U.S. stocks began Monday’s session lower but looked to reverse course as the indices quickly popped to positive territory in the first 30 minutes of trading; that was until a dire IMF (International Monetary Fund) statement was released about 9:30CT. That release stated there was no end in sight to the housing woes and warned deteriorating credit conditions for consumers and banks may prolong a period of slow growth. (Interesting how they are now reframing their negative predictions as “slow growth” rather than “recession.”)
On this point for a moment, there is no doubt the credit markets are going through a period of trouble, but let’s not act as though things are worse than they actually are. I’ll point out that commercial and industrials loans have risen 18% over the past year and at a 9% annual rate over the past six months. The pace has slowed, but comments that credit has slowed to a halt are removed from reality. Below is a chart of C&I loans.
Losses among the benchmark indices increased in the afternoon after Treasury Secretary Paulson held a press conference that failed to address the market’s chief concerns – we’ll touch on this below.
Market Activity for July 28, 2008
To no surprise, financials and consumer discretionary shares led the market lower – these are the pressure points on days of weakness as concerns over housing, tax rates, price stability and the job market effect these sectors more than any other.
The good news that people should have been focused on yesterday was exactly that IMF report, as this organization’s predictions are rarely accurate. While we expect housing to remain weak for some time still, likely another year due the elevated nature of home supply and higher foreclosure rates, the fact that the IMF has predicted no end in sight may be the best indication the worst is over.
While financials and consumer disc. shares led the indices lower, nothing really helped as all 10 major industry groups were down yesterday. Industrial and information technology shares got wacked with the rest of the market. Utility, energy and basic material shares were the relative winners down 0.19%, 0.46% and 0.58%, respectively.
On the earnings front, outside of the financial sector, things continue to look quite good. Ex-financial profits are up 12% with 55% of S&P 500 members reporting thus far. Seventy-percent of those reporting have beat expectations. Still no one cares right now.
Take Verizon’s results as an example. The phone giant reported Q2 operating profit rose 15.5% as their wireless business was strong. Yet, all people could focus on was their weaker-than-expected landline business. Now, which segment is the growth story? Bad news would have been weak wireless activity, not the case though. So you have a stock that offers a 5.12% dividend yield and is delivering high single-digit profit growth trading at 12.8 times 2008 earnings. And this isn’t even one of the more compelling buys out there. The problem is investors may have to wait a while for attractive returns to materialize, but when they do, it will be big.
For now there are plenty of uncertainties in front of us. The shame of it is policy makers have created most of these uncertainties. A Fed that left rates too low for too long into 2004 and 2005 encouraged the mortgage mess we find ourselves in. The economy was rolling along at a very nice pace, yet they waited until June 2005 to get fed funds above 3.00%. Heck, they were still easing in the back-half of 2003, cutting fed funds to 1.00% in June of that year even as the stock market was signaling a boom and their own June 11 Beige Book report showed things were turning. Now, the same reckless easing policy is on again. Yes they must ensure liquidity and they are doing that via their lending facilities, but to jack their benchmark rate down 325 basis points in nine months (225 of that in six months) is reckless.
And then there is the Treasury Secretary.
Paulson Tries Again
Treasury Secretary Hank Paulson held a press conference yesterday afternoon -- in an attempt to reassure the markets I presume – explaining the virtue of “covered bonds” and the beneficial affect such debt instruments would have on the credit markets. However, while this may be the direction the industry goes over the next several years, it doesn’t do much for now because banks are still set up under the securitization framework – hence, many times they do not hold the assets that back these debt instruments on the balance sheet.
(The way I understand it: Covered bonds are securities issued by a bank and backed by a dedicated group of loans – a “covered pool.” If the issuing bank becomes insolvent, the assets in the covered pool are separated from the issuer’s other assets solely for the benefit of the covered bondholder. This is the major difference between covered bonds and asset-backed securities. Loans backing a covered bond remain on the balance sheet and should the originating bank fail to make payments, interest payments from the underlying mortgages would go to investors.)
Anyway, Paulson’s attempt whiffed, reminiscent of a Dave Kingman strikeout – for you 1970s and 1980s baseball fans, because this is not that which market participants are currently concerned – at least regarding the here and now.
At risk of sounding repetitious, it is the uncertainty over the housing market and its effect on consumer behavior, questions over tax rates, and the possibility/likelihood that the Fed is ignoring price stability.
The housing market will simply take time to correct; after several years of outsized gains, there is nothing Congress or anything other than time can do to fix it. The Fed will do what they are going to do; this is not Paulson’s turf, so nothing he can really do there either. But this is the Treasury Secretary we are talking about, the appropriate person (after the President) to offer tax rate proposals.
What he should be doing is demanding that Congress make the tax rates on capital, dividends and income permanent – as permanent as Washington gets anyway. Follow that up with a proposal to cut the corporate income tax -- which has become one of the highest rates in the world as virtually every other serious country has cut this rate -- and vastly reduce the tax on repatriated income. (This income earned overseas will stay there so long as it is taxed at a 35% rate) You want to bring it home, cut this rate down to single digits; it will come home in droves.
This would combine beautifully with the increased current-year business equipment write-off allowance and bonus depreciation that was delivered in May, and by the way has kicked started business spending as we discussed yesterday. This combination would be a big job and productivity producer, but Paulson doesn’t get it, and thus the market will continue to send the message that he is not delivering what it wants.
Look, these are times the equity investor must deal with on occasion. But this economy is fundamentally sound; allow the housing correction to run its course, get monetary policy back in order and simply do not damage after-tax return expectations by driving tax rates higher and the market will get back on its horse We only need a little tweaking, U.S. businesses are more streamlined than anytime in history, able to compete and dominate on a global scale, but bad policy should not get in the way. Raise tax rates in this environment of intense global competition and you get your hat handed to you.
As of the latest count, there was $3.5 trillion sitting in money-market funds – plenty of capital out there. Give it a reason to come out of hiding and you’re looking at a powerful market run – long-lasting. That said, the equity investor will need patience here, but when things turn, it will make it all worth it.
Have a great day!
Brent Vondera, Senior Analyst
On this point for a moment, there is no doubt the credit markets are going through a period of trouble, but let’s not act as though things are worse than they actually are. I’ll point out that commercial and industrials loans have risen 18% over the past year and at a 9% annual rate over the past six months. The pace has slowed, but comments that credit has slowed to a halt are removed from reality. Below is a chart of C&I loans.
Losses among the benchmark indices increased in the afternoon after Treasury Secretary Paulson held a press conference that failed to address the market’s chief concerns – we’ll touch on this below.
Market Activity for July 28, 2008
To no surprise, financials and consumer discretionary shares led the market lower – these are the pressure points on days of weakness as concerns over housing, tax rates, price stability and the job market effect these sectors more than any other.The good news that people should have been focused on yesterday was exactly that IMF report, as this organization’s predictions are rarely accurate. While we expect housing to remain weak for some time still, likely another year due the elevated nature of home supply and higher foreclosure rates, the fact that the IMF has predicted no end in sight may be the best indication the worst is over.
While financials and consumer disc. shares led the indices lower, nothing really helped as all 10 major industry groups were down yesterday. Industrial and information technology shares got wacked with the rest of the market. Utility, energy and basic material shares were the relative winners down 0.19%, 0.46% and 0.58%, respectively.
On the earnings front, outside of the financial sector, things continue to look quite good. Ex-financial profits are up 12% with 55% of S&P 500 members reporting thus far. Seventy-percent of those reporting have beat expectations. Still no one cares right now.
Take Verizon’s results as an example. The phone giant reported Q2 operating profit rose 15.5% as their wireless business was strong. Yet, all people could focus on was their weaker-than-expected landline business. Now, which segment is the growth story? Bad news would have been weak wireless activity, not the case though. So you have a stock that offers a 5.12% dividend yield and is delivering high single-digit profit growth trading at 12.8 times 2008 earnings. And this isn’t even one of the more compelling buys out there. The problem is investors may have to wait a while for attractive returns to materialize, but when they do, it will be big.
For now there are plenty of uncertainties in front of us. The shame of it is policy makers have created most of these uncertainties. A Fed that left rates too low for too long into 2004 and 2005 encouraged the mortgage mess we find ourselves in. The economy was rolling along at a very nice pace, yet they waited until June 2005 to get fed funds above 3.00%. Heck, they were still easing in the back-half of 2003, cutting fed funds to 1.00% in June of that year even as the stock market was signaling a boom and their own June 11 Beige Book report showed things were turning. Now, the same reckless easing policy is on again. Yes they must ensure liquidity and they are doing that via their lending facilities, but to jack their benchmark rate down 325 basis points in nine months (225 of that in six months) is reckless.
And then there is the Treasury Secretary.
Paulson Tries Again
Treasury Secretary Hank Paulson held a press conference yesterday afternoon -- in an attempt to reassure the markets I presume – explaining the virtue of “covered bonds” and the beneficial affect such debt instruments would have on the credit markets. However, while this may be the direction the industry goes over the next several years, it doesn’t do much for now because banks are still set up under the securitization framework – hence, many times they do not hold the assets that back these debt instruments on the balance sheet.
(The way I understand it: Covered bonds are securities issued by a bank and backed by a dedicated group of loans – a “covered pool.” If the issuing bank becomes insolvent, the assets in the covered pool are separated from the issuer’s other assets solely for the benefit of the covered bondholder. This is the major difference between covered bonds and asset-backed securities. Loans backing a covered bond remain on the balance sheet and should the originating bank fail to make payments, interest payments from the underlying mortgages would go to investors.)
Anyway, Paulson’s attempt whiffed, reminiscent of a Dave Kingman strikeout – for you 1970s and 1980s baseball fans, because this is not that which market participants are currently concerned – at least regarding the here and now.
At risk of sounding repetitious, it is the uncertainty over the housing market and its effect on consumer behavior, questions over tax rates, and the possibility/likelihood that the Fed is ignoring price stability.
The housing market will simply take time to correct; after several years of outsized gains, there is nothing Congress or anything other than time can do to fix it. The Fed will do what they are going to do; this is not Paulson’s turf, so nothing he can really do there either. But this is the Treasury Secretary we are talking about, the appropriate person (after the President) to offer tax rate proposals.
What he should be doing is demanding that Congress make the tax rates on capital, dividends and income permanent – as permanent as Washington gets anyway. Follow that up with a proposal to cut the corporate income tax -- which has become one of the highest rates in the world as virtually every other serious country has cut this rate -- and vastly reduce the tax on repatriated income. (This income earned overseas will stay there so long as it is taxed at a 35% rate) You want to bring it home, cut this rate down to single digits; it will come home in droves.
This would combine beautifully with the increased current-year business equipment write-off allowance and bonus depreciation that was delivered in May, and by the way has kicked started business spending as we discussed yesterday. This combination would be a big job and productivity producer, but Paulson doesn’t get it, and thus the market will continue to send the message that he is not delivering what it wants.
Look, these are times the equity investor must deal with on occasion. But this economy is fundamentally sound; allow the housing correction to run its course, get monetary policy back in order and simply do not damage after-tax return expectations by driving tax rates higher and the market will get back on its horse We only need a little tweaking, U.S. businesses are more streamlined than anytime in history, able to compete and dominate on a global scale, but bad policy should not get in the way. Raise tax rates in this environment of intense global competition and you get your hat handed to you.
As of the latest count, there was $3.5 trillion sitting in money-market funds – plenty of capital out there. Give it a reason to come out of hiding and you’re looking at a powerful market run – long-lasting. That said, the equity investor will need patience here, but when things turn, it will make it all worth it.
Have a great day!
Brent Vondera, Senior Analyst
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