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Are taxes, regulation killing Keynesian 'animal spirits'? Add to ...

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The Great Suppression Strategists at UBS Securities say the United States is in an era of "the Great Suppression," where rising taxes and regulation are killing what Keynes called "animal spirits," that spontaneous urge to action instead of inaction.

And the gains expected by the Republicans in tomorrow's mid-term elections will, they say, mark the beginning of the the political reaction to that. While it's difficult to "un-pass" legislation amid swollen budget deficits, it's not clear how successful the effort to roll back this era will be, or how long that will take.

"We think growth in GDP and employment is being retarded by an interlocking set of policies, put in place over the past couple of years, that we call 'The Great Suppression,'" the UBS strategists said in a lengthy report.

"... We think The Great Suppression is curbing hiring and domestic economic growth by dampening Keynesian 'animal spirits' and diverting investment elsewhere."

They cited nine elements of this:

A federal spending surge. This "was necessary to moderate the economic downturn, but the prospect of continued high levels of spending is alarming to many investors and entrepreneurs because it presages higher taxes."

  • Tax hikes slated for 2011, when the Bush era cuts for the affluent expire, and more hikes in 2013 under health care reform.
  • Corporate tax hikes.
  • High deficits that point to even more tax increases.
  • Health care reform that is dampening hiring.
  • Financial regulatory reform.
  • Tougher environmental regulation.
  • The Gulf of Mexico drilling restrictions and the "rough treatment" of BP, which may discourage investment by some foreign players.
  • The proliferation of red tape.

What does all this mean for stock markets? The biggest winners from "The Great Suppression" are big, well entrenched companies, as are companies with large exposure to economies showing growth and pro-growth policies. Those include industrial and technology companies, low-end consumer companies, but also consumer plays such as Coca-Cola and McDonald's, UBS said.

"We would stick with these themes, but look for stocks that would benefit from a rollback of The Great Suppression, including selected health care, financial, energy, utility, and high-end consumer stocks," they said.

What will the week mean for the greenback? It's a key week not just for stocks, but also the U.S. dollar , given the U.S. mid-term elections tomorrow and a crucial Federal Reserve meeting a day later, when the central bank is expected to unveil a new round of stimulus.

There isn't anyone who doesn't believe the Fed will launch a fresh program of quantitative easing, which has come to be known as QE2 and, through purchases of Treasury paper, will be aimed at driving down long-term interest rates as short-term rates can't get any lower. The question is more the size and the scope. There's also the widely-watched jobs report on Friday.

Investors have generally boosted stocks and pushed down the greenback in anticipation of QE2, though concerns that the program might not be as big as hoped caused some hiccups last week.

"With President Obama's Democrats set to get a battering in tomorrow's mid-term elections, and the Federal Reserve set to embark on a further round of quantitative easing on Wednesday, the dollar doesn't appear to have a lot going for it right now and it isn't likely that Friday's October employment report will offer any comfort," said CMC Markets analyst Michael Hewson.

"It would therefore be easy to think that the U.S. dollar is set for further falls. However, having lost about 8 per cent of its value against a basket of currencies since mid-August there is a case for suggesting that this week's events could well precipitate a relief rally, especially if the Fed aren't as aggressive as the market expects on Wednesday."

As for the political scene, noted Scotia Capital economists Derek Holt and Gorica Djeric, "Republicans are expected to take the House in tomorrow's Congressional mid-terms, and the political stalemate that may ensue could lower expectations for tax cut extensions for all and thereby raise expectations for a negative impact on consumer spending into 2011, thus shifting more of the policy burden to the Fed."

Manufacturing in China, India surges Manufacturing in China and India - The 'C' and the 'I' in the BRIC countries that also include Brazil and Russia - is still going strong. In China in particular, today's purchasing managers index reading is no doubt a relief to those who feared that the economy driving the global recovery was losing steam.

China's PMI climbed in October to 54.7 from 53.8 in September, while India's PMI jumped to 57.2 from 55.1. The 50 mark separates expansion from contraction.

"China's latest PMIs suggest that the economic rebound has further to go," said Mark Williams, senior China economist for Capital Economics in London.

"Input prices have picked up, but manufacturers are not passing price increases on to consumers. As a result, the People's Bank will feel no pressing need to raise rates."

Today's numbers add to other readings that indicate a soft landing in China. But they also show that the fuel is domestic, which could have ramifications for other countries in the region that depend on China for their exports.

"The strong demand is mainly coming from within China: new orders overall have rebounded since the middle of the year, consistent with other evidence ... that domestic activity has picked up," added Mr. Williams. "But new export orders remain more subdued."

In the United States, the Institute for Supply Management's manufacturing PMI also climbed, to a five-month high of 56.9.

"Manufacturing may account for a small share of the U.S. economy but its tentacles are far-reaching, so this is very good news indeed," said BMO Nesbitt Burns senior economist Jennifer Lee.

AIG to repay U.S. American International Group, the poster child of the bailout era, said today it has raised almost $37-billion (U.S.) to repay the U.S. government.

The money was raised through the sale of one of its units, American Life Insurance Co., or ALICO, and the initial public offering of another business, AIA Group Ltd.

"We promised the American taxpayers we would repay them and the initial public offering of AIA last week and the completion of the ALICO transaction move us closer to delivering on our promise," said chief executive officer Robert Benmosche.

"... As we said on Sept. 30, AIG will restructure itself around its core property casualty and life and retirement services businesses, which are performing well, and will provide our company with a strong foundation to build value for all stakeholders going forward."

Brick to convert The Brick Group Income Fund said today it plans to convert to a corporation by Dec. 31 given Ottawa's tax changes.

The retailer said the change should give it greater access to capital and the potential to attract new investors. But note that there have been no distributions since mid-February of last year and it doesn't expect to pay dividends after the conversion."

From today's Report on Business

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