Contradictions

A couple of weeks ago I titled my weekly musings “Let’s Get Serious” and in the State of the Union address last week, President Obama said:

….it’s time to get serious about fixing the problems that are hampering our growth.”

Never let it be said that we don’t get results around here. I even noticed in our visitors log recently that we got a visit from someone in the “Executive Office of the President of the United States” so maybe it isn’t so farfetched to believe that someone with the President’s ear is cribbing some ideas from my scribblings. If so, please pass this along to the President: Game to 21, make-it-take it, and don’t try that weak a** cross over move. Tim Hardaway you ain’t.

The State of the Union address captured the contradiction that is President Obama. He spoke of the difficulties facing families trying to save but instead of just cutting taxes across the board and increasing everyone’s after tax income he offered tax credits only if you spend the money as he sees fit (child care, home or auto, college). He promised to double trade even as his administration raises tariffs on tires and steel pipes and in another part of the speech threatened to tax the foreign profits of US corporations. He announced a National Export Initiative but hasn’t pushed Congress to approve previously negotiated free trade deals. He promised to provide funds for community banks to lend more but also promised to tax the large banks that will then have less to lend. He offered a job creation plan that included lower capital gains taxes for investment in small businesses but the same taxes will be raised on investments in large businesses next year when the Bush tax rates expire. HIs plan offered tax credits for hiring but put a limit on the amount as if he is concerned that businesses might create too many jobs.

It is obvious that President Obama gets the big picture about the economy. His plans offer a glimpse of what could be if he stopped the political pandering that he spent so much of his speech hectoring Congress about. He knows that lower capital gains taxes will incentivize investment and therefore create jobs, but he also knows that bashing big business is popular so he limits the lower rate to investments in small businesses. He knows that more trade creates jobs but demonizing the Chinese as stealers of jobs and imposing tariffs makes the unions happy. He knows that lower corporate taxes will create jobs but he also knows that taxing evil big corporations keeps the far left wing of his party happy so he disguises it as a job tax credit and offers it only to small businesses. He knows that free trade helps the poor the most – here and elsewhere – but he also knows that poor people don’t make campaign contributions and businesses and unions who want protection from foreign competition do.

He even favorably mentioned opening up offshore areas to oil and gas development in the SOTU but his administration has so far blocked new offshore drilling and also any drilling on public lands. To their credit the administration has auctioned off new parcels in the Gulf of Mexico but has also continued to delay any exploration off the east coast. Interestingly, the administration has approved $2 billion in financing through the Export/Import Bank for Petrobras to develop Brazil’s offshore oil fields. Why Americans should subsidize Brazil’s energy independence but not our own is a mystery. The President is offering loan guarantees for nuclear plants but I’m not sure those would even be necessary if he’d just get behind a simple carbon tax. The administration continues to push for a cap and trade bill that is too complicated, too corruption prone, too easily gamed by lobbyists and won’t accomplish the Democrats stated goal of reducing green house gas emissions.

All these contradictions make for a very uncertain environment for investors and it is starting to overwhelm the continued good news on the economy. The news flow of the last two weeks has been consistently positive and yet the stock market is now in the throes of what I hope is just a correction. Earnings have been much better than expected with over 70% of companies reporting bottom line numbers better than analysts’ estimates. Revenue has also surprised on the upside with over half of companies beating on the top line. And many companies are raising their guidance for future earnings.

The economic news has also been surprisingly strong although the pessimists among us, not content with the few bad reports, always seem to find the cloud behind every silver lining. Various housing reports have been on the ugly side and unemployment claims have shown a nasty blip higher in recent weeks, but the Philly Fed Survey, the Chicago PMI and GDP reports were all strong. The durable goods report showed that companies are increasingly more willing to invest; non defense capital goods orders excluding aircraft (a good proxy for capital spending) were higher for the second straight month. The pessimists pointed to the more lagging measure in the GDP report which showed another big drop in non residential structures investment and a weaker than expected contribution from the residential side.

The economic pessimists have been with us through the entire rally off the March lows though so I don’t think they are the problem. In fact, the plethora of pessimists is a comforting sign to me that investors aren’t getting overly confident in the economic outlook. The contradictory signals sent by the Obama administration since the Massachusetts election are the source of the recent rise in fear and volatility. Not that it is entirely the fault of the President. His welcome at the Republican retreat Friday was not exactly friendly and it does take two to tango. Just a hint to both sides of the aisle: bipartisan does not mean both sides acting in a partisan fashion.

So, Mr. President (or whoever is reading this over in the Executive Office of the President of the United States), here’s my advice. Like that Tim Hardaway crossover move that you see on so many Chicago playgrounds, economic policy takes commitment. You can’t do this halfway. If lower capital gains taxes create jobs, cut them for all investments. If lower taxes on companies create jobs, cut them for all companies. If raising the cost of carbon emissions will increase investment in alternatives, impose a simple carbon tax and offset it with a cut in payroll taxes like you proposed in your jobs program. If offshore drilling is good for Brazil, it’s good for us too. If increased trade creates jobs, push Congress to pass the South Korea and Columbia free trade agreements. If cutting families taxes will let them save more just cut them rather than trying to micromanage how they spend their own money. Make economic policy simple and trust the market to do the rest. Trust in the market is after all nothing more than trust in the American people. But you won’t get ours until we get yours.

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Weekly Economic and Market Review

As I said above, the economic news was generally upbeat. The exceptions were the existing and new home sales, down 16.7% and 7.6% respectively, and jobless claims which fell 8000 but remained high at 470,000. Even in the weak home sales reports there were glimmers of good news. Median and average prices for existing homes were up 4.9% and 6.4% respectively. Median and average prices for new homes were also higher and previous months sales were revised higher. The durable goods report showed a continued momentum in the manufacturing sector and more importantly showed growth in orders for capital goods.

The GDP report showed better growth than expected but as I mentioned above, the pessimists found plenty wrong with the report. Most of the attention was on the fact that a good chunk of the growth was due to a deceleration in inventory disinvestment. That was taken to mean that the growth wouldn’t last without a pick up sales but what everyone seems to be missing is that the restocking cycle hasn’t even started yet. The gain was just due to a slowing in inventory liquidation not from actual restocking. The inventory to sales ratio is low enough now for a true restocking to start so I expect inventory investment to add further to growth in the next quarter. There were other items that weren’t as robust as I would have liked but nothing was that surprising. Real final sales were a bit weak - 2.2% increase. Investment looked strong though with the exception of non residential structures.  Equipment and software were up 13.3%, real residential investment up 5.7% and total real non residential fixed investment rose 2.9%. Overall, a solid report if a bit less than one would expect given the depth of the recession.

The Chicago PMI report released Friday was overshadowed a bit by the GDP report but should have gotten more attention. The headline was better than expected at 61.5 and new orders were also strong at 66.4. Even more impressive, production didn’t keep up with new orders and so backlog orders showed growth for the second straight month. Most importantly the employment component rose 59.8. We’ll get the national ISM report on Monday but this report along with the strong Philly and Empire State reports from earlier this month point to a strong number.

Despite the strong economic and earnings news, stocks continued their recent correction, dropping about 1.5%. I do think this is just a correction and it should end relatively soon. Sentiment had become overly exuberant but the bears have been quick to come out of hibernation. The VIX backed off from its recent highs and put/call ratios are climbing. Commodities had another tough week as the dollar rally continued. Gold and platinum do appear to be stabilizing at these levels and the dollar rally is extended. I am still a dollar bear long term and the willingness of traders to get long dollars so quickly makes me wonder how much longer it will last. It will be interesting to see how the Greece situation is resolved and what effect it has on the Euro, but I think the whole drama is a bit overblown. Greece isn’t exactly the heart of the European economy.

Selected Charts

Stocks continued to correct but are now oversold. There is risk down to the 1025-1030 level but I would be surprised if it was realized.

Gold is at support

As is platinum

The dollar rally is ahead of itself and I expect to see at least some consolidation if not a more serious correction.

The Brazilian Real has had a major correction. If you believe in the Brazil growth story this might be a good time to take a position in the currency.

 

2 Responses to Contradictions
  1. [...] is the original: Contradictions | Alhambra Investments Share [...]

  2. [...] hundred times already but Welch and Gillespie say it more eloquently though so give it a read. Obama understands what needs to be done for the economy, he just can’t bring himself to do it because he thinks it will cost him re-election. I think [...]

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