New Fiscal + Monetary Policies = A New Market Dynamic

A deeper look into the November NFP report reveals just how fast the pace of job losses from September has accelerated. The chart provides a good illustration of the steep decline. Nonetheless, we believe a combination of the new administration’s economic stimulus and unorthodox monetary policies presents a new investment dynamic in the immediate term. First, a review of just how bad the job market is.

Employment peaked in December 2007 with 138,078,000 jobs in the economy. Through the first seven months of the year, a total of 655,000 (-0.47%) jobs were lost. For the three months from September through November 1,255,000 jobs (-0.90%) disappeared, which means we've lost 1.91 times as many jobs in the last three months as were lost in the previous seven. Put another way, the economy has lost 1.38% of its jobs from the December 2007 peak, with 65.67% of the loss occurring in just the past three months alone.

Looking at it on a per month basis, the average loss of jobs has gone from 93,571 in the first seven months of the recession to 418,333 in the past three, an increase of 347%. And remember, the October and November numbers are still preliminary and likely to be revised downwards.

While the unemployment rate increased by a less dramatic pace, from 6.5% to 6.7% (the highest since 1993), you have to understand that this belies yet another alarming story. Unemployed Americans are automatically removed from the labor force if they fail to seek work in the previous month, and many did just that. The number of people who have been counted out of the workforce increased by 637,000 in November, which means when you add in all those too discouraged to look for work plus the number of Americans accepting low-pay, part time jobs just to earn some income the unemployment rate soars to 12.5% in November, the highest since the BLS began tracking this measure in 1994.

All in all the numbers point to one thing; an economy in virtual free-fall. So what's to be done?

Speaking on Saturday, President-elect Obama announced the new administration will embark on an economic stimulus designed to "create millions of jobs by making the single largest new investment in our national infrastructure since the creation of the federal highway system in the 1950s."

Additionally, the plan will focus on making federal buildings more energy efficient and launch "the most sweeping effort to modernize and upgrade school buildings that this country has ever seen."

Mr. Obama stressed the need for wise stewardship of taxpayer money. "We won't just throw money at the problem," Mr. Obama said. "We'll measure progress by the reforms we make and the results we achieve; by the jobs we create, by the energy we save, by whether America is more competitive in the world."

More than 5,000 highway projects are ready to go today, state transportation officials say, if Congress will allot $64.3 billion as part of an economic aid plan. The American Association of State Highway and Transportation Officials, which compiled the list, said the projects would provide jobs and help reduce a backlog of crumbling roads and bridges. Economists have estimated that for each $1 billion invested, approximately 40,000 jobs are created.

On the monetary side we can expect to see additional expansion of the Fed's balance sheet which has already grown over $2 trillion in the past year. As announced back on November 25, the Federal Reserve will continue to reliquify the mortgage market with a $600 billion dollar plan to purchase direct obligations of the housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Additionally, the Fed will lend up to $200 billion against the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

And as Bernanke mentioned in a speech on December 1, the Fed could purchase longer term Treasuries which would lower their yields and reduce mortgage rates even further. Rates on 30 year fixed-rate mortgages decreased over 50 basis points within days after Bernanke spoke.

Additionally, the Fed may move to a "conditional" monetary policy, which means the FOMC would communicate plainly it intends to keep borrowing costs low for as long as conditions require. Fed watchers will be looking to see if such language is included in the statement accompanying the FOMC decision on December 16.

There's an old saying in economics; housing leads the economy into and out of recessions and certainly, the collapse of the credit-fueled housing bubble has led us into what could turn out to be the worst recession in the post-war period. Fiscal policies designed to boost employment combined with monetary policies designed to increase the supply of mortgage credit and drive borrowing costs down is the best way forward.

As far as the immediate market direction is concerned, it would seem the S&P has entered a new phase within the context of the overall bear market, one in which rallies can be seen even when economic news is bad. The market could begin to speculate the combined force of a sustained economic stimulus (fiscal policy) designed to produce jobs (and not just provide a one-off rebate check) along with monetary policies designed to directly affect interest rates on the retail level can begin to mitigate the recession. As of last week, the interesting movement on the S&P was seen at the 819 level. This was the intraday low on Monday December 1, as well as where buyers came into the market on Friday, December 5 after the NFP report.

As the market rallies (buys risk) and until proven otherwise, we can expect to see the dollar depreciate against the higher yielding currencies (euro, pound, Australian and New Zealand dollars) as equities are bought. The yen cross-pairs, including USD/JPY will advance. Commodities, including gold, will trend higher.

Comments

[investor88:]

OK short term equity rally mode. Interesting if sp500 crosses 1,000 mark, whether it can sustain above that. We have to respect the tape, so maybe close shorts and go long now.

2008 Dec 08 07:26 AM