The market has ralliedsome 10% for a variety of reasons, not the least of which has been the prospect of a change in control of the House of Representatives this fall.
Investors are hoping that Republican-backed initiatives, such as the extension of the Bush tax cuts across all income levels, will be supportive of stronger economic growth in the future.
For our part, we agree that recent weak economic data have argued for a continuation of existing stimulus initiatives (at the very least). And we do not believe that letting the Bush tax cuts expire would be very stimulative for the economy. A change in control of the House would not only make it more likely that the Bush tax cuts are extended, but it would also make it less likely that any new taxes are instituted while our economy struggles to stand on its own.
The public is beginning to understand that the economic recovery remains very tenuous. Therefore, we do not believe that any new taxes, including an increase in rates on the "rich", would receive much popular support at this stage.
We still believe that deflaton is an unlikely scenario, mainly because we have confidence that Bernanke will take aggressive action to avoid this outcome.