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Wall Street shrugs off 'sequester': Why is it ignoring Washington this time?

The stock market, flirting with all-time highs, seems relatively unfazed by Washington's latest fiscal stalemate over the sequester. Here are six reasons for the new attitude.

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“The market has in large part moved on,” says Art Hogan, a managing partner at Lazard Capital Markets. “By that I mean, as you look at the fiscal cliff, how much angst was in the market, we’re not seeing anything that resembles that whatsoever.”

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Here’s why:

Wall Street is buoyed by an improving economy.

Broadly speaking, the economy is continuing a slow but steady recovery, and Wall Street has reacted accordingly, assuming that growth in strong sectors of the economy will largely offset the impact of spending cuts.

“We have what appears to be an improving economic picture,” Mr. Hogan says. “When you juxtapose better economic data ... against the potential impact of cuts in government spending, investors are more attuned to the stronger economy. That may well outweigh the potential impact of cuts.”

Government spending cuts, adds Morgan Housel, a macroeconomic analyst with the Motley Fool, an online financial education website, are just one part of the stock-market equation.

“The market looks at corporate America in its totality, and right now the rebound in housing and energy are likely to offset any damage from the sequester,” Mr. Housel says.

Furthermore, the economy has improved in part because the Federal Reserve has kept interest rates low to encourage growth. Low interest rates mean low yields on bonds, which in turn drive investors toward stocks, driving the market higher.

The stock market is a reflection of the health of corporate America.

As Washington bickers, corporations are enjoying record profits, strong balance sheets, and plenty of liquidity, so it’s no wonder the market is strong.

“We have record corporate profits and record dividends, so it's not surprising that stocks are doing well,” Housel says. “So even though we have high unemployment and political dysfunction, corporations have never been more profitable. And over the long run, profits are what drives the market.”

And it seems investors are finally taking notice. With weak returns on bonds, investors are returning to stocks, further bolstering the market. 

“Bonds and cash have really run their course,” Housel says. “Investors are realizing that if they want to earn a return on their money, they need to come out of their bunkers and participate in the stock market.”

Financial markets have had time to adjust.

With news of the sequester dominating headlines for weeks, investors have had plenty of time to assess the potential impact of cuts long before they go into effect. In other words, the rug isn’t being pulled out from under the economy overnight. 

“Having known this was coming, some of us may well be prepared,” says Hogan of Lazard Capital Markets. 

More important, the impact of the sequester will be gradual, not immediate, with spending cuts and furloughs taking place over a period of time. For example, legislation dictates that most federal employees are given a 30-day notification before furloughs are enacted. Cuts are also likely to be staggered to minimize their impact.

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