Really, how high did everyone think stocks could go in this economy?

I’ll begin this post with a bit of candor: I moved almost all of my retirement savings out of stocks in the early part of 2010.

So I missed the big run-up of the last 15 months, and I missed the big declines of the last few weeks.

But stocks right now are about where I jumped out, and the markets appear to be on the verge of a big selloff in the first part of the day Tuesday. Meanwhile, my fixed income and bond funds have increased by about 8% since I got out of the markets.

Some friends good-naturedly (I think) refer to me as Mr. Doom and Gloom, but does anyone think in this economy that the recent peaks in the markets made any sense? Really?

A few posts lately about the underlying weakness in the economy and about this entirely predictable slide in stocks:

The Eurozone has been dithering while the sovereign debt crisis deepens. Unemployment in the U.S. remains high and the opposition party, which has a powerful faction who seem eager to drive the entire economy over a cliff, has even fewer credible ideas for reducing it than the party in power. China is about to dampen its growth. The U.S. Federal Reserve is winding down its second round of quantitative easing because . . . well, because why exactly?

Stocks were under severe pressure before Standard & Poor’s downgrade on Friday, but it’s worth noting that Moody’s did not downgrade U.S. debt and treasuries are still seen as a safe haven — perhaps the “tallest of the midgets” as one commentator suggested today on NPR, but in the land of the blind the one-eyed man is king. Sorry for the mixed metaphors.

So stocks were going south no matter what S&P said; it’s just that the timing might have played out differently without Friday’s downgrade.

Stocks could bounce around their current level for some time. Or they could fall considerably farther — and they will for sure if we embrace bad policies at this point.

We’re capable of doing this right, and I’m actually cautiously optimistic that the American public is becoming better educated about the unsustainable path we’ve been on for the last forty years, especially the last decade.

In the short run:

  • Congress could extend the most recent payroll tax cuts pushed through by Obama at the end of last year even though they will increase the deficit in the short run.
  • Congress can give tax breaks to employers for new hires, even though that too would increase the deficit in the short run.
  • Congress can extend unemployment benefits — that money prevents loss of homes in some cases and is generally recycled right back into the economy.
  • With interest rates so achingly low, we can borrow for infrastructure projects that we know must be done. That too will hurt the deficit in the short run, but we have to get people working and get paychecks flowing.
  • The Federal Reserve can get rolling with QE 3.
  • I read an interesting suggestion today that Fannie Mae and Freddie Mac encourage all mortgage holders — no matter their current status — to refinance at the current low rates. That would mean vast savings each month for many homeowners.

None of these ideas are magic bullets, but they will all help spur growth in modest ways. If we do nothing, or if we insist on austerity cuts or massive government layoffs, we’ll either see the current stagnation continue or we’ll enter another spiral downward.

It’s going to be a long slog even if we get it right. Which means: make moves that are likely to boost economic activity in the short term and at the same time lay out a clear plan involving modest cuts and modest tax increases to achieve long term debt reduction.

Then the stock markets will do what they should.