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Wall Street shrugs off sequester

FinancePetroleum IndustryStock MarketT. Rowe PriceBarack Obama

The drumbeat for weeks has been that $85 billion in across-the-board federal spending cuts known as the sequester would be so horrendous for the economy that lawmakers in Washington would be forced to compromise by the March 1 deadline.

When no deal was reached, not only did the stock market shrug it off, but the Dow Jones industrial average of 30 blue-chip stocks soared to new heights. On Tuesday, the Dow blew past its old record of 14,164.53 from Oct. 9, 2007, and continued to climb, ending the week at 14,397.07. Even the prospect of a government shutdown later this month did not deter investors

There appears to be a growing disconnect between Wall Street and Washington in which investors are becoming immune to the politician-manufactured crises that pop up every few months.

"There is kind of an economic exhaustion of the rhetoric," said James Hardesty, chairman of Hardesty Capital Management in Baltimore. Last week, he said, "the market and everybody said, 'Enough, there is more good in the world than bad.'"

Robert Hagstrom, chief investment strategist with Legg Mason Investment Counsel in Baltimore, said the market learns from the past and adjusts.

Late last year, for instance, the country went through a similar high-stakes drama when it didn't know whether lawmakers could prevent automatic tax increases and spending cuts known as the "fiscal cliff." A deal was reached a day after the deadline, and disaster was averted.

"It was all for nothing," Hagstrom said. "You could have easily gone to the beach and not even worried about it and been in better shape."

Market experts said investors focused this time on the many positives in the economy: Housing is recovering. Auto sales are up. Banks are stable and corporate profits and balance sheets are healthy. Employment is improving. The federal deficit is shrinking as a percentage of the overall economy. Low natural gas prices here are giving manufacturers an edge over foreign competitors. And the Federal Reserve appears ready to take whatever steps it can to shore up the economy.

"The market is a forward-looking organization, and it sees past the political chicanery of the sequester," said Michael Dougherty, vice president of investments at Chapin Davis, a Baltimore financial firm. "It knows the Fed has our backs. The Fed might be the only grown-up at the table at this point."

Another factor is that the sequester's spending cuts are limited to certain industries, said Paul Chew, head of investments at Brown Advisory in Baltimore. And the economy is still driven by consumer consumption, and less so by government spending, he said.

"The fact that the sequester has gone into effect has reinforced the idea that there is broad agreement that the government has to control spending," said Larry Puglia, manager of T. Rowe Price's Blue Chip Growth Fund in Baltimore.

Puglia said it's encouraging that President Barack Obama has recently reached out to congressional Republicans, a sign that a broader agreement to rein in government spending and simplify taxes might be in the works.

If there is a disconnect between Wall Street and Washington, it's not the only one. Corporate America and small investors also seem to exist in different realities.

Less than five years after the financial crisis that sent the stocks crashing, corporations have recovered. Their earnings are strong, particularly among multinational companies that get about half their profits from outside the United States, Hagstrom said.

But the many small investors who bailed out of the market to save what was left of their vanishing retirement nest egg have yet to catch up.

And those not invested in stock — roughly half the population — have not benefited as stocks scale to new heights. Yet these people continue to feel the repercussions of the recession in terms of stagnant wages and high unemployment.

Indeed, the investors driving the market up these days are pension funds and other institutional investors, not small investors, said Richard Cripps, chief investment officer with EquityCompass Strategies in Baltimore. These big players are looking at stocks as the best place to invest for the next five years or so, anticipating that interest rates will rise and wreak havoc for bonds, he said.

In the grand scheme of things, $85 billion in cuts this year is not that much, Cripps said of the sequester.

"It would appear it will not be that harmful," he said.

The portfolios Cripps' firm manages have been invested entirely in stocks since early last year, after holding as little as 40 percent in equities in October 2011.

Chapin's Dougherty said he's not hearing from individual investors clamoring to get into the market right now.

"They are still cautious," he said. "They will believe what they see if they see some sustained positive action."

Dougherty is optimistic that can happen, predicting that the Dow could reach 20,000 by the 2016 presidential election.

But others are wary.

Christopher Parr, president of Parr Financial Solutions in Columbia, said Wall Street has gotten ahead of the game.

Sure, there are positive signs, Parr said, but the economy's annual growth rate will be cut by at least half a percentage point once the sequester cuts are in force. That's significant, given the current modest growth rate, he said.

"I'm more worried about: Is this the time to dump fresh money into the market?" he said.

Lyle Benson, president of L.K. Benson & Co. in Towson, said a few of his clients are pulling some money out of the stock market to build up their cash reserves.

Many investors are dangerously overconfident that nothing bad can happen while the Fed maintains its current course, said John P. Hussman, head of the Hussman Funds in Ellicott City.

"At least for now, it encourages them to ignore other economic factors and concerns," he said.

If the government makes inroads in deficit reduction and consumers start saving more, corporate profits and margins will shrink, and today's stock prices will seem excessive, Hussman said.

Hardesty, though, contends that stocks are undervalued now. But he said the time to worry will be when latecomers flood into the stock market, pushing the Dow above 16,000.

"I get nervous at 16,000," he said.

eileen.ambrose@baltsun.com

twitter.com/eileenambrose

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