Why Another Stimulus Package May Be On The Way

Expectations are running high that the Obama administration will put forward another major stimulus package by early 2010. With political seats on the line for mid-term elections, there …

Expectations are running high that the Obama administration will put forward another major stimulus package by early 2010. With political seats on the line for mid-term elections, there is an urgency for the democratic majority to show progress on the jobs front, even if it means increasing the record deficit. See the following article from Money Morning for more on this.

Is the recent market softness something to be worried about?

Not if U.S. President Barack Obama & Co. comes through with a second stimulus package – as I’m expecting.

Let me explain …

There are a few reasons to suspect that the softness we’ve been seeing will continue for a week or so. Small-cap stocks –  which continue to drag along like road kill caught on the rear bumper of the market – are our main cause of concern at the moment.

There is also the possible head-and-shoulder reversal pattern on the Nasdaq Composite Index and “double top” patterns on the Russell 2000 Index and Standard & Poor’s 500 Index. And a number of short-term indicators have moved into over-bought territory.

As you can see in the chart that follows, there’s a battle going on at the 85-day moving average, which was the support level back in July. Small-caps fell below that level two weeks ago, pressed above it last week, and now could go either way. If they drop more decisively below the 850-day moving average, the weakness is likely to persist.

Within the context of a bull market elsewhere, the most sensible response is to step away from small-cap stocks. More aggressive investors may actually wish to short them. With the index in suspended animation at the moment, though, neither action should be taken yet. The next move will come soon enough, and is likely to be both explosive and just the start of something larger.

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And with good reason.

More Stimulus? Count on It

Stocks are most likely still just consolidating, because that’s what they do. They go up, they back off, they go sideways, they go up again.

Let’s just call it wash, rinse and repeat.

The development of a “double top” now in the S&P 500 is going to get bears excited, and the fact that a head-and-shoulders topping formation may be forming to boot will also renew their courage.

For a new round of buying to emerge, we’ll need a catalyst to provide a spark. And just what might come along to spark a new round of buying? What would bring people who are currently on the sidelines into the market, and what would cause investors who currently have a high bond allocation to make the switch into equities?

A company like Swiss eye care products maker Alcon Inc. (NYSE: ACL), which was one of my newsletter positions this summer, is a great example of a leader so far, with a perfectly lovely recovery chart (See below).

But what will lead skeptic to blink and join the action?

I might have an answer. Late Thursday, I learned that Goldman Sachs Group Inc. (NYSE: GS) is telling its clients that the Obama administration is going to announce another major stimulus package. That would mean that the combined monetary and fiscal infusion package that is already historic in proportions might actually be kicked up a notch.

Of course the administration would have to persuade Congress to pass the legislation at a time when conservatives are already screaming about the extreme state of the nation’s deficit. But this would fit into my view, expressed here many times, that the government has gone all-in with low interest rates and fiscal stimulus, and is ready to go way overboard in its attempt to get the U.S. economy rolling again.

This is not because the politicians are altruistic, mind you. It’s because they’re, well, politicians. And my many years of covering government at the Los Angeles Times led me to realize that the first, second and third motivation of politicians is to get re-elected. Everything else pales in comparison.

If President Obama wishes to make sure it retains a Democratic majority in Congress in the mid-term elections, it must act swiftly to boost employment. Stimulus packages act with a lag, so Obama & Co. must get the new package passed and get the money spent as quickly as possible.

In that context, Goldman says that we should pay attention to two developments that suggest a greater likelihood of more stimulus ahead:

  • First, we have comments from U.S. Senate Majority Leader Harry Reid, D-NV that the Senate was likely to consider a jobs bill in early 2010.
  • Second, President Obama announced Thursday that the White House would convene a jobs summit in December.

Goldman says a more-explicit focus on job creation would achieve four things:

  • Increase the likelihood of new polices, rather than simple extension of existing ones.
  • Raise the odds of additional fiscal assistance for states and infrastructure spending.
  • Incrementally increase the probability of additional tax relief in 2010.
  • And push healthcare reform and energy legislation down lower on the agenda for 2010 – and probably increase the likelihood that Congress scales back the legislation it is contemplating in these areas.

Goldman analysts believe that Congress will enact $250 billion in additional fiscal measures to support growth over the next three years, including $75 billion more in 2010. However, recent developments – including the $45 billion bill to help homebuyers enacted last Friday – make this assumption look conservative.

The analysts say that the timetable would be similar to what we’ve seen in each of the past two years: policy formulated internally in December, debated publicly in January, enacted in February. But they note that it would likely take longer to create and pass due to concerns about the effectiveness about prior efforts.

So how would stocks react? Considering that the entire rally out of the March lows has resulted from the first major Obama stimulus package, I would think that the reaction to a second package would also be positive. This could be news that kicks off the next leg higher, or at least forestalls the recent consolidation phase that seems to have gotten under way.

This article has been republished from Money Morning. You can read the full article at
Money Morning, an investment news and analysis site.

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