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Why The Stock Markets Are Collapsing

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 10, 2009

IN THIS ISSUE:

1.  The Economy Continues To Slump Badly

2.  US Stock Markets Continue To Plunge

3.  Obama’s Multi-Trillion Dollar Spending Spree

4.  Obama’s Budget – The First $2 TRILLION Deficit?

5.  Obama’s Plan To Nationalize Health Care This Year

6.  Obama’s “Cap-and-Trade” Environmental Proposal

7.  Conclusions – Why The Stock Markets Are Collapsing

Introduction

Economic news continues to worsen week after week.  As I will discuss below, Gross Domestic Product contracted at almost twice the previously reported pace in the 4Q of last year, and most analysts now expect a similar or worse slowdown in the 1Q.  Many forecasters now believe the recession will last all year, with a modest rebound beginning in 2010.  We will look at the latest economic data as we go along.

The stock markets continue to plunge, even as trillions of dollars in bailouts and government spending have been announced.  The Dow and the S&P 500 fell 33.8% and 38.5% respectively in 2008.  So far this year, the Dow and the S&P 500 are down another 25+%.  Both indexes are down more than 50% from their peaks in October 2007.  While the equity markets are grossly oversold, there is still no evidence of a bottom, although I fully expect that we are close. 

Investors around the world are stunned, not only as a result of the collapse in the US and global equity markets, but also due to the continuing severe credit crisis.  More and more analysts and politicos are calling for the US to nationalize the major money center banks that are teetering on the brink of insolvency.  Clearly, people around the world are preoccupied with the economic and financial crises. 

In the following pages, we will recap the unprecedented spending that President Obama has proposed over the last six weeks, including his first federal budget proposal totaling a record $3.55 trillion for fiscal 2010.  Obama’s 2010 budget projects a record deficit of $1.75 trillion, and I believe it will be even higher as I will discuss below.  No wonder the markets are not happy!

It is also clear now that President Obama has decided to use these crises as an opportunity to cram down all of his big liberal plans for the country this year.  In addition to spending trillions of dollars, he is also moving forward with other major plans including “Cap & Trade” (carbon emissions), “Card Check” (expanding unions) and nationalized health care – just to name a few, all of which will eventually mean higher costs for American consumers.

When Mr. Obama was elected, most political analysts believed that he would attempt to enact these major liberal plans over the course of his four-year presidency.  Yet it is obvious now that he wants them all this year, while Americans are preoccupied with the economic and financial crises.  If he gets his way, it will dramatically change the face of America.  More on this as we go along

The Economy Continues To Slump Badly

It will come as no surprise to readers of this E-Letter that the US economic numbers continue to falter.  But by far the most shocking number released over the last several weeks was the latest 4Q GDP report released in late February.  In late January, the Commerce Department’s advance estimate for 4Q GDP was -3.8% (annual rate), which was the worst in well over a decade.

Then on February 27, the government revised this number to -6.2%, the deepest quarterly decline since early 1982.  I have been watching US economic data for over 30 years, and I have never seen the Commerce Department miss the GDP number this badly over just a one-month period of time.  Clearly, this economy is contracting severely.

The US unemployment rate continues to ratchet up rapidly.  On Friday, the Labor Department reported that unemployment rose to 8.1% in February, up from 7.6% in January.  Many forecasters predict this number to rise to near 9% by year-end, and some even project the jobless rate to reach 10% by the end of this year.

The Consumer Confidence Index plunged again to a new record low in February of 25.0, down from the previous record low of 37.4 in January.  Consumers’ appraisal of overall current economic conditions, which was already bleak, worsened much further in February. Those claiming business conditions are “bad” rose to 51.1% in February from 47.9% the prior month.

On the manufacturing front, reports are equally grim according to the reports for January (latest data available).  Durable goods orders plunged 5.2% in January following a drop of 4.6% in December.  Factory orders fell 1.9% in January following a plunge of 4.9% in December.  Industrial production fell 1.8% in January following a drop of 2.4% in December.

The nation’s factory operating rate fell to 72.0% in January, down from 73.3% in December.  Elsewhere, the construction spending rate fell another 3.3% in January, down from 2.4% in December.  This is the worst manufacturing downturn in decades.

On the housing front, the numbers continue to worsen.  Existing home sales fell to 4.49 million in January from 4.74 million in December (again, latest data available).  New home sales fell to 309,000 in January, down from 344,000 in December.  Housing starts in January fell to 466,000, down from 560,000 in December.  Meanwhile the median home sale price continues to fall, sliding to $170,300 in January, down 15% from a year earlier.

In summary, we find ourselves in the worst economic slump since 1981-82, and many would argue something worse.  A growing number of forecasters are coming to the conclusion that we may be headed into a depression.  But as I will discuss as we go along, Obama has authorized over $3 trillion in new spending, the Fed will spend up to $2 trillion and Congress has just passed more new spending projects.  So, that much money should start to show up in the economy before long.

US Stock Markets Continue To Plunge

As noted in the Introduction, The Dow and the S&P 500 fell 33.8% and 38.5% respectively in 2008.  So far this year, the Dow and the S&P 500 are both down over 25%.  Both indexes are down more than 50% from their peaks in October 2007.  The Nasdaq Composite Index fell 40.5% in 2008 and is down another 17.6% so far in 2009, down over 55% since the peak in late 2007.

Stocks have been battered with a steady stream of bad news so far this year, as noted in the latest economic reports above.  In addition, there has been report after report of faltering banks.  The government now owns 36-40% of Citigroup, which saw its share price fall below $1.00 last week.  The 30 companies that make up the Dow Jones Industrial Average are commonly referred to as “Blue Chips” or the strongest of the strong.  Over the last year, however, the number of Dow stocks trading under $10 per share has increased dramatically.

In addition to Citigroup, other beleaguered Dow stocks include General Motors at $1.50 per share, Bank of America at $3.00, General Electric at $6.00 (down 60% this year alone), and Alcoa at $5.00.

The government has also increased its equity stake in AIG, now reportedly owning over 80% of the insurance giant.  Speaking of insurance, I am hearing from sources inside the industry that we could be hearing announcements soon that some major insurers are in serious financial trouble.

Investors around the world want to know what is driving the equity markets down so dramatically.  Certainly, the credit crisis and the economic recession are weighing heavily on stock prices.  But I believe there is much more to it than that.  As I will discuss later on, I believe that the markets are voting NO on the massive spending Obama has authorized in his first 40 days in office.

Obama’s Multi-Trillion Dollar Spending Spree

In sheer size, the economic measures announced by President Barack Obama to address “a crisis unlike we’ve ever known” are remarkable, rivaling and in many cases dwarfing the New Deal programs that Franklin D. Roosevelt famously created to battle the Great Depression. Here is a list of the massive spending that Obama has gotten passed or is proposing:

1.  In February, Congress passed and Obama signed into law a record $787 billion stimulus bill, which is mostly new federal spending along with aid to struggling states and tax incentives.

2.  Treasury Secretary Geithner announced last month that the government would make available up to $2 trillion on top of what has already been spent or promised in a rescue effort for banks and other financial institutions, including credit card companies and those who make student loans.  We have yet to see the details on this massive rescue plan.  Clearly, the lack of a detailed financial rescue plan for the banks is spooking the stock markets.

3.  The president pledged up to $275 billion in federal aid to help stem the tidal wave of home foreclosures.  Here, too, the details are unclear as to how it will work.

Add it all up and the total for these three spending proposals alone is over $3 trillion in new government debt over the next 2-3 years.  In all, the plans noted above would raise the federal portion of the US economy to some 31%, more than twice the level after eight years of FDR’s historic New Deal spending.

This does not include the remaining $350 billion in TARP money that Obama will get to spend this year.  Plus, there is also talk of a second stimulus package later this year, one supposedly aimed at consumers directly. 

And let’s not forget that the Federal Reserve has purchased over $1 trillion in troubled assets and related securities over the last year alone.  Fed chairman Bernanke told Congress recently that the Fed is prepared to double that amount this year.

President Obama and Bernanke tell us that all this massive spending is necessary to avoid a “catastrophe.”  Yet no one knows if these huge spending programs will work.  No wonder the stock markets are tanking.

Obama’s Budget – The First $2 TRILLION Deficit?

President Obama unveiled the largest federal budget in history in late February – a whopping $3.55 trillion.  With the economy in recession, the Obama administration projected that the budget deficit for fiscal 2010 would be a record $1.75 trillion.  However, there are reasons to believe it will be even higher.

For example, Obama’s budget plan assumes that Gross Domestic Product, the sum of all goods and services produced by the nation, will shrink by only -1.2% this year and rebound to about 3.2% by next year.  Given that GDP plunged by 6.2% (annual rate) in the 4Q, and the likelihood that the 1Q will be just as bad or worse, we would have to see a huge rebound in the second half of this year for GDP to average only -1.2% for the year overall.

Furthermore, none of my trusted sources expect GDP to rebound to 3.2% in 2010.  The point is, federal tax revenues in 2010 will almost certainly be lower than the assumptions in Obama’s $3.55 trillion budget, so the deficit is almost certain to be larger than projected.

Obama’s budget plan also assumes that the US unemployment rate will average 8.1% this year and get slightly better in 2010.  The US unemployment rate stood at 7.2% for December 2008.  It has since risen to 7.6% in January and to 8.1% in February.  Most economists now expect the unemployment rate to reach 9% by year-end.  That does not average out to 8.1% for the year.

Here again, the unemployment realities will mean that federal tax revenues in 2010 will almost certainly be lower than the assumptions in Obama’s $3.55 trillion budget.  As noted above, the Obama administration projects a budget deficit of $1.75 trillion for fiscal 2010.  But it will not surprise me if the deficit is $2 trillion or more in 2010.  No wonder the markets are tanking!

$410 Billion Omnibus Spending/Pork Bill

The Senate is expected to pass the huge $410 billion omnibus spending bill that will finance the government through the end of September any day now.  This is possibly the most pork-laden spending bill in history.  It is widely reported that the bill contains over 8,500 “earmarks” (pet spending projects for lawmakers’ states and districts).

The omnibus spending package ran into trouble last week when several Democratic senators opposed not only the pork-barrel spending in the bill, but also the shear size of the bill - $410 billion.  That is an 8% increase over the prior omnibus bill.  Among the Democrats in opposition was Senator Evan Bayh of Indiana who told the Wall Street Journal:

“The omnibus increases discretionary spending by 8 percent of last fiscal year's levels, dwarfing the rate of inflation. Such increases might be appropriate for a nation flush with cash or unconcerned with fiscal prudence, but America is neither.”

During the presidential campaign, candidate Obama promised that he would wholly change the budget process in Washington by going line by line through spending bills, picking out the wasteful earmarks, vetoing the bills, and telling Congress to send them back stripped of the pork. President Obama has echoed that promise since he took office - but just not for this bill. Since this omnibus bill was largely negotiated last year when Bush was still in office, Obama labeled it “unfinished business,” which he says he will sign and “start fresh next year.”

So, it is politics as usual in Washington, only the numbers are much bigger!  These historically huge spending programs and bailouts that Obama and the Democrats in Congress have authorized have really spooked the stock markets.  And the Democratic spending machine isn’t finished yet.  Using the “never let a crisis go to waste” doctrine, Obama has made it clear that he plans to pursue massive spending for other pet liberal programs over the next couple of years. 

Obama’s Plan To Nationalize Health Care This Year

President Obama recently convened a health care summit at the White House, which was attended by “experts” across the health care and insurance industries. The Washington summit is to be followed by regional meetings across the country in the weeks and months ahead.

The summit concluded without specific details as to what an Obama health care system would look like. We do know that Obama’s 2010 federal budget calls for the creation of a $634 billion health care reserve fund to cover reforms over the next 10 years. The President’s remarks at the summit included the following:

“To the liberal bleeding hearts hoping for universal health coverage, I don't think we can solve this problem without talking about costs.  And to those obsessed with costs…[we will] not slash the social safety net. I just want to figure out what works. We don’t have a monopoly on good ideas. We’ve got to balance heart and head.”

For those fearing a total socialization of health care, this is at least some good news.  By all accounts, President Obama is resisting the liberal calls for a “single-payer” socialized health system of the type that exists in Canada and Europe.  So what can we expect?  No one knows for certain just yet, but two of the ideas being floated are: 1) an expansion and retool of Medicare; and 2) some variation of the health plan that members of the federal government enjoy.

It is abundantly clear that Obama intends to enact his massive health care reforms this year, and unlike the Clinton administration, Obama appears to have the votes in Congress to get it done.  So, now the question is, how to pay for it?  As noted above, his 2010 budget includes $634 billion over 10 years to help fund his health care “reforms.”  But where does this money come from?

The Obama administration says that $318 billion of it will come from tax increases on the “wealthy.”  Another large portion will supposedly come from “internal reforms” to the Medicare system.  Specifically, Medicare Advantage would be placed into a new competitive biding system that will supposedly do away with federal subsidies paid to these private medical plans, which is projected to save $175 billion over 10 years.

They say another $37 billion could be saved as home health care payments to Medicare are reduced, and a further $20 billion could come from higher rebates from drug companies for drugs sold to the Medicaid program.  All of this only adds up to $550 billion. Where will the other $84 billion come from?  I have no idea, and at the moment, neither does the Obama administration.

The Obama plan does not seem to be in danger of going the way of the ill-fated Hillary-Care proposal in 1993.  House Representative Joe Barton (R-TX) was on hand for Obama’s health care summit last week.  Barton was pivotal in derailing Hillary-Care, but he told those assembled at Obama’s summit that he largely supports the health care reforms that President Obama has outlined thus far.

Barring some big surprises, President Obama is going to get his massive reform of the health care system, whether we like it or not, possibly before the end of this year.  While it may stop short of socialized medicine, the government will be in charge of our health care system, and we all know how well the government controls spending, costs and quality.  Again, no wonder the stock markets are tanking!

Obama’s “Cap-and-Trade” Environmental Proposal

The “cap-and-trade” concept is not a new idea.  The type of cap-and-trade program that President Obama wants is very similar to that of the European Union.  Yet, the EU’s cap-and-trade program is in near-collapse, which demonstrates the weakness of this strategy. 

Under a cap-and-trade system, polluters (think power generation plants, steel mills, etc.) are given a cap on greenhouse gasses they can emit into the atmosphere.  If they exceed their limits, they can either make their process more environmentally friendly by upgrading technology and equipment, or they can buy credits from other entities that produce fewer emissions than their caps.  The goal is that, as the overall emissions caps are reduced over time, industries will find that reducing emissions is more cost efficient than buying credits. 

The cap-and-trade idea is often confused with a “carbon tax,” but the two are different.  In a carbon tax, the government charges a fee for the production, distribution or use of fossil fuels, rather than creating a system of emission credits that can be traded among companies.  Whatever the structure, virtually all agree that any program to curb greenhouse gasses will increase prices as higher costs are passed on to consumers.  Even President Obama admits this. 

President Obama’s recent $3.55 trillion budget proposal calls for a cap-and-trade system to be implemented by the year 2012.  The government would auction credits to power plants, industrial plants, etc., with some of the proceeds over the cost of administering the program to go back to taxpayers (I wouldn’t count on it). 

The Congressional Budget Office (CBO) estimates that a cap-and-trade system will cost middle-income families as much as $880 to $1,500 per year in added costs.  Thus, Obama’s plan to offset these increased costs through a payroll tax rebate ($400 for individuals, $800 for families) won’t cover all of these costs.  Plus, the liberals in Congress have not yet had their say.  The final bill may concentrate the rebates on lower income families, possibly leaving many middle income and high income families out entirely.  Of course, the rationale is that higher-income families will reduce their costs by lowering their energy bills through conservation.  …Right.

Also, it is important to recognize that certain areas of the country will be hit much harder by cap-and-trade, especially those that rely heavily on coal for electricity.  I have included a link to a very good article on which areas will be hurt the most in Special Articles below.

Here again, Obama’s cap-and-trade plan serves as yet another tax on higher income folks who create most of the new jobs in this country.  Critics also say that a cap-and-trade program could lead to the loss of as many as four million jobs and reduce the US GDP, but still may not effectively reduce emissions.  Again, no wonder the stock markets are tanking!

Obama’s “Card Check” Proposal To Strengthen Unions

It is no secret that Obama has long been an advocate for the organized labor unions.  As a senator, he co-sponsored the “Employee Free Choice Act of 2007,” which was very favorable to unions but was fortunately never enacted.  As a presidential candidate, he had a very pro-union agenda, including repeated promises of making “Card Check” the law of the land.

Card Check, considered one of the most sweeping revisions of labor law since the 1930s, would allow unions to do away with secret ballot voting by workers who are deciding whether or not to unionize.  Instead, workers would be required to vote in public by signing a card signifying their desire for, or against, union representation. 

Secret ballot elections have been the law of the land for a very long time, and even many union members do not want this to change.  Critics of the Card Check system say that a secret ballot election is the only way to insure that employees are not faced with undue coercion when making their decision.  Card Check changes all that, since union organizers can place a card in front of a worker and know exactly which box they check.  Liberal union leaders have wanted Card Check for a long time, since it makes unionization much easier. 

Union membership has been steadily declining since the 1950s when an estimated 35% of the American workforce belonged to a union.  Today, the Bureau of Labor Statistics reports that only 12.4% of wage and salary workers belong to a union.  By far, government employees are the most likely to be unionized, with a membership rate five times that of private employees. 

Unions hope that the new Card Check rules, which are almost assured to pass and be signed into law, will help to put them back on a growth path.  The economic consequences will be higher labor costs for producers, lower productivity and higher prices for goods and services to consumers over time.  Just look at the big three carmakers and see how beneficial increased unionization is likely to be for the US economy.

Conclusions – Why The Stock Markets Are Collapsing

I now firmly believe that President Obama and his top advisers have made a calculated decision to try to ram through the largest parts of his liberal agenda this year, while the American people are preoccupied with the economic and financial crisis.

I recently wrote that Rahm Emanuel, Mr. Obama’s new Chief of Staff, told a Wall Street Journal conference of top corporate executives late last year (comments he almost certainly probably wishes he could take back):

“You never want a serious crisis to go to waste. Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with. This crisis provides the opportunity for us to do things that you could not do before.”

So Obama’s liberal policy agenda that would have been considered aggressive over the full four years of his presidency is apparently going to be crammed down the American peoples’ throats this year if possible.

Obama’s massive emergency spending/bailout plans announced in just the first 40 days of his presidency total over $3 trillion, something never before remotely seen.  Obama’s 2010 federal budget of $3.55 trillion will likely result in a budget deficit of $2 trillion next year, and over $1 trillion in each of the next 2-3 years.

Meanwhile, the Fed is in the process of printing and spending another $2 trillion in debt to fund banks and buy toxic assets.  Where this Fed printing and spending will stop is anyone’s guess, unfortunately.  The implications for inflation down the road are ominous.

And let’s not forget the Congress which is about to pass a $410 billion omnibus spending package to keep the government running through September that was 8% higher than last year at this time, and included over 8,500 pork-barrel earmarks.  Obama obnoxiously broke his campaign promise to veto earmarks by saying this enormous omnibus spending bill was “unfinished business” left over from the Bush administration, and promises to sign it into law.   

On top of all this, Obama’s liberal policy initiatives such as nationalized health care, cap-and- trade and Card Check (just to name a few) will add hundreds of billions in cost to American consumers over the years ahead.  And despite what Mr. Obama says, taxes at all levels will have to eventually be increased to pay for this massive spending.  It will change the face of America as we know it, but that is a story for another time.

The long-term implications of these unprecedented multi-trillion dollar spending plans are unknown.  No one knows for sure if all of these huge spending efforts will work to revive the economy and unfreeze the credit markets.  If they do, then there is the prospect for spiraling inflation in the years to come.

Investors around the world are watching their stock portfolios being decimated – down over 50% in just over one year – and are asking WHY is this happening?  Sure, the subprime mortgage debacle was the catalyst.  But in my view, the radical changes that President Obama is pursuing – sooner rather than later – are in large part why the stock markets are in a freefall collapse instead of a normal bear market.

Fortunately, the professional money managers I have recommended to you in this E-Letter over the last several years have done their jobs admirably.  Their active management strategies that have the ability to move to cash or hedge long positions have limited losses to less than half what the stock markets have lost.  Some have even made money in this historic bear market.  As always, I must add that past performance is no guarantee of future results. 

As always, I invite you to call us at 800-348-3601 so we can help you make sense of this frustrating investment environment. That is all for this week, depressing as it may be once again.

Wishing you the best in tough times,

 

Gary D. Halbert

SPECIAL ARTICLES:

Deception at Core of Obama Plans
http://www.realclearpolitics.com/articles/2009/03/a_dishonest_gimmicky_budget.html

The Anti-Stimulus Plans
http://weeklystandard.com/Content/Public/Articles/000/000/016/249nhfrg.asp

Winners & Losers in Huge Congress Spending Bill (who got what in pork)
http://www.foxnews.com/politics/2009/03/09/winners-losers-proposed-massive-spending/

Who Pays for Cap and Trade?
http://online.wsj.com/article/SB123655590609066021.html


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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