Daily Insight

U.S. stocks extended the winning streak to six days on Monday as investors shook off what looked to be playing out as a mid-afternoon rout. Roughly an hour into the afternoon session the broad market tanked, erasing earlier session gains, after Homeland Security Secretary Napolitano told Bloomberg News that it was “fair to say” terrorists with al-Qaeda-style beliefs are in the U.S..

This is hardly news as everyone should assume we’ve got all kinds of terrorist cells in the U.S.– I guess the remarks must have been initially interpreted as the government saying they believed an attack was imminent. Stocks rebounded an hour later, able to hold onto about half of the early-session gains

The economic and earnings calendars were light as yesterday was Columbus Day so the only thing that really drove things was optimism about earnings season, which gets rolling in earnest later this week. The market will be particularly attentive to what executivessay in addition to results; investors will want to hear some willingness to grow capital expenditures. Intel will report after the bell and may help in shedding light on this subject.

My concern is that firms will remain extremely cautious and keep their cash held close as they understand the government will be on the hunt for revenue in 2010. I often find Thomas Paine’s “Common Sense” coming to mind, specifically these comments: “we still find the greedy hand of government thrusting itself into every corner and crevice of industry, grasping the spoil of the multitude. Invention is continually exercised, to furnish new pretenses of revenues and taxation.” Business is very concerned about the direction of tax rates.

The bond market was closed for the holiday.

Commodity prices rallied too. Gold hit $1,055 per oz. (and is up another $13 this morning), oil surpassed $73 per barrel (and has moved onto $74 this morning), and copper hit $2.85 per lb.(an elevated level even if the global economy were humming, which it is not). The dollar continues to get wacked, and that’s what’s driving these prices higher.

A former Federal Reserve researcher stated global central banks continue to diversify away from the greenback and the trend accelerated in the third quarter – the U.S. dollar’s share of new reserves fell to 37% from 63% on average over the past decade. This spells trouble, as we’ve been discussing, if the trend holds. It also means it could force the Fed to hike rates much quicker and more dramatic than the market currently expects – if this trend does not reverse, a significant move in rates will be the life preserver necessary to rescue a drowning dollar.

Considering this stock rally is based upon the easy-money trade, this also spells trouble for stocks if investors begin to grow concerned a quick strike from the Fed is necessary – for now they don’t seem concerned about anything. If the Fed lets this one get away from them, it will really screw up the luxury of being able to keep monetary policy floored.

Volume was weak again, with just barely more than 900 million shares trading in the NYSE Composite – the six month average is 1.3 billion. Although, I guess relative to last week’s average volume of little more than one billion shares per day, 900 million shares ain’t bad for a holiday.

Market Activity for October 12, 2009
Second Stimulus? (actually the third, counting Bush’s failed rebate-check scheme in 2008)

Worried that job growth won’t be significant enough (when it arrives) to lower the unemployment rate to a level that is even close to the long-term average, Congress is now in the process of devising a another “stimulus” plan. Lord help us.

There are a number of things being contemplated right now, so no idea on what will prevail, but the leading ideas are as follows:

• Extending subsidies to laid off workers, paying for up to 65% of their COBRA premiums
• Sending checks of $250 to more than 50 million Social Security recipients and railroad retirees to make up for the lack of cost-of-living (COLA) increase in 2010 – CPI has been printing negative-to-flat y/o/y readings so no COLA increase was scheduled for next year
• Reviving the “net operating loss carryback” plan, which died in Congress last year when the previous “stimulus” plan was being devised
• Awarding tax credits to companies that add jobs. This too failed to make it into the previous “stimulus” plan as Congress couldn’t figure out how to implement it. One of the proposals is to provide a $4,000 tax credit to be paid out over two years for each new employee.
  

Oh my, let’s look at these one at a time.

Ok, sending more checks out. Not only has Friedman’s Permanent Income Hypothesis been proven via several rebate-check schemes over the past few decades. We have the luxury of not having to go back and study the effect of those in the past, although it’s easy enough to do with the right resources, since we have recent memory to go off of via the 2001, 2008 and 2009 rebate-check plans.

In 2001 the checks provided a little help to GDP the quarter in which they were received. It was a one-and-done event. In terms of Bush’s second rebate check attempt to revive the economy, personal consumption rose 0.1% in Q2 2008 and was followed by a collapse in spending in the following two quarters.

Fact is not even all of this money is spent, as several academic studies have shown. When consumers see this as a one-time event, instead of a more permanent increase in disposable income via reductions in tax rates, consumers choose to either pay down some debt or save it.

The 2009 rebate-check plan, as a result, attempted to trick consumers into spending the money as it dribbled something like $25 per paycheck until the amount reached the intended $400. One could obviously argue that the economic troubles mask the effect of the plan, but let’s get serious, this is not a real stimulus agenda.

On extending COBRA subsidies: This is a typical countercyclical response. The government makes payments to laid off workers, which allows them to keep more money in their pockets to spend on other things. Fine, but we have all kinds of programs like this, extending them or creating even more turns our economy into something that looks more like Western Europe than that of the USA. Time and money would be better spent on firing up business optimisms, which will get them to spend and the jobs will soon enough come along for the ride.

On the net operating loss carryback to five years: This means the government will send out checks to firms that have reported losses the last two years, refunding taxes paid over the previous five years. Oh, that’s nice. Not only will this balloon the deficit, but if firms are uncomfortable with the direction of policy and thus remain cautious, then why would they spend this money? It seems to me this would only exacerbate the cautious nature of business as they will expect higher tax rates to follow as this adds onto an already heavy budget deficit.

On the tax credit to businesses that add jobs: Maybe we don’t have to waste time on discussing this one. Two-thousand dollars a year for two years? – maybe members of Congress should bring themselves up to speed on how much it costs to add a worker. This is a flat out joke, just as it was the last time it was tried – 1977.

And this brings us to how Congress plans to pay for this stuff. The idea that seems to have the most support would be to apply the Social Security payroll tax to incomes between $250,000 and $359,000 – currently the 12.4% tax caps out at $106,800. This is a huge job killer. It is a growth killer in general as it would suck $24,000 out of the private sector on average for the segment of workers that drives consumer spending, not to mention the reduced level of investment that would result. Further, it raises the cost of employment as employers pay half of the Social Security tax – making the temporary tax credit “reward” for adding to payrolls all that more laughable.

They don’t get it, and I don’t think they care to.

Have a great day!


Brent Vondera, Senior Analyst