that score. But share prices are meant to be based on more than just the next 12 months’ earnings, and the medium term is as treacherous as ever; perhaps more so
The original article is linked here.