A Day We Have Been Waiting For - And More Headwinds Ahead as Corporate Performance Erodes

January 20, 2009 – It is finally here. The day that we get rid of the worst administration this country has ever seen. An administration that came into office smugly telling us (Cheney) that “Reagan proved deficits don’t matter” and an administration that left that national debt at $10.6 trillion. Not everyone was fooled by this administration’s buffoonery and bad policy. Nobel prize winning economist George Akerloff led several other Nobel Prize winning economists in taking a full page ad out in the NY Times back in 2004 which warned that “This is the worst president in the history of the United States”, that Bush’s economic policies would devastate the country and that Bush had, in effect, looted the surplus. Here is the ad:

http://berkeley.edu/news/media/releases/2003/02/nyt_economists.pdf

As Nietzsche said, perhaps the madman came too soon. Yeah, we know the German philosopher was opining about God, but isn’t the U.S. economy godlike on some level (or at least it was)?

We get the fact that this administration can’t be blamed for everything. After all, it wasn’t Bush who was clever enough to devise the exotic investment strategies that inflated the U.S. housing markets. And it wasn’t Bush that leveraged Wall Street to the hilt. But it was Bush that set the “tone at the top.” It was Bush who told us the day after 9/11 to not worry and ‘to just go shopping.’

And it was Bush that pushed an outmoded version of “supply side economics” (which his father called “Voodoo Economics”) leaving the government further exposed to the implications of its spending habits against a backdrop of less government revenue. By the way, money didn’t trickle down and poverty in the U.S. expanded pretty significantly under Bush’s watch. And it was Bush that increased federal spending under defense to $2,200 per person by 2008, up from $1,300 per person in 2007 – an increase of 69%, while cutting spending on education to $140 per person from $200 per person over the same time period. It was Washington’s tone at the top which advocated interest rates to be held at such low levels back in 2001 and 2002, and it was that tone at the top which advocated a systemic pattern of debt spending and leverage on Wall Street and Main Street over the past eight years that effectively created the conditions of this mess that we are now in.

Nobody raised concerns about the plight of the consumer, which represents more than 70% of GDP as the consumer fell into negative personal savings on Bush’s watch and would then have to rely on home equity and credit cards to keep driving the economy. While Bush was in office, he made borrowing easier for consumers and created a more favorable environment for the credit industry in the case of consumer default and failure to pay. We could go on, but our point is simply that this mess we are now in is the byproduct of bad fiscal policy.

Fiscal policy which errantly commits to debt and leverage on all fronts to drive the economy. That kind of policy is unsustainable – pace the major majority of states that are underwater, and the Federal government which is accelerating deeper into debt each day, relying on T-Bill purchases from China, Japan et. al. to help us sustain our way of living. By the way, that standard of living will go by the way of the dollar if it collapses under the weight of the national debt.

Yes, Dick – Cheney, deficits do matter. Now, in terms of the markets today, it looks like traders are preparing for a negative opening. Don’t be too surprised. Inauguration days typically run into negative territory. On the other hand, the dour mood can also be chalked up to a heavy schedule of corporate earnings releases which are generally expected to be downbeat, with more profit warnings ahead.

The pound and the euro are both sliding against the dollar amidst further erosion in the UK’s economy. The euro is back below 1.30 against the dollar, at 1.2937. Meanwhile, gold prices are up $9 to $848, which shouldn’t be too much of a surprise in light of all of the bad news out there. Currencies can’t seem like too much of a safe haven for investors as every economy stacks on debt and cuts rates to try and deal with this crisis.

Oil prices are slipping again, down $2.84 to $33.67. We remains remarkably surprising is that OPEC hasn’t cut production again yet to deal with declining demand on a global basis. We continue to think the oil is way oversold but perception is king. The fact that oil continues to soften to the low $30s is a testimony to just how pessimistic oil traders are about how deep this recession is going to get and how long it is going to last. We would be buying energy companies and utilities on the current weakness.

On the corporate front,

·         Auto Sector – Fiat and Chrysler announced a tentative agreement which will give Fiat a 35% stake in Chrysler. Fiat won’t be investing cash but it will be providing infrastructure. BMW is reducing work hours of 26,000 employees in a plan to slow production and cut costs. Mitsubishi is halting production at its biggest plant in Japan for three weeks in February.

·         Corporate Earnings  and Warnings – TD Ameritrade Q1 profit fell and it cut outlook for FY2009; Johnson & Jonson expects weaker results in FY2009; United Rentals cut 2008 guidance; Air France-KLM warned for the Q3;

·         Job cuts – Burberry (more than 500 jobs); In international markets, consumer confidence in Germany improved with the monthly index rising to minus 31 points  from minus 45.2 in December. Germany’s economy is expected to contract by 2.5% in 2009.

In terms of what we expect in today’s session, downward pressure in a thinly traded market while most eyes focus on either the Obama inauguration (a message of hope) or corporate earnings reports (messages of despair). We think that the markets have adjusted for the hope side of the message by this point and the recalibration in play is based on the corporate news, while analysts are adjusting expectations downward. So far this earnings season, the average S&P company has shown a loss. We could see a test of the 8,000 level on the DJIA in the next session or so, and we wouldn’t be surprised to see a test of the lows around 7,500 on the DJIA hit on November 21.

We are bullish on several sectors at current levels, which in many cases we think conditions are oversold, but we would not try to fight the momentum. Keep in mind that the markets can stay irrational longer than you can stay solvent. That being said, our recommendation remains to use the market weakness in your favor and sell puts on stocks you want to own into the weakness which will increase the premium you receive for committing to buy a stock you want to own at a lower price. This is the best strategy, in our opinion for markets like this.

Quotables

Noted economist Nouriel Roubini said the banking system is effectively insolvent this morning.

What we wrote on December 14, 2007:

In our opinion, recession is inevitable…. a consequence of really bad fiscal policy, and as Nobel winning economist George Akerloff says, “the worst president in the history of the United States” from an economic perspective. The administration rolled its dice and chose debt spending and easy money as the drivers that it would rely on to spark the economy. The administration was right. Debt spending and easy money did spark the economy. Wall Street loved it. But the problem is, is that it can’t last. You can only spend so much money you don’t have and you your foreign debt holders will only sit by calmly for so long as the Fed prints more money to dilute their interests that much further. 

At some point, it all comes crashing down, and you have to pay the piper. Making the costs for borrowing even more attractive, which is essentially what the Fed cuts are doing, will not work this time. There has got to be a fundamental shift in fiscal policy to change our course. Until then, the markets are going to have to brace for more uncertainty and tougher times. The problem that has, and is still being created by the Fed’s continual validation of the Street’s expectations for more rate cuts, is that we are enjoining the current recessionary outlook with an inflationary one. And the implications of a stagflationary economy have not even begun to be considered by our pundits in the financial media.