It’s 18 degrees outside with more than a foot of snow on the ground, but news of Washington politics, worse than usual, still manages to make my blood boil.  I know it’s 2002 and control of the Senate and House are up for grabs by Republicans or Democrats.  But, I still manage to allow my optimistic nature the latitude to expect that, occasionally and for longer than a few days, congressmen and women could place concerns of our economy and our national well being above political point making.  Tom Daschle, Senate Majority Leader, in a noon speech today, will call for a tax credit for companies that create jobs as part of an economic policy highlighting the differences between President George W. Bush and Democrats.  The “job creation tax credit” would be packaged with depreciation bonuses for capital investments and tax benefits for business losses in previous years under the plan.  These measures are essentially Trojan horse with tax increases lurking inside.  In his speech, Daschle, will attack Bush's $1.35 trillion, 10-year tax cut enacted last year and call for budget discipline. He'll argue that a return to government surpluses will help keep interest rates low and that this is the best way to spur growth.  “The most important thing we should do is restore long-term fiscal integrity to our budget so we can bring long-term interest rates down,” Daschle will say, “the tax cut has taken away our flexibility and left us with only two choices, both of them bad.”  Those choices include shortchanging needs such as homeland security or raiding the Social Security surplus, he says. 

Did you really expect the U.S. Senate to come together at the last minute to craft a stimulus bill in time for Christmas?  The last target date for such an economic lifesaver was Thanksgiving.  They are further apart now than they were before Thanksgiving.  Senate Majority Leader Tom Daschle “Dr. No,” said the Senate wouldn’t take up the stimulus bill passed by the House early Thursday, or any other stimulus bill this year.  He left open the possibility that talks will resume when Congress returns in late January.  Investors took their anger to the markets yesterday as the Dow and S&P fell almost 1%.  The battered NASDAQ fell 3.25% on the failure because of its heavy dependence on an economic recovery.  Bondholders are paying attention to the bill because passage would lead to more government borrowing, while defeat would cap the supply of Treasury debt making bonds more expensive and rates lower. 

To the casual observer, this week’s markets seem overly concerned with news that should have been expected and already priced into stocks.  We know, for instance, that a recession means higher unemployment numbers, declining payrolls, and weaker retail sales.  So why did it seem like investors ran for the exits this week after the buying spree of the week before?  The answer lies somewhere between human nature and the tax code.  Last week saw a market poised shake off months of pessimism in favor of the possibility that the economy would be turning soon.  Stocks rallied as investors and portfolio managers bought to avoid being left behind in case a new bull market was emerging.  Another common characteristic of investors is their tendency to hold positions with losses as long as possible hoping that time will reduce their losses.  As the year comes to a close, investors must sell their losses to recognize them for tax purposes.  Some years the process is orderly.  This year’s tax selling season will likely be more erratic because of the significant losses sustained by investors in 2001, generally bad economic news, and disappointing quarterly corporate earnings reports.  Sellers may panic into ‘selling at any price’ on market decline days, forcing some stocks to decline further than they would in more normal markets. 

In April of 1991, the National Bureau of Economic Research declared that a recession had begun eight months earlier in July of 1990.  They later announced that same recession had ended in March of 1991.  The recession was actually over and recovery in progress before the recession was officially declared.  The same official body recently declared that our economy entered a recession in March of this year. The economy contracted at a 1.1% annual rate between July and September as consumer spending slowed, business spending slumped, and companies slashed inventories. It is the largest decline since the first quarter of 1991, at the end of the previous recession. 

Often, the fear of the monster lurking in the darkness is greater than the actual sight of it.  The monster’s out, the U.S. is in recession.  The National Bureau of Economic Research on Monday said the U.S. entered a recession in March even though contraction did not actually show up until the third quarter.  A common definition of a recession is two consecutive quarters of economic contraction, but the NBER, considered the official arbiter, relies on a variety of factors to determine the state of the economy.  Most expect contraction in the fourth quarter of this year as well.  On that news the markets actually rallied for a couple of days. 

On Tuesday of this week the government announced that U.S. retail sales rose more in October than in any month in the government's 10 years of record-keeping.  Consumers spent money at auto dealers, department and discount stores, and building supply outlets.  Sales surged 7.1%, almost three times analysts' expectations, after falling 2.2% in September. The Commerce Department's report also showed sales excluding a record increase in purchases from car dealers rose 1% after falling 1.5% in September. The rise in vehicle sales was a result of no-interest financing offered by automakers.  General Motors has announced a continuation of their 0% program through January 15th

Over long periods of time the stock market outperforms bonds by a substantial margin.  But, it should come as no surprise that bonds were the winners over the past two years.  In fact, bonds have outperformed the S&P 500 by a 60% premium, the strongest difference in seventy years (1931 and 1932).  Tom Galvin of Credit Suisse First Boston notes that the year following the strong bond performance, stocks posted a 54% return in 1933 as the cycle reversed.  A similar story of good treasury returns during two consecutive bad years for equities came during 1973 and 1974.  That period was followed by greater than 60% returns in 1975-76.  The left-hand graph below reveals just how significant the signs are that we are at a critical turning point for stock and bond investors.  If the cycle repeats, the next twelve months could bring strong returns to stock investors. 

Just like the Yankees, this market refuses to give up.  Down two games to none, the Yankees faced the possibility of a sweep by the upstart Arizona Diamondbacks as they came back to New York for game three of the World Series.  But with faith, determination, and more than a little luck, they homered their way back into the series, winning all three of their games in front of the home crowd.  In the last two games, the Yank hitters overcame the Diamondbacks in the ninth innings as they capitalized on the weakness of Arizona’s relief pitcher staff. 

One of the rituals of autumn is setting back our clocks to return to standard time (2:00 am this Sunday morning).  That extra hour of sleep in the midst of such a busy time is welcome indeed.  Fall, so often, also brings a falling stock market.  The tragedies of September moved that event forward this year. 

Wednesday’s market opened with much promise.  Our president said there were indications that our efforts against the Taliban and Al Qaeda were showing success.  IBM and several other notable companies reported earnings that were better than expectations.  The DOW and NASDAQ opened up 100 and 30 points, respectively, above their Tuesday close.  Investors seemed to ignore the news that terrorists had crossed yet another line by assassinating Israeli Tourism Minister Rehavam Ze’evi outside his hotel room.  Later in the morning, though, the weight of two events finally began to drive the resilient market down.  The first was a lack of financial inspiration from Mr. Greenspan followed by a steady flow of new anthrax letters cropping up in places of high visibility.