Farra: Thoughts on Recent Market Turmoil

While we can’t make a prediction with 100% certainty, we can assign probabilities to the next trend for the U.S. stock markets. The major U.S. market indexes (Dow Jones 30, S&P 500 and NASDAQ Composite) all reached new highs for the rally on or about April 28.  Additionally, technical indicators of the market’s underlying health were all strongly positive as well. The correction that has ensued since April 28 has erased between 9% and 11% of the averages’ value. In a less tumultuous time, this kind of performance would be seen as a normal correction and not the start of a new bear market.

There are two root causes for the stock markets’ performance since the end of April:

  1. The U.S. market had not experienced a 10% correction since the start of the new uptrend in March of 2009. We saw two corrections (in June 2009 and January 2010) that declined less than 9% on both occasions. The selling was less intense than of late and the markets quickly rebounded from their lows. This correction probably marks the end of the first stage of the new bull market, where nearly all stocks — regardless of size or quality — go up. The second stage will see more selectivity among investors and moderating returns compared to the past 14 months.
  2. The Greek debt crisis and fallout among other members of the Euro currency zone has reminded investors that risk still exists in the debt markets. The U.S. experienced a private debt crisis in 2007-2008 when the mortgage market imploded and caused several large financial institutions to fail or need significant government help to stay afloat.  The Euro crisis is a government debt issue with Greece being unable to sell new debt without the explicit guarantee of the European Central Bank (akin to the Federal Reserve). This rescue package was announced two weeks ago but has yet to allay fears that more trouble may be brewing for Greece, Portugal, Spain and Italy. We think the rescue package has been effective by bringing down interest rates for all four countries though significant work remains to be done to reduce their budget deficits without causing major recessions in those countries. (This is something all governments need to do!)

A silver lining to the decline of the past few weeks is oil prices have declined from almost $90 to $70 per barrel. Look for lower gas prices as a result. Interest rates have also declined as investors have fled to Treasuries as a safe haven.  Mortgage rates will likely decline as well. Finally, the U.S. economy may have finally entered a durable recovery and this momentum is hard to reverse in a short period of time.

Investors can expect that volatility could remain elevated over the next few weeks or months as more news coming out of Europe could influence opinions about the impact on U.S. economic growth.

———————-

George Farra is co-founder and principal of the investment firm Woodley Farra Manion Portfolio Management in Indianapolis.

America Receiving Declining Grades on Education

Not to pile onto the myriad reports of the decline of the American education system, but the New York Times relays one educational expert’s testimony that many nations, including our neighbor Canada, are surpassing America when it comes to educating youth: 

America’s education advantage, unrivaled in the years after World War II, is eroding quickly as a greater proportion of students in more and more countries graduate from high school and college and score higher on achievement tests than students in the United States, said Andreas Schleicher, a senior education official at the Organization for Economic Cooperation and Development in Paris, which helps coordinate policies for 30 of the world’s richest countries.

“Among O.E.C.D. countries, only New Zealand, Spain, Turkey and Mexico now have lower high school completion rates than the U.S.,” Mr. Schleicher said. About 7 in 10 American students get a high school diploma.

Mr. Schleicher’s comments came in testimony before the Senate education committee and in a statement he delivered. The panel plans to rewrite the Elementary and Secondary Education Act, the main law governing federal policy on public schools.

The committee also heard from Dennis Van Roekel, president of the National Education Association, the largest teachers’ union; John Castellani, president of the Business Roundtable, a group that represents corporate executives; and Charles Butt, chief executive of a supermarket chain in Texas, who said employers there faced increasing difficulties in hiring qualified young workers.

The blame for America’s sagging academic achievement does not lie solely with public schools, Mr. Butt said, but also with dysfunctional families and a culture that undervalues education. “Schools are inheriting an overentertained, distracted student,” he said.

For more on the state of education in the Hoosier State, peruse some of the articles in the latest edition of BizVoice.

Hat tip to the Chamber’s Derek Redelman for bringing the NYT article to our attention.

World Speeds Past U.S. in Rail Movement

There has been plenty of talk lately about high-speed rail. If that talk eventually turns into action and Indiana ends up in the fast lane, all we can say is it’s about time.

America takes a back seat (way back) to other countries when it comes to moving people on the rails. A few examples from around the world:

  • Japan’s Shinkansen bullet train between Tokyo and Osaka, built in 1964 and averaging 150 mph, was the first. Seven more lines have been added and 300 million passengers a year are served
  • France’s major cities are connected by the TGV line with additional links to Germany, Belgium and England. Passengers: 100 million a year; miles: currently 1,800 with 1,200 more planned
  • In Spain, more people travel between Madrid and Seville by rail than by car and air combined

Some question whether American efforts will add up, with proponents saying true high-speed requires dedicated track, no freight traffic and speeds of at least 150 mph. Midwest plans don’t meet that criteria, but at this point any realistic rail options would be better than what we have now.

Countries to Watch, (Intellectual) Piracy Wise

Did you know there was a Congressional Anti-Piracy Caucus? (I’ll take a chance and guess not). Neither did I.

The caucus has been in place for six years. The primary goal is laudable — protecting intellectual property, particularly for the entertainment and software industries. I just didn’t know it took a caucus of members of Congress to focus on this issue.

Anyway, the group released its watch list of countries to keep a close eye on. The caucus will offer briefings for congressional delegations traveling to these countries.

The five countries range from the expected (China and Russia) to several surprises (Canada, Spain and Mexico). Do you agree or disagree that these countries are threats? Any anecdotes you can share?

Time to Lower Federal Corporate Income Rate

If tax rates can in fact be said to influence where companies locate and invest, the U.S. has a problem. As our economy becomes increasingly global our combined (federal and provincial/state) income tax rate is higher than every other country in the world, except Japan. Both presidential candidates have recognized the need to do something. Sen. John McCain proposes a significant reduction of the current 35% federal rate to 25%. Although coupled with other proposals and not nearly as definite or assertive, Sen. Barack Obama also indicated he is open to lowering the rates.

The U.S. can’t afford to ignore what most other industrialized countries have already figured out: the corporate income tax rates affect investment. This year China dropped its rate from 33% to 25%; and Taiwan, Hong Kong and Korea, which already had much lower rates than the U.S., dropped theirs even more. And it is not just in Asia. The adjustments swept Europe with Germany, Italy, the U.K. and Spain all making rate reductions. It is truly a global thing. Other countries that are part of the wave of cuts: Turkey, Bulgaria, Israel, South Africa and Colombia.

So with so much talk of change in other contexts, it is important to point out that it is also time for a change to our corporate tax rate. A full listing of the corporate rates in nations belonging to the Organization for Economic Cooperation and Development, along with other revealing information on this subject is available from the Tax Foundation.