Don’t panic

Larry Kudlow Senior Contributor, CNBC



Our financial system is in vastly better shape than it was in September 2008. Vastly better shape.

The Federal Reserve is highly accommodative, as illustrated by the upward-sloping yield curve. Using the yield-curve measure alone, the chances of recession based on historical analysis are very low.

And energy prices are coming down, with oil moving toward $80 a barrel. Oil analyst Peter Beutel points out that gasoline prices in the last two weeks have fallen by 35 to 40 cents. Adding in other oil-related savings, the energy-price drop amounts to a $100 billion tax rebate for consumers.

Plus, corporate profits will continue to rise while business balance sheets are pristine and chock full of cash. Consider the combination of solid productivity, moderate wage rates and falling commodity prices. These are all plusses for the economy and stocks.

So in light of all these factors, it seems to me that the economy can hold up. It’s not the kind of rapid growth I’d like to see. But it’s not the deep and dark recession that seems to be embodied in the stock market plunge.

Whether or not one agrees or disagrees with Standard & Poor’s decision to downgrade the federal government’s credit rating, the agency’s message was never about U.S. debt default. Instead, S&P was warning that U.S. fiscal trends are deteriorating and our future debt trajectory is going up, not down.

Serious entitlement reform is not yet on the table. Nor is pro-growth tax and regulatory reform. And since none of this is brand new news, I don’t think people should be shooting the messenger.

Getting our debt and spending under control is very important. But the fact remains that warnings from S&P, and even lesser warnings from Moody’s, could spur Washington into taking more aggressive action. So could the market sell-off itself.



In addition, Europe’s economy suffered the same oil shock last winter and spring that suppressed the U.S. economy. And as that energy shock recedes, both economic zones will do better.

Actually, the stock market correction here in the states can be traced back to April 29, the day Ben Bernanke announced that QE2 would end on time and there would be no QE3. Since then, the S&P 500 has lost 17 percent as the Fed introduced a less accommodative policy. Now, the central bank is still loose, but it is no longer adding to its balance sheet. So in some sense what should have happened has happened: Cyclical stock sectors have corrected significantly lower, along with commodities, and the whole stock market has had to adjust.

Most importantly, the dollar has stabilized. While in the short run a stronger dollar and lower commodities (except gold) may have hurt the market, in the longer term they create a foundation for non-inflationary growth.

I am not a market timer, and I do not have a monopoly on stock market and economic wisdom. So readers should take this for what it’s worth. I am not wildly optimistic, but I am not nearly as pessimistic as the market is right now.

