During the market rally in August I was asked several times about September and October, as it seems to be widely known that these are historically bad months for Wall Street. I explained that there have been a number of times in the last century when there were market crashes in these two months Ė the most notable being 1929. The reasons often have had to do with Congress either doing good things before the August recess that are reversed when Congress returns in September, or good things being promised before the recess Ė and discounted on Wall Street Ė but then blocked after the recess. In other words, the movements have nothing to do with the climate or other fall variables. We continue to believe there is enough good happening because of what took place earlier in the year on tax cuts, with the possibilities of more to come, to support the continuation of this modest bull market to the end of the year. Some items:
IRAQ: The obvious fact that Iraq remains a messy situation -- with few indications there soon will be improvement -- is not bad for the markets. The mounting costs are forcing the Bush Administration to make major concessions at the United Nations in power sharing, which we believe reduces the risk of new conflict or pre-emptive wars. The Pentagon still believes it can get a UN resolution without having to relinquish sole political and commercial influence, but the UN Security Council members know the U.S. cannot handle Iraq without financial aid and manpower from the rest of the world. Responding to a request from Sen. Byrd [D-WV], the Congressional Budget Office yesterday reported the 136,000 troops in Iraq and Kuwait will have to start coming home by March. Unless foreign forces take their place, the number will steadily drop until the number reaches 38,000 to 64,000.† Money canít fix the problem, which lies in the shallowness of the manpower pool and other U.S. commitments around the world. At bottom, cheaper diplomacy has to replace more expensive force of arms. Secretary of State Colin Powell automatically gets more leverage and Defense Secretary Donald Rumsfeld gets less.
REFLATION: With gold at $370, there is now no pressure anywhere in the world for monetary deflation by itself to force unemployment. At least for the near term, fiscal and monetary policies are pulling in the same direction not only in the United States, but also in Europe and Asia. The anxiety over Chinaís explosive growth by American exporters soon should fade as that growth translates into a greater appetite in China for capital goods and consumer goods from the rest of the world. At the same time, the ďjoblessĒ recovery here will end as all sectors here go as far as they can with the workforce they have and can see the profitability of hiring and training the unemployed or underemployed at higher wages. We had been expecting this turn to become clear by next spring, but it may show up sooner given the continued advances on Wall Street and the reports of heightened economic activity.
FSC: The fixing of the Foreign Sales Corporation to satisfy the World Trade Organization (WTO) did not make any of the lists of Congressional things-to-do we have seen during the past few days. There is still no clear picture on what will happen with the Jobs Creation Act now awaiting action by House Ways and Means, but if Chairman Bill Thomas can get it out of committee in the next few weeks after negotiating enough votes for passage, it could provide another boost to Wall Street. Iíve never said that the Thomas package would pass as is, but as long as some part of its supply-side provisions gets to a Senate-House conference Thomas will make the most of it. Just as it took the market some time to discount Thomasí skills in getting the tax cuts this spring, it has yet to discount a favorable outcome on FTS. Heís the most important supply-sider in Washington.
CALIFORNIA: Arnold Schwarzenegger still seems a good bet to come out on top when the recall process ends next month. There are still no signs of Reaganesque tax cuts in Arnoldís arsenal, but the Democratic alternatives are so weak that Californiaís economy would be better off with a no-new-taxes governor. Schwarzenegger is at least firmly committed to reforming the workmanís comp provisions pushed through the legislature by Gray Davis in recent years. Thatís a minimum to halt the exodus of businesses from the Golden State.† Iím still expecting something more from the Terminator in the time remaining, the best to hope for being a commitment to cut the stateís onerous capital gains tax. He may need it to inspire more enthusiasm from conservatives in this complex voting process.
DEMOCRATS: Howard Dean looks better all the time as the likely Democratic presidential nominee, especially as the Iowa and New Hampshire polls showing him leaving John F. Kerry in the dust. Iíve made the point before that as strong as Dean might look come the general election if Iraq remains as messy as it is now, he would need a better economic plank than he has had thus far. In checking his website today, I find he has committed himself to ďa fairer and simpler tax system,Ē a phrase he tossed around a few weeks ago. Iím not sure what Dean has in mind, but this is certainly a step in the right direction if he comes up with a positive outline that includes this as a key part of his election strategy. Iíll be watching the Democrats debate tonight in New Mexico to see if it comes up.
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