UNCERTAINTY AND OPPORTUNITY 10-3-2008

Uncertainty and Opportunity

This week’s market volatility was all about confidence and emotion, or the lack of confidence and too much emotion. While it is clear that we are in a protracted economic slow down, and may very well be in a recession, it is also clear that the economy is much stronger than the media would represent and recent market volatility would indicate.

With unemployment holding steady at 6.1%, energy prices decreasing rapidly (oil is now less that $95 per barrel), the federal funds rate at 2% and likely decreasing when the Fed meets on October 29th, the dollar increasing against foreign currencies, and the trade deficit coming into line, there is more than enough to be optimistic about. At the same time, we can’t ignore the possibility that unemployment may increase, consumer spending during the critical holiday season is likely to decrease, recent durable goods orders are off, and there is continued pain in the housing sector. This reflects a mixed bag for the economy. Add to this the uncertainty of the upcoming presidential election and real concerns over the credit crisis, and we have a setting that breeds fear for some and spells opportunity for others.

It is precisely this sort of unsettling financial environment that gives consummate investors, such as Warren Buffett, the confidence to invest $5 billion in Goldman Sachs and another $3 billion in GE in the course of one week. Financial fortunes are made in this type of market by those who are willing to stay the course, continue to work their plan, and hold firm to their long-term objectives.


Wall Street versus Main Street

Much of the debate over whether the Financial Rescue package would be good for the country has centered on the concepts of Wall Street versus Main Street, as though there is a difference. In a day when over 50% of the population owns stocks, either through various investment funds or directly, when some 79% of adults use various credit instruments to help manage their lives, and when the vast majority of Americans over the age of 16 have a bank account, Main Street and Wall Street are the same street, and we all live and work on them.

Certainly, there are many corporate executives with earnings well in excess of the national average, and many more who enjoy substantial investment holdings. This is evidence of a free market economy. When we begin to limit opportunities for these individuals, we limit the leadership strength of our society. Corporations become feeble, workers become disenfranchised, and leaders become corrupt. We have too many tremendous examples of such limits throughout the former Soviet block countries and in economically ravaged dictatorships and communist holdout nations where oil is not a major export.


Financial Rescue Package

Jeff Thredgold’s article in TEA Leaves this week, titled The Blame Game, is excellent. Thredgold discusses the $700 billion financial rescue package, the FDIC, congressional leadership, and the national media in an insightful and concise manner. It’s worth taking the time to go to Thredgold Economic Advisors website: http://www.thredgold.com/html/leaf080930.html

What Thredgold doesn’t discuss is whether or not our economy can live without the house and senate’s passage of this bill. The answer of course, is yes we can. We can also live without electricity, running water, cell phones, and sushi, but why would we want to? There are some that suggest the passage of this bill takes us one step closer to a socialist society; others decry the intrusion of government in our lives and in what is intended to be a free market. Okay, I understand each of these things. I also understand that when I left my home this morning to come to my office, I was one step closer to getting into an accident. When I put my foot on the gas pedal and unleashed 370 horse power worth of engine, I was closer still. When I then chose to obey the speed limit, stop at the red light, and respect the other drivers around me, I effectively steered clear of any avoidable accidents.

My point is this: there are certain obligations that must be met, roles that must be fulfilled, and risks that are unavoidable. In the case of our government, one of the roles is to help facilitate an orderly market and to maintain the value of our currency. At the end of the day, we need to have some confidence in our lawmakers and their willingness to maintain the tenants of the free market system we enjoy. We saw on Monday of this week what can take place if our legislative representatives don’t step up to do their jobs, and we don’t ever want to see that again. Seeing to it that the economy and the markets have sufficient liquidity to operate efficiently is critical to our national interest.


Signal Value

The house, senate, and executive branch leadership brought out their biggest guns this week in order to assure the passage of the Financial Rescue Package. In an attempt to turn up the heat on those legislators that had yet to ‘see the light’, the administration focused on the fears of the nation, and in so doing resorted to a level of fear mongering that will exacerbate some of the problems at hand. We heard from corporate executives concerned about making payrolls, investment guru’s wringing their hands over recent losses, fathers and mothers afraid of losing their homes, and economists assuring us that a recession is now a certainty. None of this is news, of course, but putting it in front of the American people in such a flagrant manner only heightens concerns and all by itself creates some of the problems being addressed. It also helped the house and senate to gather the courage to pass the legislation.

This is referred to as Signal Value, the lasting effect that comes from a signal sent to a group and the resulting impact that it creates. In this case, the hope has been that the passage of the Financial Rescue Package would provide enough of a counter measure to the exaggerated fears presented that any harm would be undone. While this may be the case, and it may have been warranted in this situation, it certainly heightens concerns in the meantime. Automobile showrooms have been virtually empty all week, mortgage applications have dried up altogether, and investor confidence has been tested.

Now that the package has passed both the house and the senate, the administration and the media must now come out and reassure the public that the measure will work and the investment of $700 billion will pay off.


Federal Reserve Rate Cut

The US markets appear to have priced in a 50 basis point, or one half of one percent, rate cut in the fed funds rate. The Federal Reserve meets on October 29th, and given their accommodative stance towards strengthening the economy it would appear that such a cut will be made. However, what is less certain is what it will actually mean. The fed funds rate is already at 2%, but consumers and business aren’t seeing much benefit from a low cost of borrowing. Low rates become irrelevant when credit is difficult to get and offer little benefit to our economy. While the Fed is likely to offer the rate cut, we can be sure that they’ll continue to work overtime to see to it that the credit supply loosens up considerably over the coming weeks.