We’ve engage in a nice 20% run over the past 11 sessions. It’s difficult to tell whether what we’re seeing here is one of those rallies that extends for a couple of months or one that will prove very short-lived and once again test the low – such as the bounce from the October 27 multi-year low that rallied 18% only to make a new low three weeks later. We get the feeling this one has some legs but it’s tough to say.
There are a lot of companies cutting forecasts as the credit crisis that took hold in October did major damage. We’re seeing forecasts adjusted by 15%-50% from guidance just offered in late October, which helps explain how quickly things have shifted. Stocks may have to deal with this news, meaning we surely haven’t escaped big down days on occasion. However, these forecasts are rearview mirror topics, the stock-market damage that has been done, one would think, reflects worst-case profit scenarios.
Congress and the White House have also neared an agreement to extend a life-line to U.S. auto makers. It appears they’ll throw $15 billion at the three as a sort of bridge to January 20. (At that time Congress will have the numbers to issue additional checks to GM, Ford and Chrysler.) It is being reported the government will take an equity stake; although, specifics have not yet been announce. Odds are they’ll do it via preferred shares yielding 5% for the first five years and increased to 9% after that, this has been their modus operandi regarding other deals.
The US autos really need to enter bankruptcy for government spending to make sense. Then government assistance can take the form of debtor in possession financing. Traditional bankruptcy would force the companies to take substantial measures to reduce costs such as cutting the number of dealerships and product lines that pretend the Detroit Three still enjoy 50% market share instead of the roughly 18% that is currently the case. They’ll also need to bring labor costs closer in line with their global competitors. Currently these costs run 50% above the rest of the market due to a “jobs bank” that pays laid off workers 95% wages and massive legacy outlays.
In an event, stocks like any Detroit Three lifeline for now that does not increase job losses, forgetting for now what is the best route with which to make these companies viable over the longer term.
Market Activity for December 8, 2008
Most major sectors rallied Monday, save the traditional areas of safety – health-care, utilities and consumer staples. Basic materials led the advance; the group has been crushed over the past few months but when the $500 billion (which quickly turns into $1 trillion when the government’s involved) spending plan rolls out mining, construction-equipment and metal production stocks are going to get a kick.
Financial, technology and energy shares enjoyed a very upbeat session as well. Industrial names continue to lag a bit, but this sector will benefit nicely, not just from short-term stimulus but longer term as the traditional economic drivers return to that role – a 15-year era of massive leverage had financials playing the lead.
For the market in general, the good news was we held onto gains for the entire session, with relatively low volatility – relative being the operative word here.
Keynesian Stimulus
You understand our concern, as expressed lately, over these spending programs – the historical record on this type of stimulus proves to be short-lived. Surely government spending is not always a bad thing, but we’re hardly short on public-sector non-defense outlays. Indeed, the federal government has spent $500 billion on infrastructure alone over the past five years. There are things we need to improve, such as a revamped electricity grid, the traffic-control system and making public buildings more efficient. These would be beneficial endeavors.
But this should be coupled with private-sector incentive effects via the tax code that continue to increase rates of productivity and profits that has resulted in the massive job creation we’ve seen over the past 25 years. It is no mystery why U.S. job creation over the past quarter century (up 44.7 million) has outpaced that of the previous 25 years (up 37 million 1958-1983) even as population growth has waned – U.S. population rose 50% 1958-1983 vs. up 32% 1983-2008. The reason for this is the private sector has seen burdens removed – tax and regulatory burdens. Lower tax rates on capital along with labor and corporate incomes will provide additional benefits to overall living standards via higher profits, jobs, incomes and stock-market savings. To forget this axiom will cost us living standard improvements over time.
The Economy
We were without an economic release yesterday, but we’ll get back to it this morning with pending home sales, and then a slew of data Thursday and Friday.
Pending home sales, which are an early indication of how existing home sales will shape up are due out this morning. Pending sales will show additional weakness as it reflects the freeze-up in credit that intensified in November.
This measure may prove a less reliable indicator than usual as we deal with this credit-market event because it measures the signing of contracts. Existing home sales are not counted until the contract is closed, and some who signed a contract may have found it difficult to obtain a mortgage prior to closing. Point is the existing home sales data (due out in two weeks) may show more weakness than pending indicates.
Tomorrow we’ll get the October wholesale inventory reading. This data has a large lag to it as it takes six weeks for the government to compile the figures, so it’s a bit stale. Still we’ll be watching to see how bad the hit actually was to the underlying sales data, which have been down for three months.
On Thursday we’ll get the usual initial jobless claims figure as everyone is familiar with. We’ll watch to see if claims fall for a third week in a row. Claims remain elevated, but after Friday’s very weak payroll report, another drop in claims (even if it is a mild one) may offer a nice boost to stocks.
Import prices for November are also due out. It will show further decline, as all inflation gauges will point to deflation over the short-term. We believe these inflation number will rebound in strong fashion 6-12 months out as the combination of massive Federal Reserve liquidity injections and a huge government stimulus program combine to re-ignite commodity prices.
On Friday, November retail sales will show a large decline in consumer activity took place. This is generally one of the more important indicators, but won’t have the weight this time as everyone expects a really bad number. We’re looking to December right now for some sort of bounce. Indications from the first week of holiday shopping are looking good, the question is whether it will extend through the month.
Also out Friday will be business inventories and producer prices.
Have a great day!
Brent Vondera, Senior Analyst
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