TRUE TO FORM, SEPTEMBER has been volatile and for the most part, down. For the three weeks ended Friday, September 23, 2011, the Dow Jones Industrial Average closed at 10,771, off 469 points, or 4.2%. The Standard & Poor’s 500 closed at 1136, down 37 points, or 3.6%, and the NASDAQ Composite closed at 2483, up 3 points, effectively flat.
What wouldn’t surprise us at all is to see a very solid week in the markets this week, as we approach the end of the month. We will know next week, when we write to you again.
Boeing has shipped the first 787 Dreamliner, three years after their targeted delivery date. All Nippon Airways appears to be pleased, however. Research In Motion continues to struggle, reporting another disappointing quarter. I like my Blackberry, though I have nothing to compare it to.
Netflix may have stepped on itself, with its recent price restructuring. This move has Redbox, Blockbuster, and others out in force to nab customers. The real competition for DVD’s however, is from the various streaming services. UBS said recent trading losses are $2.3 billion. UBS chief Oswald Grubel has chosen to return to retirement, which I suspect is not a bad personal move.
It remains to be seen whether the Solyndra story is simply classic mismanagement, or a case study in what happens when attempts are made to have the government intervene in private markets. Moody’s has cut ratings on Credit Agricole SA and Societe Generale SA, citing concerns about funding and liquidity needs.
The inability of government leaders around the world to wean themselves of promises that require cash continues to create concern, and have a negative rippling effect. These promises make perfect sense though, if we understand that the ultimate goal of those in power is to stay in power.
In economic news, residential foreclosures were up 7% in August, compared to July. Consumer credit was up $12 billion in July, with auto loans increasing sharply, and credit card debt continuing to decline. Initial jobless claims continued in the low 400,000 range. The CPI was up 0.4% in August, with gasoline and food prices leading the way.
Retail sales were flat in August, while industrial production was up 0.2%, and inventories were up 0.4%. What’s interesting is that consumers appear to be buying new autos, rather than new school clothes. This has stumped a few commentators. It makes sense though, given that alcohol, chocolates, and cosmetics were growth industries during the 1930’s. If the outside world appears to be a mess, people will do a variety of things, and spend money in interesting ways, in order to look good and feel good.
Since we wrote to you last, the FOMC has met, and their comments released for public consumption did nothing to assure investors that they had a meaningful game plan. Of course, some operate from the assumption that the government can create jobs in the private sector, which it most assuredly cannot. What government can do is create an environment that causes companies and business owners to want to deploy capital and make new hires. At the moment, both sides of the aisle in Congress, and the White House, are doing nothing of the sort, and are, in fact doing the opposite.
Perhaps the best approach would be to adopt a flat 10% sales tax, and do away with any and all income or estate taxes. Tie this to a federal legislature that meets for eight weeks a year, and mandate an 80% reduction in federal programming and employees? Something certainly needs to change.
President Obama introduced his new tax plan. The proposed plan would extend the 2% payroll tax cut for employees through 2012. The employer share of payroll tax would be cut from 6.2% to 3.1% on the first $5 million of payroll, and eliminate it entirely for any net increase in payroll. The plan would also extend current enhanced depreciation provisions, and create a “Returning Heroes” tax credit of up to $9600 for hiring unemployed veterans.
Mitt Romney has proposed a tax plan that would move some of the current percentages around, and generally lower. John Huntsman has proposed a plan with similar features, though his plan would offer rates of 8%, 14%, and 23%, do away with the AMT, and eliminate tax on capital gains and dividends. Huntsman’s challenge is that he isn’t faring well with those most likely to vote in a Republican primary.
Herman Cain’s tax plan would eliminate payroll taxes completely, cut corporate and personal taxes to 9%, and impose a 9% national sales tax.
Derivatives Explained: Heidi owns a bar in Detroit, whose customers are mostly unemployed alcoholics who can no longer afford to patronize her bar. Heidi introduces a new plan to allow her customers to drink now and pay later. Heidi tracks her customers’ drinks, effectively lending them money. Word gets out of her new plan, and Heidi is swamped with business. Since her customers are relieved from the need to pay now, Heidi gets no resistance as she raises prices at regular intervals. At year end, Heidi shows unprecedented growth in both gross revenue and net profits.
A young bank vice-president at Heidi’s bank recognizes these customer debts as future assets and increases Heidi’s borrowing limit. The bank’s underwriters express little concern, as they have the resources of unemployed alcoholics as collateral. Over at the banks trading desk, expert traders find a way to make huge commissions, and transform these loans into DRINKBONDS. These bonds are bundled and traded on international markets, and are given an investment grade rating.
Investors don’t understand that the DRINKBONDS (Symbol: DUMB) they are buying are really debts of unemployed alcoholics. The bond prices continue to climb, and soon become the hottest selling items at some of the country’s leading brokerage houses.
One day, a new risk manager at the local bank decides it’s time to demand payment on the debts incurred by the drinkers at the bar, and so informs Heidi. Heidi lets her customers know, but being unemployed alcoholics, they cannot pay their debts. Heidi can’t pay her loans and is forced into bankruptcy. She and her eleven employees lose their jobs.
Overnight, DRINKBOND prices drop by 90%. The collapsed bond prices destroy the banks liquidity, preventing it from making new loans, thus freezing credit and economic activity in the community. Heidi’s suppliers had granted her generous terms, and had invested their firms’ pension funds in the bonds. They now write off the bar’s bad debts, and face the prospect of a seriously impaired retirement plan. The wine supplier also declares bankruptcy, closing the doors on a family business. The beer supplier is taken over by a competitor, who closes the local plant and lays off 150 workers.
Fortunately, the bank and brokerage firms, and their executive suite, are bailed out by cash infusions from government loans. The funds for this bailout are obtained by new taxes levied on employed, middle class, non-drinkers who have never been to Heidi’s bar.
This is how many see the events of the last few years. Thanks to my friend David Burrell for the analogy.
Quotes of the week:
“According to the latest poll, a record 73% of Americans think the country is headed in the wrong direction. The good news: Gas is so expensive we’ll never get there”.
-Jay Leno
“The U.S. Census Bureau reports that American homes are 650 square feet larger today than they were in 1980. Unfortunately, so are most Americans”.
-Conan O’Brien
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