Daily Insight

U.S. stocks got clocked again yesterday, marking back-to-back 5% declines, after Cisco Systems reported its first revenue decline in five years and a reduction in outlook, increasing concerns over global growth and fourth-quarter earnings results. The two-day slide is the worst since 1987.

While the current earnings season (third-quarter) is shaping up better-than-expected, ex-financial profits are up a strong 16.3%. The problem now is this quarter’s results will show the effects of the economic deterioration that followed the Lehman Brothers collapse in mid September and the credit-market disturbance that ensued.

Putting additional pressure on stocks is the expectation that the October jobs report will show payrolls declined by 200,000 positions – and it may be as bad as 250,000. We believe current valuations already reflect these events, as the very broad NYSE Composite trades at 13 time trailing 12-month earnings, but in the current environment fundamentals have been thrown from the train. Hedge funds continue to deal with redemption calls and as they sell to raise cash mutual-fund investors bail, exacerbating the plunge.

Market Activity for November 6, 2008

Global Rate Cuts and the Dollar

Wow! The Bank of England (BOE) slashed their benchmark interest rate by 150 basis points (or 1.50 percentage points) and the ECB (European Central Bank) cut its rate by 50 basis points as they try to catch up to our Fed’s degree of rate cutting – good luck keeping up with that pace. The BOE rate reduction is the largest since 1992 and the current 3.00% level on what is called the Bank Rate is the lowest they’ve had it since 1955.

This is all part of the coordinated effort global central banks are now engaging in as they attempt to ease the credit-market disturbance that took hold last month. As a result, the US dollar is in rally mode again, rebounding from the recent pullback.


The Economy

On the economic front, the Labor Department reported initial jobless claims for the week ended November 1 fell 4,000 but remains elevated at 481,000. We’re likely to see this reading move above the 500,000 mark and thus surpass the level we saw during the 2001 downturn.

The states reporting an increase in claims relative to those reporting a decrease reversed course to return back to the ratio we saw two weeks ago – 40 stated and territories reported an increase/13 reported a decline.

The general theme was cuts in construction, manufacturing and transportation employment. Pennsylvania, California, Illinois and Ohio were the hardest hit. Texas and Tennessee bucked the trend as these states saw relatively large decreases in claims


Continuing claims rose to the highest level in 25 years, which shows laid off workers are having a more difficult time finding new employment. Of course, Congress keeps extending the period with which one can collect jobless benefits, so this has an effect as well.

While the continuing claims number is very elevated it is important to note that the labor force is much stronger today. For instance, back in 1983 the labor force stood at 112 million and by the 1990-1991 recession it was 126-million strong. Today the labor force is 154 million, so jobless and continuing claims of this magnitude are not what they used to be. The thing to focus on is whether or not we hit a number that is comparable to previous periods of weakness as we adjust for the rise in the workforce pool – we’d have to get to about 600,000 on initial claims and 4.5 million in continuing claims to match those previous levels.

This news is just another clear indication monthly payroll losses are going to be ugly over the next few months, but we’ll get through it assuming no major mistakes out of Washington that prolongs the situation – always a big if.

Proper Way to Stimulate

With all of this stimulus talk out there all we keep hearing about is the same old Keynesian-style rebate-check/public works/jobless benefit schemes that have proven to be nothing but feckless in the past. But this is no surprise as the current make-up of Washington, and certainly its structure after January 20, lives for this type of government spending. We hope they reconsider…oh, to dream.

What we need to do is implement polices that spur economic growth and the most efficient and lasting way to do this is by slashing marginal tax rates on income and capital. As has been true every time it’s implemented, this will kick start capital formation, which leads to more innovation, higher levels of productivity, increased competitiveness and more jobs.

Following the path of Keynesian-style “stimulus” is a clear sign Congress doesn’t get it. Engaging in the following proposal will get this economy rolling again as activity on the business and capital side more than offset the easing in debt ratios (and thus activity) for both consumers and the financial industry.

Besides leading to a lasting period of above-trend growth – assuming the Federal Reserve gets its act together; nothing can work if they don’t focus on price stability first and foremost over the next several years – the agenda below will result in a massive increase in federal tax revenue and allow us to meet the challenges of the future: (Even if few know it because the financial press has chosen not report it the broad-based tax cuts of 2003 resulted in the largest inflation-adjusted three-year explosion in tax receipts ever – up $785 billion for the fiscal years that ran 2005-2007.)

Move back to just two federal income tax brackets, ala 1986, this time 10% and 25% and make the current increased yearly allowance for business spending write-offs permanent (as of now this expires in January 2009) – you can bet on job creation to follow this change. (Slashing the top brackets down to 25% -- 75% of this make-up are small business taxpayers -- would be huge.

Cut the capital gains tax in half and watch the cost of capital fall, while the Treasury is inundated with tax receipts as investors unlock old investments for new.

• Cut the dividend tax rate further and – in addition to the new capital gains tax rate – the stock market will get on its horse.
• Cut the corporate tax rate and remove all doubt that the U.S. is the greatest place in the world to headquarter. You’ll get a two for one benefit as corporate profits rise and prices fall – corporate taxation is ultimately passed on to the consumer.
• Eliminate the dead-weight loss which is the repatriated tax and watch capital that is currently hiding overseas to escape this taxation come home to provide billions in funds for R&D, equipment spending and stock buybacks.
• Double the child tax credit, which should help long-term demographic issues and in the meantime help the labor force keep more of its own earnings

This is the prescription that is needed. We can fiddle around with an agenda that offers short-term stimulus only to see the give back in the following quarter or we can get serious. It is time to get serious.

Have a great weekend!



Brent Vondera, Senior Analyst