What's Moving the Markets Jude Wanniski July 23, 2003

My assessment that we are in a “sawtooth” stock market with a small bullish tilt seems to be unfolding as imagined. The forces pulling the value of the capital stock up are ahead of us and are outweighing the forces of the past that are still dragging. Here are some updates:

Saddam’s Sons: Tuesday’s market rally was widely attributed to the morning news that U.S. Special Forces killed Saddam’s sons, Uday and Qusay. The reasoning works, I suppose, if the market sees their departure as milestones in the end of violence in Iraq. The supposition is that the guerrilla fighting that continues to take the lives of U.S. troops is being orchestrated by the Ba’ath Party supporters of Saddam, and once Saddam and his heirs are eliminated, peace will prevail. That is a rosy scenario which one would hope would be the case and that Saddam himself will soon be in hand to have it play out. My Iraqi sources tell me the opposition is broad-based, not at all connected to the remnants of Saddam’s regime. It isn’t unified under a single leader, but is motivated by a uniform desire to end what they see as a permanent U.S. occupation of Iraq through a puppet government. The Governing Council hand picked by the U.S. civilian administrator Paul Bremer seemed broad-based to me on paper, but I’m told it does not have the support of either the clerics or the intellectuals and that nationalist anti-Saddam political parties were kept off the Council precisely because they can’t be counted on to support the imperial designs of the Pentagon intellectuals who are still running the show. I’m told there are efforts underway to have the Arab League withhold recognition of the Governing Council.  Only time will tell how this will play out, with negotiations on the "road map" to a Palestinian state having major spillover effects on what happens in Iraq.

Earnings: The major market indices continue to sag with disappointing earnings from one corporation or another, reviving with good news from some others. Remember that every penny of earnings has been affected in one way or another by the recent history of deflation. Those management teams that lucked out by taking timely defensive measures even though they did not understand the exact nature of the deflation are now in a better position having survived the worst of it. Others who made their bets on an early “V-shaped” recovery are having a harder time accommodating, forced to downsize and give up market share while hoping for a brighter economy ahead. The unfounded pension liabilities are a major problem for many, but relief comes as the equity markets improve. As long as there is no repeat of deflation in the period ahead, with the dollar/gold price providing all the signals we need, this repair work will eventually be completed and the brighter economy will emerge with lower costs of marginal capital and its greater availability. There are some supply-siders worried about the export of white-collar jobs by U.S. multinationals such as IBM, but this would only occur as the IBM’s find bigger markets abroad for their product and services. Low wages abroad cannot compete with higher domestic wages + higher capital availability. 

Regulation: We’re now “celebrating” the first anniversary of the Sarbanes-Oxley corporate governance legislation that I believe knocked 800 to 1,000 points off the Dow Jones Industrials as it moved through Congress. Some of this discount to the increased risk of conducting business will be reduced as managements learn how to live with the new regulations. But because all the regulations have not yet been written or clarified, the risks might increase too. When government causes problems – as it did in this case by floating the dollar – it often creates new problems by addressing individual or corporate behavior with onerous regulation. 

Drug Importation: The White House did issue a firm statement of opposition to the proposed bill to permit Canadian firms that buy U.S. pharmaceuticals to re-sell them into the U.S. market. The situation arises because of Canada’s socialized health scheme, which limits the prices the government will pay for drugs. If the U.S. firms are to sell into that rigged market, they have to discount from prices charged here, opening the loophole by which the drugs can be resold here. The House will probably pass the bill with GOP support this week and it will probably pass in some form in the Senate. It will of course damage the industry by cutting into profits to the degree the costs are arbitraged. The pressures to do something about the high costs of prescription drugs is driving the Congress in that direction regardless of arguments that it will kill the goose that lays those golden life-saving miracle drugs. The New York Times gets around the arguments this morning by saying the drug companies will be forced to raise their prices in the foreign markets and the governments practicing price controls will have no choice but to up their caps and thereby share in the R&D costs. There may be something to that argument in the long run, although it is not clear why the companies don’t raise their prices now, especially when they have patent monopolies. In any case, this is another item we have to watch while Congress is still in session. 

Bonds: As long as gold hovers at its optimum rate of $350 per ounce, deflationary and “reflationary” pressures are inoperative. This means that the Fed is satisfying market’s demand for liquidity – no more, no less. This permits the yield curve to gradually shift to optimum rates that reflect the real demands for credit in the exchange economy. The 10-year bond should not have to go much beyond 4.2% given all the other variables at work, and to get back down under 4% would take new deflationary signs and a gold price significantly lower than $350. 

Natural Gas: Fed Chairman Alan Greenspan’s recent pleas to Congress to worry about natural gas prices have been surprising, as it is not supposed to be his business to promote one form of energy over another. His warnings are accompanied by arguments for important liquefied natural gas in LNG tankers, reminiscent of the bad old energy-crisis days, again caused by the floating dollar. Refixing the dollar to gold at $350 would fix some of the energy problems Greenspan ponders. The optimum solution would be permitting the importation of methanol to fuel the nation’s cars and trucks, as there is an unlimited supply of methane on the planet. If we also permitted the construction of nuclear power plants to supply the energy we need for stationary energy-users, homes, offices and factories, we could theoretically do without gasoline at all. The major roadblock is Iowa and its presidential caucuses, which require contenders to swear fealty to ethanol, squeezed out of corn. The nation’s energy needs could be satisfied for untold centuries with no pollution, real or imagined, but some serious presidential candidate would have to be prepared to plough under those Iowa farmers. 

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