Monthly Archives: October 2011

On a broad basis, U.S. stocks had their third straight week of gains. The DJIA rose 1.4%, while S&P 500 gained 1.1%. The NASDAQ did not fare as well, losing 1.1%. For the year, the S&P 500 remains down 1.5%. Globally, stocks have not fared as well, with the Global Dow down 11.5% for the year.

As expected, third quarter corporate earnings have been solid. 41% of the S&P 500 constituents have now reported earnings, with 72% beating expectations. Only 17% have been below estimates. Annualized growth rates for earnings are in the 14-15% range so far. However, earnings growth rates are expected to slow to just below 12% in the fourth quarter. Growth rates are important because a stock’s price generally trades based on the anticipated future cash flows of the company.

European debt woes continue to dominate headlines. Despite pressure from the G20 to announce a formal plan for the containment of damage from the debt crisis, European leaders continue to debate how they will increase the European Financial Stability Facility’s (EFSF) funding. Anticipation is that an announcement will happen this week, but it may not be feasible. This is because the only way to know how much to fund the EFSF is to know how much of a haircut Greek bondholders are going to have to take. In other words, how much are the European banks that hold Greek debt going to lose? It is imperative that these banks are able to withstand the losses in order to avoid global contagion.

It remains likely that that the European issues will be solved. It may take China, the U.S., and other members of the International Monetary Fund stepping up to help fund the EFSF. So far, Treasury Secretary Geithner has been firm in his stance that the European Union has enough amongst its members to handle the issue. When push comes to shove, we’ll see where he really stands.

Recent census data indicates that the median household income in the U.S. is $49,445, meaning half the households in America make more and half make less.  If your household income is above $170,000, you made the top 20% in the country; at $288,000, you make the top 5%.

Statistics also show that almost all of those below the median household income pay no federal income taxes at all.  The top 10% of wage earners pay 70% of all federal income tax and the top 5% pay 58%.  My question is: what is the “fair share” for each of these segments?

The chart below shows a 65-year historical perspective of federal government spending (black line) and taxes (blue line) as a percentage of GDP.  When looking at our debt, spending and taxes, it seems to me that a combination of increased revenue and reduced spending is necessary for us to dig our way out of our debt hole.  I like the idea of some sort of tax reform combined with marginal tax rate cuts (for individuals and corporations) as this would raise incentive along with producing revenues.  With taxes running below the 65-year mean of 18% at 17.1% of GDP, I believe this is achievable.

The other point I would make from this chart is that government spending has exploded to 25.5% of our economy, well above the historical mean of 19.6%.  The Simpson-Bowles deficit commission argues that this should be cut to 21%.  I think 21% should be our minimum goal.

After spending several weeks in a fairly narrow trading range (as we predicted), the odds are increasing for a year-end rally in stocks.  – Stacey Wall

Stocks ended the week mixed, with the DJIA gaining 1.32% and the S&P 500 and NASDAQ losing 0.44% and 2.73% respectively.  Concerns over a Greek default lingered over the markets as the third quarter came to a close.  Fortunately, the German parliament voted overwhelmingly to increase its contribution to the European Financial Stability Facility (EFSF) and expand its bond purchasing program.  Finland and Austria also agreed to the expansion of the EFSF.  In the meantime, to help balance its budget and qualify for its next round of bailout money, Greece adopted new property taxes.

After a positive first half of the year, the third quarter hit investors like a ton of bricks.  All major stock indexes are down for the year.  The S&P 500, which represents a broad basket of U.S. large cap stocks, is down 10%.  U.S. small cap stocks, represented buy the Russell 2000, are down 18%.  Globally, stocks have not fared any better, with the MSCI EAFE Index down nearly 15% and the MSCI Emerging Markets Index down over 23% for the year.

The question investors are now faced with is, “will the fourth quarter be better?”  Chances are that markets will remain volatile.  From a technical perspective, we have not broken through the lows made in early August.  History suggests that we need to retest and probably break through those lows. However, seasonal tendencies suggest we could get a year-end rally.  Look for equity markets to get worse before they get better; however, this should set up a tactical buying opportunity.