The latest manufacturing data showed factory activity in the New York Federal Reserve Bank region remained very depressed, which certainly didn’t help investor sentiment, but this isn’t really news. Yes, the employment gauge tied to this index fell to the lowest level since 2001 (for context, this survey has only been around since 2000), but no one expected the labor market to bounce back in quick order. In fact the expectation is for another 250,000 decline in payrolls for the November survey, as the jobless claims figured indicate.
What’s missing is a tax-rate response; investors are begging for it, yet all we hear is an agenda to increase unemployment benefits, foods stamps, checks to those that do not pay federal income taxes (a.k.a. handouts) and infrastructure projects – projects that just shift jobs instead of creating them.
There’s only one way to actually create jobs: sustained economic growth. To accomplish this worker productivity must rise, which means the cost of capital must remain at a reasonable level. The most efficient way to keep the cost of capital low is to lower that which burdens the formation of capital – tax rates.
In reality, we may not even need reduced tax rates to inspire some confidence right now, just clear statements that tax rates on labor income and capital are not going higher, and thus will not erode after-tax return expectations. Heaven knows expectations are already in the dirt, this just compounds the situation.
Market Activity for November 17, 2008
News over the weekend that economies in Asia and Europe have officially slid into recession didn’t help psychology either, but it’s not like the equity markets have not priced this weakness in – the Dow Jones Industrial Average is 41% off its peak, the S&P 500 is off by 45% and the very broad NYSE Composite has lost 49%. The credit event that hit in September did major damage to the global economy, but the marketplace is fully aware of this cause and effect. Investors have moved on to worry that what should be a 12 month event will be prolonged by failed initiatives. This is really pathetic. It’s a pathetic display by the current political leaders and it’s a pathetic display by those that will take the helm in January.
The Treasury is in the process of using half of the $700 billion via the TARP plan to re-capitalize financial institutions. The Federal Reserve has more than doubled its balance sheet and vastly increased its level of risk to provide the system with massive amounts of liquidity. Yet, we choose to not even propose a tax-rate response in addition to these other actions? This makes zero sense; you don’t hold back on the most accurate and immediate policy tool in your arsenal. We need confidence and nothing drives confidence like a sustained stock-market rally – lower the tax rates on capital gains, dividends and corporate and individual incomes and the response is immediate. By neglecting this tool; by not even proposing such action, is a very big mistake.
The Economy
On the economic front, the New York Federal Reserve Bank released its manufacturing index for November, which showed factory activity remained very weak. Although, expectations for a nice pick up six months out appear to be rising.
The Empire Manufacturing index posted its third-straight negative reading, coming in at -25.43 in November after October’s -24.62. The index arrived at a reading of -25.43 as 43.9% of respondents reported a decrease in activity, while 18.5% reported an increase – 37.5% stated activity was unchanged.
The sub-indices that offer some picture of the next couple of months worth of readings came in very we also as the new orders and unfilled orders indices worsened.
The employment index exhibited the sharpest drop, falling to its lowest level since December 2001 – another bad sign for November payrolls; the initial jobless claims figure surpassed the 500k mark last week and now this number is another indication the November jobs report will be every bit as bad as the October reading.
All of that said, we will really have to wait for the Chicago and ISM manufacturing surveys – Chicago being the largest region for factory activity and the ISM being the national look – as Empire has not proven to be the best indicator in the past. Still, due to the level of weakness in Empire it’s clear the extremely depressed state of economic activity in October, extended into this month.
In a separate report, the Commerce Department reported that industrial production bounced back nicely from September’s weak report, although the bounce was due to weather and strike-related events in the prior month that caused the reading to post its largest decline in 59 years.
Industrial production easily surpassed the 0.2% expectation, jumping 1.3% for October after a horrendous downwardly revised 3.7% decline in September (the September reading was previously estimated to be down 2.8%) due to weather and strike-related forces as Hurricane Ike forced the shutdown of Gulf-coast energy production and the Boeing strike made the level of change from the prior reading plummet.
For October though things bounced back nicely as mining (largely oil and gas extraction) and utility output stormed back. Mining activity jumped 6.1% in October, following a hurricane-related 8.5% plunge during September.
Consumer goods production rebounded to post a 1.3% rise after falling 1.1% in the previous month. Business equipment production fell 2.2%; however, this was an improvement from the 7.1% decline in business-equipment production during September as the level of change was affected big time by the Boeing strike that began on September 2. This impasse ended roughly two weeks ago, but it will take some time to get production up and running again.
While it’s nice to see industrial production snap back, we do not expect this rebound to have legs as oil and overall mining activity is in the process of pulling back due to large declines in commodity prices. Also, the bounce was helped by the big decline in the previous month (ie. the level of change).
We’d look for another three-four months of weakness before the data becomes so depressed that activity begins a generally sustained rise.
Today’s Data
This morning we get producer prices for October. The overall index will show prices declined, due to the huge decline in energy prices. We’ll be watching the core intermediate goods figure for clues of imbedded inflation. This figure involves the materials used to make finished goods --excluding energy -- and barely budged in the previous reading.
It’s pretty clear overall inflation rates will come down substantially over the next couple of months, but as the economy comes back to life the massive amounts of liquidity the Fed has pumped into the system will very likely push prices higher again – Bernanke and Co. will be very reluctant to take this liquidity back out until it is more than clear the economy is back on its feet – ala the 2003-2005 mistake that kept rates too low for too long (real short-term interest rates were negative during this period, which subsidized debt and encouraged the increased level of borrowing).
In addition to the growth-enhancing tax policy mentioned above, it is essential the Fed gets its act together – monetary policy mistakes are at the origin of this mess.
Have a great day!
Brent Vondera, Senior Analyst
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