C.M.O. 8.8.2011

In mid July Eric Cantor was in a cabinet room with President Obama sitting between Nancy Pelosi and Steny Hoyer.  The tangling of the debt ceiling debate was tense.  At one point the President invoked Ronald Regan and as Mr. Cantor recalls in an interview in this weekend’s WSJ after Eric’s retort Mr. Obama said, “Eric, don’t call my bluff”, and then left the room.

On August 5th just after 8:00 p.m. Standard & Poor’s called everyone’s bluff when it said, “The downgrade reflects our view that the effectiveness, stability, and predictability of American policy making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.” Thus lowering it’s rating of the United States of America’s sovereign debt to AA-plus.

One of the items S&P might have been focusing on when they cut one A from the U.S.A.’s AAA was that of the $2.4 trillion of the deficit that is scheduled to be reduced over the next 10 years only $21 billion of that is charted for 2012 (or just 8.75%) and most of the heavy lifting doesn’t start until way after the next election, giving everyone a little too much room to maneuver for S&P’s liking.

That President Obama invoked Ronald Regan is recent but not revolutionary and there have even been some policy shifts such as the proposal to extend the payroll tax holiday beyond its current December 31, 2011 end date; but if there is a mentor the President should seek to emulate it might not be Ronald Regan but that President’s role model, Calvin Coolidge.  Under “Silent Cal” as he was called, the economy grew a touch better than 7% from 1924-1929 and all while he cut taxes, balanced budgets and slashed government spending by over a third in a decade.  His efforts started with comments he made from the White House lawn in 1924 saying, “I want the people of America to be able to work less for the Government and more for themselves.  I want them to have the rewards of their own industry.  That is the chief meaning of freedom.”

As you are reading this the world will have already started to figure out the implications of S&P’s actions.  What was made clear last week was that regardless of the number of A’s on America’s debt, when the going gets tough, the tough buy US Treasuries as the yield on the 10-year broke down through the 2.50% level at one point on Thursday.  As scary as that might sound there are some that think that this could produce a buying opportunity in the stock market as it is one of the rare occasions that the dividend yield on the Dow (2.62%) is higher than the yield on the 10-year note (2.50% +/-)

By Friday the S&P had fallen more than 10% in 10 trading sessions which is only the fourth time that has occurred since the end of WWII.  Thomas Lee, equity strategist for JP Morgan says that in each of the other three instances the market was 18% higher three months later.

Jim Paulsen, investment strategist at Wells Capital would seem to be in Mr. Lee’s camp as he recently stated, “The economy is doing well enough to keep earnings rising and bring some bullishness back to the stock market”.  This is borne out by the numbers as with 331 of the S&P 500 having reported Q2 earnings 71.6% have exceeded expectations, 10.6% were in line and 17.8% had disappointed.

David P. Goldman, the former head of credit research at Bank of America saw last weeks movements more as a “liquidity event” a.k.a. 1987 than a “systemic crisis” a.k.a 2008.  David thinks this had made stock cheap as the earning yield on the S&P 500 (the inverse of the price earnings multiple) is 650bps above the yield on the 10-year note.  This Mr. Goldman observes is an equity risk premium not seen in a generation.

John Roque, technical strategist for WJB Capital would seem to be another voice in the bull’s chorus as he notes that Thursday’s sell off moved the percentage of S&P 500 stocks trading below their 200-day moving averages to 19%.  The seven times this has happened in the last 17 years produced two week gains of 5% and three month gains of 15%.

For those looking for real world indicators that all is not going to hell in a hand basket FreightCar America (RAIL) disclosed last Thursday that is delivered 1,309 railcars in the 2nd quarter versus 614 in the same period last year and is planning on hiring up to 300 people by year end.  Ed Whalen, the company’s president said that railcar manufacturing was “trending in a positive direction”.  CSX Corp (CSX) is also in expansion mode as they are buying 3,800 new freight cars after transporting 10.4 million tons of coal in 2Q11, a 30% increase over 2Q10.  Trinity Industries Inc. (TRN) a Dallas based railcar manufacturer, said it expects to deliver as many as 14,200 new railcars in 2011 up from 4,750 in 2010.

Maybe, just maybe this is one time when the light at the end of the tunnel being a train is a good thing!

Enjoy the week.

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