Daily Insight

U.S. stocks fell on Friday, led by financials (what else?), after Wells Fargo revised its latest earnings report, stating results were worse than first reported. Consumer discretionary shares also kept pressure on the broad market after the University of Michigan’s preliminary consumer sentiment index hit its lowest level since 1980 – we will receive the main consumer confidence reading, put together by the Conference Board, in a week.

Stocks fell another 4.8% last week, essentially all of that damage occurred on Monday after the much-hyped Geithner press conference (the green light to short banks again speech) offered zero with regard to new details. This marked the fifth week of decline out of the last six.

No major industry groups managed to gain ground last week, even basic material stocks – which have caught some fire of late – ended lower. It appears we’ll test the November 20 multi-year low as we’re just 3% from that mark regarding the Dow Industrial Average – although still 9% above that level from the S&P 500’s perspective.

The main issues right now are the state of the financial and consumer sectors and the intense uncertainty that results from government’s increased involvement.

On the first, we need to get mark-to-market removed (there you go I said it, even after telling myself not to bring it up) or banking industry woes will continue to be exacerbated. The consumer, despite the first rebound on retail sales in six months after the latest reading, is not going to come around in a sustained manner until the cash savings rate approaches 5% -- which is probably 4-6 months out at the current pace of increase.

On the second, investors need to know the rules of the game. The government can come out with something good, or they can continue to fumble the ball; no ones knows. In addition, they seem to keep getting in their own way – which is kind of the history of the Washington response.

For instance, they want private money to come in and help fund the “bad bank” idea (known as the Public-Private Investment Fund) yet are in favor of “cramdown.” Now, why would private money come in and buy mortgage-related securities when a bankruptcy judge will have the authority to change principal and terms of the loan? They won’t. This just increases the uncertainty issue.

Market Activity for February 13, 2009

The Group of Seven

The G-7 got together this weekend (maybe I should say the G-6 since it appeared Japan’s Finance Minister was bombed – he has now resigned) and the prevailing message coming out of the meeting was a warning against protectionism This topic dominated the talks due to Treasury Secretary Geithner fomenting the issue when he called China a currency manipulator. Without getting into a specific history, China has been pegged to the dollar since 1994 – outside of allowing the yuan to strengthen during the previous couple of years. This peg has served us all well, but when the Federal Reserve is going to drive the dollar into the dirt, the manufacturing industry is going to have problems with this policy. And this is the issue we here need to deal with. Instead of blaming others for their actions, we should first concentrate on sound monetary policy here at home. That is the first order of business when talking about currency valuations.

Back to topic, the G-7 has proven to be sort of like the UN in that we hear a lot of words, but they rarely deliver action. Words are certainly not action and the realities on the ground are such that we’re all moving toward protectionism. It appears the U.S. kept the “buy American materials” provision in the stimulus plan – despite the President’s statement that he’d remove it; French auto companies (largely state-owned) have stated they’ll close overseas plants before closing ones in France – instead of focusing on those that are the least efficient; the U.K. stimulus plan stipulates that banks commit lending to British businesses -- probably causing some issue with international-trade financing.

These issues don’t seem like much, but protectionism is growing under the surface – and we haven’t even mentioned Congressional attempts to block additional trade pacts. We must be very careful here this is dangerous stuff, it doesn’t take long for retaliation to set in and at that point the global economy is in big trouble. The U.S. needs to take the lead because the G-7 is not capable of unification. This means our Treasury Secretary must change his tone. He’s going to be the key Treasury-debt salesman (as a result of all of this “stimulus” spending) and the wrong comments will make this job much more difficult.

The good news is we’re talking about the G-7 and not the G-8. Russia has apparently gotten the boot as of late.

Stimulus Plan

Congress passed the stimulus bill this weekend. It will inject $800 billion over several years into everything from welfare payments, health-care benefits, infrastructure projects, more health-care benefits, and tax rebates and incentives. In terms of the tax segment in the legislation: On the incentives, higher business write-down allowances and bonus depreciation will help things on the capital spending front so long as government stops scaring the hell out of the business community. On the tax rebates, the plan is a joke as it trickles in $12-$14 dollar increments per pay period – and no that’s not a typo.

Proponents of such nonsense say it will make people feel like they’re getting a permanent tax cut – of course, actually providing such a thing would be a mistake apparently. There are actually economists that are saying this is a worthwhile experiment. I’d rather these people be brought up to speed as to what works, rather than the rest of us being bludgeoned each day via such nonsensical proposals. A quick read of Friedman’s Permanent Income Hypothesis may do the trick. As to tricking people into thinking a one-time $400 shot-in-the-arm (spread over 28 weeks) is permanent – well, good luck with that one.

Say what you want about the likelihood of efficacy regarding the stimulus plan, they are going about it all wrong.

First, you know where I come down. The most effective approach would be to slash tax rates across-the-board and eliminate mark-to-market. But that’s not going to happen.

The alternative should be to encourage China to engage in massive stimulus – maybe three times the amount of their already huge $600 billion plan, which is spread over two years. In return, we will say we’re happy with the current dollar/yuan exchange rate. (Look, if China took the yuan off the peg it’s not like those low-paying manufacturing jobs would come back to the U.S. They will go to the next place, like Thailand or Vietnam. And China will be worse off and have less funds to buy our expensive capital equipment.) It is counter-productive right not to call them a currency manipulator. Besides, who are we kidding? The world is run by fiat money; who isn’t a currency manipulator?

China has an incentive to do this as they need to tamp citizen uprising due to higher unemployment. For our benefit, we wouldn’t have to drive annual budget deficits to $1 trillion-plus and thus reduce the chances (maybe) of higher tax rates two years out.

But we don’t like to think outside the box all the time. We instead like to throw money at the problem because this gives politicians a way of saying they did something. And they’re doing something alright.

Could Be a Rough Session

Overseas bourses closed yesterday’s session lower on reports Japan’s economy shrank 12.7% at an annual rates last quarter – the biggest decline since 1974. This marks the third-straight quarter of contraction as exports activity is very depressed. Reportedly, exports slid 13.9% in the fourth quarter (45% annualized), the worst since WWII.

While down, international stocks held up pretty well considering that report out of Japan, down roughly 1% across the board. But today things are a bit worse as stock indices are down 2%-3% this morning.

Economy Watch

We’ll be watching for the New York-area manufacturing number for February this morning. Tomorrow the big data will be housing starts and building permits along with industrial production (all for January).

Have a great day!


Brent Vondera, Senior Analyst