The Dow Jones Industrial Average and S&P 500 Index closed at their highest levels since June 2008 on Tuesday after strong earnings and signs of a surge in U.S. manufacturing.
The Dow Jones Industrial Average gained 148.23 points, or 1.25 percent, to 12,040.16. The Dow closed above the psychologically important 12,000 level for the first time since June 2008, up more than 83 percent from the March 9, 2009 bottom of 6,547.05.
The Standard & Poor's 500 Index rose 21.45 points, or 1.67 percent, to 1,307.57, closing above 1,300 for the first time since August 2008. The Nasdaq Composite Index added 51.11 points, or 1.89 percent, to 2,751.19.
Breaking through the 12,000 barrier should also prove a major boost to President Barack Obama's ongoing campaign to convince Americans that the economy is on the rebound, despite the lingering high unemployment rate of above 9 percent.
An open question is whether voters' appetite for fiscal austerity will wane if the economy is strong enough to shrug off the nation's growing national debt and stage a resurgence. If it does, it would be harder politically for grass-roots conservatives to convey the urgency often needed to actually reduce the pace of federal growth.
But the gap between Wall Street and Main Street is as wide as ever. Data show small investors have yet to take part in the bull run and, amazingly, might simply stay out.
Stock investment inflows were net positive by $3.8 billion as of Jan. 12, but those figures added just 0.09 percent to stock funds, reports The Wall Street Journal. In comparison, over the past year investors took out a net $35 billion.
Startlingly high unemployment and a negative “wealth effect” from collapsing home prices — people think they are poorer because their main asset, a home, is losing value — could be factors.
New-home sales ticked up in December but overall values have been bouncing along a bottom (if not “the” bottom) for months. Annual new-home sales fell 14 percent in 2010 to just 321,000 homes, the lowest level since 1963. Various prognosticators believe another 20 percent decline is ahead.
Meanwhile, new budget estimates predict the federal deficit will hit almost $1.5 trillion this year, a new record. That would mean borrowing 40 cents on the dollar of spending at the federal level, on top of tens of billions in red ink among the states.
Shockingly, the Congressional Budget Office now sees unemployment at 8.2 percent by Election Day 2012.
It wouldn’t take much to plunge the country back into recession, warns economist A. Gary Shilling.
“With slow growth, only a moderate shock will initiate a recession,” he told clients in January.
“Candidates include the deepening eurozone crisis, a hard landing in China, and the 20 percent further drop in house prices we expect over the next several years," he said. "That would push underwater mortgages to 40 percent and hype strategic defaults while severely damaging consumer spending and the economy.”
Perennial bear David Rosenberg of Gluskin Sheff in Toronto says he is looking for good news and finds the economy wanting.
He told clients in his newsletter that the bull market is far too dependent on easy money from the Federal Reserve and government spending.
“An economic expansion and bull market built on rampant expansion of the Fed and federal governments’ balance sheet is neither sustainable nor desirable,” he added. “I am desperately looking for reasons to turn more optimistic, but to do so some major policy shifts have to take place.”
Among those changes, Rosenberg cited eliminating dependence on foreign oil, rewriting the tax code to promote savings and investment while cutting both loopholes and tax rates, reversing the increase in debt-to-GDP ratio, which is getting ever closer to 100 percent, and getting banks to write down the principal on mortgages so upside-down homeowners can regain equity.
As some howl for a pullback in stocks, a few money managers instead believe that a big bull run is still ahead.
"When you have an 80 percent move off the bottom as we did . . . it always has resulted in a long-term market because quite frankly so many people miss so much of it and they have to try and catch up," money manager Laszlo Birinyi told CNBC.
Nevertheless, dark clouds gather just a few years out, warn others.
Clinton-era Treasury Secretary Robert Rubin warns that major budget cuts are vital to avoid a run on U.S. Treasury bonds, which if it happened would push up financing costs and break the economy.
“Most dangerously, there is a risk of disruption to our bond and currency markets from the fear of much higher interest rates due to future imbalances or from fear of inflation because of efforts to monetize our debt,” Rubin warns.
“The result could be significant deficit premiums on bond market interest rates, seriously impeding private investment and growth or, worse, acute bond market declines that cause an economic crisis,” wrote Rubin, a former Goldman Sachs banker who later served as an adviser to Citigroup.
“This could also start in the currency markets,” he warned.
Food inflation, already destabilizing emerging giants in Asia, is coming soon to the United States as well.
The government expects rising commodity prices and energy demand for ethanol to push up food prices by between 2 percent and 3 percent in 2011, according to the U.S. Department of Agriculture's Economic Research Service.
Such a rise would be a return to normal food-price increases, according to the government.
Also, overall inflation may stay “officially” low, however, since the government regularly removes food and energy costs from its calculations.
“Although food-price inflation was relatively weak for most of 2009 and 2010, higher food-commodity and energy prices have recently exerted pressure on wholesale and retail food prices,” the USDA said in a statement.
“Hence, higher prices are projected to push inflation toward the historical average inflation rate of 2 to 3 percent in 2011.”
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