Tuesday, December 5, 2006

News - November 2006

In our last commentary, we discussed the public’s concern regarding the markets in the face of a possible change in control of Congress from the Republicans to the Democrats. As you probably recall, political upheaval was in full force during election week. Two Senate races were “too close to call” until the Republican candidates conceded their races in Montana and Virginia, therefore surrendering the majority in the Senate to the Democrats. Defense Secretary Donald Rumsfeld resigned on the Wednesday after the election. The timing of his resignation was curious considering part of the knock on the Republicans leading up to the election was an unwillingness to adjust to new circumstances in Iraq. Would the Republicans have retained several seats in the House and possibly the majority in the Senate if this change in leadership had taken place earlier?

The financial markets did not have much of a reaction to the news of the election results. Healthcare and defense related stocks, which are two sectors often tied to Republican political success, have even reacted rather benignly. Healthcare stocks have been virtually flat, slightly underperforming the market since the election, but the defense sector has outpaced the gains of the broader market over the past month. The S&P 500 gained 1.6% for the month of November, the DOW gained 1.2% and the NASDAQ gained 2.7%. Year to date through November 30th, the S&P has gained 14.2%, the DOW 16.5%, small cap stocks gained 18% and international stocks have gained 22.3%.

The bond market has been a bit more peculiar: the 10-year Treasury yield fell to the lowest levels since the beginning of the year to 4.47%, further inverting the yield curve, while short-term Treasury bills continued to pay close to 5% on an annualized basis. The yield curve inversion is troubling to some because it implies lower rates in the future, which could be the result of a slower growing or contracting economy.

Despite the fact that the Federal Reserve has not reduced the short-term lending rates for banks, many of the most widely followed interest rates for consumers and businesses have also decreased in the months since the Fed stopped raising rates. For example, mortgage rates nationwide have dropped from an average of 6.8% in July to the latest average of 6.14% during the week of November 30th. Atlanta actually enjoys rates that are even lower than the national average. Consumers and businesses gaining availability to cheaper debt could actually encourage growth in the economy in the coming months. As such, it may be a great time to refinance to a fixed-rate mortgage for those of you still paying an adjustable rate mortgage.

Milton Friedman, the Nobel Prize winning and undoubtedly one of the most influential economists of our time, passed away in November. He was probably best known by economists for his work on the relationship between the money supply and inflation. Friedman may have been better known by the public as the theorist influencing Reagan’s tax-cutting and deregulatory policies of the 1980’s. Some of his controversial anti-government opinions included support for school vouchers, support for an all-volunteer military, a negative income tax for the poor, and the legalization of drugs. Friedman reasoned that the war on drugs was not worth the cost to Americans and that crime rates would be drastically reduced if illicit drugs were legalized.

Although some of Friedman’s opinions have clearly not been embraced by economists and politicians, his monetary policies have been widely accepted. Former Fed governors Volcker and Greenspan have used monetary policy to fight inflation, sometimes without regard to the short-term consequences. Friedman believed that low unemployment could be possible only after inflation, or more accurately expected inflation, was contained.

Economics lost a pioneer in Milton Friedman. Some of his ideas may seem outlandish, but when you research his theories, the economic justification is convincing. Right or wrong, his opinions inspire a debate distinguishing the economic rationale for his arguments and the ethical considerations. Legislators did not readily consider abolishing the draft or implementing a form of a negative income tax when those ideas were first suggested. Now, through the all-volunteer armed forces and the earned income tax credit, these policies are regarded as mainstream. We should all hope there are plenty of Friedman disciples who share that same creativity for solving the economic dilemmas we will encounter now and in the future.

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