Why Negative Numbers Can Sometimes Be Good For The Markets

This week saw continued volatility in the US and global equities markets, with the DOW claiming the second highest single point gain in history on Tuesday of 889 points. Most expected the markets to post substantial losses Wednesday as sellers might have stepped in to take short-term profits; but instead of high volume and steep declines, we saw a modest day-over-day point swing on light volume, as the Federal Reserve offered a widely anticipated .5% cut in the Fed Funds rate. Trading on Thursday showed meaningful gains in spite of the release of two obviously negative economic reports: 3rd Quarter 2008 GDP decline of .3%, and weekly jobless claims of 479,000.

So why is it that the market can get so excited about a .5% rate cut when rates are already so low as to be nominal, and how can the markets not react to reports of declining GDP and jobless claims representing continued unemployment of almost half a million workers? The answer has everything to do with expectations and confidence.

Though a .5% fed funds rate cut will obviously decrease the overall cost of short-term borrowing, the relative benefit is minimal with rates already deeply discounted; but it was an important move in terms of the Federal Reserve showing its ongoing commitment to support the credit markets through an extraordinarily difficult period. Equally as important was the Fed’s indication that inflation appears to be a non-issue when compared to overall financial concerns. This helped to calm the fears of those concerned over the possibility of a period of stagflation, a time period in which the economy might shrink while the costs of goods, services, and borrowing might increase.

The announcement of a decline in GDP for the 3rd quarter was actually better than expected, and may be an indicator of a milder, shorter recessionary period than the markets are currently bracing for. Economic consensus expected a .5% decline in GDP for the 3rd quarter to be followed by 4th Quarter 2008 and 1st Quarter 2009 declines of 2% and .7% respectively, before seeing a return to economic growth of 1% , 2% and 2.3% in the 2nd, 3rd and 4th Quarters of 2009. These appear to be very small numbers, but they have significant impact on employment. If we are to endure a more mild recession than has been feared, then fewer jobs will be lost, more debt payments will be made on a timely basis, more goods and services may be purchased, and the economy could have a less difficult time of regaining solid footing. Most important is the potential for a swifter return to a stable real estate market.

Even with jobless claims remaining steady and the unemployment rate unchanged for the past two months, we can expect that unemployment will increase from the current level of 6.1% to as much as 7.3% before the end of 2009, with a reduction back towards 5% in 2010. These are low unemployment rates for a recessionary period, as unemployment during sustained recessions often exceed 10-12%. So far in 2008, the economy has lost 760,000 jobs with non-farm payrolls standing at 137.3 million jobs.

The last few weeks have also represented the heart of the corporate earnings reporting season, and we’ve seen more surprises of higher than expected earnings than we have those that are lower than expected. Most of this has been ignored by the markets as confidence has remained low and uncertainty has remained high. Interesting to note: the three major hurricanes and natural disasters experienced during the 3rd Quarter reduced GDP by 1%. Without these events, our economy might have posted gains rather than the lower than expected decrease reported Thursday morning.


Oil and Energy Costs

In last week’s Signature Update, we discussed the economic and political benefit to reduced energy costs and how the timing of reduced fuel prices as we enter the holiday buying season couldn’t be better. With consumer confidence figures released for October reflecting a substantial decrease from September, 38 versus 64.1, it is critical that oil costs remain below $70 per barrel through the end of the year. OPEC met within the last week and announced their decision to cut production by 2 million barrels per day and the oil markets barely reacted, signaling that the global demand destruction is further entrenched than OPEC might have supposed.

This bodes well for a sustained move towards fuel efficiency that must transcend the price of oil. If we are to stave off future runs on the price of oil, we must continue our reduction in energy demands, otherwise $147 per barrel oil might seem like a bargain in the future. We must avoid the temptation to eschew ‘greening’ policies simply because the cost of energy declines. To not do so will simply continue to unnecessarily export billions of US dollars to foreign governments and to expand our nation’s dependency across the globe.


‘Wackonomics’

Walter E. Williams, a popular economic and political columnist published in numerous major US news publications and a Professor of Economics at George Mason University, wrote an article that appeared this week in the Deseret News (October 29, 2008 A13) in an attempt to explain what he refers to as ‘Wackonomics’. Williams’ comments address the irrational attitudes expressed by the news media, many politicians, and the population at large, over executive compensation and corporate greed. He rightly contrasts the outcry over executive compensation versus the silent acceptance of celebrity compensation, which most often dwarfs that received by CEO’s of publically held corporations. Though Williams stops short of describing how these highly paid CEO’s strive to increase their shareholder value in contrast to the personal motivation of most celebrities, he does state his interest to ‘talk to these people and learn their strategies’. The article is worth reading and can be viewed at http://www.gmu.edu/departments/economics/wew/articles/08/Wackonomics.htm.