Kudlow’s Money Politics

Unknown Unknowns

Stocks got slammed today. The Dow dropped 228 points as the much anticipated correction appears to be taking hold. Year-to-date, the broadest index, the S&P 500, is still up 3 percent, and the Dow is up 3.5 percent. Curiously, a $2 drop in oil did not rescue the market. But a lot of worries about China growth, a Spanish credit downgrade, and a widening U.S. trade deficit weighed down the market right from the opening trade.

All eyes are turned to Saudi Arabia as the so called “day of rage” begins. Reports are that Saudi police opened fire on protesters in the kingdom’s east. Most experts do not expect a major protest to develop, such as in Egypt. But frankly, who knows?

The Shia underclass comprises most of the workers in the oil fields. And former Saudi ambassador Robert Jordan told me in a CNBC interview that he didn’t think the fully employed Shia workers would have any desire to shut down the oil fields. That may be why the Saudi stock market jumped 15 percent this week and the world price of oil edged lower.

As Donald Rumsfeld would say, it’s an unknown unknown.

But in the midst of today’s stock market gloom there are two positives: First, a new government report shows that corporate profits  – the mother’s milk of stocks — reached new all-time record highs. In fact, after-tax economic profits are up 107 percent from the late 2008 trough. That’s a bigger gain than the 91 percent increase in the S&P 500. The growth of future profits will undoubtedly slow. But the level will continue to rise. The same could be said for the overall stock market, despite today’s 2 percent correction.

A second positive is trade. While the monthly trade deficit increased slightly, total U.S. trade — exports plus imports — reached its highest level since August 2008. That is a sign of growth. What’s more, large import gains for industrial supplies and capital and consumer goods is another sign of strong domestic growth.

But even with these positives, I acknowledge some more unknown unknowns.

For example, the big rise in gasoline prices since last August, with pump prices hitting $3.53 today, is a $182 billion annualized tax on motorists, according to veteran analyst Peter Beutel. He goes on to say that including diesel, heating oil, jet fuel, and other parts of the rising cost of the oil barrel, the total energy tax on the economy is $330 billion.

And the fact remains that Fed head Ben Bernanke is monetizing the energy-price spikes by pumping in excess QE2 money. That could set a significant inflation threat.

So I am being realistic. There are unknown unknowns out there. That may be the message of today’s stock market sell-off.

Larry Kudlow — Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

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