To All,
New Budget Deal May Help Aging Bull Market
NEW YORK (Reuter) - The aging bull market may have been given fresh legs by the agreement to balance the nation's budget
for the first time in 28 years.
Experts say the landmark deal between the White House and Congress to wipe out the deficit in five years would cut the U.S.
appetite for borrowing, setting the stage for a drop in interest rates.
This could reenergize corporate earnings just as they were expected to slow after six long years of steady growth.
The proposal to balance the budget by the year 2002 caused a lot of excitement on Wall Street this week, creating a sense of
urgency to buy stocks on the prospect that lower interest rates would boost the economy and corporate profits.
The Dow Jones industrial average blazed to back-to-back record highs on Monday and Tuesday, breezing through the
7,200-point level for the first time. In late trading Friday, the Dow was up 28.50 points at 7,165.12. For the week, it was up
93.92 points.
In the previous week, the blue-chip index soared 332 points in its biggest weekly gain ever.
Michael Evans, professor of economics at Northwestern University said the five-year budget pact would do wonders for
stocks because it will drive down the cost of borrowing.
"With the budget balanced, the government won't need to do any deficit financing ... and long-term bond interest rates could
fall to 5 percent," he said.
The Treasury's 30-year bond, known on Wall Street as the "long bond," is the front runner of stock market activity. The rate,
which currently stands just below 7 percent, affects everything from home mortgages to corporate financing.
A jump in the cost of borrowing erodes corporate earnings, and can put home ownership out of the reach of some buyers.
"Not only is the government the biggest borrower in the credit market but it gets first call in the market," Evans said. "It
borrows at whatever the going rate is and in doing so, it pushes interest rates up."
President Clinton and Republican leaders in Congress hammered out a historic five-year plan last Friday that cuts $115 billion
from planned growth in the Medicare health care program for the elderly.
It also takes $16 billion from the Medicaid program for the poor, offers tax cuts of $85 billion for the rich and the middle-class
and promises a balanced budget by 2002.
Not since 1969 has the U.S. budget been balanced.
The budget deal also includes a capital gains tax cut that could attract new investors to the stock market.
Currently, the top capital gains tax rate is 28 percent and it is expected to end up anywhere from the 19.8 percent that Senate
Republicans proposed early this year to 21 percent.
"Overall, the budget deal is definitely positive for the stock market and it makes the expected investment return higher than it
would have been if they had not reached an agreement," said Allen Sinai, chief global economist, Primark Decision Economics.
"Over the longer run, one to five years, it will be a definite plus for the economy," he said.
Sinai said the market may be in for a period of volatility until the pact is signed, sealed and delivered, which is expected by the
July Fourth holiday weekend.
Some experts are reluctant to build a stock market rally strictly based on the first sighting of a budget pact. They say that, at
this stage of the negotiations, it may be unwise to declare victory on budget deficits.
"The policy change is a small step forward and the savings in Medicare and Medicaid ... will provide some small contributions
in bringing the deficit down which will raise the national savings rate that will help boost investment," said Richard Rippe, chief
economist at Prudential Securities.
The federal government's willingness to get its financial house in order also will be a big plus in drawing offshore investors to
the U.S. market.
"It will boost foreign investors' confidence," Rippe said.
Will the budget deal bring a shift in the Federal Reserve's thinking on interest rates?
Wall Street has been on pins and needles lately, trying to anticipate whether the Fed, which raised interest rates in March, will
hike rates again at its May 20 policy-setting meeting.
Fed Chairman Alan Greenspan has hinted that the central bank might adopt a more relaxed monetary policy if there was a
serious effort to balance the budget.
The timing of the budget deal is crucial as the package is expected to be in place by July, when the Fed holds another
interest-rate-setting meeting.
"The Fed will be happy that there is a budget agreement but it is not going to affect monetary policy," Sinai said.
"Interest rates in the futures will end up a lot lower than they are now if inflation stays at current levels, but the rates will be
determined by the economy," he said. "Balancing the budget will be a much smaller factor in setting long-term interest rates." |
