When the Government Makes The Market 4-1-2009

April 2, 2009 Edition, Volume III

Inside Signature Update

- The Rally’s Dependence on Earnings Reports & Employment Figures
- Can Free Markets Exist When the Government Makes the Market?
- Congressmen and Senators as the worst kind of shareholders
- Mark-to-Market Accounting Changes at the FASB


The Rally’s Dependence on Earnings Reports and Employment Figures

The recent rally in the equity markets continued this week in the face of relatively disappointing news regarding housing, auto sales, consumer confidence and the labor markets. The market’s response to Friday’s unemployment data could be critical as we head into 1st Quarter earnings reports next week. Market strength or resiliency in the face of less than positive economic reporting is often present in markets that have gone through the sort of bottoming process the US market appears to have recently passed through, and is another indicator that economic recovery is in sight.

The Case-Shiller Home Price Index reflected continued weakness in housing prices, though the number of units sold is improving, and auto sales reports confirmed the dire condition of the domestic auto industry. The Consumer Confidence Index, which had been expected to post a slight increase on the back of January and February retail sales increases, came in unchanged at 26. The ADP report, which acts as a relatively accurate indicator of the Department of Labor’s Jobs Report due out Friday, represented an increase of some 12,000 new unemployment claims and may represent an increase in March unemployment to 8.8%.

Next week marks the beginning of the 1st Quarter earnings reporting season and the market’s reaction to them is key. Early reports from a number of banks and technology companies have been positive, but that’s to be expected, otherwise they might not have been released prematurely. We already know that auto manufacturing and supply, and construction reports will come in low, but where will they post in relation to early guidance and expectation?

If corporate earnings reports come in above expectations, even for a small portion of each industry or market segment, it may support an extension to the current rally. However, without positive results it is most likely that the rally will stall and we may retest the 7,000 or 6,500 point level for the DOW. With that said, we continue to see the current level of the major markets as grossly undervalued and note that the markets have priced in significantly greater economic weakness than has been seen to date or that we are likely to see. The prospects for measurable economic recovery by the end of 2009 become more likely each month and have gained greater focus in just the last 2-3 weeks.


Can Free Markets Exist When the Government Makes the Market?

Since before World War I our nation’s position as the leader in global economics has been unquestionable, and over the years we’ve built an extraordinary agricultural, industrial, and technological marketplace on a foundation of free market capitalism, the rule of law, and a free democracy. We’ve accepted the value of a reasonable level of regulation in the financial markets and have considered the federal government’s role in our economy as one of influence more than one of capital market maker.

In recent months we’ve seen the US Treasury and Federal Reserve take unprecedented steps toward strengthening our economy. Trillions of dollars have been pumped into the financial markets to increase bank capitalization, restore credit facilities, and shore up an ailing automobile industry. Federal ‘stimulus’ packages have been passed in an effort to restore public confidence and to seed economic growth. As a result, the Federal Reserve’s balance sheet has swelled, the Treasury has made capital investments that would have previously been unfathomable, and the federal budget has ballooned to represent a larger portion of gross domestic product (GDP) than at any time since World War II. Our economy has changed.

So what happens when the government begins to exert capital influence on the markets and our elected representatives begin to act as though they’ve become directors or shareholders in our publically held corporations? The answer lies in whether or not we have the public will to allow such intrusions to be long term, or if we are prepared to hold our political leader’s to their word.

We’ve come to expect our federal policy makers to influence the markets through monetary policy, taxation, and various economic initiatives, but we now see a new role developing as the Federal Reserve and Treasury have become major players in the capital markets. President Obama and Treasury Secretary Geithner have clearly stated that they do not want to nationalize our banks or have the government run major corporations. However, in recent weeks we’ve seen equity positions of up to 80% taken in certain financial institutions, congressional leaders act out as though they’ve become the shareholders or members of the board, the Obama administration openly participate in effecting leadership changes at GM by ousting CEO Rick Wagoner, and the Treasury announcing plans to insert personnel in businesses in receipt of federal funds.

Some months ago I coined the term ‘free market nationalism’ and supposed I was exaggerating a point; now I’m not so sure. If the management of our capital markets becomes the purview of our elected representatives, then we’ll need to assess how ‘free’ our markets have become and question whether or not we’re holding onto an ideal that may possibly have slipped away.


Congressmen and senators as the worst kind of shareholders – a bully pulpit, populist pandering, and standing

I’ve never been a fan of politics. I’ve recognized it’s import in our society and I’ve even lent a helping hand at times, but in truth, I’ve found myself increasingly disappointed the closer I’ve observed politics and politicians, regardless of their party affiliation.

From the ‘bully pulpit’ of the US Capital, we’ve recently been forced to endure pitiful displays of populist pandering as the US House and Senate have sought to shape corporate compensation plans, travel policies, and executive ‘perks’. As the ‘big three’ auto makers came hat in hand to their government for help we witnessed a shameful display of congressional ignorance and lack of courtesy. And yet worse has been a blatant abuse of authority as lawmakers have attempted to break contracts or use the tax code in the event that they fail. Had most of the rest of us attempted to act in such a manner our mothers would have stepped in and shaped the discussion, if not our bottoms.

Oversight of our economy, or the ability to control the federal purse, ought not to afford our elected representatives the license to use their standing in such egregious ways – it serves us all very poorly. Admittedly, much of this is a result of the failure of corporate leadership to adopt and adequately maintain policies to strengthen the position of shareholders and employees, but in the end two wrongs do not make a right.


Mark to Market Changes at the FASB

The Financial Accounting Standards Board (FASB) has now voted to approve greater flexibility in ‘mark-to-market’ accounting practices in an attempt to shore up earnings reports of major financial institutions, just in time for 1st Quarter earnings releases next week. The move, though greeted by stock market gains, does little to address the problems of how to value ill-liquid assets, but may provide some relief to bank capitalization efforts. It may also be a step in the wrong direction regarding transparency.

We recently suggested a two-pronged approach to changing ‘mark-to-market’ rules to allow appropriate mark downs on troubled assets to impact income statements, and thereby stock values, but not to use those same figures to affect capital ratios as they form a bank’s ability to lend. It’s one thing to accurately represent the value of a company in the market and yet another to interrupt the critical lending systems so important to our economic recovery. As the FASB continues to monitor ‘mark-to-market’ policies and as well as other accounting standards that impact our economy we hope they continue the recent trend towards transparency without stifling prospects for growth.



Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management