For those still wondering about the causes of the upset win by Scott Brown in the Massachusetts Senate race last week, consider this; it has been over a year since we faced the brunt of the financial crisis and not one issue that has been considered as a cause has been addressed. The largest banks have paid back their TARP funds but still enjoy the implicit government backstop of "too big to fail". Some of them still enjoy an explicit backstop in the form of government guaranteed debt issues. Credit default swaps have not come out in the open of an exchange. Fannie Mae and Freddie Mac continue to operate with the assistance of Fed and Treasury funding. FHA continues to provide mortgage guarantees for borrowers with no down-payments. Capital requirements for banks are largely unchanged. The Fed even seems to be repeating the mistakes of earlier this decade by holding interest rates too low. The problems that we faced a year ago, we still face today. That is a complete failure by the entire political class and last week's election was a warning to politicians that business as usual is not acceptable.
The election of Scott Brown to the Senate was not just a repudiation of health care reform although that may be a potential consequence. It cannot have been an endorsement of the Republican Party since Brown spent the entire campaign doing his best not to mention his party affiliation. It wasn't a rejection of President Obama since a majority of the MA voters still support him. President Obama got it right when he said that Brown rode the same wave of anger into office that also elected him. That is true; it was definitely anger that drove voters, but what was the source of the anger? Was it anger at the financial sector and their bonuses? Or was it anger at the politicians who gave them access to the public purse and made the bonuses possible? Or was it anger at the complete failure of the political class to address the larger issue of the economy and jobs? President Obama opted for the first explanation but I think he missed the mark.
The President unveiled a plan to limit the risk taking ability of banks last week, something that Paul Volcker has been advocating. The proposal will limit proprietary trading and will prevent banks from sponsoring hedge funds and private equity funds. There are also provisions to limit the size of financial institutions. The idea of limiting the risk taking ability of firms with implicit or explicit government guarantees is one that certainly has merit, but is that really what the public is clamoring for right now? Proprietary trading wasn't a root cause of the crisis and neither were hedge or private equity funds. And without a very specific definition of proprietary trading, there is no chance that this will limit risk taking by the likes of Goldman Sachs. It seems more likely that the one and only issue for most Americans right now is jobs and worthy though it may be, the Volcker plan will not put one American back to work. Indeed, it may cost jobs since it seems highly unlikely that Europe will follow suit and some financial sector jobs may just move to the EU.
I think what the electorate is so angry about is that our politicians aren't even addressing our problems in a logical sequence. The first issue has to be the overall state of the economy. The restructuring of the financial sector is important but it is not necessary for the immediate economic recovery. President Obama seems to have made a bad assumption in believing that the stimulus package would be effective at holding unemployment down to reasonable levels. Whether that was a miscalculation on the part of Larry Summers and Christy Romer or whether it is the fault of Harry Reid and Nancy Pelosi is irrelevant. What the public sees is that we've spent a very large amount of money we don't have and haven't gotten any results. They want a new approach that doesn't involve just letting politicians spend our money willy nilly. The President believed that he could just sign the stimulus package, check the economy off his list and move along to health care reform. Sorry to be the one to tell you Mr. President, but our economic problems run a little deeper than that and will require a bit more of your attention.
We have a debt problem and shifting it from the private sector to the public sector will not solve the problem. We cannot borrow our way out of a problem of too much debt. We cannot spend our way out of a problem caused by too much consumption. We need to reorient our economy to one that is led more by investment than consumption and that is not an easy transition, but it can and must be done. The longer we take to start the deleveraging of our economy the longer it will take.
The immediate problem is jobs and to reduce unemployment we need to reduce the real cost of labor. That is another reason health care was the wrong issue for now. Basic economics tells us that we can increase the demand for a good by reducing the price. Health care reform as envisioned by Congress does the opposite; it makes it more expensive to hire or maintain an employee. If there is a way to improve the healthcare system that doesn't raise the cost of labor then by all means we should pursue it, but the last thing we need right now is to do anything that makes it more expensive to hire. An example of a policy that reduces the cost of labor would be a cut in payroll taxes. It reduces the cost of hiring and can be implemented with little time lag.
I said last week that it is time to get serious about our economic problems and it seems that the voters of MA agree. So what does that mean? Well, I suppose it could mean a lot of things, but what the voters seem to want is for Congress to start working together and include some ideas from both sides of the aisle. We need to use more domestic sources of energy and we need to provide support for alternatives. We need to reduce taxes on capital and raise taxes on consumption. We need to stop wasting money on programs that don't meet their stated goals such as ethanol mandates and subsidies. We need to get other countries to pay their fair share of the global defense budget. We need to reduce corporate taxes to attract more investment and we need corporate managers to be held more accountable. We need to give the Federal Reserve one mandate they can accomplish - a stable value for the dollar. Those are just a few examples, but it shows that there is no reason we can't solve our problems in a bipartisan fashion. Bipartisan to me means both sides have to compromise. Those who are telling President Obama that even the minimal outreach to the most liberal Republicans was too much are wrong. Maybe the shock of last week's election will convince the politicians that it is in their best interests to compromise and get some things done. If not, they will face the same wrath in November that was so evident last week.
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Weekly Economic and Market Update
The market was allegedly down last week due to the announcement of the Volcker bank plan but a look at the economic data makes me wonder if there weren't better reasons for the decline. Housing starts were pretty dismal although permits were up a bit. Starts are running at a rate of 557,000 annualized and permits are at 653,000 annualized but neither of those numbers is exactly robust in a country where household formation has averaged well over 1,000,000 annualized over the last couple of decades. I guess it means there's only one way to go but it sure is taking a long time. Produce prices were up 0.2% which was in line with expectations. The year over year rate is now up to 4.7%. I hate to keep repeating myself but all of you folks looking for deflation are just wrong. Jobless claims were up to 482K last week which was much more than expected. On the bright side, someone at Labor was quoted as saying there were administrative reasons for the jump so it shouldn't be taken too seriously. No matter what the real story is though there is no doubt the number of new claims each week is still running way too high. The leading economic indicators were up big in December in the best news of the week. All 10 components were positive. The Philly Fed Survey was 15.2 down from 22.5 last month but still a good, solid number. Bottom line "“ another mixed week with employment still the weak point.
Stocks made new post crisis highs on Tuesday before the election but sold off later in the week. Whether it was due to the Volcker plan, the economic date or just that earnings expectations had gotten too high, this correction is nothing unusual for an economy emerging from recession. There will always be disappointments in the data coming out of recession and the market will always be a bit nervous at this point in the recovery. Every recession I can remember, there is always the fear of a double dip and the market always has to deal with that. I don't expect significant weakness in the economy until 2011 and even that can be avoided if policy changes positively. Unless something more fundamental changes my mind, this is just a correction and not the beginning of anything more severe. At this point the key is still monetary policy and for now I'm not too concerned. The dollar and gold are in corrections of longer term trends, but at this point it doesn't appear to be anything more than that. TIPs show steady to rising inflation expectations so fear of deflation is not what is driving the dollar market. Monetary policy is still pretty easy and I don’t expect that to change. I may have to re-evaluate that as we get closer to the end of quantitative easing but for now things look okay.
Selected Charts
Stocks took it on the chin Thursday and Friday but we are now basically at support:
This could be a double top in the Aussie dollar but the fundamentals still favor the longs. I wouldn’t be a seller yet, but a break below 87 would be very bearish:
The natural gas ETF is forming a bullish chart. A move above the 200 day MA would be very bullish. I am starting to warm up to the fundamentals of nat gas but I am leery of the ETFs which have had some tracking issues. This warrants watching though:
Gold is at support:
Korea’s market pulled back to its previous break out point. If you are bullish this is the place to be a buyer:
Brazil’s correction has been deeper than the US, but I don’t think the Brazilian growth story has changed. The fear is a slowdown in China and that is a risk but I don’t buy the China bubble story and therefore don’t buy the China bubble popping story. Growth in China slowing to high single digits will not derail Brazil’s economy:
And if you believe in the China growth story, this is the place to be a buyer. It isn’t for the faint of heart but buying after a correction never is:
Healthcare stocks took a hit on the perceived death of Obamacare, but the uptrend is intact:
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