December 2, 2002
Supply Side Faith Adds Springs To Stocks
When Kevin Costner replaced his corn field with a baseball diamond in the movie ‘Field of Dreams’, the audience was asked to indulge the actions of a lunatic. Granted, hoards of people eventually arrived at Costner’s Iowa corn field, and although the movie did not specify it is assumed that these people paid for the privilege of watching ghosts play baseball, and that Mr. Costner did not lose his proverbial farm. Nevertheless, before reaching this dramatic end the audience had to take a giant leap of faith: the audience had to believe in miracles.
By contrast, in the late 1990s when Ralph Acampora uttered ‘Dow 13,000’ and CNBCs Larry Kudlow planted the idea of ‘Dow 20,000’, the investing public was not asked to innocently partake in a couple hours of entertainment, but to invest their hard earned money. To be sure, and assuming the ‘professional’ opinions of economists and analysts like Kudlow and Acampora were not meant purely for the sake of entertainment, it can be concluded that many people followed their advice and lost money.
With this in mind, Costner’s movie character is a hero because he took a risk and beat the odds, while the Acampora’s and Kudlow’s are villains because they took no risk, didn’t beat the odds, and are still allowed to play the game (still selling their opinions for riches). Remember, Kevin Costner would have lost his farm if his vision didn’t come to pass, yet these 2 individuals are still sewing the seeds of their erroneous delusions…
Regardless, the feeling during the 1990s was, and there remains a residue of this inane warmth today, that anyone who threw money at the stock markets was building their own personal field of dreams.
Depressurizing A Pressure Cooker
The consensus from team bull no longer focuses solely on the expectation that strength in consumer spending is going to convince companies to start spending money. Rather, and even though team bull is trailing 9-6, there are two outs, it is the bottom of the ninth, and the bases are loaded, the bulls have concluded that since Mr. Stimulus is at bat that everything is going to be OK:
Mr. Stimulus is going to belt a home run and give team bull the win!
Question: did not the U.S. economy only briefly benefit following a record amount of monetary stimulus in 2001? Nevertheless, today many argue that Mr. Stimulus did not fail, but that he has been training in the weight room for the last year. Now it is a stronger Mr. Stimulus, one with biceps coined the ‘stimulus twin towers’ (referring the dual force that is monetary and fiscal stimulus), that is about to unleash its might.
And who is imploring the crowd to cheer for the ‘Stimulus Twins’? Who is saying that the government can unite with the Fed to save the day so long as they forget about tomorrow? Well, it is none other than supply side economist Larry Kudlow.
Indeed, after incorrectly concluding that an IT economy somehow meant the Dow would rally into perpetuity Mr. Kudlow is now howling for (and expecting) more government tax cuts, he is confident the Fed has injected ‘the right’ amount of stimulus, and he is forecasting good times in 2003. ‘Cut the double dividend tax!’ Kudlow screams… and yes, some are deluded into believing he has all the answers yet again; some believe the problems impacting the U.S. economy can be resolved by simply by achieving deeper government deficits.
Will The Government Supply Growth?
The supply sider’s contend that by cutting taxes this will fuel economic growth which, in turn, can actually increase government tax revenues. And although Bush is touting that this model is working, he argues that without the previous tax cuts government income would be lower not higher, it remains to be seen when, if ever, the windfall of supply side economics will ever arrive (or when the deficits (required to stimulate growth) will begin turning into surplus’s).
Is there a need for deficits to ever turn into surpluses? While the answer appears to be yes, after all it was Reagonomics which prompted people to worry about deficits leading into the 1990s to begin with, during times of sluggish growth the answer patently becomes no – at least not now! – when the economy is at risk of recession!
What is clear within the murky topic that is ‘supply side’ is that so long as deficits are measured as a percentage of GDP that maintaining GDP growth is of critical importance. In the U.S. total debt outstanding continues to escalate, the burden on this debt continues to escalate, and this could lead to problems down the road…but not if GDP remains strong.
Death To The Dividends Tax
Do dividend investors want income, or some income and the possibility for bull market growth?
What Kudlow is specifically calling for, and what he believes will help the stock markets next year, is a cut in the double dividends tax. Suffice it to say, there is reason to believe that he is wrong.
What the Kudlow’s quaintly ignore is that part of the reason why dividends fell out of favor to corporate buy backs was because both corporate America and the SEC agreed buy backs would help the markets more so than increases (easier payments) in dividends (in 1982 the SEC loosened buy back rules and since then dividends have steadily fallen out of favor). Are we to believe that the exact opposite is true today: that investors will appreciate dividends more so than buy backs?
Tech Dividends
There is a question of how much money the average tech company, or one of the worst dividend paying groups, could afford to pay shareholders. Consider industry leader Microsoft, which is regularly touted as one tech stock that should be paying dividends:
Microsoft earns roughly the same amount of income as Philip Morris ($10 billion a year), has more than double the amount of outstanding shares (5.35 billion versus 2.07 billion for MO), and is trading at $57 a share versus MO’s $37. Philip Morris pays out roughly $5 billion in dividends a year, or 50% of income, which equates to a current yield of 6.7% while Microsofts pays out nil.
In order for Microsoft to achieve MO’s yield it would have to pay out roughly $3.86 a share/year, or $20 billion. If Microsoft had paid out 50% of its income for the last 12 months its current yield would be roughly 1.7%. Does Mr. Kudlow believe a 1.7% dividend yield is going to excite investors and help unleash a new bull market?
Yes, comparing Microsoft to dividend king-pin Philip Morris is hardly fair: the court/taxation risks associated with owning MO are largely the reason why its yield is abnormally high. Nevertheless, the simple fact is that Microsoft cannot pay out enough dividends to make its stock price attractive to dividend investors: its stock price is too high! In fact, very few companies maintain the cash flows necessary to fund attractive dividend yields, and those that do, including Tobacco, utilities, and REITs, are often ignored during bull markets because they supposedly lack growth potential.
Cutting the dividend tax would help more money filter to shareholders, and this would be welcomed news. However, will an investor be extra attracted to say a yield of 1%-2%? No. How about 3%? Probably not. Don’t get me wrong, there is nothing wrong with a 2%-3% dividend yield and the chance for capital gains. But when stock prices seem to be rising and falling by 2%-3% on a daily basis believing that investors, and more importantly the fund managers that play with investor money, will be compelled to hold a position for 12 months to get a 2% payoff is ridiculous.
In sum, companies and investors would benefit from a cut in the dividends tax, and the government would initially lose out. End of story.
Conlcusion
Without doubt, the U.S. economy could be coerced into growing by the stimulus twins. However, and much like last years ‘recovery’ in 4Q01 and 1Q02, the stimulatory effects of an easy monetary and fiscal policy can quickly subside. As for those pesky resistance levels on the Dow, S&P 500, and the other indices that have no matched the short induced rally in tech stocks, Acampora concludes:
“We now find the Dow Industrials and S&P 500 indices closing in on their respective peaks…If exceeded, which we suspect could be just days or weeks ahead, we should be able to project similar percentage upside (to that of the NASDAQ) for those averages.”
Yes, Mr. Acampora hasn’t changed much – he is still a bull using TA to back his opinions, and he still a bull that ignores the fact that he hasn’t been able to ‘project percentage upsides’ for more than 2 years because the bear market has turned his ‘key buy levels’ into key selling levels.
Eventually Acampora and Kudlow will be right, but remember the adage: even a stopped clock is right twice a day. That these individuals are given the time of day following the myopic opinions they offered in he late 1990s is proof that investors still believe in miracles, that they still want to buy bloated Microsoft shares while ignoring the Philip Morris’s, and that they still believe higher stock prices equates to higher stock prices.
Yes, near the end of the movie we all wanted to see Kevin, the lunatic, succeed; we were all suckers for a Hollywood melodrama done right. However, remember that movies are two hours of entertainment while betting on a sustainable U.S. economic rebound could cost you money.
This Week – Bears Behind 8 Ball
Wal-Mart reported record sales last Friday and ShopperTrak estimates that sales surged 10% on Friday/Saturday when compared to 2001. While WMT’s sales could be acquired by a jump in new stores (not necessarily an increase in same store sales), the ST data is clearly encouraging start to the Christmas spending season.
When combining the sales figures to the most recent raft of positive economic reports the bulls are clearly heading into the week in control. Add to this the fact that December is usually a pretty good for the markets, and the expectation of an immediate pull back in prices becomes even more remote. Quite frankly, without any surprises, be it Iraqi developments, 4Q02 earnings warnings, or an ominous economic report, the markets look steady to strong for the remainder of the year.
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The two key report this week are the ISM manufacturing index (due out later today) and the jobs report (Dec 06). After better than expected signals for manufacturing from Philadelphia and Chicago traders will keep a close on the ISM. Furthermore, after two weeks of slumping jobless claims the jobs report, and in particular the payrolls number (currently expected to be around +50K) has the potential to propel or crush stocks dependent on where the number arrives.
In sum, the U.S. economy is holding onto growth, Kudlow says 2003 will be a great year, and Acampora argues that the Dow and S&P are set to match the Nasdaq’s rally. All these things combined would undoubtedly be great news for the stock markets if prices were not already absurdly overvalued and the markets didn’t just rally by 20+%. As it stands now, the response to any positive economic report, like the strange sensation one gets to drive to an Iowa corn field for no reason, is providing the fuel for further stock markets gains: few seem to care about valuations, quality of earnings, FASB accounting changes, etc…
“Going into the end of the year, you have people that need to make their performance numbers. If someone is 15% to 20% in cash, they cannot afford to miss a rally like this.”
Ben Hovermale, head trader at Wells Capital Management Finance Minister Masajuro Shiokawa (TheStreet – Nov 29).
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