The Political Rally of 2003: when will it end?

The basis for this summary is reflected in the one chart illustrated below. This daily chart of the U.S. Government's Daily Treasury Statement shows the US Treasury's daily net cash flow and the YTD cash flow along with the SP500 nearby futures close. The reason behind this chart is simple. If tax receipts, or revenues to the Government are up, America is growing. If tax receipts are down then the macro economic engine is slowing down. This chart doesn't tell us if the Government is spending more or less and it doesn't tell us if corporate America is stronger or not. But one fact is clear, the Government is getting less money.

Tax receipts originate from many sources such as individuals, corporations, inheritance, trust funds, and other sources. However, if the red line is rising, the Government is getting more money or taking in more money. So you can see, 2003 was worse than 2002 and the dramatic The red line is generally lower than is was last year and the spikes are lower than last year. Just look at the monster spikes that occur in September. These September spikes occur just before the Government closes its books on its fiscal year. As of 9/16/03, the 2003 September spike represents $4.3 Trillion versus 2002's spike of $5.7 Trillion. This means America gave the Government less money.

On one hand, this is good. We are giving less money to the Government and hence we get to keep more of our hard earned dollars. And if the Government were reducing its spending, then this would be a positive. Unfortunately as you can see, the Government received less money and it spent more (as was reported in the media). So the Government is in more debt than last year.

On the other hand, this can be interpreted as we earned less and therefore we owed the Government less. In this scenario, America is weaker than is was last year. Both companies and individuals (which make up the bulk of tax receipts) are earning less. So despite the media's hype that things are getting better, the fact is tax receipts are down. So there is a disparity between what is perceived and what is real. This chart attempts to focus on what's real so that any hyperbole can be identified and refuted.

One simple view of the rally of 2003 is that is was entirely politically induced. Once the first shot was fired in Iraq the market started its rise in late March 2003. The fear of the unknown diminished and we could quickly see our superiority. Then 7 weeks later, Congress approved a reduction of the tax on dividends. This long awaited retreat from the "double taxation" on dividends renewed investor interest in returning to the stock market. In addition, companies increased the offering of  dividends and increased their propensity to announce stock buybacks as they would now increase their retain earnings (keep more of their profits). So investors and companies had an incentive to buy more stock. Then in July, the Government tax rebate checks were issued. This money was to fuel a buying spree which of course lifted the expectation of increased retail sales. This in turn was why a late summer rally in stocks has appeared, when in the past, this is traditionally the worst time of the year. The retail sales figures released in September and October will show everyone if the Government's "gimmick" works. Unfortunately, job losses still outnumber job gains and this must be reversed if Government truly wants to fix our economy. As you'll see reflected in future reports, these job losses will lead to increased foreclosures and bankruptcies which aren't the positive recovery signs that everyone is looking for.

As a caveat, another interesting point can be made. As "Wall Street" has increased its brand name recognition, more investors than ever have purchased stocks as an investment than in any time in history. With this increase propensity to buy stocks came the roaring bull market of the late 1990s. During that time our Government was only to eager to assist Wall Street and IRA's and other tax deferred investment vehicles were created. In addition, a 60 year old law was removed that prevented banks from entering the investment business. Another old rule that changed was the introduction of  "decimalization" of stock prices. Investors could now buy and sell stocks priced in pennies rather than in fractions. This was hailed as an improvement for all investors because the lower spreads would give investors the edge. However, what wasn't in the press release were the negative ramifications of these new laws and rules.

IRA's and other tax deferred investments now didn't offer any tax relief from investment losses. So investors that had incurred losses weren't allowed to deduct these losses from their capital gains. Of course the investor loses and the Government wins. Plus Wall Street won because is sold it to you. Banks are now allowed to do what was determined 60 years ago to root of all evil, and the Government gave them more power to create financial monopolies. Decimalization made it easier than ever for professionals to "sell short". An uptick now only meant a one penny increase, whereas prior to this rule 1/8 represented a 12.5 cent increase in the stock's price. Decimalization became effective Jan. 19, 2001 and the rest is history (the decline started in March 2001). On the corporate level, nobody was policing the markets and it became apparent that fraud and corruption were easy infractions to commit. Malfeasance became "standard operating procedure". These events coincidentally occurred just prior to the biggest market decline in 70 years.

Another point is that technical analysis became wildly prevalent during the 1990s as computers gave investors the perception that making money was easy. All you needed to do was follow the momentum and trends, but history tells us that earning more than 6% per annum isn't likely ( "The Triumph of the Optimist" 101 Years of Global Investment Returns written by Elroy Dimson, Paul Marsh, and Mike Staunton). If it were so easy, then why did so many investors lose money?

It is clear that technical analysis has come into vogue but technical analysis doesn't provide the foundation for understanding the mega-trends from which the underlying "bull" or "bear" market begins and ends. The technicians say that it is all in the numbers, but the numbers and oscillators have been pegged in the over bought zone for some time now. We're in the seventh rising month in a row. However had an investor understood the mega-trends, the trend was clear. Politics always wins and the bankers and Wall Street always follow the Politicians. They are on the inside and know the outcome. That's why last year you could see the big money flow into stocks when no one else was interested. In addition, why was there a resurgence, or increase, in the number of stock offerings this past May and June 2003 into the strongest rally since 1998? Wall Street is selling into strength and is back to take your money. Number crunching can assist in market timing but knowing when investors are over-reacting to events still hasn't been quantified. Analysts know when it's likely to be over-bought and over-sold, but there's still a 50% chance of being wrong at those junctures. They're just calculated losses. But watching politicians isn't in vogue and fundamental analysis is outdated. As a contrarian, this ought to teach you something. Cycles come and go, and perhaps the pendulum is swinging back to fundamental analysis.

created 9/18/03, ©2003 The Small Investor's Software Co. All rights Reserved.