Monday, December 13, 2010

Notable comebacks

The S&P 500 index is still about 20% below its 2007 all-time high, but as these charts show, there are a lot of key financial indicators which are at or very near all-time highs. Copper is now at an all-time high, as are a variety of industrial commodity prices (first two charts). The CBOE index of technology stocks is at a post-2000 high, while the S&P 500 consumer staples index is with just a few percentage points of an all-time high (third chart). The VIX index of implied equity option volatility is almost back to its pre-crash lows (fourth chart), and it shows how the decline in fear and uncertainty has helped stocks in general to recover. The Dow Transports index is within shouting distance of new all-time highs (fifth chart). Finally, 5-yr swap spreads (six chart) long ago made a complete recovery (swap spreads are very good leading indicators of economic and financial market health, as I have noted many times since late 2008), and swap spreads continue to suggest that the economy too will make a complete recovery sooner or later.

These recoveries stand in sharp contrast to the still-depressed levels of financial and homebuilders stocks, which is another way of saying that the 2008-9 recession's wrath was concentrated in just a few sectors of the economy (next two charts, respectively). The devastation in housing and banking was so great that it will take many years to fully recover, but this is no reason to be pessimistic about the economy's medium-term prospects.

At this point it seems quite likely that Congress will pass legislation which extends the Bush tax cuts for all taxpayers, and that will remove one more barrier to an eventual, full recovery because it reduces uncertainty and it improves the incentives to work, risk-taking, and investment. It also marks a sea-change in Washington's attitude towards the private sector, and that is a very welcome return to policies that are more likely to foster rather than retard growth. It highlights the fact that higher tax rates are not the remedy for our budget ills, so it will put inexorable pressure on Congress to rein in spending. As I noted in a post last week, continued economic recovery will boost tax revenues automatically, without the need for higher tax rates, so simply holding the line on spending is quite capable of balancing the federal budget within 5 years. The future is hardly grim, and there is plenty of reason to think that the economy and the country can get back on a prosperity track before too long.

Two years ago, the prospect of a full economic and financial market comeback was so remote as to be almost unthinkable. Now, it's just a question of how much longer it will take. That's probably the biggest comeback I can think of.

UPDATE: One more chart (below) that shows the impressive comeback in retail sales, now truly just inches from a new record high.


Benjamin Cole said...

Excellent review by Scott Grannis.

One quibble: "so it will put inexorable pressure on Congress to rein in spending.'

Oh, the pressure.

Mysteriously, Congress has stood up to pressure to cut spending for about 70 years. The last real reduction in federal outlays was the wide-ranging demobilization following WWII.

But nowadays, rural states, each with two Senators, often get back $1.50 for every dollar they send to DC--not sure they will ever get on board of the "cut spending" bandwagon, except rhetorically of course.

I am afraid spending cuts have to come from the top--El Presidente.

Clinton ran surpluses--it can be done. But you need the top guy to show resolve.

Congress, comprising 435 and 50 money-hungry districts and states, will never cut spending.

Scott Grannis said...

Don't forget that we now have the Tea Party that is supported by a huge portion of the electorate, and the Tea Party is going to be an extremely vigilant watchdog over congressional spending.

Benjamin Cole said...


I hopeyou are right.

But Mitch McConnell and Rand Paul, Kentucky Senators, are in a state that gets back $1.50 for every $1 sent to DC. More than $4,000 net for every Ky. resident.

Without Uncle Sam, Kentucky goes the way of Detroit. Shrinking populations, eroding tax bases, outmigration to urban areas. I am all for it, it is the price of free enterprise and destructive competition. but our rural economies are largely subsidized, and such nuaces are lost of Tea Partiers.

Consider this reality: $8 billion annual in subsidies to rural telephone systems, and a $2 billion one-time subsidy Cash for Clunkers propgram.

Which program do Tea Partiers bash the most?

What I predicted has already happened: Congress cut taxes (good).

I predicted we would not cut spending. I hope I am wrong.

Bill said...

I had an interesting conversation last night with a multi-family housing developer who said that most of their deals have been tied to the 10 year T-bill and that deals were booming until recently when the yields started to spike. Everything is on hold now. It seems that QE2 might have the exact opposite effect of its intended benefit

Benjamin Cole said...

And did the fiscal stimulus package ever get mentioned? The government will be borrowing another $900 billion or so, a sum that dwarfs the QE2.

And with the tax cuts extended (which I favor), but no spending cuts contemplated (which I do not favor), the $900 billion could be an annual sum, not a one-time shot like Bernanke.

T-bills still down 70 bps from start of the year...boy if rates are too high now....I can't imagine a better rate sense is that the demand is not matter how low rates go, first we have boost demand....

septizoniom said...

only you would celbrate the destruction of money wealth by inflation, evident and coming on like a tidal wave in commodity prices. wake up

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Frozen in the North said...

Ok, now the tax cuts have been extended in perpetuity, what shall we cut. America's budget deficit is out of control, and the tax cuts will add to the shortfall.

I suggest:

1) Cut military spending by 20%
2) Means testing Medicare and Social Security.
3) Cut department of Education -- obviously the thing doesn't add value -- you just have to look at the US reading/math/science comps.

I don't care what anyone says, the cuts have to come out of the largest entitlement projects -- that's where the savings are the rest is just political grandstanding.

That should help reduce the deficit by a few percentage points. Still not in surplus. Does anyone think the GOP will make any budget cut proposal beyond a few billion here and there?

BTW Scott the Tea Party only care about spending that is not direct at them.

The stop the earmarks lasted all of 10 days, because in some senators' world earmarks are what the other senators ask.

Benjamin Cole said...

Frozen in the North:

CXut military spending by 20 percent?

Do you realize military outlays have doubled, in real terms, from 2000? And it already was a bloated, coprolitic bureaucracy then?

And the only enemy we face today uses homemade bombs ignited by cell phones?

Time to think outside the box. Yes, total sunset on Dep't of Education, USDA, Labor Department, Commerce Department and think 75 percent reduction in military outlays.