Lots of things going on today. The Fed confirmed its intention to keep short-term interest rates very low for quite some time. The House is supposed to vote on a mega "stimulus" bill today. Bond yields rose sharply, and the Treasury-TIPS spread widened further as inflation expectations increased. 3-mo. T-bill yields are now up to 0.17%. Volatility fell and swap, agency, and credit spreads fell. Commodity prices and the Baltic Dry Index rose, but gold fell and the dollar strengthened. The S&P 500 index only needs to rise as much tomorrow as it rose today (3.4%) in order to be in positive territory for the month of January. (And if that happens, the technical guys say that will be a very bullish sign for the rest of the year.)
Without trying to read too much into one day's market action, though, I think the message the market is sending us over the past month or two is that the economy is on the mend; that we have likely seen the worst of the economic news.
I don't think the stimulus bill is going to stimulate anything. Indeed, I think if it passes as is, then it will prove to be a drag on the economy because it will waste enormous amounts of economic resources. Plus, it will end up making the economy less efficient because government will control a larger portion of the economy. But since the market has been fearful of a massive expansion of government since before the election, the passage of a faux-stimulus bill won't necessarily be a negative for the market.
In the final analysis, the only way that government policy can make a significant difference to the economy is by changing incentives (e.g., raising or lowering tax rates in order to change the after-tax rewards to work, investment, and risk-taking). The stimulus bill currently under consideration won't do any of that. There's still a chance for some last-minute compromise that might prove significant—a cut in corporate tax rates, for example, would be hugely positive. But barring that, I think it's time to accept that many hundreds of billions of dollars are going to go down a rat-hole and we are going to be burdened by more government in the future. We are also likely to be burdened with higher inflation in the future, because it is likely that the Fed will not be able to reverse its massive monetary accommodation in a timely or proactive manner.
But we need to remember that Fed policy has been terribly erratic and misguided for at least the past decade, so this is nothing very new. The politicians will want the credit for an eventual recovery, but they will forget that bad policies (e.g., Freddie and Fannie, the Community Reinvestment Act, failures to exercise regulatory oversight, bungled takeovers of Wall Street firms and banks) are what got us into this mess in the first place.The stock market has made zero progress since 1997, and it wouldn't be crazy to blame it on a decade of bad fiscal and monetary policy.
If one is to be optimistic about the future, optimism must be based on an improvement in the economic fundamentals. This economy has an incredible ability to grow and overcome adversity. Recall, for example, that the 9/11 tragedy came almost at the very tail-end of the 2001 recession—it hardly registered on the GDP scale.
I've been documenting improvements in the fundamentals for quite some time now, and I think the seeds for a recovery have already been sown. Financial markets have digested the bulk of the subprime losses; massive deleveraging has already taken place; all measures of financial stress have declined significantly; housing prices have erased almost all of their excesses; asset prices in many markets have gone through wrenching adjustments; new signs of life are appearing every day.
So I still think we're on the path to recovery, and I am still optimistic, even though I view the stimulus bill as a massive boondoggle, a massive waste, a fountain of corruption, etc. It just means the future won't be as bright as it otherwise could have been. We are going to pay the price of decades of bad policies, and that price will be slower growth and living standards that don't rise as high as they otherwise might have. It's not a rosy picture, but it's not the end of the world by any stretch.