Daily Archives: January 28, 2009

The future is never certain—that is what makes forecasting so much fun and investing so dangerous.  We seem to find ourselves at a crossroads, one of many we have already faced, with more sure to come.  The announcement out of Washington, D.C., of a new economic stimulus plan has the stock markets up for a fourth consecutive day—something not seen in months.  Is this excitement warranted?  In other words, should we put all of our money back into equities?  The best answer is to be hopeful and optimistic about the future, but not with your money, at least not yet.

In a conference call, entitled “Fiscal Stimulus Plans and Implications for the Economic Outlook,” hosted by Goldman Sachs Investment Strategy Group on January 28, 2009, two Goldman Sachs’ economists analyzed the proposed $828 billion fiscal stimulus plan that is currently being considered by Congress.  The call was moderated by Sharmin Mossavar-Rahmani and featured commentary by Alec Phillips, Washington Economist, Goldman Sachs Global Investment Research, and Ed McKelvey, US Economist, Goldman Sachs Global Investment Research.

In my view, three major themes emerged from the discussion:

1. The proposed fiscal stimulus package is heavy on tax credits and state fiscal assistance;
2. The timing of the proposed spending is such that the majority will not impact the economy until 2010 and beyond;
3. Private sector spending has evaporated, and, for good reason, will not return to pre-2008 levels.

Structure of Stimulus Package

Much of the equity market excitement in the package is due to infrastructure spending.  However, only 15 percent of the total package is allocated to such stimulus.  The other portion of the package that has the markets buzzing, new technology (alternative energy) and information technology spending (especially healthcare-related IT) is only 10 percent of the package.  Nearly 60 percent of the total is dedicated to tax breaks and state assistance.

The tax reductions include reduced withholding taxes for personal income.  Thus, in each paycheck over the course of the year, workers will receive more of their income as take-home pay.  This is considered a better alternative to sending rebate checks, like those in 2008 which were more or less saved or used to pay down debt, because workers will perceive income growth by receiving the benefit over time and may be psychologically more inclined to spend.  One problem with this idea is that it requires one to be employed to receive the benefit, whereas the rebate checks were based on income thresholds and the filing of tax return.  With the multitude of layoffs announced this week and in the past couple of months, the benefit of reduced payrolls taxes in the short-term may not be very stimulating.

The other tax reduction benefits businesses by offering bonus depreciation for assets and certain tax refunds.

Timing Limits Impact

Of the proposed $828 billion, only $218 billion is scheduled to be spent in 2009.  In 2010, another $357 billion would be spent, with the remaining $254 billion coming between 2011 and 2018.  Thus, our expectations for economic recovery must be tempered by the fact that the impact of the stimulus plan will be felt until next year and the years beyond.  We can look forward to an end of the decline in asset prices within the next 12 months and a steadying of the economy, but we must not expect a return to prior economic growth rates and rapidly rising standards of living.

Private Sector Demand Destroyed

Personal savings rates have risen dramatically in the aftermath of the credit crisis, as has been noted in sharply reduced consumer spending and borrowing data.  Businesses are following the same path and largely for the same reasons.  This is expected in recessions.  What is different this time, is that private sector spending, consumer and business, will not pick up where it left off in the coming years.

Phillips and McKelvey made the following observations:

• The private sector balance represents the difference between the income and spending of US households and businesses. It has gone from a deficit of 3.5% of GDP in 2006 to a surplus of about 1% in mid-2008, meaning that the US private sector has swung from being a net spender to being a net saver.

• Statistically, the ups and downs of the private sector balance can be explained by three factors: equity prices, house prices, and credit spreads. Based on a set of “naïve” assumptions for these three factors, a model predicts that the private sector balance could rise to 10% of GDP by 2010.

• The core component of retail sales has fallen nearly 10% at an annual rate in recent months; more worryingly, he deepening slump in demand has triggered a sharp reduction in payrolls.

• The interplay of these dynamics spawn a downward spiral: income losses thwart the desired increase in saving that prompted consumers to trim their spending in the first place. If consumers then redouble their efforts to boost saving by cutting spending still further, the downward spiral will continue.

• We believe the government can short-circuit this process in two ways. First, enact a fiscal stimulus program quickly. Second, include measures that can take effect immediately upon enactment.

 

 

Because private sector spending will not resume at the previous rate, and the other usual leader out of a recession, investment in housing, is likely going to be dormant for several years, the government will need to fill the spending gap.  Therefore, while the new fiscal stimulus program is encouraging and should offer us reason to look forward to the future, it will likely not be the last stimulus program.