Daily Insight

What a difference a year makes. It was a year-ago today the Dow Industrials Average and S&P 500 indexes touched their all-time high – 14,164 on the Dow and 1565 on the S&P 500. Nine-trillion dollars in stock-market value was created during the bear market that began in the spring of 2003 to that peak, as measured by the NYSE Composite – today that rise in stock-market wealth stands at 44% of that figure, 4.16 trillion.

U.S. stocks bounced around again yesterday – and the swings were significant – but we gained momentum going into the afternoon session and appeared poised to close strong. But then Treasury Secretary Paulson stepped to the microphone and…well, the same thing happened that occurs just about every time a government official open his mouth, the rally fizzled. (And no, I’m not being sexist here because the pronoun is correct; I won’t disparage the other gender because when FDIC Chair Sheila Bair speaks the stocks market does not retreat.)


I’ve been pretty hard on Paulson in the past – he’s weak on the dollar, failed to convene the G7 as the FOMC was digging a larger hole for the greenback and has offered zero with regard to a tax-rate response to this entire mess – big mistake.

But what he’s proposed with the TARP plan has a great shot of freeing up the credit markets – assuming the auction does not end up being rigged, can’t rule that out; this is the government we’re speaking of. Really though, you’ve got TARP passed and signed, please don’t step to the mic. again until you’ve got something constructive to say and your ducks are in a row to buy, buy, buy.

Market Activity for October 8, 2008 At midnight the short-selling ban expired, that ban pertained to something like 800 stocks, and conventional wisdom may assume this will result in more pressure for stocks. Not sure about that though, the indices may rally on the news as hedge funds come back in to buy now they have more freedom with putting proper hedges in place. These market participants may have sat out while the ban was in place.

IBM announced quarterly results earlier than expected, stating operating earnings rose 22% last quarter and margin growth was strong, widening to 43.3% from 41.3 a year ago. Revenue growth was a little light, surely the woes in the financial sector have caused some issues, but it was a good decision to pre-announce in this environment lest rumors take over and crush your stock.

Overall earnings will be weak for the quarter, no getting around that, but maybe tech-land will be stronger than most expected.

On the economic front, the National Association of Realtors (NAR) stated pending home resales unexpectedly rose 7.4%, as the median price of existing homes fell sharply in August.

One has to expect home sales to fall further, especially with how locked up the credit markets are, but mounting foreclosures are helping the sales data and this may help to offset the credit-market issues – pending home sales are an arbiter of the direction sales will take over the subsequent two months when these contracts close.

By region, pending sales were up 2.3% in the South, 3.6% in the Midwest, 8.4% in the Northeast and soared 18.4% in the West.

Digressing

I ran across an article Monday night that stated how the slide in home prices has left nearly 16% of homeowners with a higher mortgage than the home is currently worth. (I’m not sure all of this is because of the fall in home prices, as a decent percentage of these people have been in their current home for several years – and home prices are higher going back to mid-2004 --, but rather because they took advantage of home-price gains in previous years to refinance and take cash out. Others of course put no money down and so it doesn’t take much to go underwater – it is pathetic though to see so many just walk away, not even trying to make the payment – as if the price of the property will not rise over the longer-term)
Anyway, the article points to the need to offer programs to these individuals to keep them in their homes.

No. What we have here is a total neglect of obligations – complete irresponsibility.

These people must not be bailed out in a direct way – of course a series of government action will bail those that made really bad decisions in an indirect way, but it may also insulate the rest of us from going down with them. The Treasury’s TARP program will offer indirect assistance to those that made bad choices, but this program is essential so that those that have lived their lives responsibly are not harmed by a bevy of mistakes made by the Fed, Congress and individuals themselves.

The most effective solution to this situation is three-fold as I see it:

• One, TARP is essential. These troubled assets must be removed from bank balance sheets.



• Two, the SEC and FASB must at least modify mark-to-market accounting – and hopefully kill the wretched rule, that is FASB rule 157.



• Three, broad-based tax cuts are imperative. Reductions in capital gains, dividends, labor income, repatriated income and corporate earnings will spark growth, increase earnings and after-tax income, rally stocks, bring more capital home, boost tax receipts, and promote jobs.

Many continue to miss the fact that broad-based reductions in tax rates do result in more tax revenue – the evidence is there; one only needs to review what occurred in the 1960s, 1980, late 1990s and the current epoch, save the last year as corporate profits have been hurt by financial-sector woes, a rebate check scheme immediately added $175 billion to the 2008 deficit and everything that has occurred since.

But we shouldn’t forget that the three fiscal year running 2005-2007 saw the largest rise in tax revenue ever, jumping $785 billion in that three-year period. Let’s not forget, the 2007 budget saw the deficit narrowed to just 1.2% of GDP from 3.9% in 2004 after the downturn of 2001 and trillion dollar hit to the economy from the 9/11 attacks.

Cutting tax rates in a broad-based way increases revenue for two main reasons:

One, with regard to capital gains more investors are willing to pay the tax at a lower rate – we all know this story. Further the after-tax return expectations that result push stock prices higher, which results in additional gains – lower dividend tax rates have the same result.

Two, lowering income tax rates means higher after-tax income, which promotes growth. Also, and what many fail to acknowledge, is that two-thirds of the top tax bracket is made up of small businesses, and as after-tax profits rise for the largest job creator within our economy they hire more – thus increasing the tax base.

So lower tax rates are vital to growth, both for the private sector and in terms of tax revenue. We face many challenges over the next couple of decades and growth will be essential to meet those challenges.

Have a great day!


Brent Vondera, Senior Analyst