Saturday, May 9, 2009

Spring Has Sprung - But the Media Are the Blooming Idiots!

From the Desk of Joe Rollins

Long time, no see. I haven’t posted to our blog in several months since my time has been consumed by my CPA firm’s heavy work schedule during tax season. But now it’s time for me to get back in the swing of things, and here I am to give you all the gory details on the financial markets and the economy over the last few months.

Since I last blogged about three months ago, things have been fairly eventful in the economic world. At least I finally have some good news to report rather than the bleak avalanche of negative publicity we were barraged with over the last 12 months.

In my February 19, 2009 post, I told you about the tree in my backyard that I use as a predictor of spring. At that time I mentioned my belief that as the winter turned to spring, the stock market would start performing better, and we would see consumer confidence start improving. While the parallels that I drew may have been somewhat silly, I honestly felt that the economy was not nearly as bad in February as the press was reporting, and it was just a matter of time before the financial markets would improve.

Here we are today, less than three months later, and the tree that I referenced in my February 19th post is now in full bloom, and almost all of my roses awake from the winter. Here are a few pictures of my garden for your reference (and before you ask, yes, I tend to the roses):

As I predicted back in February, the financial markets have improved greatly over the past three months – since February 19th, the Dow Industrial Average is up 12.5% and the S&P 500 is up 15.5%. The market continued going down even after my February post, but it appears to have finally bottomed as of March 9, 2009. Since that bottom was established, the Dow is up 28.3% and the S&P is up a stunning 33%. The S&P 500 is now slightly positive for 2009. It’s hard to imagine that these indices moved up so quickly in the face of such horrible financial news. Also, don’t forget that on Election Day in November of 2008, the Dow was at 9,625; today it’s at 8,436 – that’s 12.5% lower.

Many of my clients continue to express their opinion that the markets will not improve because the economy is so bad. I would like, however, to take the opportunity to go through the reasons why the financial markets do not need the economy to improve before they go up. The financial markets only need for the economy to quit going down before they improve, and it appears that as of today, the gradual deterioration of the economy has slowed, if not turned towards the better.

The first quarter financial earnings results for the S&P 500 have been quite interesting. While they are significantly down from this time last year, they are still significantly better than anyone projected. I absolutely do not believe the poor quality of the reporting regarding the earnings and financial data provided by the national media. It seems that these “learned” reporters cannot believe that the banks made any money during the first quarter of 2009 much less billions of profits.

The bigger question to me regarding bank earnings is how banks could possibly not make money. Have you checked out what money market accounts are paying now? Even harder to believe is that CD rates are paying below many money market account rates. Therefore, the cost of money to the banks is practically zero. If they can loan money at 4%, 5%, or 6% when their money cost is practically zero, then even a less savvy investor can make money with that interest rate spread.

The national media just cannot seem to wrap their brains around the fact that the environment for loaning money has rarely been better. There are basically two ways to subsidize the banking industry: one is that you actually subsidize them, which we have already done. But the most efficient way is to simply allow them to make more money by making their cost of money at nearly zero. That is what we are seeing now.

I suggest you re-read my February 19th post wherein I set out two criteria for the financial markets to improve and for consumer confidence to get better. One was the elimination of the mark-to-market rules. I am glad to report that in early April, mark-to-market was dramatically revised, and it now implements common sense rather than just mathematical calculations. Maybe they read our blog… While the uptick rule has yet to be completely restored, there is no question that it’s coming.

Almost all of the major pension plans have removed their shares from brokers if those brokers were allowing the shorting of stocks. The combination of the SEC’s enforcement of the laws that have been on the books since the 1930’s along with the availability of fewer shares to short have dramatically leveled the playing field for those of us who are long in the market. The combination of these two items has drastically improved stock market performance in the intervening three months.

As I indicated in prior posts going back six months ago, I didn’t feel there was any question that the economy was going to improve. The reality of the situation was that the economy was never as bad in October and November of 2008 as the media was trying to make you believe; and it’s not as good today as they would like for you to believe, either.

The fact of the matter is that in many respects, the recession was manufactured by media hyperbole. Had it not been for the hysteria caused by the media in the fall of 2008, this recession would have been much milder than it eventually became. The enormous scare tactics from the media and our own government caused consumers to shut down their spending habits. The end result was a complete bankruptcy of the automobile industry in America. While the fallout started there, it certainly didn’t end there.

For those who are interested, my prediction is that there will be no American auto manufacturers in the United States – that will soon be a thing of the past. This is not so much because of design or production failures, but because of the failure to control the unions, which have essentially destroyed car building as we know it in this country. Don’t get me wrong; there will be millions of cars produced in America in the coming decades. Unfortunately, they will not be produced by American companies.

When I’d expressed my confidence in the past that the Federal Reserve and its very able chairman, Dr. Ben Bernanke, would restore level footing to the economy, I was greeted with incredible skepticism by my readers. I knew from economic history that the steps taken by the Federal Reserve would work, but many of my clients remained unconvinced. In fact, it wasn’t uncommon for me to be told that while that might’ve been true in the past, “things were different this time.”

While I suppose everyone would like to believe that the world is different now, when it comes to economics there haven’t been any significant new developments. Money trends and flows tend to have the same effect as they have always had on the economy. If you flood the system with money, eventually that money will end up in the pockets of the people and then it will eventually be spent. The beauty of flooding the system with money is that it creates commerce; the negative is that the flooding eventually creates inflation. Given the two, we would rather have growth than inflation, and that’s the risk Bernanke took in the fall of 2008.

It is often believed that it takes at least a year for the Federal Reserve’s moves to positively impact the economy. Here we are today – only eight months into this process – and there are already clear signs that the economy has stabilized. The economy isn’t nearly as good as it should be, but at least it has quit falling.

Before anyone jumps to any conclusions regarding where this improvement has fallen short, it’s important to understand the facts. The tax stimulus changes only went into effect on April 1, 2009, so we’re only five weeks into this relatively small tax decrease for 150 million Americans. While the tax decrease will benefit the average taxpayer as we go forward, it has had very little effect so far.

The remainder of the $800 billion in the stimulus package has yet to be spent. I read almost daily of roadblocks set up by Congress and by various state governments to actually spend the money. The money is coming and it will help, but it just hasn’t started yet. Expect to see this money in the economy by the summer.

Does that make you wonder why the economy has already started to turn around even before the stimulus bill has been spent? You might recall from prior posts that I suggested the stimulus act was necessary, but that it was for way too much and for way too long. The current environment of an improving economy, even before the vast majority of the stimulus bill was spent, has clearly proven that effect.

Don’t you find it somewhat ironic that President Obama signed an executive order basically requiring union labor on all stimulus funded projects? Aren’t these the same unions that systematically destroyed the automobile industry in America? Isn’t it also interesting that only 11% of workers are now covered under union contracts? That means that 100% of taxpayers (only 50% actually pay income taxes) will fund jobs for workers only covered by 11% of the workforce. I guess all of those political statements regarding an administration with no biases and no preconceived allegiance to campaign money got lost somewhere in the application of the stimulus act.

The stock market is a forecasting vehicle. It looks into the future and evaluates stocks not as of today, but forecasts where it will be six months or a year from now. The stock market forecasted the downward turn in the economy before it actually happened and the stock market today is forecasting an improvement in the economy even though it’s not here. Yes, we see optimism all around us, and hopefully the bottom has been hit. However, as of today, there is too much unemployment, little (if any) activity in the housing market, and there is still a reluctant consumer who is unwilling to part with their hard-earned money.

The beauty of the American political environment is that the majority rules – whatever the majority decides is the rule of the land, be it good or bad. Since the majority elected that current administration, all of us – regardless of our beliefs – must support the actions taken by our government. It is clearly the majority that is driving the train at the current time, and all of us will have to deal with its repercussions.

Unfortunately, the current administration is not following the history books. Higher taxes have never led to helping the deficit situation. Nationalizing health care will soon be known as Medicare II. None of these enormous acts to make government bigger will work, but I guess the current administration hasn’t learned anything from the past. However, the U.S. is a broad and diverse economy; we will survive these acts and the economy will grow bigger and stronger as a result of the knowledge we get from even these misplaced efforts. I am very optimistic.

Many of the advocates of higher taxes point to the Clinton years to prove that you can have higher taxes and a good economy. No one can argue that the economy wasn’t good during the Clinton years. As you recall, with the help of the Federal Reserve, the country came out of a recession in 1993 and was basically strong through 1999. It is also true that Bill Clinton, in the last few years of his final term, increased taxes and actually balanced the budget. However, it’s often forgotten that this one act alone threw the country into a relatively severe recession during 2000 and 2001. Those of us who lost in the stock market during that time do not readily forget it.

I have often wondered why a country that has grown and prospered so much under capitalism for the last 233 years would suddenly want to scrap its heritage and move to a socialistic system. But that discussion is for another day… In any case, the majority rules, and we will need to see how it all turns out.

There is no question that the financial markets are seeing inflation on the horizon. The benchmark 10-year Treasury bill has moved from a rate of 2% to well over 3% in just the last few months alone. The financial markets would not be bidding-up interest rates if it did not see significant inflation coming and the economy improving. All of this is incredibly ironic given that home mortgages are now maintained at artificially low interest rates by the Federal Reserve. If you have not looked into refinancing your home by now, your opportunity is quickly evaporating. It would not surprise me in the least to see home mortgages start to rise dramatically in the coming months once the Federal Reserve quits subsidizing long-term interest rates.

The Obama Administration just proposed stricter tax policies on overseas earnings of U.S. corporations. Once again, this is a misplaced act that is being proposed in a time when it is needed least. The fact of the matter is that the U.S. would be much better off if corporations paid no income taxes. I realize that sounds like a radical approach, but economic history has proven this to be crystal clear. Corporations do not pay taxes; individuals pay taxes. If anyone believes that tax rates paid by corporations are not passed along to consumers, then they really do not understand cost accounting.

It would be best for all Americans if corporations were completely exempt of United States income taxes. You often hear about corporations relocating to countries without taxation. If we had no taxation in this country, there would be no reason for our great corporate entities to relocate to tax havens. Many corporations from around the world would come to the United States to enjoy the tax benefits. With them, they would bring their capital, their employees and their prestige.

There have been many studies on the subject that prove the economics that no corporate taxes would be much more beneficial than higher taxes by corporations. While it does not seem intuitive, the economic benefits of bringing new and better corporations along with their capital, personnel, resources and prestige is far greater than the minor economic impact of tax rates on these corporations. Once again, the current administration has failed to read the economic textbooks, and once again, it is not different this time.

The reality of the situation regarding foreign corporations is that most of the employees that U.S. companies employ overseas are not performing highly skilled jobs. Yet the profits from these overseas companies allow the U.S. to maintain managerial and skilled positions here in the United States. The claim that punishing corporations abroad will create more jobs at home is completely false. It’s more likely that they will drive away domestic and foreign investors, leading to few jobs, not more.

Washington needs to quit trying to punish corporations; at some point, companies and entrepreneurs will simply go elsewhere, taking their investment capital – and the jobs that go – with them. The United States currently has the highest corporate tax rate in the developed world. Our rate is almost 50% higher than the composite of all other developed countries. To make that matter worse by increasing overseas taxes is another misplaced effort by Washington.

The economy will get better for the remainder of 2009. It will be a gradual but slow improvement. 2010 will be even better than in 2009. As the trend continues, 2011 will be better than either of the two previous years. As workers resume full-time employment in 2010, each of them will continue to contribute a small part to an economy that, by then, will be growing at a very healthy pace.

Yes, there are problems coming down in the economy. At some point there will be inflation. We must rely upon the skill of the Federal Reserve to take away some of the punch from the party when the economy improves. We have a very able head of the Federal Reserve. Hopefully he will react as well then as he has recently.

The government was slow to attack this recession, but they moved aggressively when they finally saw the light. They did not change the mark-to-market rules until April, when many of our great bank institutions had already been destroyed. Literally trillions of dollars of wealth have been destroyed by the failure to install the uptick rule. All of these moves came late, but at least they came.

Contrary to what you read in the newspaper and what you hear on TV, no major United States banks will be nationalized. Yes, they went through a hard time, but if it had not been for mark-to-market accounting issues that destroyed many banks, it would have been just another recession that the banks would have had to survive. As the economy continues to improve, and as the banks make more money, there will be a substitution in the capital positions by extraordinarily high earnings. Contrary to what you hear from the media, there is no need now, nor was there a need then, to ever nationalize a major U.S. bank.

If you wonder how I can express such certainty that the economy is going to improve, basically the axioms of economics dictate this result. There is an extraordinarily large freight train of money that is getting ready to be dumped into the economy. Not only are we going to have the stimulus act money, but also the literally trillions of dollars in government supported bonds and debt instruments. As the banks stabilize, lending will improve and the car companies will once again issue debt on new automobiles. This overwhelming avalanche of money will make its way through the economy and ultimately into consumer’s hands. As consumers start to feel confident, they will once again spend and the battleship of economic stability will turn.

I envision the stock market taking a summer swoon and then having a very good fall season. Many of the well-known mutual funds are now up for 2009. All of the skeptics that failed to make their 2008 or 2009 IRA contribution because they thought the economy was so bad were wrong. The stock market doesn’t react to the economy; rather, the stock market predicts the economy. Right now, the stock market is clearly predicting a better economy.

All of the above is just my opinion; I could be wrong!