U.S. stocks closed lower Wednesday as the credit markets remained disturbingly locked up, but the major indices recovered from the session’s lows as confidence grew the Senate would pass a “rescue plan” bill that may kick the House into gear to do the same.
Six of the 10 major industry groups lost ground yesterday -- industrial, basic material and information technology shares were hit the hardest. Financials, consumer staples, utilities and telecom shares were the gainers. The 2.15% gain among financial stocks is what held things up. Shares of Bank of America (up 8%), JP Morgan (up 6%) and Citigroup (up 12%) accounted for 68 Dow points – without the jump in these three members the index may have been down triple-digits.
Market Activity for October 1, 2008
And the Senate did pass a bill that has the TARP plan as its primary focus last night by a decisive margin of 74-25. Of course, the bill includes things that have nothing to do with the situation at hand, but that is Washington. However, it does include the extension of certain tax breaks and credits, an AMT patch, an increase in FDIC insurance to $250,000 and reiterates the authority the SEC has to suspend asset-valuing rules (mark-to-market accounting) that has exacerbated the problem to one that was manageable to one that has become a never-ending loop.
Now this moves to the House and I think the AMT patch is probably the component that gives the bill the best shot of passing – no one is going to want to vote against that. We’ll be watching to see what Congressman Shadegg says today, because he’s a very important member of the House and brings many along with him.
We’ll also point out that there’s a shot that this plan will work faster – and when I mean faster we’re talking about getting these assets sold off and resulting in a relatively quick return to the taxpayer (the Treasury Department). There will be an auction process (something the government is quite good at) that will set a price for these assets and once the Treasury take control and a price, or market, has been set we may find firms flow in to buy up these assets as they see the longer they wait the higher the price to acquire them. This would mean less money is made by the Treasury, or it may result in a loss, but it gets the program completed in short order and the cost won’t be anything close to the $700 billion everyone is focused upon. (I do not want anyone to think this commentary sets an expectation that this will occur, I just bring it up as a decent possibility. Further, if the House does pass this thing on Friday, the credit markets will not ease overnight. This will take some time, but the first step is necessary to take right now.)
From there we must concentrate on what got us here, starting with monetary policy mistakes and the Keynesian models that drive the FOMC, causing the Fed to lower fed funds to 1.00% in June 2003 even as the economy began to boom. (One can simply go the Federal Reserve website and read their minutes, they saw the economy rebounding, but simply because employment didn’t begin to bounce back by that point – as if this occurs on a dime anyway – they eased further.) It is these low rates – kept at 2.00% or below for three full years – that encouraged much of what we are now working to correct.
In addition, failure to pass more appropriate regulations on mortgage GSEs Fannie Mae and Freddie Mac certainly didn’t help. This was tried, but it was blocked. And as we’ve discussed many times the Community Reinvestment Act, specifically changes that took place in the mid-1990s – referring to subprime lending and hostile/politically fueled use of the term “redlining” --, has also contributed. Rounding it out are accounting rules that have only done harm. All of these things must eventually be addressed; a move in a different direction – as some are suggesting -- will only lead to more unintended consequences down the road.
Yesterday’s Data
On the economic front, the ADP employment report fell 8,000 for September – this is a preliminary number the market looks to for a sense of what will occur within the Labor Department’s monthly job report. This reading was much smaller than expected as a figure of minus 50,000 was the estimate.
ADP noted that the report does not include the Boeing strike (37,000 machinists) or the effects from Hurricanes Gustav and Ike. Then again, the Labor Department’s strike report showed zero workers for September so Friday’s jobs report won’t reflect that either – the September revision or the October data will reflect this. Surely, the Labor Department’s data will reflect the effect of the Hurricane’s.
Overall though, the ADP readings have not been a good indication over the past couple of years and I wouldn’t be surprised to see the figure dropped as something the market looks to as an indicator Specifically over the labor market contraction of the past nine months, the ADP readings have averaged a gain of 2,000 jobs per month, while the Labor Department’s figure has that monthly average at minus 75,000. Not a very good indication to say the least.
In a separate report, the ISM (Institute for Supply Management) Manufacturing Index fell to 43.5 – a level that reflects significant weakness. This reading marked the lowest level for ISM manufacturing since October 2001.
Heretofore, the manufacturing sector has held up remarkably well considering the double whammy of housing and auto-sector weakness. But it appears that business spending weakness in September has taken away much of the offset to those well-known areas of contraction. (While I was expecting a better ISM reading, we did point to the weakness in business spending in yesterday’s letter that has occurred suddenly. Part of this is due to the direct effects of the credit market trouble with regard to small businesses and the indirect effect regarding large businesses as the situation has increased their level of caution.)
Overall, I believe this can be transitory event as there is decent likelihood businesses are taking a wait and see approach right now. If the credit markets are freed up in quick order, the manufacturing sector will bounce back to something close to or mildly in expansion territory. If not, we will likely see this sector endure several months of meaningful weakness.
Below is a look at some of the sub-indices within the report:
Production was affected by weak metals, machinery and electrical equipment orders, segments that had shown strength over the previous few months. Still, the degree to which production declined is puzzling considering the strength in the Chicago PMI (factory activity in that region).
New orders were down big. Again, I believe this could prove transitory, but depends on the credit markets, and hence the TARP bill passage or elimination of mark-to-market death spiral.
Export orders remained in expansion mode even with European economic weakness of late.
Six of the 10 major industry groups lost ground yesterday -- industrial, basic material and information technology shares were hit the hardest. Financials, consumer staples, utilities and telecom shares were the gainers. The 2.15% gain among financial stocks is what held things up. Shares of Bank of America (up 8%), JP Morgan (up 6%) and Citigroup (up 12%) accounted for 68 Dow points – without the jump in these three members the index may have been down triple-digits.
Market Activity for October 1, 2008
And the Senate did pass a bill that has the TARP plan as its primary focus last night by a decisive margin of 74-25. Of course, the bill includes things that have nothing to do with the situation at hand, but that is Washington. However, it does include the extension of certain tax breaks and credits, an AMT patch, an increase in FDIC insurance to $250,000 and reiterates the authority the SEC has to suspend asset-valuing rules (mark-to-market accounting) that has exacerbated the problem to one that was manageable to one that has become a never-ending loop.Now this moves to the House and I think the AMT patch is probably the component that gives the bill the best shot of passing – no one is going to want to vote against that. We’ll be watching to see what Congressman Shadegg says today, because he’s a very important member of the House and brings many along with him.
We’ll also point out that there’s a shot that this plan will work faster – and when I mean faster we’re talking about getting these assets sold off and resulting in a relatively quick return to the taxpayer (the Treasury Department). There will be an auction process (something the government is quite good at) that will set a price for these assets and once the Treasury take control and a price, or market, has been set we may find firms flow in to buy up these assets as they see the longer they wait the higher the price to acquire them. This would mean less money is made by the Treasury, or it may result in a loss, but it gets the program completed in short order and the cost won’t be anything close to the $700 billion everyone is focused upon. (I do not want anyone to think this commentary sets an expectation that this will occur, I just bring it up as a decent possibility. Further, if the House does pass this thing on Friday, the credit markets will not ease overnight. This will take some time, but the first step is necessary to take right now.)
From there we must concentrate on what got us here, starting with monetary policy mistakes and the Keynesian models that drive the FOMC, causing the Fed to lower fed funds to 1.00% in June 2003 even as the economy began to boom. (One can simply go the Federal Reserve website and read their minutes, they saw the economy rebounding, but simply because employment didn’t begin to bounce back by that point – as if this occurs on a dime anyway – they eased further.) It is these low rates – kept at 2.00% or below for three full years – that encouraged much of what we are now working to correct.
In addition, failure to pass more appropriate regulations on mortgage GSEs Fannie Mae and Freddie Mac certainly didn’t help. This was tried, but it was blocked. And as we’ve discussed many times the Community Reinvestment Act, specifically changes that took place in the mid-1990s – referring to subprime lending and hostile/politically fueled use of the term “redlining” --, has also contributed. Rounding it out are accounting rules that have only done harm. All of these things must eventually be addressed; a move in a different direction – as some are suggesting -- will only lead to more unintended consequences down the road.
Yesterday’s Data
On the economic front, the ADP employment report fell 8,000 for September – this is a preliminary number the market looks to for a sense of what will occur within the Labor Department’s monthly job report. This reading was much smaller than expected as a figure of minus 50,000 was the estimate.
ADP noted that the report does not include the Boeing strike (37,000 machinists) or the effects from Hurricanes Gustav and Ike. Then again, the Labor Department’s strike report showed zero workers for September so Friday’s jobs report won’t reflect that either – the September revision or the October data will reflect this. Surely, the Labor Department’s data will reflect the effect of the Hurricane’s.
Overall though, the ADP readings have not been a good indication over the past couple of years and I wouldn’t be surprised to see the figure dropped as something the market looks to as an indicator Specifically over the labor market contraction of the past nine months, the ADP readings have averaged a gain of 2,000 jobs per month, while the Labor Department’s figure has that monthly average at minus 75,000. Not a very good indication to say the least.
In a separate report, the ISM (Institute for Supply Management) Manufacturing Index fell to 43.5 – a level that reflects significant weakness. This reading marked the lowest level for ISM manufacturing since October 2001.
Heretofore, the manufacturing sector has held up remarkably well considering the double whammy of housing and auto-sector weakness. But it appears that business spending weakness in September has taken away much of the offset to those well-known areas of contraction. (While I was expecting a better ISM reading, we did point to the weakness in business spending in yesterday’s letter that has occurred suddenly. Part of this is due to the direct effects of the credit market trouble with regard to small businesses and the indirect effect regarding large businesses as the situation has increased their level of caution.)
Overall, I believe this can be transitory event as there is decent likelihood businesses are taking a wait and see approach right now. If the credit markets are freed up in quick order, the manufacturing sector will bounce back to something close to or mildly in expansion territory. If not, we will likely see this sector endure several months of meaningful weakness.
Below is a look at some of the sub-indices within the report:
Production was affected by weak metals, machinery and electrical equipment orders, segments that had shown strength over the previous few months. Still, the degree to which production declined is puzzling considering the strength in the Chicago PMI (factory activity in that region).
New orders were down big. Again, I believe this could prove transitory, but depends on the credit markets, and hence the TARP bill passage or elimination of mark-to-market death spiral.
Export orders remained in expansion mode even with European economic weakness of late.
The prices paid index fell substantially, which is quite different from other manufacturing reports and general inflation gauges. The drop in ISM prices paid was due to a 41% plunge in scrap steel prices in the past month.
Lastly, the Commerce Department reported that construction spending came in flat for August – beating the expected 0.5% decline. Although, the July figure was revised lower to show twice the weakness as initially estimated so the two-month look isn’t a good one.
Private residential construction outlays have fallen 27% on a three-month annualized basis – faster than the 15% decline in the second quarter – so housing will again place a significant drag on Q3 GDP. You may be saying, “no kidding,” as if this wasn’t known. I bring this up because housing’s drag on last quarter’s GDP was only half what we’ve seen over the past couple of years, which gave some hope that a flattening out may take place soon. The housing data of late is showing this is a misguided hope.
Now private non-residential spending has shown weakness of late after providing a nice offset to the residential side of things for many months – that offset is over in my opinion. Construction spending is going to remain weak for some time – outside of a catalyst to boost the economy.
In addition to all of this credit-market stuff, and the government proposals to unclog the capital distribution channels, we need to seriously consider a broad look at tax rates. Eliminating or vastly reducing the repatriated tax and lowering the corporate income tax (not to mention cap gain, dividends and labor income rates) can reverse this course and lead us out of the current funk. I realize this may be unrealistic in the current political climate, I’m just stating these actions would provide a big boost to economic growth, the stock market and capital formation – which eventually flows through to construction activity.
Have a great day!
Brent Vondera, Senior Analyst
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