Wednesday, December 8, 2010

Morning Note...


Futures ~20bps higher this morning as investors continue to digest yesterday’s Bush-era tax cut extension (and subsequent Obama press conference – see WSJ editorial in quote section below for more on this - indicating that the cuts will in no way be permanent), increased negative speculation surrounding the U.S.’s massive insider trading probe, and a higher-than-expected 3pm Consumer Credit increase (whither personal balance sheet de-leveraging?).  The USD is generally higher (+20bps) on the announced tax cut extension, which is also weighing slightly on equities.  The ten-year Treasury yield also spiked higher yesterday as bonds sold off on the tax cut extension and speculation that the tax relief means the Fed could temper their bond purchases via QE2.  In Asia, markets were mostly lower (ex-Japan) on continued speculation that China will tighten again.  Europe is generally (+75bps on average) higher this morning.  In corporate news, McDonald’s (MCD; -1.4%) missed November comparable stores sales estimates (+4.8% vs. +5.6%/e).  Fortune Brands (FO; +4%) announced its intention to split the company into there separate businesses.  Texas Instruments (TXN; -65bps) lowered guidance slightly.  Costco (COST; -40bps) beat earnings estimates by 2c and Home Depot (HD; -85bps) slightly raised guidance ahead of today’s investor day.  Oil -40bps.  Gold -140bps.  EUR/USD 1.3236. 

Here are a couple interesting reads regarding yesterday’s Obama tax deal:

            Obama’s Deal to Extend High-Earner Tax Cuts Unpopular (2010-12-08 13:24:57.494 GMT)

Dec. 8 (Bloomberg) -- Americans don’t approve of keeping the breaks for upper-income taxpayers that are part of the deal President Barack Obama brokered with congressional Republicans, a Bloomberg National Poll shows. The survey, conducted before, during and after the tax negotiations, shows that only a third support keeping the lower rates for the highest earners, and less than half of those respondents say the breaks for the wealthy should last for a shorter period than cuts for the middle class. Overall, two- thirds of those polled favor a permanent extension of the lower rates for the middle class. More than a fourth say all the tax cuts should be allowed to expire Dec. 31, as scheduled.  The agreement Obama announced Dec. 6 would temporarily sustain the tax cuts for all income levels. The president said the compromise was needed to break a deadlock with congressional Republicans who vowed to block tax cuts for middle-income Americans if those for individuals earning more than $200,000 and couples earning more than $250,000 weren’t extended, too. “I’m as opposed to the high-end tax cuts today as I’ve been for years,” Obama told reporters yesterday. “In the long run, we simply can’t afford them. And when they expire in two years, I will fight to end them.” Still, many of the respondents in the poll conducted Dec. 4-7 said they wouldn’t support the compromise.

Tax-Cut Deal Alone Won’t Add Enough Jobs: Mohamed A. El-Erian (2010-12-08 02:00:00.4 GMT)

Dec. 8 (Bloomberg) -- President Barack Obama made a very important policy announcement Monday while also noting that it was “not perfect.” If approved by Congress, which is likely, its impact will be felt both inside and outside the U.S. Still, the key objective -- to generate durable jobs -- will be possible only if this is part of a broader policy push. After protracted negotiations that crossed party lines, Obama explained his willingness to maintain for two years the Bush tax cuts for all income brackets, extend federal unemployment insurance, cut payroll taxes by 2 percentage points for one year and reduce other taxes. The accord is important in three ways. First, it shows that America’s unemployment problem is finally at the top of Washington’s legislative agenda. Second, the measures take some pressure off the Federal Reserve, which has been pushed into unusual activism and policy experimentation to combat unemployment that remains stuck at almost 10 percent. Third, it signals that political compromises are possible in a city that has been characterized by massive polarization and fragmentation. While important, the package is a product of political compromise that is far from perfect. Its limitations are seen in both what the deal does -- and doesn’t -- include. Though it promotes economic activity, the package doesn’t do so in the most efficient manner. And it does little to address growing income inequality in the U.S.

                          Tensions Rise

This week’s announcement will also heighten tensions within each of the two political parties, with the Democrats being most at risk as the tax-cut compromise will disappoint Obama’s core supporters, who backed the president’s campaign promise of refusing to extend the tax cuts to the nation’s top earners. These imperfections, while notable, are inevitable outcomes of difficult political compromises. More important, they pale in significance when weighed against what the policy approach doesn’t include so far. The impact of the measures on economic growth will erode over time if not accompanied by two additional policy efforts.
Officials must explain how further short-term deterioration in America’s budget deficit will eventually give way to medium-term fiscal responsibility. In addition, we need a more meaningful push to improve America’s long-term competitiveness, which has been compromised by our lagging behind in infrastructure improvements and education, as well as resource misallocations.

                      Multiple Challenges

Without these two features, the compromise plan’s ability to generate durable job growth will be challenged by national and international forces. U.S. economic growth will rise in the short-term but at the cost of complicating economic management elsewhere in the world; and, over time, the U.S. will face an even greater challenge in dealing with its large and rising public debt. Markets understand this, judging from their immediate reactions to Obama’s announcement. The stimulus-induced boost to growth was reflected in an immediate rally in global equities and other risk assets, which fizzled by the end of the trading day in the U.S. yesterday. Commodity prices and the currencies of emerging countries strengthened, and Treasury bonds sold off sharply, consistent with a rise in medium-term fiscal concerns. These market reactions serve as a reminder to the Obama administration that this week’s important policy announcement is just a step in a long and complicated journey. More will be needed if the U.S. is to decisively address its most pressing economic and social problem: persistently high under-employment and unemployment.

(Mohamed A. El-Erian is Pimco’s chief executive officer and co-chief investment officer, and the author of the book “When Markets Collide.” The opinions expressed are his own.)

NFLX downgraded at JEFF.  GSCO ups FWLT, KBR.  ASMI upgrade at JPHQ.  CEU announces $10M buyback.  COO beats by 22c.  GDOT announces secondary pricing at $61/share.  KFN (KKR) announces 18M share offering.  KFY beats by 6c.  MIND beats by 3c.  MW beats by 10c.  NEWN raises guidance.  POWL misses by 24c.  PPO files for shelf offering.  STWD announces 20M share offering.  SWC secondary priced at $19.50.  VVUS higher on approval for OREX’s Contrave.  Global Hunter cuts WTI.  BofAMLCO ups VVUS.  JEFF ups NHP.  MSCO ups D.  DBAB cuts JCI.  GSCO cuts MMM.  MSCO cuts ETR, NEE.  BARD cuts SRV.  UBSS cuts WY. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia:  According to The Economist, what percentage of New York City residents are foreign born?
                                                                                                                                                           
Yesterday’s Question:  Name the world’s largest cocoa exporter.

Yesterday's Answer:  Ivory Coast is the world’s largest cocoa exporter. 

Best Quotes:  Wall Street Journal Op-Ed…

Obamanomics Takes a Holiday

A two-year tax reprieve is better than current law but far from ideal.

Does President Obama like or loathe the two-year tax deal he has struck with Republicans? It was hard to tell from his grudging, testy remarks Monday and yesterday, but perhaps that's because he realizes he is repudiating the heart and soul of Obamanomics as the price of giving himself a chance at a second term.
In accepting the deal to cut payroll and business taxes and extend all of the Bush-era tax rates through 2012, Mr. Obama has implicitly admitted that his economic strategy has flopped. He is acknowledging that tax rates matter to growth, that treating business like robber barons has hurt investment and hiring, and that tax cuts are superior to spending as stimulus. It took 9.8% unemployment and a loss of 63 House seats for this education to sink in, but the country will benefit.

***

In this sense, the political symbolism is as important as the policy. Mr. Obama is signaling that businesses must be encouraged to make profits again so they can hire more workers, that "the rich" he so maligns should be able to keep more of what they earn, and even that wealth built up over a lifetime shouldn't be confiscated wholesale at death. In policy if not in Presidential rhetoric, class war and income redistribution are taking a two-year holiday.
This is not to say the deal is optimal for economic growth, and Republicans should not pretend it is. A two-year reprieve is far better than an immediate tax increase amid a still fragile recovery, but it also means that the policy uncertainty is carried forward. In the Keynesian universe, "temporary" tax cuts are virtuous because they stimulate immediately while ostensibly allowing government to reclaim the revenue later when the economy is stronger.
In the real world, businesses make investments based on the estimated return on capital over time, including the expected tax rate. What matters is the overall cost of, and return on, capital. The temporary nature of the tax cuts will provide less incentive to invest than would permanent reductions in the cost of capital. (See Messrs. Cooley and Ohanian nearby.)
The provision to allow business a 100% expensing deduction for 2011, and 50% in 2012, will help growth in those years. But it will do so in part by pulling investment forward from 2013. This is good for President Obama's re-election chances, but not so good for increasing the permanent level of business investment.
The same goes for the temporary cut in the payroll tax in the name of encouraging more hiring. The one-year cut to 4.2% from 6.2% in the employee portion of the Social Security tax increases the incentive to work. Because it doesn't favor some workers over others, it is also superior to the tax credits that Democrats wanted. But the proposal does nothing to reduce employer costs, even as ObamaCare is raising those costs as its mandates and regulations take effect.
This incentive to work also conflicts with the disincentive to work provided by another extension in jobless benefits. The deal's 13-month extension will cost taxpayers about $56 billion. As economist Larry Summers noted before he joined the White House, every jobless person has a "reservation wage," or the minimum wage he'll accept to take a job. The jobless rate will thus stay higher for longer as benefits induce some people to hold out for a better job than those that are available.
Another half-victory is the provision to set the estate tax at 35%, with an exclusion of $5 million. The rate was set to return to 55% with a $1 million exclusion on January 1, and Mr. Obama had wanted 45%. While the 35% rate also lasts only two years, the level of bipartisan support will make this rate politically difficult to increase even if Mr. Obama wins re-election. Meanwhile, Republicans can continue to campaign for repeal of this immoral tax on a lifetime of thrift.
Should Republicans have held out for more, since they would return in January with a stronger position? We wish they had won a longer extension, kicking the next possible tax hike further into the future. As it is, Mr. Obama made clear on Monday that he'll try again to raise taxes in 2013, figuring he'll be politically stronger if the economy improves. The growth policy victories here are partial and temporary.
Yet this deal is superior to anything we could have imagined six months ago. Much credit goes to Mitch McConnell and Senate Republicans for holding together against the class war attacks of Chuck Schumer and other Democrats. By holding firm, they divided the opposition. This proves again that Republicans win the economic debate when they make the case for lower taxes for everyone in the name of faster growth and job creation.

***

They should nonetheless not advertise this deal as an economic panacea. It is at best a transition from the failure of Obamanomics to what we hope is a better growth agenda when it expires in two years. GOP Presidential candidates in particular can explain why this deal improves on the last four years but also where it falls short and how to restore the prosperity of the 1980s and 1990s. Tax reform is one promising area for Republicans to tackle in the wake of endorsements by the deficit commission and Mr. Obama's own economic advisory group.
As for Democrats, many and perhaps most in Congress will oppose this deal as an ideological betrayal by Mr. Obama, but it is really an admission of reality. Democrats lost the election because their economic policies failed. Their caterwauling now is mostly short-attention-span theater for the MSNBC crowd. Mr. Obama's heart is still with the left, and he's making it very clear that he'll return to fighting to redistribute income in 2012, but for now he had to dump the Democrats to save his Presidency. As he likes to say, elections have consequences.