U.S. stocks gained ground yesterday, ending a two-day decline that had erased the previous six-session gain. Energy shares led the way as crude-oil rose for a third-straight day. Financials also enjoyed good results. The S&P 500 indices that track energy and financial stocks rose 2.77% and 1.67%, respectively.
It was interesting to see a trend broken yesterday as the market managed to gain ground even as consumer discretionary shares fell 0.55%. As we’ve been discussing, the direction of financial and consumer disc. shares has determined the path of the overall market on a daily basis for quite a while now.
Now if we can get the indices to gain ground even on days that financial shares fall, we may be moving past fears over the credit markets – maybe, just a thought. That said, credit spreads remain pretty wide and until those narrow, it will be tough for this trend to break. It is becoming easier though as financial shares make up just 14.4% of the S&P 500 Index today, down from 20.7% one year ago.
Market Activity for August 20, 2008
On oil, crude for October delivery remains well below the peak closing price of $145.29 hit on July 3, but has gained 4% over the past three sessions. Certainly Russia’s Cold War-like activity is not helping in this regard. I see they are calling themselves “peace-keepers” even as they pillage residential areas, destroy infrastructure, block ports and make L.A looters look like amateurs. They have moved well past South Ossetia and Abkhazia and into other cities, such as Gori – it is far from certain they’ll refrain from entering the capital, Tbilisi. I also see they have taken over the hydroelectric plant that provides much of Georgia’s power.
For those that remember the Cold War era, this looks quite familiar to what occurred in the Czech Republic and Poland in the 1960s and 1970s – it is the same playbook and their aim is clear: take over the Baku-Tbilisi-Ceyan pipeline – which is the only regional pipeline supplying Western Europe that the Russian’s do not yet have control over – and determine the future of Eastern Europe. NATO needs to step up or they risk becoming as feckless as the UN. The good news is this may rally support for Eastern European entry to NATO and hopefully sound the alarm to Western Europe to accept this needed result, which they have been blocking.
Moving on…
We were without an economic release yesterday, so I thought we’d touch on a topic that has been plaguing the market of late. There are a number of uncertainties that have hurt investor sentiment – the housing market – and the duration of that correction, inflationary pressures -- and future Fed action to control this situation, and geopolitical risks. The other major concern is the uncertainty over tax rates.
Lower tax rates on capital gains and dividends have been instrumental to the 64% rise of the S&P 500 (9.81% annualized) since March 2003 as it offered a boost to after-tax return expectations and provided the incentive to take on measured risk. The capital gains tax rate reduction -- from 20% to 15% at the federal level -- led to a 6.25% increase in the after-tax return of retained income for an additional dollar put at risk – as Larry Kudlow importantly pointed out a couple of days back.
The dividend tax cut raised after-tax income from this source dramatically as the rate was reduced to 15% from 39.6%, for those in the top tax bracket. Not counting state taxes, this meant an investor kept 85 cents on the dollar, as opposed to just 60.4 cents – a 40.7% incentive boost on an additional dollar put at risk. Needless to say that was enormous and explains why investors have demanded higher dividend payouts and the dividend component of the personal income data has soared. Make no mistake, this extra income does flow through to the rest of the economy by way of higher capital formation and thus higher innovation, productivity gains and jobs growth.
In terms of federal income tax rates on labor, one should know that small business makes up roughly 65% of those within the top tax bracket – this group is the largest job creator in the country. Raise their after-tax income growth (by reducing tax rates) and you get more jobs and higher levels of business investment over the long term.
This is why when a presidential candidate, or members of Congress, talks about raising these tax rates it has a significant effect on investor sentiment and the proclivity of investors to take risk. Raising the capital gains tax rate from 15% to 20% results in a 6% reduction in after-tax retained income for an additional dollar put at risk – from 85 cents on the dollar to 80 cents. Same is true for the dividend tax. Of course, if these rates are pushed even higher, as some have suggested to 28%, that after-tax income number becomes smaller.
In an attempt to justify these tax rate increases, proponents have stated that these rates are the same or less than where they were in the 1990s – most of which were big growth years as everyone knows.
But this not the 1995 global economy, the world is much more competitive today as there are more legitimate players and many countries have slashed their tax rates on income and investment. You try to raise tax rates – and thus lower the after-tax rate on investment and income – in this environment and it means you lose by way of competitiveness. These are the reasons this stuff is so important.
This morning we get initial jobless claims for the week ended August 16. It will be important to see this figure decline; it is not yet known the extent at which the government’s Emergency Unemployment Compensation Program has affected this reading, which has jumped. The BLS (Bureau of Labor Statistics) believes the impact may have peaked. Hopefully over the next couple of weeks we get a cleaner look and can surmise whether the monthly job losses will remain relatively tame or not.
Have a great day!
Brent Vondera, Senior Analyst
It was interesting to see a trend broken yesterday as the market managed to gain ground even as consumer discretionary shares fell 0.55%. As we’ve been discussing, the direction of financial and consumer disc. shares has determined the path of the overall market on a daily basis for quite a while now.
Now if we can get the indices to gain ground even on days that financial shares fall, we may be moving past fears over the credit markets – maybe, just a thought. That said, credit spreads remain pretty wide and until those narrow, it will be tough for this trend to break. It is becoming easier though as financial shares make up just 14.4% of the S&P 500 Index today, down from 20.7% one year ago.
Market Activity for August 20, 2008
On oil, crude for October delivery remains well below the peak closing price of $145.29 hit on July 3, but has gained 4% over the past three sessions. Certainly Russia’s Cold War-like activity is not helping in this regard. I see they are calling themselves “peace-keepers” even as they pillage residential areas, destroy infrastructure, block ports and make L.A looters look like amateurs. They have moved well past South Ossetia and Abkhazia and into other cities, such as Gori – it is far from certain they’ll refrain from entering the capital, Tbilisi. I also see they have taken over the hydroelectric plant that provides much of Georgia’s power.
For those that remember the Cold War era, this looks quite familiar to what occurred in the Czech Republic and Poland in the 1960s and 1970s – it is the same playbook and their aim is clear: take over the Baku-Tbilisi-Ceyan pipeline – which is the only regional pipeline supplying Western Europe that the Russian’s do not yet have control over – and determine the future of Eastern Europe. NATO needs to step up or they risk becoming as feckless as the UN. The good news is this may rally support for Eastern European entry to NATO and hopefully sound the alarm to Western Europe to accept this needed result, which they have been blocking.
Moving on…
We were without an economic release yesterday, so I thought we’d touch on a topic that has been plaguing the market of late. There are a number of uncertainties that have hurt investor sentiment – the housing market – and the duration of that correction, inflationary pressures -- and future Fed action to control this situation, and geopolitical risks. The other major concern is the uncertainty over tax rates.
Lower tax rates on capital gains and dividends have been instrumental to the 64% rise of the S&P 500 (9.81% annualized) since March 2003 as it offered a boost to after-tax return expectations and provided the incentive to take on measured risk. The capital gains tax rate reduction -- from 20% to 15% at the federal level -- led to a 6.25% increase in the after-tax return of retained income for an additional dollar put at risk – as Larry Kudlow importantly pointed out a couple of days back.
The dividend tax cut raised after-tax income from this source dramatically as the rate was reduced to 15% from 39.6%, for those in the top tax bracket. Not counting state taxes, this meant an investor kept 85 cents on the dollar, as opposed to just 60.4 cents – a 40.7% incentive boost on an additional dollar put at risk. Needless to say that was enormous and explains why investors have demanded higher dividend payouts and the dividend component of the personal income data has soared. Make no mistake, this extra income does flow through to the rest of the economy by way of higher capital formation and thus higher innovation, productivity gains and jobs growth.
In terms of federal income tax rates on labor, one should know that small business makes up roughly 65% of those within the top tax bracket – this group is the largest job creator in the country. Raise their after-tax income growth (by reducing tax rates) and you get more jobs and higher levels of business investment over the long term.
This is why when a presidential candidate, or members of Congress, talks about raising these tax rates it has a significant effect on investor sentiment and the proclivity of investors to take risk. Raising the capital gains tax rate from 15% to 20% results in a 6% reduction in after-tax retained income for an additional dollar put at risk – from 85 cents on the dollar to 80 cents. Same is true for the dividend tax. Of course, if these rates are pushed even higher, as some have suggested to 28%, that after-tax income number becomes smaller.
In an attempt to justify these tax rate increases, proponents have stated that these rates are the same or less than where they were in the 1990s – most of which were big growth years as everyone knows.
But this not the 1995 global economy, the world is much more competitive today as there are more legitimate players and many countries have slashed their tax rates on income and investment. You try to raise tax rates – and thus lower the after-tax rate on investment and income – in this environment and it means you lose by way of competitiveness. These are the reasons this stuff is so important.
This morning we get initial jobless claims for the week ended August 16. It will be important to see this figure decline; it is not yet known the extent at which the government’s Emergency Unemployment Compensation Program has affected this reading, which has jumped. The BLS (Bureau of Labor Statistics) believes the impact may have peaked. Hopefully over the next couple of weeks we get a cleaner look and can surmise whether the monthly job losses will remain relatively tame or not.
Have a great day!
Brent Vondera, Senior Analyst
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