Desperate times call for desperate measures
Bush. George Bush. He likes his economic recovery stirred not shaken.
When a sports team is on a losing streak often times a general manager will make player changes to try and shake things up. Sports fans typically react to such ‘shake ups’, justifiably so, by concluding that management is getting desperate. After all, when a team is winning few player changes are ever made.
Apparently U.S. investors are not like sports fans. Rather, they seem to possess an ability to root for stocks regardless of whether the U.S. economy is winning. To be sure, and in response to what many refer to as a ‘losing economic policy’, last Friday President Bush gave two of his most prominent players their walking papers. The markets responded to the news by rallying sharply.
Is Rising Unemployment Good News?
What is also worth noting about last Friday’s rally is the terrifically bad employment report (a report that immediately knocked the stuffing out of the growing theory that a steady decline in weekly jobless claims meant the unemployment picture had to be improving.)
Needless to say, for some people the ‘positive’ reaction in the markets following the worse than expected jobs report means good things:
“The economists found that when the economy was in recession, the stock market invariably fell when there was a negative unemployment surprise. But when the economy was expanding, the market rallied -- as it did Friday” Brimelow, CBS MarketWatch
Brimelow is correct in that 3 economists came to the conclusion that ‘bad unemployment news can be good news for stocks’. However, what he fails to mention is the fact that employment data forecasts have only been made since 1977 (the economists used a formula to guess what the forecasts where from 1962-1977). What this suggests is that 25 years ago maniacal investors were not biting their nails once a month and readying to buy and sell stocks on the basis of 1 economic report. Rather, they literally didn’t know what to expect.
As for the 3 economists who believe when stocks rally following a bad employment number this is good news for the economy, their research stopped at 1995, or a split second before the stock market mania took hold. As any economist would admit, nothing the economy or markets have done since around December 1996, or when Mr. G was first fearful of ‘irrational exuberance’, has made much ‘historical’ sense.
Even so, taken at face value the data sets are really not that convincing anyways:
“Table 5 presents the estimates when the dependent variables are: the stock index return on the day prior to the announcement day (Thursday), on the announcement day (Friday) and on Thursday and Friday taken together. For all of the three event windows, and for all three estimation methods, a consistent pattern emerges. The coefficients are negative in contractions and positive in expansions, and are usually statistically significant.” NBER
The stock markets closed lower when last Thursday and Friday are added up: does this not crack the ‘consistent pattern’? Furthermore, remember that the markets were down immediately following the unemployment report, and only after Bush signaled player changes did prices rally. As such, and given that NBER didn’t track the intraday movements following employment reports, can it not be accurately stated that the markets dropped following the jobs number but rallied later for some other reason?
Suffice it to say, a statistical comparison of the markets reaction to employment reports is flawed, and if anyone other than Brimelow latches onto the NBER report they should do so with an ounce of objectivity.
Incidentally, the argument could be made that Bush was reading NBER’s report at the same time he received advanced notice of the unemployment report. Did Bush plan to ax O’Neill and Lindsey to cushion the blow from a lackluster jobs report? The point may be mute but it nonetheless makes sense.
Debt: The Magic Elixir?
Auto finance King Pin AmeriCredit Corp’s stock price has collapsed this year even as auto sales/financings have gone through the roof. Similarly, even as the action in mortgages has heated up, a la record refinancings and new mortgages, those companies that sell and/or package mortgage (backed) debt have nearly all suffered share price declines. Why are the creators of debt suffering even as business remains brisk?
For certain, part of the reason why companies that lend to others are not profiting as much as they did during the late 1990s is because of falling interest rates. However, another reason has to do with rising defaults: personal bankruptcies and home foreclosure rates are running at or near record levels. In sum, more debt is being created, but on lower rates of interest and with more defaults.
What this type of lending environment has created is a tightening creation/ destruction cycle. In other words, debt is not being grown efficiently. For example, during the 1990s for every 50 cents in debt created 2 cents was being destroyed (defaulted on), and today for every $1 created in debt 5 cents is, at the same time, being destroyed. Why can’t such a trend persist into perpetuity? Well, if the trend did persist eventually debt destruction would near that of creation, thus rendering the Americredit Corp’s of the investment world as non profitable middle men.
The Debt Quandary
During every modern day recession the debt creation/destruction cycle has eventually widened -- in other words, debt creation has been more efficient when economic expansion took hold than it was during the recessionary trough. Such is not the case today.
Point being, those that ignore ‘creation/destruction’ considerations today assume that money creation, which is in reality debt creation, is infinitely efficient. They, referring to supply side economists and Wall Streeter’s touting ‘the great 2002 2003 recovery’, have given up predicting when companies will start spending and begun, like a sick child hoping their hero hits a home run, to envision the government belting a grand slam. For certain, Wall Street is calling for deeper tax cuts, Washington will soon cut the double dividends tax, and everyone initially applauded last weeks firing of O’Neill and Lindsay. Why? Because acknowledging the truth – that the U.S. economy is losing -- hurts.
Incidentally, it is not as if any government can steer an economy clear of recessions and/or choppy growth economic – if a government tries too hard their currency will suffer.
As for the 1930s, or period which elicits many comparisons to today, American’s didn’t have credit cards in the 1930s, and financial institutions did not have the seemingly ingenious ability to package debt for sale to investors (thus displacing some of the risk in holding this debt). Enough said.
Conclusion
Just as the fan realizes his team is making numerous player changes because the team is losing, the investor should also realize that the government is only adopting a ‘deficits don’t matter’ gameplan because their other plan failed. To be sure, advances in consumer debt, facilitated by a steady reduction in interest rates and government tax cuts, have failed to ignite broad based economic growth.
Upon revealing his new economic plan Bush will likely argue that he is simply stirring in some extra stimulus to ensure that the economic recovery sticks. Nevertheless, in reality he is firing anyone who Wall Street dislikes, and he is trying to turn the Treasury and Fed into the government’s own personal offshore Enron accounts. In sum, Bush is desperately trying to shake things up, just as Greenspan tried to do last month...
Unless Bush’s efforts are aimed at making the creation/destruction of debt more efficient, something no amount of tax cuts but only time can do, he will be unable to build an economy that can sustain growth. That said, who ever said he was looking past the next election?
This Week
Due out this week are retail sales (Nov), current account (3Q), import/export prices, producer prices (Nov), Business inventories, and preliminary Mich. Consumer Sentiment (Dec). The Fed will also meet on Tuesday and likely offer no new words in their FOMC statement.
The markets are likely to take their cues from Iraq developments, if any, and the appointment of new Treasury Secretary Snow. That said, producer prices shocked to the upside last month and may be worth watching.
BWillett@fallstreet.com
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