U. S. stocks were pounded again yesterday and frankly I’m not buying the claim that this is because of poor earnings assumptions. Stocks have priced in these earnings assumptions and a substantial recession at this point. Yes, there is uncertainty over how badly profit results will be affected by this mess a quarter or two out, but heavens the broad market is down 42% from the peak – it’s priced in at this point. At least some of this move is about the election.
Credit markets are in the process of thawing, so we don’t have that to blame right now, certainly not to the degree we could a week ago. Uncertainty, or rather near certainty that market-sensitive tax rates will erode after-tax return expectations, is causing additional damage as a de-leveraging event may still be playing out.
Certainly, the economic damage locked up credit markets have wrought continues to pressure stocks. For each 5% move lower – and that’s not a scientific trigger point, I’m just throwing a figure out there – hedge funds and mutual funds receive additional redemption calls, and must sell stocks as a result.
Yet, the bounce off of the lows of the session yesterday does not suggest the move was due solely to this phenomenon. When redemption calls drive these sell offs we see erosion increase to the close, that didn’t occur on Wednesday.
Market Activity for October 22, 2008
The S&P 500 is back to levels not seen since April 2003, and June 1997 when the broad market hit this level for the first time – a round-tripper.
However, we are holding above the 849 intra-day low in terms of the S&P 500 and 7890 for the Dow, which were hit on October 10. I’m not going to pretend to be a technician, but the longer we hold above those levels the better.
It isn’t fun going no where for a decade. But multiples continue to compress and history shows after round-trippers of this duration, the Great Depression being the exception, it isn’t long before a sustained rally takes hold. This multiple compression action is an important one.
When we hit this level for the first time back in 1997 the broad market traded at a P/E of 23 times earnings and after-tax profits were about to go flat (many don’t know this but after-tax corp. profits declined Q3 1997 to the end of the decade). When we touched this level again in 2003, the index was trading at 30 times, after-tax corporate profits were in the process of an extraordinary five year growth run. Currently, the S&P 500 trades at 18 times trailing profits. Based on profit expectations for the next four quarters, the index trades at just 11 times – assuming profit growth expectations are off the mark by a huge 50%, you still have a forward P/E of just 14.
Problem is we may have some policies that aren’t exactly market-friendly to deal with. Further, a President Obama will be tested by our enemies (which Senator Biden has now warned us of, was he privy to a recent intelligence report suggesting this?), which could delay that sustained rally we’re all hoping far. It’s unfortunate we must rely on hope, but when no one is going to step up with a sensible fiscal policy response, that’s all you’ve got.
This is where the current administration takes the blame. With all that has been said, what got us here is hardly Bush’s fault; plain and simple the origin of this situation is Federal Reserve monetary policy mistakes – keeping rates too low for too long. (What were they thinking as they continued to cut fed funds to 1.00% in June 2003 even as the economy began to come back in 2002 and was rolling by the spring of 2003?) In fact, the Bush tax cuts (on income, dividends, capital gains, repatriated income and business write-off allowances) helped us withstand a 178% jump in the price of oil (mid 2003-mid 2005) – even before the super-spike occurred two years later – and housing’s drag on the economy that has lasted for 2 ½ years now.
However, for the administration to ignore a tax-rate policy response to the current troubles is mind-boggling. We’ve thrown everything at this issue – and for sure much of this does not have an immediate effect, but will in time – yet to hold back on the most powerful policy tool there is strange. So President Bush fears he doens’t have the numbers to get it through Congress, what does it hurt to try your darnedest?
On to better thoughts -- The Greenback
Wow! The dollar continues to soar. Wonder if Giselle is ready to accept US dollars as compensation again?
Another Congressional Lashing
Ratings agency executives were on Capitol Hill attempting to defend yet another berating by those who hold themselves up to be as pure as the wind-driven snow yesterday.
Funny how regulators never come under attack. For instance when the SEC’s regulatory division head (Annette Nazareth) decided it was a good idea to switch from fixed capital ratio standards to “sophisticated” Basel II mathematical models in the middle of a housing boom it didn’t’ turn out to be an award-winning idea. But few are talking about that terrible mistake. Doing so when housing was on fire, thanks to Greenspan’s recklessly easy money policy – effectively subsidizing debt –, meant that highly rated mortgage–backed securities were treated as if they were nearly as safe as cash. This meant less capital was required – a major source of the current problem. I don’t recall those now pointing the finger at the private sector questioning this regulatory move back then.
No doubt the ratings agencies are guilty as charged, but it’s not like moronic regulatory decisions have not played a major role. The next time someone sells you on something because of its sophistication, run!
This morning we get back to data. It’s Thursday, so we’ll be watching the jobless claims release for the week ended October 18– it’s not likely to be pretty but will hold below the peaks of the past two labor-market downturns.
Have a great day!
Brent Vondera, Senior Analyst
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