01/29/2009 12:25 pm ET Updated May 25, 2011

Why is the Market up 17%? It Should Be

I last wrote after inauguration day, the memorable day when the excitement of Obama's ascent to the Presidency was juxtaposed with the worst stock market performance yet this year. Fortunately, since then, the market has recovered somewhat, though still not quite recapturing the highs reached at the outset of the year. However, with President Obama now in office, we are already seeing a number of positive changes to which the market is cautiously beginning to respond.

The view from 10,000 feet is this: the war is wrong and costs trillions; the markets are vulnerable to speculators who control wealth greater than global GDP; our domestic economy has slumped and will continue to slump without direct and highly effective stimulus. Finally, Wall Street cares about corporate earnings.

The War. I myself take a moral stand on the war, but simply from economic impact, the cost is in the trillions and the returns actually a drain. Robert Gates, Secretary of Defense, has stated that he is on board with finding effective ways of ending our expensive and unpopular war in Iraq. If so, he will save the nation an estimated $10 billion a month.

Speculation. Remember that the derivatives markets are estimated to be upwards of $560 trillion a year and global GDP is only about $45 trillion. Finance is running roughshod over the planet. Mary Schapiro, the 29th Chairwoman of the Securities Exchange Commission, stated during her confirmation hearings that she would move quickly to address speculation. She has also made clear that she believes executive compensation issues should be reviewed by the S.E.C. and that the notorious reversal of the 'uptick rule' in 2007 must be reconsidered. I believe she is on the right track. Additionally, the Congressional Oversight Board has just released its recommendations. I might have written much of it. To see the sensible details, look at this.

The Domestic Economy.
At present, the greatest obvious threat is unemployment. As it grows, more people stop consuming. This may seem like a callous reason to care about employment, but recall that our economy is largely consumer-driven. That means our national well-being rests on people having money to spend. Past efforts to stimulate have presumed that it did not matter who spent. Now we remember our old ECON 101 textbooks that told us that many small purchases do much more for the economy than one large one. That leads us to want to create many small consumers, not a few rich ones.

Fortunately, the proposed stimulus package addresses this in a very direct way. This bill, which is moving through Congress quite quickly, contains extension of unemployment benefits and adds access to various forms of health care (most notably Medicaid) to the unemployment package. It gives tax breaks to the lowest wage earners. It will keep an estimated 250,000 teachers and health-care workers working. Now recall the shock that layoffs of far fewer have caused financial markets on recent days.

It is refreshing to see a stimulus package that "gets it." Moody's recently released a study of the Fiscal Stimulus Package. Here are some of their findings: The "single most efficient ways to prime the economy's pump" are food stamps. Food stamps increase Gross Domestic Product by $1.73 for every dollar spent. Extending Unemployment Insurance benefits boosts GDP by $1.63 per dollar spent; increased infrastructure spending $1.59. Compare these results with past policy. Cuts in corporate tax rates dragged GDP down by $.70 in addition to every dollar not collected, accelerated depreciation that the small business community has been arguing for would cost $.75 on top of every dollar not collected. I like this stimulus package.

The Stock Market.
What will get this stock market moving? Well, actually we are up over 16 percent from the bottom November 20, 2008. What does Wall Street see ahead that we have overlooked? Consider the facts. Over the past months consumer spending plunged. We did not stop purchasing shampoo, but we bought a lower cost brand. The trading down phenomena certainly affected retailers hard, and many will not survive. However, it also affected companies like Colgate Palmolive or Procter & Gamble. The fat margin end of their business was squeezed lean, but they are still in business.

We start where we are. Wall Street is looking for signs that the turn is soon upon us. The signal will be seen when these companies report that they are doing better than the prior quarter. (While we generally want them to do better than the same quarter last year, things are different now.) Colgate does not have to do better than their fat years, it only has to improve from recent lean quarters.

When might this begin? Not long now. The squeeze was well under way by last September. Certainly, September 30, 2009 earnings reports should show this sort of improvement. Possibly, by June 30th earnings reports at some companies will show better than recent figures. Moreover, it is important to remember that Wall Street looks ahead, so current prices should reflect future expectations. As a result, the market tends to recover well before the headlines do.