72% Say US Headed in the Wrong Direction

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 25, 2011

IN THIS ISSUE:

1. Poll: 72% Say US Headed in Wrong Direction

2. “Misery Index” Hits 28-Year High

3. Latest Economic Reports Were Mixed

4. Key GDP Report Due Out on Thursday

5. The GOP Pro-Growth, Flat-Tax Movement

Introduction

As is often the case, we will cover several different topics this week. We begin with some new Associated Press polls released last Friday. Lead among them is the poll which found that 72% of Americans now believe that the US is headed in the “wrong direction.” This is consistent with a Time poll earlier this month in which 81% rated the US economy as “poor.”

From there, we move on to the news that the so-called “Misery Index” rose to a 28-year high in September due to a higher than expected rise in the Consumer Price Index. The Misery Index is the sum of the inflation rate (3.9%) and the unemployment rate (9.1%), or 13 in this case.

Following that discussion, I will summarize the latest economic reports, most of which were disappointing, but there were at least a few bright spots. The key will be this Thursday’s first (advance) report on 3Q GDP. The pre-report consensus suggests a rise to 2.0-2.3% (annual rate) from 1.3% in the 2Q. A number in the 2.0-2.3% range will confirm that we are not in a recession.

Finally, I will address a political issue that is just beginning to make the rounds in the media. Namely that the Republican presidential hopefuls are gravitating to a “flat tax” and “jobs growth” agenda that could stand up very well against President Obama’s tax-and-spend, punish- success policies in the 2012 election.

While some readers prefer that I not delve into political issues, I think you’ll find this discussion quite interesting and different as well. Plus, I don’t remember a time when economics, investments and politics were so closely linked.

Poll: 72% Say US Headed in Wrong Direction

A new AP poll released on Friday found that 72% of Americans believe the country is headed in the wrong direction. That’s actually down from a high of 75% in August. A Time poll earlier this month found that 81% described the economy as “poor,” and in a new high, 43% of respondents describe the economy as “very poor.”

In the latest AP poll, only four in 10 people said they approve how President Obama is handling the economy, while 60% said they disapprove. More than half of respondents said Obama does not inspire confidence about a recovery.

The majority indicated that there was no improvement in the state of the economy last month, with 68%saying the economy “stayed about the same.” Only 9%said they thought it got better, according to the AP poll.The outlook wasn’t much better looking into the future, with 41% saying they thought the economy would stay the same over the next year. Only 30% said they thought the economy would get better.

The Obama administration claims that a majority of Americans support his recent $450 billion jobs bill, which was dead on arrival in Congress. However, the AP poll last Friday found that only 41% say the government can do much to create jobs, and less than 40% say the main elements of Obama's jobs proposal would increase employment significantly. 40% believe unemployment will be higher in the coming year, and only 23% expect unemployment will be lower next year.

There was one bright spot for President Obama in the latest AP polls, if you can call it that: 27% said President Obama is to blame for the economy, whereas 44% still blame President Bush. Despite that, Obama’s job approval remains the lowest of his presidency at 41% according to Gallup.

“Misery Index” Hits 28-Year High

The so-called Misery Index – which is simply the sum of the country’s inflation rate and the unemployment rate – rose to 13.0, the highest since 1983. The Index was pushed up by higher price data the government reported on Wednesday. The Labor Department reported that the Consumer Price Index rose 3.9% over the last 12 months, the fastest pace in three years.

The data underscores the extent that Americans continue to suffer even two years after a deep recession ended, with a weak economic recovery imperiling President Obama’s hopes of winning reelection next year. The last time the Misery Index was at current levels was in 1983. But in 1984 an improving economy helped President Ronald Reagan win re-election. This year, the Index has risen more than two full points.

The Misery Index is an unofficial economic indicator created by Chicago economist Arthur Okun back in the 1970s.

Latest Economic Reports Were Mixed

A few key economic reports over the last two weeks may be cause for some guarded optimism. Last Thursday, for example, the Labor Department reported that “initial claims” (new filings for state unemployment benefits) for last week came in at 403,000 – down modestly from 409,000 the prior week.

On the surface, that report doesn’t look too positive. Any number above 400,000 is generally looked upon as negative. However, many economists look at the four-week average of initial claims to detect a trend, and with last week’s report of 403,000, the four-week average dropped to the lowest level since mid-April. That is at least encouraging.

Next, there was some good news on the housing front. The Commerce Department reported that housing starts jumped to 658,000 in September, up from 572,000 in August. It was also well above the pre-report consensus of around 585,000 and was also the highest monthly total since April.

The only disappointing element to the housing starts report was the fact that the increase in building was led by a surge in construction of apartments and other multi-family dwellings. More construction of apartments may support the building industry, but it also means that the overall housing slump is turning more Americans into renters. The vacancy rate for apartments dropped in the 3Q to 5.6%, the lowest since 2006 according to Reis, Inc., a New York property research company.

Unfortunately, a decrease in building permits, a proxy for future construction, took some of the shine off the housing numbers. The Commerce Department’s report showed applications dropped 5% to a 594,000 annual rate in September, a five-month low.

The National Association of Realtors reported last Thursday that existing home sales dropped 3% in September to a seasonally-adjusted annual rate of 4.91 million homes. That was the worst showing in 13 years.

There was some encouraging news in last Friday’s retail sales report. The Commerce Dept. reported that retail sales rose a better than expected 1.1% in September, up from only 0.3% in August. This was well above the pre-report consensus of 0.7%.

While the retail sales report was encouraging, the Reuters/University of Michigan Consumer Sentiment Index remains in the tank this month. For the first half of October, the index fell to 57.5, down from 59.4 for September. To put this in perspective, this index averaged 89 in the five years leading up to the recession which began in December 2007.

Finally, the Consumer Confidence Index for October was released this morning, and was yet another negative surprise. The Index, which had already declined sharply during the summer, fell more than expected in October, falling from 46.4 in September to 39.8 this month. This was well below the pre-report consensus which expected the Index to be about unchanged.

The Conference Board which compiles the Consumer Confidence Index released a statement noting that:"Consumer confidence is now back to levels last seen during the 2008-2009 recession.” The US stock markets all reacted lower this morning in the wake of the report.

Key GDP Report Due Out Thursday

The Commerce Department’s “advance” report on 3Q GDP will be released on Thursday morning. This is our first glimpse on how the economy did in the July-September quarter. The pre-report estimates suggest a rise to 2.0-2.3% (annual rate) in the 3Q, up from 1.3% in the 2Q and 0.4% in the 1Q. A number in the 2.0-2.3% range will confirm that we are not in a recession, and I suspect a number in that range would be positively received by the markets. But look out below if the number is less than 2%.

The GOP Pro-Growth, Flat-Tax Movement

Have you wondered why the stock markets have moved to their highest level since late July so far in October? I have maintained since July that the European debt crisis would be the main driver of the equity markets, and sure enough, almost every time there has been bad news from the Eurozone, stock markets around the world have plunged.

The other main driver I have warned about is the so-called debt “Super Committee” that is charged with finding at least $1.2 trillion in spending cuts over the next decade. I am not optimistic that the Committee will succeed by its November 23 deadline, which looms as another big potential negative for the stock markets.

Yet even with these and other negatives looming on the horizon, the Dow Jones has cruised from below 10,500 to near 12,000 as of yesterday’s close. The S&P 500 has climbed from below 1,100 to around 1,250. So what is driving the markets higher amidst all these negatives?

S&P 500 Index Dec 2011

Economist Larry Kudlow, host of CNBC’s The Kudlow Report, advanced a theory over the weekend which he believes is driving the stock markets higher. I don’t know if he is correct or not, but his theory is very interesting. I’ll summarize it for you below. The article was entitled “The GOP Pro-Growth, Flat-Tax Competition” and appeared on RealClearPolitics.com on Saturday.

With President Obama’s job approval rating at a new low of 41% in the latest Gallup poll, it is looking more and more likely that the Republican candidate – whoever that turns out to be – will be our next president. That alone could be encouraging stocks.

But it’s more than that, according to Kudlow. Increasingly, the GOP candidates are moving toward a pro-growth, flat-tax agenda. Herman Cain, with his “9-9-9- plan,” has soared in the polls. Texas Governor Rick Perry is set to formally announce his own flat-tax proposal today, reportedly a 20% flat tax option. The other GOP candidates are increasingly turning to more jobs growth and tax reform initiatives.

President Obama, on the other hand, continues to campaign on huge tax increases for individuals making over $200,000 and families making over $250,000 (the so-called “millionaires and billionaires”). He continues to demonize businesses and entrepreneurs with his populist attacks on risk-taking and success. This is wearing thin on independent voters.

So here is what the 2012 presidential campaign is likely to boil down to, according to Kudlow: the GOP’s pro-growth tax reform versus Obama’s “their fair share” redistribution and soak- the-rich tax increases. Kudlow thinks pro-growth, flat-tax reform will win that battle. Maybe that’s why stocks are moving higher even as the news out of Europe and on our economy remains disappointing. Maybe the sudden stock market rally is reflecting the growing GOP growth/tax reform plans to replace Obama’s tax-the-rich mantra.

Wall Street analysts argue that the recent rally is driven by better than expected earnings in the 3Q. After all, almost three-quarters of reporting companies have beaten expectations, with overall profits up about 14% over year-ago levels. Certainly that’s part of the recent rally, but could a bigger picture be developing?

Could it be that investors sense that the Republican Party is reinventing itself, with candidates competing over who can offer the most pro-growth, tax reform policies? Could it be that investors are envisioning a new Reagan-like era where success is rewarded, not punished, where consumption is taxed more and saving and investment are taxed less? Where capital investment surges, leading to higher productivity, new jobs and rising incomes?

Kudlow thinks it’s all that and potentially even more, that this is the beginning of a new trend. For example, there is widespread agreement among the Republican candidates that we need to: 1) impose strict spending limitations on the government; 2) roll back onerous government regulations; 3) remove oil and gas drilling and exploration restrictions; and 4) stop the Fed from devaluing the US dollar and end quantitative easing. The GOP frontrunners all say they would replace Ben Bernanke.

Herman Cain’s 9-9-9 plan is far from perfect. We are told that Rick Perry’s flat-tax plan due out today will feature an optional single tax rate around 20%. These flat-tax plans might create significant growth incentives and serious tax simplification, but the devil is in the details, as always. As best we can tell at this point, both plans would eliminate the double tax on capital gains and foreign earnings by US corporations.

As Kudlow points out, all of these ideas represent a complete reversal from Obama’s plans of taxing the rich and penalizing successful small business owners. If he is correct that this is where the GOP candidates are trending – especially with regard to tax reform, regulatory rollback, spending limits and Fed policy – the Republican platform would represent a total repudiation of Obamanomics.

Kudlow believes that if the GOP contenders get really serious about creating an environment for job creation and significant tax reform, any one of the leading candidates can defeat Obama in 2012.

I must end by saying that all of this may just be wishful thinking on Kudlow’s part. Likewise, there is no guarantee that any of the GOP candidates would wholeheartedly embrace all of the suggestions noted above. They certainly didn’t the last time they controlled both houses of Congress and the White House.

Then there’s the question of whether a flat-tax would ever be passed pass in the Congress. Many feel that it will never happen. In any event, Kudlow’s article is a very interesting read:

http://www.realclearpolitics.com/articles/2011/10/22/the_gop_pro-growth_flat-tax_competition_111780.html

Very best regards,

Gary D. Halbert