Daily Insight

U.S. stocks gained ground for a second-straight session, fully erasing the declines of the previous two sessions. There was only one economic release, which wasn’t exactly bullish but it was headlined as being so and got credit for market’s gains. We’ll get to that below.

Maybe helping the market more than anything was the decision from the Reserve Bank of Australia to hold their cash rate (the equivalent of our fed funds) steady. Most economists believed they would hike for the fourth time in four months and that had the market a bit uneasy as China is also tightening policy in the region. Commodity prices rallied on the news.

Even so, basic material stocks, which usually trade in tandem with commodity prices, were the worst-performing sector for the session – up by just 0.39%. Health-care, industrials (fueled by an earnings report from Emerson Electric that easily surpassed expectations) and consumer discretionary shares led the advance – up 1.92%, 1.91% and 1.46%, respectively.

In a sign that economic activity isn’t exactly as robust as recent manufacturing data has suggested, UPS warned that the current quarter will be challenging and profitability will be just slightly better than a year ago – analysts were expecting a 13% jump. Total package volume rose just 1.4% last quarter. Factories have ramped up production as the inventory rebuilding process is underway, but that cycle is going to prove especially short-lived if end demand remains lackluster.

UPS is a key barometer of activity as it is the biggest package-delivery firm to businesses and consumers. For the fourth-quarter, the company reported an operating profit (excluding extraordinary items) of 75 cents/share. That’s down from Q4 2008’s 83 cents. Total package volume rose just 1.4% and average daily volume was flat. International volume jumped 12% last quarter, but was helped by an air-cargo capacity squeeze that prompted a shift to UPS. As a result, the company voiced uncertainty as to whether those volume gains were permanent.
(That squeeze resulted from China’s stimulus-induced volume pick up following the total collapse of trade that occurred a year ago. Carriers will have the resources in place now to more appropriately managed the increase in orders, but with China now tamping its stimulus measures one can see orders waning in the back-half of 2010.)

Market Activity for February 2, 2010
2011 Budget

The Obama Administration unveiled its 2011 budget plan on Monday (government’s fiscal year ends in September) and its proposed $3.8 trillion in spending – it was just a couple of years ago in which the federal budget was $3 trillion and you don’t have to go back that far for a $2.5 trillion budget, that was 2004. That means federal government spending has risen at more than twice the rate of economic growth. So federal outlays as a percentage of GDP will come in at 26.2% (a postwar record – man, there have been a lot of those made lately), which is up from 22% in 2004 and 20% in 1995 ( that final number is in line with the 40-year average).

But this is not the ratio that causes problems, at least directly. The ratio that hampers economic growth is the government revenue (taxation)-to-GDP ratio – a higher figure obviously saps more capital from the private sector and does damage to economic growth over time. That figure ran between 18-20% over the past quarter century – and proved to be a growth-inducing/prosperity-driving level, but sits at just 15% currently. Thus, we have an outlay (spending)-to-GDP ratio of 26% and a taxation-to-GDP ratio of 15% -- uh, something has to give and I’m going to guess it ain’t gonna be the spending side, not with more boomers hitting “retirement age” and sending SS and Medicare outlays soaring. No, the government will seek to boost that taxation-to-GDP ratio well above the 18-20% range in the coming years in order to keep up with spending.

You know I keep referring to business anxiety and caution – businesses know what occurs when the government goes hog wild on spending, or at least more hog wild than normal. And that is exactly what the outline of the budget lays out. Various tax rates are going up.

On Monday I went into another one of these rants as to why the nascent economic rebound will not be durable, but rather extremely transitory in nature. As I’ve also done on a couple of occasions, I laid out a scenario in which none of my major concerns come to fruition by writing this: But even if we forget about real estate and loan quality realities and assume that a spectacular events occurs: the government comes out and states that the two top federal income-tax brackets (60% of which is small business ) will not increase in 2011; the capital gains and dividend tax rates won’t increase by 86% and 166%, respectively; the tax deferral on overseas profits will remain in place; and private equity isn’t burdened (the carried interest tax) with the proposed tax rate increase to 35% from 15% -- hence, this weight of uncertainty is removed from the economy’s shoulders. Even if the spectacular were to occur, Washington gets a clue, we still have the Fed in front of us.

Well, after reading the outline of this budget, we have more than just future Fed tightening to worry about because if this budget is passed all of those various tax rates are going higher. The only aspect that’s different now that we’ve seen the budget proposal is the cap gains and dividend tax rates apparently won’t rise by 86% and 166%, respectively – they’ll rise just 33% each, which means after-tax potential returns will shrink by that amount. So it could have been worse, but it is far from optimal and we need optimal right now.

To ultimately get things right, we will have to reform and contain the largest budget problems our government faces: the entitlement programs. We can start by raising the “retiremenet ages” for those 50 and younger and in one stroke of the pen erase much of our long-term funding deficits.

In addition, we will have to engage in pro-growth policies. This means getting off of this idea that government can create growth and jobs and getting to the things that actually do – greatly reducing various tax rates and making the tax structure much more efficient. One key rate is the corporate income tax, which needs to be eliminated – remember, corporations don’t directly pay taxes, people do; these costs are passed on to the consumer. Eliminate the tax and watch U.S. firms bring overseas jobs back home, along with the capital they have sitting overseas so it doesn’t get taxed at 35% -- the highest rate among OECD members. Further, watch international firms bring factories and corporate headquarters to the U.S. like never before. That would bring the job growth we need; the lasting job growth we need.

That is the way you boost government revenues, by expanding the tax base, not by raising tax rates. Increase tax rates on the wealthy and they’ll simply find ways to avoid those taxes. Increase taxes on business by eliminating the deferral on overseas income and they’ll shift more jobs overseas.



Pending Home Sales

The National Association of Realtors (NAR) reported that pending home sales (contract signings to finance an existing home purchase) rose 1.0%, exactly in line with expectations. This follows the large 16.4% (which was revised lower, initially printed -16.0%) decline in November.

So not much of a bounce, and the data suggests that January/February existing home sales won’t rebound much off of December’s 16.7% slide – a plunge that erased the single-family existing home sale gains (at an annual rate) of November, October and part of September. Existing home sales are officially counted when contracts close, and since it takes 4-6 weeks to close a contract this pending figure is a good indication of what will occur over the next two readings.


In terms of region, contract signing were strongest in the Midwest, up 5.2%; followed by the Northeast, up 2.3%; the South saw signings rise 2.2%; pending home sales fell 3.8% in the West.

Have a great day!

Brent Vondera, Senior Analyst