Can the TARP be Fashioned into a Safety Net?

Good Evening: As the U.S. stock market heads into earnings season, one immediate question on the collective minds of investors is whether the correction in equity prices since the January 6 highs has run its course. The Dow, S&P, and NASDAQ have all corrected 8% or so (from high print on 1/6/09 to the low print today), while the Russell 2000 has retreated 10% and the Dow Transports have suffered to the tune of 15%. For the first time since mid November, the bad news has started to re-enter Mr. Market’s thought process. How the share prices of various companies react to what will likely be horrendous Q4 earnings reports may give us a clue whether the old goat is now willing to go back to shrugging off the news flow (for now). Who knows, maybe there is even a creative way we can all benefit from the loathsome TARP.

After stocks in Asia and Europe went down overnight in sympathy with our poor showing yesterday, U.S. stock index futures were down, but only grudgingly so. The news that the U.S. trade deficit sharply contracted during November sort of muddied the waters. The positive aspect is that one of our twin deficits (the other being the budget deficit — more on this one later) is finally receding. The negative, of course, is that both imports and exports both fell sharply, boding ill for Q4 corporate earnings. Bloomberg broke out the numbers as follows: “In November, exports posted a 5.8 percent drop while imports plunged a monthly 12.0 percent. The overall improvement in November was led by the oil deficit which narrowed to $19.4 billion from $32.3 billion in October. The non oil goods deficit also shrank – to $31.4 billion from $35.3 billion the month before.” (source: Equities didn’t know quite what to make of this mostly oil-related decline, but the results certainly helped the dollar (+1.25%).

After opening with a brief peek at the downside, the major averages pushed their way higher until they were up just shy of 1%. The indexes then headed sideways until another move to the downside eked out new lows for the year. At about the same time, the Treasury announced its monthly budget deficit figures, and they set an unusual record. As the BAC/MER piece below points out, the $83.6 billion deficit for December means that the first three months of fiscal 2009 (Oct/Nov/Dec) sported a higher deficit total (-$485 billion) than any full year in history. The Merrill piece rightly points out that much of this deficit is due to TARP outlays, so it’s not a fair comparison. On balance, therefore, our twin deficits may be going in opposite directions, but the disparity is not entirely due to our punk economy.

As if to support this rather benign view of the budget deficit, the major averages rallied during the final hour of trading. The final tally was mixed, with the Russell 2000’s gain of 1% forming one bookend and the Dow Transport’s 1.2% loss forming the other. Some credit spreads narrowed again (e.g. Munis had a nice day), but others widened a bit. Treasurys moped through a quiet day with little change ahead of tomorrow’s retail sales report. As mentioned above, the dollar climbed better than 1%, but the strength in the greenback didn’t hurt commodities. Oil and its products rose enough to overcome dodgy results in other sectors, and the CRB index posted a gain of 0.75%.

Alcoa kicked off the earnings season last night with a miss, and while AA’s shares were dragged down by 5% today, they still remain comfortably above their 52 week lows. Some tech companies pre-announced negative results, but not all of the offending stocks went down in response. We know business activity fell off a cliff during the fourth quarter, but many market participants feel that the resulting decline in stock prices over the same period means the bad earnings news is “priced in”. We’ll find out just how much Mr. Market has discounted Q4 during the weeks ahead, but many investors are paradoxically hoping companies decide to post awful results. More than one person I spoke with today wants to see a “kitchen sink quarter”. “Kitchen sinking” refers to the management practice of disclosing as much bad news as possible in the current quarter in order to clear the decks for better performance in the future. “Market participants have low expectations, anyway, so why not trot out all the problems now” is their logic. Whether such a tactic by U.S. CEO’s will work (or even tried) is impossible to know beforehand. But if our capital markets can manage to limp through earnings season and then rally a bit, then some of the money currently idling on the sidelines might start to get performance envy.

And, speaking of idle money, far too many people are either complaining about the TARP or are fighting over how it’s being spent. I have a modest proposal for this catch-all fund: Since it’s our money anyway, why doesn’t the Bush administration offer a parting gift to future generations by proposing to dump the TARP assets into Social Security? We need to mend the gaping holes in this social safety net anyway, and to do so will require substantial funds. Tossing the TARP and its sundry investments into the Social Security fund has a huge advantage over the other, politically-charged solutions proposed in the past — it’s already in the budget! The TARP has another advantage; it would serve as a rubber blanket thrown over this famous third rail of politics. Mr. Bush could point to it as a positive legacy of his administration’s bailout policies, and Mr. Obama will be able to take credit, too, since it will become law on his watch. While this concept doesn’t quite fulfill republican desires to privatize Social Security, it does at least allow the GOP to claim private assets are being set aside for all Americans. Democrats, too will benefit, since their previous fears of a high price tag for such a fix will disappear with some simple accounting tricks. There’s no need to add to our burgeoning deficit because, according to today’s budget figures, it’s already in there! Liberals, conservatives, centrists, and even deficit hawks will all rejoice. Rare is the occasion when everyone wins, but this might be it. It will never happen, though. It makes so much sense, Washington proably won’t even consider it.

— Jack McHugh

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