The Fed Can’t Help the U.S. Economy Anymore

U.S. EconomyAt the end of the day, there is very little the Federal Reserve can do to help the U.S. economy. The central bank has done all it can with interest rates and will have to let the business cycle play itself out.

Recent policy action by other central banks was met with a one-day bounce on the stock market, and the reaction wasn’t really worthy of note. (See “Non-U.S. Central Banks’ Action the Best News for the U.S. Economy.”) What is happening out there? Declines in economic growth rates. We’ve been experiencing it in Western economies for a few years, and China is now experiencing the same thing after coming off a real estate boom. Given the current information, 2013 is not looking good.

So with this backdrop, it’s difficult to envision rising earnings growth, and therefore, the stock market outlook is pretty grim. In order for the U.S. economy to accelerate, both the eurozone and Chinese economies have to do so as well. China’s GDP is still growing, don’t get me wrong, but the rates of growth are decelerating, and this means that demand for U.S. goods will as well. In a way, it’s like the perfect storm for the U.S. economy, which has so far done a decent job of staying out of recession.

I figure the U.S. economy is headed for another recession next year, and this means that the stock market is poised for a decline. However, I would add that corporate earnings, while not growing very much, should be consistent going into 2013, and the stock market’s reasonable valuation will be helpful. This doesn’t mean that the stock market won’t go down when the U.S. economy experiences another recession, but the decline will be tempered by its lack of overvaluation.

If this expectation comes to fruition, I’d argue that the stock market now is holding up very well. I firmly believe that the foundation is being created for a new upward business cycle in the U.S. economy, but the Federal Reserve can’t do anything more to help. What we require after the next recession are some economic growth in the eurozone and a reacceleration in China’s GDP. This is all possible, but you could say that the U.S. stock market is in the hands of policymakers in China and Europe.

With a large portion of S&P 500 corporate earnings coming from abroad, earnings growth is likely to decline over the next two quarters because foreign economies are slowing. The stock market being forward looking, the earnings outlook for 2012 has already come down quite significantly, and slower growth abroad is mostly factored in.

The U.S. economy has further to go in terms of correcting itself from the real estate crash. Things are much better in the industrial economy, but it’s the individual consumer (the biggest part of the U.S. economy) who is constrained. Other than income from dividends, you really can’t expect much from the stock market going forward.