Daily Insight

U.S. stocks declined Tuesday as a number of issues caused investors to flee for a little bit of safety – Treasury securities and the dollar rallied – but the equity market’s move lower was a mild one. Stocks have traded sideways for seven weeks now, moving as low as 1035 on the S&P 500 and topping out at the 13-month high of 1110, but overall no where since October 14.

This latest bought of weakness all started off with Bernanke’s speech on Monday in which, among other things, he mentioned that the economy faces “formidable headwinds.” A decline in German industrial production, a credit rating downgrade of Greek debt (which highlights government deficit risks) and a decline in small-business optimism, all occurring yesterday, put additional pressure on stocks. The budget problems in Greece, which is hardly the only nation with issues right now, follows the troubles out of Dubai that surfaced in late November.

Energy, basic material and industrials shares – all early business-cycle plays – led the broad-market’s decline. All 10 of the major industry groups lost ground on the session.

As a result of the dollar’s climb, back up to the 76 handle on the Dollar Index, commodities sold off. Gold fell for a third-straight session, down 7% over this stretch, and oil is back down to $72/barrel after holding in the high $70s since mid October.

Outside of some geopolitical event or a sovereign default it is tough to imagine the dollar breaking its downward trend – especially as the Fed continues to signal their zero interest-rate policy will remain in place.


Market Activity for December 8, 2009
Too Big Too Fail Fix – Give Me a Break

The House Financial Services Committee voted 31-27 last week to approve legislation that would augment government authority to police large firms that pose risks to the economy. Debate on the House floor will begin this week to create a council of regulators that monitor financial industry risks and impose costs (funds that would bail out reckless firms) on the largest firms within the industry. The legislation would grant the Treasury Secretary, among others, the authority to dismantle healthy, well-capitalized firms whose size threatens the financial system. It also removes a 30-year ban on audits of monetary policy – it’s not clear to me whether this pertains to just the Fed’s balance sheet or interest-rate policy as well; this is a treacherous road if it includes the latter, the Fed has made large mistakes this decade but you can expect plenty more if Congress and the GAO are allowed to get involved.

If this is passed, we may all watch firms take on even greater risks over time as healthy firms will see their costs rise, effectively backstopping those that get themselves in trouble – this has a certain moral hazard problem attached as far as I’m concerned.

Giving the government the ability to dismantle healthy and well-capitalized financial firms carries its own problems -- more government involvement in the private sector has never been long-run helpful and its not going to be this time. Further, it will eventually have to be acknowledged that we wouldn’t have had a credit bubble, and thus this de-leveraging process that ensued, if the Fed would not have kept fed funds below the level of inflation (negative real fed funds) for three full years earlier in the decade. Firms wouldn’t have been lured, taunted and encouraged to take on stupid levels of leverage in the first place -- implement insanely low levels of interest rates and you’re going to get more debt and whacky 30-to-1 leverage, unless of course the economy is so crushed that both the supply of and demand for financing craters, as is currently the case.

Rather than going down this road, imposing costs on the industry at this time of distress and possibly encouraging reckless behavior down the road, what we need is to allow the market to determine interest rates (not the Fed) and the Federal Reserve need only be there as a lender of true last resort. If the period we’ve just been through doesn’t wake everyone up to this reality, the high-probability that current monetary policy will engender new problems should do it.

Another key point is when new costs are imposed on industry those costs are passed through to the consumer. If the government decides to add on new fees to the largest banks in the financial sector, and they’re already looking at imposing much higher costs on all banks via the FDIC funding agenda, then we’ll see consumers face higher financing costs. This will add another impediment to credit expansion and thus increases the velocity of the headwinds confronting the economy.

NFIB Small Business Economic Trends

The National Federation of Independent Business (the largest small-business organization) stated that their economic trends index fell in November to 88.3 from 89.1 – the lowest level in four months. The six-month average is 88.2. The cycle low of 81.0 was touched in March; the all-time low of 80.1 was hit in April 1980, but just four months later the index was back to 94 and never returned to the 80 handle until this latest recession.

The report showed that six of the index’s 10 components registered negative responses – the key gauge being the hiring figure, which decelerated to -3 from -1. The six-month avg. is -2. As we’ve been talking about, this report is another indication that small businesses will be slow to hire – small firms account for at least 60% of job creation.

Another key reading is the measure of capital spending plans, this is important as an increase in plant and equipment outlays is a major job producer. The gauge fell to 16% from 17% in October –- this matches the lowest point on record; the first time this low was put in was March. The six-month avg. is 17%.

The share of executives expecting better business conditions six months out dropped to 3% from 11% in October. The six-month avg. is 6%

The NFIB’s chief economist stated that “sales are not picking up, so survival requires continuous attention to costs – and labor costs loom large.” He also stated that reductions in stockpiles (the gauge of executives expecting to increase inventories was unchanged at -3; the all-time low of -13 was put in in March and the six-month avg. is -5) “sets the stage for support for new orders in future periods.” This is something we’ve talked a lot about, but firms must first gain confidence in the future.

“New” Stimulus

President Obama, in a speech at the Brookings Institute yesterday, unveiled some “new” ideas – many of which aren’t exactly new. The administration continues to rely on additional extensions to unemployment benefits, food stamps, this idea of providing $250 payments to seniors and veterans and subsidizing health insurance costs for the unemployed – none of which fires up economic activity or job growth, but they’ll seek to spend another $100 billion on these programs. Yes, jobless benefits are the countercyclical programs that put more money than would otherwise be the case in the pockets of the unemployed. But look, benefits already extend out to 99 weeks and each dollar spent by government simply takes a dollar away from the private sector -- either in future taxes or currently as funds are needed to finance this deficit spending.

He also explained that the administration will seek to add $70 billion to infrastructure spending.

However, Mr. Obama did offer some things that actually work. He stated that they would push to extend the higher current-year expensing on business equipment and bonus depreciation schedules through 2010 – such initiatives have a track record of incentivizing business-equipment spending as it allows a business to quickly recover the cost of major asset purchases. (Why does it take a 10% unemployment rate to drag policymakers toward implementing efficacious polices?)

Still, this program that is held over from the Bush years is only effective so long as other government decisions don’t smother its otherwise beneficial effects. I applaud him for offering something here that makes sense.

In all, any stimulus plan that is not simply a function of government getting out of the way of private industry only drags out the adjustment process, elongating economic weakness. Sure it may offer the appearance that improvement has arrived, but in actuality results in weaker levels of growth and more frequent business-cycle contractions. Capitalism is about creative destruction, tearing down old industries that no longer compete and replacing them with more innovative ones that provide for higher living standards in the future. It is also about washing out excesses. While the adjustment process is unpleasant, it does allow for a more fundamentally sound and longer-lasting recovery to ensue. We seem to be forgetting this.

Have a great day!


Brent Vondera, Senior Analyst