Energy shares led the gains, bouncing 11.15%, as measured by the S&P 500 Energy Index; these stocks have gotten crushed as oil prices have been cut in half from the fed-induced peak hit back in July and some bargain hunters are coming back in. Basic material and utility shares also enjoyed a huge day, jumping 8.15% and 8.06%, respectively.
The big news of the day is the continued thawing in the credit markets. It’s too early to get terribly excited, but the market has to feel much better as inter-bank lending becomes a bit more open (as illustrated by the decline in three-month LIBOR) and investors are not seeking out the ultra-safe investments to the extreme degree that was the case just a week back (as illustrated by three-month T-bills). The TED Spread shows the narrowing between these two rates – a very very good sign but it must continue.
Market Activity for October 20, 2008
Substantial economic damage has been done as the credit markets locked up for a full month, but stocks should get juiced if these spreads continue to narrow, as this is what will determine the extent and degree of the downturn. Sure there are other factors weighing on growth and investor expectations, but this is at the heart of the issue.
On the earnings front, things are looking pretty good, at this point. Thus far roughly 20% of S&P 500 members have reported and ex-financial profit results are up 8.8%. Financial profits are down 119% with 30% of the group reporting. (How can something fall more than 100%? It’s called profit losses.) But we do have four of the 10 major industry posting double-digit earnings growth (consumer discretionary, energy, tech and basic materials). Expect this ex-financial figure to ease as earnings season progresses, but for now things are looking pretty good.
On the economic front, the Conference Board’s Leading Economic Indicators (LEI) index rose 0.3% for September, marking the first increase since April. Nevertheless, this is not an accurate indicator – at least it hasn’t been over the past few years. We usual refrain from touching on this figure, but since it was yesterday’s only economic release, I thought it was worth mentioning.
The index got a boost from money supply growth (added 0.45%), interest rate spreads (slope of yield curve, up 0.19%) and consumer expectations (up 0.26%). The drag came from stock prices (down 0.20%), building permits (down 0.23%) and jobless claims (0.23%).
The index is designed to forecast the direction of the economy over the next six months, but that has not been the case. For instance, the LEI posted negative readings in half of the 36 months that ran January 2005 through December 2007. During that period GDP advanced at a real annual rate of 2.5% (and that’s with a major housing drag during half of that period), certainly better than the LEI was forecasting.
From here, the index will continue to get a boost from money supply growth (which will surge as the Fed pumps cash into the system to unfreeze credit markets), interest rate spreads (very positively sloped yield curve) and consumer expectations – not that consumer’s are going to be feeling great over the next couple of months, but from currently low levels, there’s really only one direction for this component to go.) The index will not take into account the harm credit-market disturbances have had on the economy over the past month, and sends the wrong signal as the short end of the curve is benefiting from the “safety” trade, making the yield curve more positively sloped than would otherwise be the case.
Moving On
I see Fed Chairman Bernanke is endorsing a second “stimulus” plan – oh, boy; here we go. Sure he states any stimulus package needs to “promote economic growth and job creation,” but in the current political environment – Bush hesitant to offer the right prescription, thus leaving it to Speaker Pelosi and Senate Majority Leader Reid to mold their variety of a “stimulant” – such words mean he is giving them the green light to say the Fed Chairman is behind their hand-out schemes.
That scheme, as I believe it is appropriate to term the proposal, involves increased unemployment benefits, food stamps and aid to cash-strapped states. (Cash-strapped stated, eh? They can’t reduce spending? It’s not like they haven’t received billions from the Federal government over the past few years. It’s not like revenue growth wasn’t huge during the previous three years. They should not be cash-strapped.) And someone please explain to me how increases in food stamps and unemployment benefits stimulate the broad economy?
Heck, the last “stimulus” plan sent checks out to most everyone ($168 billion worth) – unless of course you made “too much” as defined by those omniscient actors in Congress – and it did nothing. The personal consumption segment of the second-quarter GDP reading rose 1.2% at an annual rate – weak. You can expect a proposal that extends jobless benefits and food stamps to be even weaker, which means it adds nothing to growth but does substantial damage to the budget. This is pathetic.
When Washington wants to get serious, they can cut tax rates in a broad-based way – this actually has incentive effects and at the same time delivers increased tax receipts to the Treasury. Here’s what works:
- Cut the top two income tax brackets (small business taxpayers) and make the current increased allowance for business spending write-offs permanent (as of now this expires in January 2009) -- you’ll get job creation.
- Cut the capital gains tax and watch the cost of capital fall, while the Treasury is inundated with tax receipts as investors unlocked old investments for new.
- Cut the dividend tax rate further and – in addition to the capital gains tax rate – the stock market will get on its horse.
- Cut the corporate tax rate and remove all doubt that the U.S. is the greatest place in the world to headquarter. You’ll get a two for one benefit as corporate profits rise and prices fall – corporate taxation is ultimately passed on to the consumer.
- Eliminate the dead-weight loss which is the repatriated tax and watch capital that is currently hiding overseas to escape this tax come home to provide billions in funds for R&D.
This is real stimulus. When Washington wants to get serious, you’ll know it. Right now, outside of some recent steps from Treasury that have reduced credit-market disturbances, everyone understands they are not.
Have a great day!
Brent Vondera, Senior Analyst
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