Daily Insight

U.S. stocks began the session lower on earnings concerns – Q4 earnings season begins to roll this week – and downward pressure increased as the day progressed as more people begin to realize that infrastructure-based stimulus has a large lag to it.

In terms of profit worries, one has to believe equity values have lower earnings priced in; it’s not like a profit decline of 20-25% comes as much of a surprise after the economic data we’ve been battered with over the past three months. So we’re not sure this was the primary concern yesterday.

It’s more likely stocks had a rough session due to growing concerns over the efficacy of the stimulus proposals, a topic we touched on last week. Those crafting the plan can say the proverbial shovels are already in the ground, waiting for the nod to begin projects, all they want. The reality is there are federal and state appropriations that must be dealt with first and the typical infighting over prioritization.

Then there is the issue of the private sector delaying spending plans as they may be expecting higher government spending will be followed by tax hikes, which will only curtail growth just when it seems things have turned. Maybe intertemporal economic decisions are not quite this lucid within the business community, but it’s a concern nonetheless.

Market Activity for January 12, 2009

Also delivering a blow to investor sentiment was news Larry Summers (Obama’s top economic advisor) sent a letter to Congress outlining onerous conditions on financial institutions.

Bank stocks got hammered, leading the losses as the sector shed 5.7%, The only good news here is maybe banks will pay the TARP money back as quickly as possible so to get out from under these damaging conditions, such as limits on executive compensation, banning dividend payouts beyond de minimis amounts, and limits on stock buybacks and acquisitions.

(Certainly, these institutions are not raising dividends and buying back stock anytime in the near future, but these restrictions may prove quite damaging for their stock prices two-three years from now. On executive compensation limits, at a time when a firm needs to acquire top talent those that can deliver most effectively will simply look in another direction if their pay is going to be held back – these demands are very near-sighted and quite hostile to relatively free market principles. But that has been one of the concerns all along.)

So the market is still assessing all of these things. We may very well extend upon the rally that has given us a 16% boost from the multi-year nadir hit on November 20, but not without a pull-back period of assessment as we’re finding.

The broad market’s 8% decline over the past four sessions comes as some credit spreads have narrowed significantly. The TED Spread (as most readers know is a measure of the market’s willingness to take risk – a wider spread means risk aversion) has narrowed the most since this whole fiasco truly began in September.


Further, the spread on top-rated credit card-backed debt and similar bonds backed by auto loans have also narrowed thanks to the Fed’s Term Asset Backed Lending Facility (TALF). These spreads moved to historic wides as investors fled to the safety of U.S. government bonds. Now with the Fed beginning to step in, these loans will come off of more prohibitive levels for consumers.

That said, no one can make consumers borrow, the large issue of a deteriorating labor market will keep activity subdued. Personally, while the Fed is the lender of last resort, I don’t believe them stepping into the consumer-loan market is part of their job, but mention it just to explain what’s occurring.

Commercial Paper issuance has also rebounded. This source of short-term funding that businesses use to meet payroll and purchase inventory was in the process of collapsing in September and October. The Fed attacked this problem via its Commercial Paper Funding Facility (CPFF), one of its most successful moves yet.


Now, the levels CP issuance hit in 2007 and into 2008 where not sustainable, so the goal wasn’t to get this activity back to those levels. Instead, the objective was to halt a very troubling slide that resulted in credit access being shut off to even fairly well-positioned small businesses as investors fled for safety when the Lehman collapse occurred on September 15.

Part of what’s occurred in the labor market has resulted from firms having to close their doors as funding shutdown. And we’re not talking about businesses that were poorly managed – that is what recessions are about, killing off these unfit firms – but rather those that were pretty well managed but merely not ready for a credit freeze-up that has not been seen for a very long time.

So while financial stability has improved, investors are still leery of additional fallout.

This morning will be another quiet one on the economic front. We do get the November trade balance and the monthly budget statement for December; however, we already know what these two are going to look like.

The trade gap will very likely narrow as the plunge in energy prices and very weak consumer activity caused imports to trail export activity for November. Both will be weak, but imports likely more so.

The monthly budget statement will show the government ran another huge deficit in December, but this is no surprise. Government spending has exploded, while the weak economy has caused revenues to decline.

The first-half of the TARP money makes up much of this spending explosion, but remember that these funds were issued via preferred shares yielding 5%. One can argue about the terms, and of course the plan in general, but the vast majority of these funds will be paid back with interest.

More concerning to me is the spending that will occur this year and next (and the overall permanence of government programs) as the funds go to who knows what with little chance of much of these projects delivering productivity enhancements down the road. This spending will massively increase the deficit, which is expected to come in at $1 trillion for fiscal year 2009. It will also crowd out private-sector activity if history is any guide.

I laugh at all of those in the press that have made a big deal about budget deficits over the past three decades – deficits that were quite manageable, averaging 2.4% of GDP. A deficit of $1 trillion amounts to 7% as a percentage of GDP, and won’t be any smaller for 2010 in my view.

Have a great day!


Brent Vondera, Senior Analyst