Financials and telecoms led the market lower on analyst downgrades of telecommunication firms and the likelihood of higher default rates put pressure on bank stocks.
Energy and utility shares were the only bright spots, adding 1.36% and 0.72%, respectively. Energy is a great way to at least partially hedge against geopolitical risk, which isn’t going away anytime soon unfortunately.
Besides the Israel/Hamas conflict, Russia has now shut off shipments to Ukraine and that affects much of Western Europe as well. While $50 per barrel oil is not a major issue – after coming from $145 just six months ago – crude is up 40% over the past seven trading sessions. These big swings makes it difficult for businesses to manage, and nearly impossible to hedge, around the issue and that’s the problem.
Market Activity for January 5, 2009
Economic Data
The Commerce Department reported that overall construction spending fell 0.6% in November, following a 0.4% decline for October -- a number that was revised substantially higher from the estimated 1.2% decline reported last month. Over the past year overall construction spending has fallen 3.3%.
Gains in commercial and government building helped to offset weakness from the private residential component of the report, which continues to fall at a substantial rate.
Private residential construction fell 4.2% in November and is down 23.4% from the year-ago period. For additional context, the three-month annualized decline in private residential construction has worsened, down 8.1% for November, compared to -5.5% for October. Public-sector residential construction spending rose 1.4% and is up 7.9% over the past 12 months.
On the commercial side, private nonresidential construction rose 0.7% in November and is up 10.3% since November 2007. This segment is holding up pretty well, but we expect the year-over-year rate to continue to decline, which has been occurring. (Private commercial construction was up 13% year-over-year back in August.)
Public sector nonresidential spending rose 1.4% -- boosted by school and highway construction – and is up 7.8% over the past 12 months.
At some point private residential spending will begin to rise again as it has been declining every month since March 2006, save August 2008. (In August the figure jumped 5.5%, causing many to believe the housing contraction had run its course, but then September followed with its collapse of Lehman Brothers and the credit-market freeze up.)
But housing will rise again. Looking at the annual increases in home prices going back to 2000, it appears we’ve fully reverted to the mean, and in fact may have gone too far. Lower mortgage rates should boost home sales, even as the weak labor market curtails this boost.
As the inventory/sales ratio moves lower home building will resume, but this does not work on a dime and will take a year or more to occur based on what we currently know – and this is more a guess than anything else, there are too many variables to call it with any confidence. Over the next several months we won’t need residential investment to add to GDP, if it only flattens out and is no longer a drag on growth it will be a big plus.
In the meantime the public sector will take over as the next administration is focused on traditional Keynesian-style public works programs.
Tax Cut in the Works
There is talk that the Obama Administration is crafting a plan to offer as much as $310 billion in tax cuts. (These costs that CBO and other assign to tax cuts are generally well off base as it does not take into account that when correctly targeted the Treasury enjoys large windfall over the ensuing years – they employ static analysis instead of the appropriate dynamic type. So we wouldn’t put much credence in the size, hopefully it’s targeted in the right way, which is what matters.)
Anyway, among the business tax cuts being discussed, one is to allow firms to write-off large losses incurred in 2008 and 2009 to retroactively reduce tax bills dating back five years. What this means is that the government will be replacing losses with current-year government spending.
That’s all fine but it does not boost government revenues (which is kind of important right now) or provide longer-lasting incentives, incentives that eventually drive jobs and productivity higher via increased business-equipment spending and higher profits. Tax policy that is longer-lasting in nature provides higher revenues two, three and four years out and thus offsets the higher deficit spending in the first year of implementation.
However, there is talk that something else is being crafted that would offer a longer incentive cycle. Word is they’ll extend the 2008 legislation that increased current-year business spending write-off allowances into 2009 and 2010.
This plan, according to press reports, offers powerful incentives to boost business equipment outlays, which boosts jobs (more workers are required to produce this equipment) and has long-lasting productivity benefits. This plan would also extend the bonus depreciation provision, which allows an additional 50% of the cost of an asset acquired and placed into service this year and next to be depreciated immediately.
This would be big and we should applaud such a move if they do it. However, as they plan to permanently boost the size of government, they should at least make these private-sector incentives permanent as well. Permanence brings the most bang for the buck as certainty makes life much easier for business decision makers and you don’t get this front-loading phenomenon only to see business-equipment spending fall off when the legislation expires.
Have a great day!
Brent Vondera, Senior Analyst
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