Stock prices fell about 1% last week,
ostensibly on the lack of a political accord ahead of looming deadlines for the
federal government budget and for raising the debt ceiling. With some kind of
deal needed by Oct. 1, political wrangling and brinkmanship caused investors to
cash in gains from the all-time highs registered Sept. 18.

The
more important issue, however—and here we’re going to assume the politicians
eventually act like adults and reach a deal—is lurking beneath the budget
turmoil. The question is: How and when will the Federal Reserve eventually
taper the quantitative easing (QE) policy that has kept interest rates
artificially low and stock prices high.

The
Fed surprised investors on Sept. 18 by not tapering. But after a strong, albeit
brief, rally, uncertainty has ensued. Since then several members of the central
bank have made speeches that have given contradictory signals about the timing
of the promised tapering of the bank’s $85 billion monthly bond buying.

The
Dow Jones Industrial Average gave up 193 points, or 1.3%, to 15,258.24, while
the S&P 500 index lost 1%, or 18 points, to 1691.75. Both indexes managed
only one up session, Thursday. Bucking the trend, however, was the Nasdaq
Composite Index, which finished the week fractionally to the upside, closing at
3781.59.

The
question for investors ahead of the Oct. 1 budget deadline is, “How big a
showdown is this going to be?” says Giri Cherukuri, head trader at
Oakbrook Investments. Assuming a deal is struck, investor focus can return to
the economy and earnings, and the market can work higher, he says, adding,
“It’s going to be wait and see for the next couple of days.”

However,
if there’s no deal by the deadline Tuesday, shares will likely continue to drop
for as long as the politicians in Washington, D.C., bicker.

Without
an agreement, stocks probably would fall further than they would rise in the
event of a deal, adds Michael Yoshikami, CEO of Destination Wealth Management.

Still,
it’s the central bank’s policy that matters most, he adds. “There are
conflicting signals coming out of the Fed, and—while investors know that QE is
eventually going to end—people don’t know what to make of it.”

The Fed’s Sept. 18 decision suggests
the economy isn’t growing strongly enough to handle any slackening of its QE
stimulus. As a consequence, the coming third-quarter earnings reporting season
might assume greater importance (Source: 
Barrons Online).