Daily Insight

U.S. stocks fell Thursday, driven by concerns GM may file for bankruptcy and big declines in energy stocks.

Merrill Lynch predicted oil will hit $25 per barrel – quite a difference from predictions crude would hit $200/barrel just four months back. Expectations that oil will continue to fall increases concerns over global growth as it would mean demand weakens further to get there. Naturally, rarely do we hear the positive side: The 60% decline in retail gasoline prices has left roughly $600 billion in consumers’ pockets.

On the autos, it was reported that GM and Chrysler executives were considering a “pre-arranged bankruptcy,” which is not all that surprising but certainly doesn’t help investor sentiment as the labor market is already under pretty much pressure.

Fourteen stocks in the S&P 500 made new 52-week lows, most being among energy and basic material firms.

It is extremely difficult to manage these businesses in the current environment; these industries were ramping up production and hiring with abandon back in August, the opposite is the case just a few months later. Mark it down as one more market distortion caused by failed monetary policy. Obviously, the Fed has no choice right now, but their reckless behavior roughly a year ago sparked the commodity bubble that has now popped – not to mention mistakes during 2003-2005 that sparked the housing bubble, resulting in so much harm when that one burst.

Retailers reported weaker-than-expected sales results, made worse by having one less week for the reporting period than last year, but we’ve already received data showing that November retail sales were depressed. I’m not sure the market was too affected by this news as we know the month ended well and December got off to a good start as results from Cyber Monday illustrated.

Market Activity for December 4, 2008

Economic Releases

It’s Friday, so we’ve got jobless claims to talk about, as that weekly data is released each Thursday. The Labor Department reported initial jobless claims fell 21,000 to 509,000 in the week ended November 29. While the figure remains elevated, it’s obviously a nice sign to see the figure tick lower for the second week in a row.

As we’ve discussed a couple of times now, the charts on jobless claims do not adjust for increases in the work-force, which is higher by 28 million since 1991 and has increased by 48 million since 1982. The point is while a reading above the 500k mark is certainly high, if we were moving to a labor market that was as troubled as previous periods the claims figures should be pushing to 600,000-700,000.

Surely, we may still get there, it is way too early to rule this out, but the fact that we’ve moved lower for two weeks now may show the December jobs picture (not this morning’s figure which is for November and will be worse than the previous report) may have improved mildly. This is a very early commentary and we’ll need to see additional improvement via next week’s claims report, but I think it’s worth touching on some bright-side developments.

The four-week average rose 6,250 to 524,500, but the past two weeks of data should push the 4-wk average a bit lower when released next week.


Continuing claims jumped 89,000 to 4.087 million in the week ended November 22 – this reading is delayed by a week relative to the initial claims data. This continuing claims number is more difficult to get our hands around as the government continues to extend the period of time one can take jobless benefits. No doubt, most will choose a job over taking these government funds, but at the margin there are those who will simply decide to continue to remain on the dole rather than accept a less than desirable position perhaps. Then others who will decide to just sap the handout because they can

In a separate release, the Commerce Department reported factory orders plunged 5.1% in October. This is old news and I don’t think it’s worth the time to go through this again, as we have discussed the event via last week’s durable goods report and the ISM figures. October was a horrible month as the credit-market chaos that began in September caused firms to halt their spending plans – caution moved to elevated levels.

The non-durables segment of the report also pushed October factory orders lower due to a large 13% decline in petroleum refinery orders

November business spending will be weak as well, the next data to look to is December durable and factory goods orders for signs of a business spending rebound. It’s really too early to expect one, but this will be the focus.

Another Treasury Plan

A plan is under discussion to use Fannie Mae and Freddie Mac to offer 4.50% 30-year mortgage loans – not available for refis, sorry to all of you that had begun calculating your savings on this news – a full one-percentage point below the current rate. Treasury would fund this by issuing Treasury debt at 3.00% and it would be available for purchases only.

I don’t know what this does for the housing market. People who sell their home to buy a new one, incentivized by this lower rate – as if the 5.5% market rate on the 30-year fixed is not ultra-low to begin with – will still end up adding one to supply. And if there isn’t a new home purchaser with 20% down to buy it, it just sits there. Supply has not been reduced.

Besides, in a normal market with the 10-year Treasury yielding just 2.56% (that’s unbelievable) this would mean a 4.36% 30-year fixed mortgage rate as the spread between the two is generally 180 basis points. But this is not a normal market as investors take into account added risk and demand a higher spread to compensate. If the government wants to artificially move the rate lower, go for it – but I don’t see how it helps.

We already find ourselves in an environment that may be rife with unintended consequences. Heck, consequences from some Fed/Treasury programs have already needed new programs/facilities to offset those consequences. For instance, the FDIC plan that guarantees bank debt sent the market moving to buy that debt and away from mortgage debt, driving mortgage rates higher. This took the Fed direct purchase of mortgage-backed securities plan – announced November 25 – to offset this consequence and move mortgage rates lower. And indeed it has done so nicely as the 30-year mortgage rate dropped from 6.20% to 5.50%. Let’s call it a day there and have the patience to let the market correct from here.

Let’s Put a Halt to Unintended Consequences Now

With all of these government programs the country seems to be forgetting that a bold tax strategy could get everything rolling again. And once the economy begins to roll home sales will bounce back, home prices will move higher and foreclosures will ease.

Why is it is constantly this desire to find a quick “fix” – there is not such thing. What to do is fundamentally change the tax structure – this way you bring in long-term incentives and optimism quickly rises.

This is not a direct shot to the housing market, but improves other aspects of the economy that then flow through to housing.

So what to do? Here’s bold for you:

• Halve the capital gains and dividend tax rates
• Eliminate all but the 10% and 25% federal income tax brackets and index those brackets to inflation (with personal exemptions of $15,000 for single and $30,000 for married -- $5,000 per child)
• Cut the corporate tax rate to 20% (currently it sits at 35% -- the second highest within the OECD)
• Increase the write-down allowance on business equipment in the year of purchase and make it permanent
• Suspend the repatriated tax rate for a year and reinstate it at 5% after that (currently the rate is 35% -- this will bring a massive amount of capital back home, capital that currently remains overseas to avoid this tax)

These bold adjustments will push the budget deficit higher next year, but that is already occurring with the trillions the government is in the process of spending on their quick “fix” plans. In years two, three and four under this new regime we’ll make it up as tax revenue soars by way of a larger tax base (as a result of job creation) and increased growth.

The first thing that will shift under this pro-growth agenda is the stock-market as it would rally to reflect the increase in after-tax return expectations (halving the capital gains tax rate from 15% to 7.5% will boost after-tax returns by an additional 9%) – thus lifting savings that have been crushed by the plunge in equity prices.

Businesses will also respond quickly by boosting capital spending, which will be the catalyst to job creation in the first couple of years; thereafter higher after tax corporate profits will provide the engine for job growth. (Oh, and the business production that results will mean more goods to help absorb the massive liquidity injections the Fed has pumped into the system, tamping future inflation. Currently this money is being absorbed by banks as they hoard cash, but when they begin to feel a bit more comfortable and increase lending, boom. The production better be there to absorb these dollars or inflation will make a troubling comeback.)

For the consumer, they’ll need a bit more time to get their legs under them, but it won’t take long as disposable (after-tax) incomes will be driven higher – a sustained increase, not some feckless rebate check one-and-done boost.

Longer-term, living standards will be driven higher as productivity improvements will remain elevated (productivity growth has been expanding for 25 years now as tax rates have been slashed) due to the incentive effects of higher after-tax return expectations – and we may also think of suspending cap.gains taxes on “troubled” assets to bring in some bids and calm the endless write-down spiral harming the banking sector. Anyway, as investors move their capital from the safety of the short-end of the Treasury curve and into more risky investments like providing venture-capital seed money for innovations, additional technological advances will come to market over time, which is the ultimate source of productivity gains that drive real incomes and thus living standards.

Of course, we could continue to ignore this path and instead come up with another 20-30 fancy Fed programs and acronyms, add in $600 billion-$1 trillion of infrastructure projects and other so-called quick “fixes” that seem to be doing so much to boost confidence, stock prices and turning the economy around.

This morning we get the November jobs report and it will be an ugly one. I heard a commentator on CNBC this morning say it is like watching a car wreck; you can’t take your eyes off of it. How stupid. Of course it will be watched, it’s one of the most important economic reports we get.

The estimate is for a loss of 335,000, but something above 350,000 cannot be ruled out. If we get a decline of 325,000 it will be the worst decline since October 2001 (and you know what that followed). A decline greater than 350,000 would be the worst monthly drop since 1974.

Have a great weekend!


Brent Vondera, Senior Analyst