Obama Tax Deal Sets the Stocks Bull Running

By: Money_Morning

Jon D. Markman writes: U.S. President Barack Obama's tax deal has yet to pass Congress, but the compromise - hatched as an appeasement to Republican opposition - already has had an effect on the currency and stock markets.

What's more is the deal looks as though it could offer a significant impetus for the U.S. economy as we move into 2011.

What has happened in the political arena over the past month has been magnificent theater. I don't believe in coincidences, so we have to try to understand what is being staged.

Consider the following:

Just weeks ago we had the stunning compromise by Irish officials with their new European overlords. Then the Standard & Poor's 500 Index reversed at the well supported 1,175-level and its 50-day average. Then came a positive reaction to a weak jobs report. Then U.S. Federal Reserve Chairman Ben Bernanke went on "60 Minutes" to explain the Fed's monetary program. And finally President Obama went on television to announce his tax compromise.

What's the play? Here's a guess.

President Obama knows he has to get the economy straightened out before 2012 to ensure re-election. So he has to find a way to stimulate further without actually writing a check.

This tax deal, particularly the investment credit, is the only way he's going to be able to add $300 billion to the financial system because he would never, ever get a pure stimulus package through the House of Representatives.

Remember from high school civics class that the federal budget process starts in the House. And the Republicans who will run the place in January are going to use their power to muddy the waters between now and 2012 so that they can accuse President Obama of messing up the economy. They can do this by cutting spending and claiming that slimming down the deficit is in the country's best interest - which it is, but that's another matter.

So strip away everything else, and the tax plan is really the first major salvo in the 2012 presidential race. And it's likely to be successful, at least in the short run. The deal lets individuals keep more of their earnings, and lets companies save a fortune through the investment tax credit. That will give 2011 gross domestic product (GDP) a fighting chance at hitting 3% or better. And growth is the best stimulus of all.

That is an out-of-consensus number, which ought to force stock analysts to lift corporate earnings estimates. Add in higher Price/Earnings (P/E) ratios - due to the low inflation environment - and more consumer spending from unemployment check transfer payments, and you've got a winning recipe for equities.

In short, my expectation is that last Tuesday's weak market following the tax compromise announcement did not represent a "sell on the news" top. It was more likely part of the normal consolidation, or rest period, that is to be expected following a torrid five-day span like the one seen last week.

Give the bears credit for showing that they still have fight in them - their third assault at the 1,230-level was well executed. But bulls are still in charge.

And then there's the dollar.

Commodity gains last week were limited to nickel, copper and hogs, while modest losses fell to gold, silver, coffee, wheat, natural gas and orange juice futures. The rise of the dollar accounted for much of the struggle, as it was up 0.5% versus a basket of currencies. The greenback's surge came amid renewed concerns about the prickly euro, and rose again in after-hours trading.

Why would the dollar rise? Because if the White House's tax-based stimulus works as expected, then the U.S. dollar may be reinvented in investors' imagination as a growth currency and not just a safe haven.

It's strange but true - especially since traders are comparing it to the euro, whose fiscal sustainability is very much in question.

My advice: Keep your eyes on the horizon. The Weekly Leading Index, the improvement in jobless claims, and rising corporate earnings tell us that the economy is strengthening, with real GDP on the verge of an expansion. ISI Group economists this week noted that recoveries can be "short and dangerous if slow, like an airplane taking off." That is what we have to look forward to.

Nominal GDP is already above its 2007 peak and real GDP (minus inflation) is on track to make a new high in the first quarter. So we've just about got our wheels off the ground, and President Obama's tax compromise likely will seal the deal. So stay positive.

Medium-sized companies may be the best way to play this rally. Just look at the iShares S&P MidCap 400 Growth exchange-traded fund (NYSE: IJK), which is one of my favorite positions for subscribers to own. The whole bull/bear debate is over for this index. It's off on a new adventure.

[Editor's Note: Money Morning Contributing Writer Jon D. Markman has a unique view of both the world economy and the global financial markets. With uncertainty the watchword and volatility the norm in today's markets, low-risk/high-profit investments will be tougher than ever to find.

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Source : http://moneymorning.com/2010/12/14/obama-tax-deal-sets-the-bull-running/

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