U.S. stocks dropped Friday after a wild ride that saw the broad market advance 3.4% during the morning session only to fall 4.7% from that intra-day peak – as the chart below illustrates.
The morning session’s euphoria was based upon the strong likelihood the TARP plan would pass the House, but once it did the benchmark indices fell sharply as the market focused on the September jobs report and the fact that there is no way to prevent a recession at this point. The effectiveness of the TARP plan, along with more traditional policy responses, will determine whether the downturn is mild or severe – more on that below.
The S&P 500’s performance last week was the worst since the 2001 terrorist attacks – the index lost 9.3%. The NYSE Composite – one of the broadest looks at U.S. stocks – fell 10.16% last week, also just slightly less than 11.24% decline the week stocks opened after the 9/11 attacks. People are beginning to realize that the TARP plan is not about “bailing out Wall Street” – as so many in the press have led people to believe – but about stopping the damage from spreading to everyone else, most of whom have lived their lives in a responsible way.
The credit markets remained locked up Friday, but we didn’t expect this to turn on a dime simply because the government’s rescue plan was passed and signed. It will take some time, but as the assets that are clogging things up come off of the balance sheets, things should improve. The extent of the improvement will determine the degree and duration of the downturn.
Market Activity for October 3, 2008
The Citigroup/Wachovia news got interesting Friday as Wells Fargo offered to pay $15.1 billion for Wachovia, or $7 per share. This gets tricky because Citigroup supposedly has an exclusivity agreement that forbade Wachovia from talking to another firm.
Wells clearly saw the TARP plan was on its way to passage and since they would be able to unload the troubled assets of Wachovia as a result, decided to throw in their bid – a far superior deal to botht he shareholder and the government. Under the Wells deal shareholders would get $7 per share (clearly still largely wiped out from where the stock had come from but a major improvement to the $1 per share from the Citigroup deal. Further, the FDIC wouldn’t be on the hook, which was not the case with the Citigroup workout.
Where it seems to stand now is some sort of split up between Wells and Citigroup based upon geographic lines.
On the economic front, the Labor Department reported 159,000 payroll positions were lost in September, which is a figure that is more in line with the typical labor market downturn – prior to this latest number, as most readers know, the monthly job losses had been mild from a historical perspective.
As the chart below shows, we normally see monthly jobs losses that move below the 200,000 level and while September’s data remained above this mark, it’s the closest we’ve come to that level of deterioration thus far.
Year-to-date, the economy has shed 760,000 payroll positions, or 9.5% of the total created since 2003. This is beginning to become significant and considering how locked up the credit markets have become over the past three weeks, one must expect this figure to get worse.
Basically every industry of last month’s employment report looked bad, except – as has been the case throughout this downturn in jobs --, education and health services. These segments have added 451,000 positions year-to-date.
Construction and transportation have been among the hardest hit as the unemployment rates for these two industries jumped from the year-ago period. For construction, the unemployment rate increased from 5.8% in September 2007 to 9.9% currently. The unemployment rate for the transportation industry increased from 3.9% a year ago to 5.8% last month.
The segments (not to be confused with industries) that have been hardest hit are teenagers – where the unemployment rate has risen from 16.0% a year ago to 19.1% and the self-employed – where unemployment has increased from 2.8% to 3.9%,
Overall Economy
In terms of the overall economy, everything has changed over the past three weeks – the turning point was when Lehman went down on September 15; the credit markets froze up.
We’ve gone from a situation in which things were significantly stronger than most had portrayed -- credit continued to flow (of course, less available than before but with much more appropriate standards), business spending had bounced back in strong fashion, factory activity remained upbeat and incomes were rising at a nice clip all things considered -- to an environment where most of these things have shut down. (Income growth remains on a nice trend – although flat in real terms due to high inflation --, but these other aspects have reversed course.)
Now we have job losses picking up to recessionary levels and what appeared to be shaping up as a 2.0% real growth quarter just three weeks back has changed to something flat or worse currently.
Government policy needs to go on the attack both from a perspective of dealing with the troubled assets that have led to the freeze up of credit distribution channels and purely from a framework of economic policy.
The TARP plan has now been passed and signed and if done right, and relatively free from Congressional intrusion, this auction process should work to create a market and pricing mechanism for these assets. We’ll note, while the government is pretty inept at managing just about everything, they are very good at holding auctions and have a good history of the type of auctions that will be held for these assets, from what I’ve learned about the issue. Moreover, they will be able to finance this plan at very low interest rates, increasing the likelihood Treasury will make money off of this plan.
Along with that plan, we must eliminate FASB rule 159 (mark-to-market accounting) especially with regard to the basis of capital adequacy ratios – and the TARP plan does have a provision to look at this and modify it. From here, we must net present value these assets. This will include in the valuation process the cashflows that run off of these assets, something rule 159 ignores.
(We see news broke last night that Europe is beginning to take action as well. They are now providing blanket guarantees on deposits and are looking at doing away with mark-to-market as well. Just to clarify, mark-to-market is used in many circumstances, what we’re talking about here is the appropriate basis with which to determine capital adequacy for financial firms. On this topic, mark-to-market is nothing but harmful.)
On the economic policy front, it’s time to stop playing around and drive tax rates down across-the-board. In basketball terminology, it’s time for “40 minutes of hell.” Cut fed funds further? Please. We’re talking about substantive action here and only tax policy can deliver the big-bang boost that is needed.
I do not express the urgency of this because of the 159,000 job losses for September, but rather because the frozen credit markets will cause this figure to become much worse. Small businesses will be eliminating many more jobs – there is no getting around this for now. What we must thwart is a spiral of job-market deterioration that will ensue if the flow of capital and credit is not freed.
In order to spark activity in the face of current caution with regard to large businesses and lack of short-term credit for the small businesses we must drive down the income tax rates – two-thirds of the top tax bracket is made up of small business – and the corporate tax. Drive these rates lower and you expand after-tax profits, which leads to more jobs and a larger tax base – more government revenue. (The benefit to the private sector would occur very quickly. In terms of government revenues, it will take a year to begin funneling in, but this will result in substantially more receipts that if we were to do nothing in this regard.)
Further, the repatriated tax must be eliminated. This will bring capital that is currently residing overseas to escape this tax to come back home. After a year or so we can get this rate back to 5% or so, but the 35% that is currently levied on these funds is not helpful.
The capital gains rate must at least be halved. Igniting the stock market right now is essential both from the standpoint of confidence and from an overall net worth scenario. It will take some time for the job market to improve again, but by igniting a stock market rally consumer activity will begin to pick up as both confidence and wealth are boosted. In terms of government revenues, this tax rate change will be felt immediately as investors unlock old investments – willing to pay this lower tax – and will move those funds into new investments.
If these actions are taken, we can thwart what a reckless monetary policy has wrought – particularly speaking of the FOMC’s decisions during the 2003-2005 period – and we can escape the worst of this situation. And once we get past this, tax rates and overall policy will be positioned to help the U.S. economy reach its intrinsic growth potential.
I realize this all seems unrealistic at this time. During this election cycle class warfare has hit a crescendo, but as more and more people see how this situation affects everyone, now is exactly the time to propose such measures.
Have a great day!
Brent Vondera, Senior Analyst
The morning session’s euphoria was based upon the strong likelihood the TARP plan would pass the House, but once it did the benchmark indices fell sharply as the market focused on the September jobs report and the fact that there is no way to prevent a recession at this point. The effectiveness of the TARP plan, along with more traditional policy responses, will determine whether the downturn is mild or severe – more on that below.
The S&P 500’s performance last week was the worst since the 2001 terrorist attacks – the index lost 9.3%. The NYSE Composite – one of the broadest looks at U.S. stocks – fell 10.16% last week, also just slightly less than 11.24% decline the week stocks opened after the 9/11 attacks. People are beginning to realize that the TARP plan is not about “bailing out Wall Street” – as so many in the press have led people to believe – but about stopping the damage from spreading to everyone else, most of whom have lived their lives in a responsible way.
The credit markets remained locked up Friday, but we didn’t expect this to turn on a dime simply because the government’s rescue plan was passed and signed. It will take some time, but as the assets that are clogging things up come off of the balance sheets, things should improve. The extent of the improvement will determine the degree and duration of the downturn.
Market Activity for October 3, 2008
The Citigroup/Wachovia news got interesting Friday as Wells Fargo offered to pay $15.1 billion for Wachovia, or $7 per share. This gets tricky because Citigroup supposedly has an exclusivity agreement that forbade Wachovia from talking to another firm.Wells clearly saw the TARP plan was on its way to passage and since they would be able to unload the troubled assets of Wachovia as a result, decided to throw in their bid – a far superior deal to botht he shareholder and the government. Under the Wells deal shareholders would get $7 per share (clearly still largely wiped out from where the stock had come from but a major improvement to the $1 per share from the Citigroup deal. Further, the FDIC wouldn’t be on the hook, which was not the case with the Citigroup workout.
Where it seems to stand now is some sort of split up between Wells and Citigroup based upon geographic lines.
On the economic front, the Labor Department reported 159,000 payroll positions were lost in September, which is a figure that is more in line with the typical labor market downturn – prior to this latest number, as most readers know, the monthly job losses had been mild from a historical perspective.
As the chart below shows, we normally see monthly jobs losses that move below the 200,000 level and while September’s data remained above this mark, it’s the closest we’ve come to that level of deterioration thus far.
Year-to-date, the economy has shed 760,000 payroll positions, or 9.5% of the total created since 2003. This is beginning to become significant and considering how locked up the credit markets have become over the past three weeks, one must expect this figure to get worse.
Basically every industry of last month’s employment report looked bad, except – as has been the case throughout this downturn in jobs --, education and health services. These segments have added 451,000 positions year-to-date.
Construction and transportation have been among the hardest hit as the unemployment rates for these two industries jumped from the year-ago period. For construction, the unemployment rate increased from 5.8% in September 2007 to 9.9% currently. The unemployment rate for the transportation industry increased from 3.9% a year ago to 5.8% last month.
The segments (not to be confused with industries) that have been hardest hit are teenagers – where the unemployment rate has risen from 16.0% a year ago to 19.1% and the self-employed – where unemployment has increased from 2.8% to 3.9%,
Overall Economy
In terms of the overall economy, everything has changed over the past three weeks – the turning point was when Lehman went down on September 15; the credit markets froze up.
We’ve gone from a situation in which things were significantly stronger than most had portrayed -- credit continued to flow (of course, less available than before but with much more appropriate standards), business spending had bounced back in strong fashion, factory activity remained upbeat and incomes were rising at a nice clip all things considered -- to an environment where most of these things have shut down. (Income growth remains on a nice trend – although flat in real terms due to high inflation --, but these other aspects have reversed course.)
Now we have job losses picking up to recessionary levels and what appeared to be shaping up as a 2.0% real growth quarter just three weeks back has changed to something flat or worse currently.
Government policy needs to go on the attack both from a perspective of dealing with the troubled assets that have led to the freeze up of credit distribution channels and purely from a framework of economic policy.
The TARP plan has now been passed and signed and if done right, and relatively free from Congressional intrusion, this auction process should work to create a market and pricing mechanism for these assets. We’ll note, while the government is pretty inept at managing just about everything, they are very good at holding auctions and have a good history of the type of auctions that will be held for these assets, from what I’ve learned about the issue. Moreover, they will be able to finance this plan at very low interest rates, increasing the likelihood Treasury will make money off of this plan.
Along with that plan, we must eliminate FASB rule 159 (mark-to-market accounting) especially with regard to the basis of capital adequacy ratios – and the TARP plan does have a provision to look at this and modify it. From here, we must net present value these assets. This will include in the valuation process the cashflows that run off of these assets, something rule 159 ignores.
(We see news broke last night that Europe is beginning to take action as well. They are now providing blanket guarantees on deposits and are looking at doing away with mark-to-market as well. Just to clarify, mark-to-market is used in many circumstances, what we’re talking about here is the appropriate basis with which to determine capital adequacy for financial firms. On this topic, mark-to-market is nothing but harmful.)
On the economic policy front, it’s time to stop playing around and drive tax rates down across-the-board. In basketball terminology, it’s time for “40 minutes of hell.” Cut fed funds further? Please. We’re talking about substantive action here and only tax policy can deliver the big-bang boost that is needed.
I do not express the urgency of this because of the 159,000 job losses for September, but rather because the frozen credit markets will cause this figure to become much worse. Small businesses will be eliminating many more jobs – there is no getting around this for now. What we must thwart is a spiral of job-market deterioration that will ensue if the flow of capital and credit is not freed.
In order to spark activity in the face of current caution with regard to large businesses and lack of short-term credit for the small businesses we must drive down the income tax rates – two-thirds of the top tax bracket is made up of small business – and the corporate tax. Drive these rates lower and you expand after-tax profits, which leads to more jobs and a larger tax base – more government revenue. (The benefit to the private sector would occur very quickly. In terms of government revenues, it will take a year to begin funneling in, but this will result in substantially more receipts that if we were to do nothing in this regard.)
Further, the repatriated tax must be eliminated. This will bring capital that is currently residing overseas to escape this tax to come back home. After a year or so we can get this rate back to 5% or so, but the 35% that is currently levied on these funds is not helpful.
The capital gains rate must at least be halved. Igniting the stock market right now is essential both from the standpoint of confidence and from an overall net worth scenario. It will take some time for the job market to improve again, but by igniting a stock market rally consumer activity will begin to pick up as both confidence and wealth are boosted. In terms of government revenues, this tax rate change will be felt immediately as investors unlock old investments – willing to pay this lower tax – and will move those funds into new investments.
If these actions are taken, we can thwart what a reckless monetary policy has wrought – particularly speaking of the FOMC’s decisions during the 2003-2005 period – and we can escape the worst of this situation. And once we get past this, tax rates and overall policy will be positioned to help the U.S. economy reach its intrinsic growth potential.
I realize this all seems unrealistic at this time. During this election cycle class warfare has hit a crescendo, but as more and more people see how this situation affects everyone, now is exactly the time to propose such measures.
Have a great day!
Brent Vondera, Senior Analyst
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