fso wrap-up .... a "should read" article

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    Financial Sense Online
    Today's Market WrapUp
    by Jim Puplava
    01.07.2003


    Got Some Aspirin?

    This year is starting off with a hangover of problems left over from last year. The geopolitical risks over the coming war with Iraq, strikes in Venezuela, a nuclear threat from North Korea are still with us. The economy is still stumbling. Or is in a delicate “soft spot” as Alan Greenspan likes to refer to it? Corporate and consumer debt are still high and in the case of the consumer debt levels are still increasing. Corporations are seeing raw material and labor costs rise along with costly government regulations. With stiff competition coming from China, companies lack pricing power. In addition, to rising costs and lower profit margins companies face large pension costs this year as three years of declining stock prices have wrecked havoc with pension returns. With stock prices no longer rising at double digits, companies will have to dip into their pockets this year to make up for underfunded pension plans.

    Looking at the economic numbers, it becomes apparent that any future growth in the economy is going to have to come from debt-laden consumers and massive fiscal stimulus from government. The stronger element within this economy is the consumer who is still going into debt to maintain lifestyles and who is still buying more expensive homes. Outside the consumer, there is government--both state and federal. State budgets are a mess especially in California and in New York.

    Dark Skies in Sunny California and Other States

    In California a fiscal train wreck has finally arrived. California has already seen its bond rating drop and that credit rating will probably be lowered again. I would not be surprised to see the state’s bond rating fall close to junk bond status. The budget deficit in California has deteriorated so rapidly that budget and credit analysts are having a hard time keeping up with the revisions. At the end of last summer, the budget deficit was $10 billion, in September it went to $15 billion, and by November it was at $21 billion. In December it jumped to $35 billion and is now projected at $36 billion. The current budget deficit for the state is equal to 25 percent of the state’s annual spending. California is headed for a major fiscal crisis.

    Then there is New York City where credit analysts predict that the city’s bonds will be downgraded. New York City’s plans to borrow $650 million this week will cost the city more money as bond investors demand higher interest rates to compensate for higher risks. The higher yield demanded by investors is indicative of growing budget deficits. New York City’s budget deficit is already $1.1 billion and will grow to $6.4 billion in the next fiscal year.

    Other states find themselves in similar situations relative to their size. Faced with these growing budget deficits, they are responding in typical fashion by raising taxes at the state and local level. New York City property taxes have been raised by over 18 percent. In California workman’s compensation premiums have been raised by 25 percent or more on top of major increases from last year as a result of legislation enacted by the state. In the words of the State Compensation Fund, “As you know, California’s workers’ compensation system is deeply troubled.” Around the nation states and cities are raising income taxes, property taxes, sales and other taxes disguised as fees. In addition to major tax increases, states and cities are cutting back on major services to taxpayers while leaving highly paid bureaucracy in place. The trend is more taxes, less services, and a bigger bureaucracy. While the President talks about cutting taxes, the states and cities will be raising them. Higher taxes will cut into already strained household budgets that can only be run on higher levels of debt.

    Spending Our Way Into Deeper Debt

    All hope for an economic recovery this year rests on the assumption that the consumer will be even more willing to go deeper into debt to maintain their lifestyle. Despite growing mountains of debt, analysts say the consumer still has the ability and the willingness to go even further into debt. They cite that debt levels have been rising for decades and are a sign of the US economy and the consumer’s resiliency. However, they also said the same thing about rising stock prices back in the late 90’s. We all know what happened afterwards--stocks went down for three straight years.

    The consumer will not be alone. The federal government and state governments will also go deeper into debt. The US is moving towards a wartime economy and that very fact has yet to register with most investment analysts. Military spending will escalate to $394 billion this year. The US will be spending more money on bombs, ships, rockets, fighter aircraft, new ships, ammunition and soldiers. One out of every three reservists has been called up for the coming war with Iraq. I would not be surprised as the war escalates if there is a movement to resurrect the draft here in the US.

    The President's Plan

    In other news the President revealed today a $670 billion plan to end taxes on stock dividends and accelerate income tax cuts in order to stimulate the economy. The economy is beginning to weaken again as economic growth slowed down to around 1.5 percent during the fourth quarter. The President’s plan would abolish the tax on dividends, which are taxed twice by government, first at the corporate level and then at the personal level when profits are distributed in the form of a dividend. There are over 34 million Americans receiving dividends in this country, mainly senior citizens and they are not rich. In fact, more than 50 percent of Americans participate in the stock market either directly from their ownership of individual stocks, mutual funds or through pension and 401(k) plans at work. There is a good chance that the President’s plan to end the double taxation of dividends stands a fair chance of being passed. Citizens of both parties own stocks and they are not all rich. The President’s plan has the backing of Wall Street. Other interested groups such as seniors, who have seen their income decline with interest rate cuts, are also expected to be in favor of this plan.

    In addition to ending the double taxation of dividends, the President’s plan would also allow the expensing of new equipment of up to $75,000 to help small businesses and boost capital spending. Bush would also give states $3.6 billion to pay unemployed workers as much as $3,000 to aid their search for new jobs. The remaining part of the plan would accelerate the tax reductions passed in 2001 that were due to be phased in over the decade. The top tax rate would fall from 38 percent to 35 percent; while the bottom rates would drop to 10 percent. Tax withholding would be reduced immediately to put more money into workers’ pockets this year that would save workers $29 billion in taxes. It will be greatly needed because states are expected to raise taxes almost as much as the President wants to lower them. There will be a long struggle ahead as both parties pitch their plans to voters. Just taking a lucky guess, if voters are presented with a one-time $300 tax rebate or a permanent reduction in tax rates, I believe struggling households will opt for the latter. They will need those tax cuts to make up for the taxes that will be raised by states and cities.

    Will The Rally Hold?

    Finally, looking at the news in the markets mid-month on corporate earnings, the economy and geopolitical tensions that seem to mount each day, I would be surprised if the New Year rally lasts beyond the end of next week. Corporate earnings confessions should begin by the end of next month. Investors may not know what the real picture is since most of the reporting will emphasize whether companies beat, met or missed lower revolving estimates. I expect that earnings estimates will start to come down even more so that they can beat estimates as we get closer to the actual reporting period.

    Despite the growing mountains of debt in this country at all levels of society, analysts and money managers remain decidedly upbeat, even more so than they were at the peak of the bubble. The chief argument for buying and investing in stocks is that they have fallen for three straight years and will unlikely fall for the fourth straight year. That only happened once during the stock market crash of 1929 and the Great Depression that followed. However, monetary and fiscal policy is following the same path. Today’s situation is very much reminiscent of the 1920’s and the early 1930’s. The only difference between today and then is things are much worse today than they were during the start of the Great Depression. Debt is higher at all levels—consumer, corporate, and government. We are now a debtor nation instead of a creditor nation. Stock valuations are higher today than they were before the 1929 crash, and corporate balance sheets are in terrible shape. As I see it, the dollar is much more vulnerable, and so are consumers and the financial industry due to the explosion in credit. The fact that nobody seems to talk about this is very disturbing. In the US, Washington and Wall Street believe all problems can be solved by borrowing and printing more money. The fall in the value of the dollar and the rise in the value of gold and other commodities are telling us the financial markets see this as problematic. The fate of this nation rests on the dollar and the bond market.

    Today's Market

    Today’s casino results showed another day of tug-of-war in the financial markets as stocks rose and fell all day long, ending on a split decision. The Dow and the S&P 500 lost money while the Nasdaq rose. Many investors questioned the 5.6 percent rise in the S&P 500 from the beginning of the year as being premature despite Wall Street calls for double-digit gains during the first half of the year. Three stocks fell for every two that rose on the NYSE. On the Nasdaq, breadth was negative by 11-10. Volume picked up on the downside. The VIX was nearly flat rising .07 to 27.48. The VIX is falling down to levels that indicate we are close to a market peak. The VXN also keeps dropping, falling .49 to 42.96.
    (Read more about VXN & VIX at www.stockcharts.com)

    Overseas Markets

    European stocks fell as a government report showed consumer confidence in the region slid to its lowest level in 5 1/2 years. Lender IntesaBci SpA, auto manufacturer Volkswagen AG and retailer Metro AG dropped. The Dow Jones Stoxx 50 Index shed 1.1 percent to 2504.27, paring its climb in 2003 to 4 percent. Oil companies including Statoil ASA slid as OPEC officials said the group may boost production quotas to fill a gap left by a strike in Venezuela.

    Japanese stocks fell, led by banks such as Mizuho Holdings Inc., after a newspaper report said the regulator may punish lenders that have received public funds unless they lend more to small businesses. The Nikkei 225 Stock Average lost 0.7 percent to 8656.50. The Topix index shed 0.7 percent to 853.93, with the Bank Index accounting for more than a quarter of its drop.

    Copyright © 2002 Jim Puplava
    January 7, 2003
 
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