U.S. stocks bounced between gain and loss a zillion times Tuesday, big surprise I know, as trading jumped 4% between yesterday’s peak and trough – although that may be considered mild volatility these days. In the end the Dow and S&P 500 moved higher, but the NASDAQ failed to end on the plus side as tech shares were pressured by global growth concerns.
Mid and small capitalization stocks enjoyed strong relative performance, gaining 1.92% and 1.46%, respectively.
Interesting thing occurred about an hour before the market opened. Stock-index futures turned on a dime – after spending most of the pre-market session negative – as Senator Judd Gregg stated the Senate would put pressure on the SEC to end mark-to-market accounting standards (in determining capital adequacy ratios) in an interview on CNBC. Increasingly, more people are beginning to talk about this very big problem as concerns rise over the endless circle such accounting changes have caused. Too bad we didn’t get the outcry sooner, maybe we wouldn’t have needed about 10 new Federal Reserve facilities and the massive level of government spending that has occurred over the past several months. But apparently that would have been too simple.
And speaking of which, the Fed rolled out two more programs yesterday.
One being a $200 billion term lending facility to purchase asset-backed securities backed by car loans, credit card receivables, student loans and small business loans. As the private sector shuns this type of short-term lending, the Fed has stepped in and it should help restart credit channels to consumers and businesses. We’re talking about AAA-rated stuff here, so it’s not quite as risky for the Fed as it sounds, but the Fed does continue to increase the risk level of its balance sheet.
I noticed that these loans will not be subject to mark-to-market requirements. That’s hilarious! It appears the Fed understands how utterly stupid, and harmful, this pro-cyclical form of accounting is. (Exacerbates the froth when asset prices are flying high as firms will need less capital, while it puts an institution – and well as the rest of the economy – in a world of hurt when asset prices are falling as they must raise more capital, which means selling assets at fire-sale prices, which means further write-downs, and thus requires more capital to be raised… anyway, you get the endless circle of death.)
Why we just don’t’ return to the old standard of basing capital adequacy on the original price of an asset is beyond me; one can bet eventually we will.
The second Fed announcement explained they’ll start a program to buy up to $500 billion GSE mortgage-backed securities to support the mortgage-lending market. The announcement has a direct effect on spreads yesterday. This should help to kick-start new home buying. Not sure how it will help re-fi activity as anyone who bought house in the past two years would have to put up additional equity to get back to 80% LTV as the price of the home as declined.
There is a problem when the government rolls out an endless number of programs. This plan to purchase mortgage-backed securities is likely meant to offset the unintended consequence of the FDIC guarantee on bank debt that began a couple of weeks ago. Since the FDIC guarantee means bank debt is backed by full faith and credit of the U.S. government it may have caused investors to move away from mortgage-backed debt in favor of the new safety in bank debt – spreads widened, meaning mortgage rates rose relative to Treasury yields, as a result and this is what the Fed is attempting to reverse.
Market Activity for November 25, 2008
On the economic front, the Commerce Department released its first revision to third-quarter GDP and it was revised down from last month’s initial estimate. The report showed gross domestic product fell 0.5% at a real annual rate during the July-September period, down from the minus 0.3% initially estimated.
The difference was a larger-than-estimated decline in personal consumption, by far the largest component of the report. Personal consumption fell the most since the 1980 recession (this is on a quarter-over-quarter basis at an annual rate) as consumers pulled back in the face of the credit chaos and a stock-market plunge.
While there are some that lack the means to consume more as the jobless rate has increased and many bought houses they could not really afford, the high level of caution that ensued from these events is the largest factor at this time and will keep this component of GDP down big for at least another quarter. The fourth-quarter GDP report will post the worst decline since the 1981-1982 recession, led by another large drop in consumer activity.
We’re coming out of the longest period of uninterrupted personal consumption growth – 66 straight quarters – in the post-WWII period. (The streak would have been interrupted sometime during the 2001-2002 if not for the substantial Fed easing that took place.) The previous record was 38 quarters that ran 1961-1970.
Business fixed investment was also revised down, which had an additional effect on the overall reading. We were on a really nice trajectory with regard to business spending but that all fell apart beginning in August and accelerating into September as businesses became very cautious and put spending plans on hold. This will continue to have a big effect on growth. However, when optimism returns, businesses (in the aggregate) have the resources available for this area to propel us out of these doldrums.
Below is a long-run look at real (inflation-adjusted) GDP. The green line represents our average long-term rate of growth – again, in real terms – of 3.4%. The yellow line represents zero.
In separate reports, we received two additional reports on home prices.
The S&P Case/Shiller Home Price Index showed a decline of 1.85% in September and 17.4% from year-ago levels. Although this was largely driven by areas that witnessed the largest speculative activity, such as San Fran, Phoenix, Las Vegas, Miami and LA. Note that this data is for September.
Based on the existing home price data for October that we received yesterday, this index will show even larger declines next month, especially considering the large decline in the West region.
We also receive the Federal Housing and Finance Agency’s (FHFA) – formerly the Office of Federal Housing Enterprise Oversight (OFHEO) as longer-term readers may be familiar – gauge of home prices, which showed a decline of 1.3% for September and 7.8% from the year ago period.
All of these home price gauges have their flaws. Case/Shiller is not a broad look, while the FHFA index is broad but misses the upper-end of the market. To get the best look is to average the four main gauges, these two along with the price data from new and existing home sales. This gives you a decline of roughly 10.5% over the past year.
Finally, the Conference Board reported consumer confidence rose from depressed levels, rebounding to 44.9 in November from the lowest reading on record of 38.8 in October. (That October plunge to 38.8 was from the typical recessionary levels of roughly 60. Such a large move illustrates the speed and degree to which the credit event, and more importantly the psychological event the stock-market free-fall, has had on sentiment.
The improvement in the overall index was entirely due to higher expectations as the expectations sub-index rose to 46.7 from 35.7. The present situations index actually fell.
Consumers’ assessment of the labor market remained weak but improved a bit. Those viewing “more jobs” will be available six months out rose slightly to 9.2% from 7.3% in October, while those assuming “less jobs” will be available fell to 33.3% from 41.5% -- thus the net “more jobs” minus “less jobs” index improved to -24.1% from -34.2% in October. Those expecting things to remain the same rose to 57.5% from 51.2%.
We generally do not spend time on these confidence surveys, but have over the past couple of months because consumer expectations and confidence are vitally important right now – same is true for business sentiment. This is why we’ve harped on a tax-rate response to the current situation, particularly on capital. Just as the headlong 45% decline in stocks from the peak (and specifically the 35% slide since September) has crushed confidence, a sustained stock-market rally can bring it right back -- and nothing can spark a swift upswing in stock prices like lower tax rates on capital.
Further, if consumers have low expectations of future disposable (after-tax) income, then raise those expectations – the Obama camp (as they hold another press conference today) can do this now by explicitly stating current tax rates will be made permanent. I know, I’m fantasizing here.
However, if we cannot lower all tax rates on income, then let’s at least collapse the 25% tax bracket into the 15% bracket – the Peter Ferrara plan. This would slash marginal tax rates by 40% for the vast majority of workers – singles making $32,500-$78,850 and married coupled earning $65,101-$131,450. This group is the middle class and such a move would be much more powerful than the feckless exercise of handing out $500-$1,000 checks, or spending $500 billion on Lord knows what.
Have a great day and a great Thanksgiving!
Brent Vondera, Senior Analyst
Mid and small capitalization stocks enjoyed strong relative performance, gaining 1.92% and 1.46%, respectively.
Interesting thing occurred about an hour before the market opened. Stock-index futures turned on a dime – after spending most of the pre-market session negative – as Senator Judd Gregg stated the Senate would put pressure on the SEC to end mark-to-market accounting standards (in determining capital adequacy ratios) in an interview on CNBC. Increasingly, more people are beginning to talk about this very big problem as concerns rise over the endless circle such accounting changes have caused. Too bad we didn’t get the outcry sooner, maybe we wouldn’t have needed about 10 new Federal Reserve facilities and the massive level of government spending that has occurred over the past several months. But apparently that would have been too simple.
And speaking of which, the Fed rolled out two more programs yesterday.
One being a $200 billion term lending facility to purchase asset-backed securities backed by car loans, credit card receivables, student loans and small business loans. As the private sector shuns this type of short-term lending, the Fed has stepped in and it should help restart credit channels to consumers and businesses. We’re talking about AAA-rated stuff here, so it’s not quite as risky for the Fed as it sounds, but the Fed does continue to increase the risk level of its balance sheet.
I noticed that these loans will not be subject to mark-to-market requirements. That’s hilarious! It appears the Fed understands how utterly stupid, and harmful, this pro-cyclical form of accounting is. (Exacerbates the froth when asset prices are flying high as firms will need less capital, while it puts an institution – and well as the rest of the economy – in a world of hurt when asset prices are falling as they must raise more capital, which means selling assets at fire-sale prices, which means further write-downs, and thus requires more capital to be raised… anyway, you get the endless circle of death.)
Why we just don’t’ return to the old standard of basing capital adequacy on the original price of an asset is beyond me; one can bet eventually we will.
The second Fed announcement explained they’ll start a program to buy up to $500 billion GSE mortgage-backed securities to support the mortgage-lending market. The announcement has a direct effect on spreads yesterday. This should help to kick-start new home buying. Not sure how it will help re-fi activity as anyone who bought house in the past two years would have to put up additional equity to get back to 80% LTV as the price of the home as declined.
There is a problem when the government rolls out an endless number of programs. This plan to purchase mortgage-backed securities is likely meant to offset the unintended consequence of the FDIC guarantee on bank debt that began a couple of weeks ago. Since the FDIC guarantee means bank debt is backed by full faith and credit of the U.S. government it may have caused investors to move away from mortgage-backed debt in favor of the new safety in bank debt – spreads widened, meaning mortgage rates rose relative to Treasury yields, as a result and this is what the Fed is attempting to reverse.
Market Activity for November 25, 2008
On the economic front, the Commerce Department released its first revision to third-quarter GDP and it was revised down from last month’s initial estimate. The report showed gross domestic product fell 0.5% at a real annual rate during the July-September period, down from the minus 0.3% initially estimated.The difference was a larger-than-estimated decline in personal consumption, by far the largest component of the report. Personal consumption fell the most since the 1980 recession (this is on a quarter-over-quarter basis at an annual rate) as consumers pulled back in the face of the credit chaos and a stock-market plunge.
While there are some that lack the means to consume more as the jobless rate has increased and many bought houses they could not really afford, the high level of caution that ensued from these events is the largest factor at this time and will keep this component of GDP down big for at least another quarter. The fourth-quarter GDP report will post the worst decline since the 1981-1982 recession, led by another large drop in consumer activity.
We’re coming out of the longest period of uninterrupted personal consumption growth – 66 straight quarters – in the post-WWII period. (The streak would have been interrupted sometime during the 2001-2002 if not for the substantial Fed easing that took place.) The previous record was 38 quarters that ran 1961-1970.
Business fixed investment was also revised down, which had an additional effect on the overall reading. We were on a really nice trajectory with regard to business spending but that all fell apart beginning in August and accelerating into September as businesses became very cautious and put spending plans on hold. This will continue to have a big effect on growth. However, when optimism returns, businesses (in the aggregate) have the resources available for this area to propel us out of these doldrums.
Below is a long-run look at real (inflation-adjusted) GDP. The green line represents our average long-term rate of growth – again, in real terms – of 3.4%. The yellow line represents zero.
In separate reports, we received two additional reports on home prices.
The S&P Case/Shiller Home Price Index showed a decline of 1.85% in September and 17.4% from year-ago levels. Although this was largely driven by areas that witnessed the largest speculative activity, such as San Fran, Phoenix, Las Vegas, Miami and LA. Note that this data is for September.
Based on the existing home price data for October that we received yesterday, this index will show even larger declines next month, especially considering the large decline in the West region.
We also receive the Federal Housing and Finance Agency’s (FHFA) – formerly the Office of Federal Housing Enterprise Oversight (OFHEO) as longer-term readers may be familiar – gauge of home prices, which showed a decline of 1.3% for September and 7.8% from the year ago period.
All of these home price gauges have their flaws. Case/Shiller is not a broad look, while the FHFA index is broad but misses the upper-end of the market. To get the best look is to average the four main gauges, these two along with the price data from new and existing home sales. This gives you a decline of roughly 10.5% over the past year.
Finally, the Conference Board reported consumer confidence rose from depressed levels, rebounding to 44.9 in November from the lowest reading on record of 38.8 in October. (That October plunge to 38.8 was from the typical recessionary levels of roughly 60. Such a large move illustrates the speed and degree to which the credit event, and more importantly the psychological event the stock-market free-fall, has had on sentiment.
The improvement in the overall index was entirely due to higher expectations as the expectations sub-index rose to 46.7 from 35.7. The present situations index actually fell.
Consumers’ assessment of the labor market remained weak but improved a bit. Those viewing “more jobs” will be available six months out rose slightly to 9.2% from 7.3% in October, while those assuming “less jobs” will be available fell to 33.3% from 41.5% -- thus the net “more jobs” minus “less jobs” index improved to -24.1% from -34.2% in October. Those expecting things to remain the same rose to 57.5% from 51.2%.
We generally do not spend time on these confidence surveys, but have over the past couple of months because consumer expectations and confidence are vitally important right now – same is true for business sentiment. This is why we’ve harped on a tax-rate response to the current situation, particularly on capital. Just as the headlong 45% decline in stocks from the peak (and specifically the 35% slide since September) has crushed confidence, a sustained stock-market rally can bring it right back -- and nothing can spark a swift upswing in stock prices like lower tax rates on capital.
Further, if consumers have low expectations of future disposable (after-tax) income, then raise those expectations – the Obama camp (as they hold another press conference today) can do this now by explicitly stating current tax rates will be made permanent. I know, I’m fantasizing here.
However, if we cannot lower all tax rates on income, then let’s at least collapse the 25% tax bracket into the 15% bracket – the Peter Ferrara plan. This would slash marginal tax rates by 40% for the vast majority of workers – singles making $32,500-$78,850 and married coupled earning $65,101-$131,450. This group is the middle class and such a move would be much more powerful than the feckless exercise of handing out $500-$1,000 checks, or spending $500 billion on Lord knows what.
Have a great day and a great Thanksgiving!
Brent Vondera, Senior Analyst
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