Making good money in stocks with another assist from Washington

Stock prices are at two-year highs and the U.S. job market is showing its strongest signs of life since spring.

Yet many Americans may find it hard to feel elated about the sudden generous bump in their 401(k) accounts this fall.

Even as the economy has brightened, Wall Street’s latest burst of optimism has been driven in large part by bets on what will happen — or won’t happen — in Washington. To that extent, going with the markets’ giddy flow requires holding your nose. And that may not change soon.

First case in point: The Federal Reserve this week decided to spend $600 billion over the next eight months to buy Treasury bonds, with the goal of keeping longer-term interest rates low to spur the economy.

Where does the Fed get the $600 billion? From the ether. The central bank creates money with the push of a computer button or two.

While world financial markets soared Thursday on the prospect of the Fed’s fresh wad of cash circulating around the globe, some of America’s biggest trading partners and creditors expressed alarm at the Fed’s latest largess.

Germany, China, Brazil and other countries worry that the U.S. is creating a new money bubble that will have ruinous inflation implications — for example, by feeding what is already a red-hot market in many commodities, from soybeans to gold to cotton, and by inflating the value of foreign currencies at the dollar’s expense.

China, which knows a thing or two about manipulating an economy, expressed alarm via comments by Vice Foreign Minister Cui Tiankai on Friday. “Many countries are worried about the impact of the [Fed] policy on their economies,” he told reporters in Beijing.

Meanwhile, a second force driving U.S. share prices higher this week was investors’ relief over the huge Republican victory in Tuesday’s elections.

Corporate America obviously wanted any anti-business tendencies of the Obama administration neutralized, and that’s what voters delivered in handing the GOP a big majority in the U.S. House.

Wall Street, it’s often said, loves nothing better than to see Washington gridlocked and unable to meddle with private enterprise. But even as fears mount that the Fed might be overdoing its support for the economy, there is a risk that a stalemate between Congress and the White House could paralyze Washington on crucial issues — say, the 2001 and 2003 income tax cuts scheduled to expire Jan. 1.

“The idea that gridlock is good for the markets is based on the notion that it prevents bad legislation from becoming law,” said Steven Ricchiuto, chief economist at Mizuho Securities USA in New York. “But when legislation is necessary to help get the economy moving, political paralysis can be a decided negative.”

Still, the biggest potential positive from the election, and from the Fed’s new commitment to throw massive sums at the economy, is that businesses that know they could use a few more employees may finally get off the dime.

For much of this year, an oft-heard excuse from major companies that have been reluctant to hire was that the Obama administration’s policies fostered gross uncertainty about the economy and were inherently unfriendly to businesses.

With the GOP’s big win, however, good luck to the White House in getting anything even remotely anti-business through Congress.

So the Republican victory “removes the political head wind excuse” that companies have offered for not hiring, said David Kelly, chief strategist at JPMorgan Funds in New York.

Maybe, just maybe, a big turn in hiring began in October, as confidence rose about a Democratic rout in the elections. On Friday the government said the economy created a net 151,000 jobs last month, the first increase since May. Private-sector payrolls rose by 159,000 positions, the most since April.

Despite the better-than-expected report, the stock market’s ascent slowed after key indexes rocketed Thursday to their highest levels since before the financial-system crash began in September 2008.

The Dow Jones industrial average edged up 9.24 points to 11,444.08 on Friday. For the week the Dow jumped 2.9%, and it’s now up 9.7% year to date — 12.2% counting dividends paid.

The rally in U.S. and foreign shares since August has been so powerful that double-digit gains year to date now are the rule rather than the exception. Through Thursday the average domestic stock mutual fund was up 12.3% for the year, according to Reuters/Lipper. The average foreign stock fund was up 13.7%, helped by a slide in the dollar.

Could this be as good as it gets? A near-term pullback shouldn’t surprise anybody after the surge of the last two months. But there are a few strong reasons why stocks’ run may not be over:

•The big-money players call the shots in markets, and many who have been leery of jumping aboard the latest rally now are getting antsy. With less than two months to go in the year, money managers’ focus will be on beating market benchmarks in 2010.

Gordon Fowler, who oversees $19 billion as head of Glenmede Trust in Philadelphia, notes that many hedge fund managers, in particular, “have hair triggers and don’t want to be left behind.”

Fundamentally, the bulls’ argument is that the economy has been underestimated and that stock prices still look shortchanged relative to continuing corporate earnings growth and to low interest rates.

“Despite a strong market rally from summer lows, stocks remain cheap, and when compared to interest rates they remain extremely cheap,” Bank of America Merrill Lynch’s stock-strategy team wrote in a note to clients Wednesday.

Of course, “cheap” always is in the eye of the beholder.

•”Don’t fight the Fed” remains a cardinal rule on Wall Street. Historically, when central bank policymakers have tried to “reflate” the economy by flooding it with money, it has been smarter to bet that they’ll succeed than fail.

By pouring more cash into the financial system, the Fed is trying to encourage risk taking, which traditionally means buying stocks. If the Fed can boost economic growth, it should do the same for many companies’ sales and earnings.

The danger is that the economy will remain weighed down by its enormous debt levels and that even the Fed’s new $600-billion infusion won’t do much to bolster growth.

Yet commodity markets don’t have much doubt about the central bank’s reflation move. The Reuters/Jefferies CRB price index of 19 major commodities jumped 4.3% this week and ended Friday at a two-year high. Gold, the classic inflation hedge, closed at a record high of $1,397.30 an ounce, up 3% for the week.

But as commodities rise, the risk is that they will sap the consumer and business spending that the Fed is trying to encourage with cheap money.

With oil nearing $90 a barrel for the first time since April and prices of many other raw materials climbing sharply, “The middle class is going to get hit,” warned Doug Kass, a money manager at Seabreeze Partners in Palm Beach, Fla.

•Investors who have shifted their portfolios heavily toward bonds in the last two years may start to rethink that move if they believe the Fed could succeed in lifting the economy and generating more inflation.

Market interest rates on bonds already have plunged in recent months, anticipating the Fed’s new bond-buying commitment. The benchmark 10-year Treasury note yield closed at 2.53% on Friday, down from 2.60% a week earlier but up from the recent low of 2.38% in early October.

“They’re making bonds more dangerous,” JPMorgan’s Kelly said of the Fed. If market interest rates rise, the market value of bond portfolios will fall. Likewise, higher inflation would erode bonds’ fixed returns.

There’s no guarantee that investors who sell bonds would move that money to stocks, but it would be a logical shift if they’re expecting the economy to continue to improve.

“We’ve been switching out of bonds to dividend-paying stocks,” said Nick Sargen, investment chief at Fort Washington Investment Advisors in Cincinnati.

“I can’t buy bonds at record-low yields knowing the Fed is trying to reflate the economy,” he said.

tom.petruno@latimes.com