Posts Tagged ‘Dow’

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During the height of the euro crisis, politicians in Europe, and indeed central bankers, blamed the markets and credit ratings agencies. Yesterday an official at the Fed followed that tactic too.

Richard Fisher, president of the Dallas Federal Reserve, told the ‘FT’: “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it.”

He also took the opportunity of being interviewed by the ‘FT’ to remind us all about George Soros – the man who shorted sterling in 1992, beat the Bank of England and hastened the UK’s departure from the ERM. He likened today’s feral hogs to Mr Soros, but is that right?

Being a messenger is never a good place to be, not if you bring bad news anyway. When Eurozone politicians blamed credit ratings agencies, and what they called bond vigilantes for the woes in Europe, they were surely deluding themselves. They had fooled themselves into thinking the crisis was less serious than it was, and they thought they could talk until the cows came home. The markets went some way towards correcting their complacency.

By hastening the UK’s departure from the ERM, George Soros probably did the UK a favour.

But what about this time?

Markets are selling because there are fears that interest rates are set to rise. The Fed has said as much, and even in China there are signs of monetary tightening.

But don’t forget that the news out of the US has been good of late. To remind you of two of the highlights: US banks’ profits were at an all-time high in Q1, and US households have cut debt substantially since 2007.

As things stand, the Dow remains substantially up on its start of year position as does the Nikkei 225 in Japan. And that makes sense.

Markets probably overdid their exuberance in May, but both the US and Japan are in a better place now than they were at the beginning of the year.

As far as equities are concerned, in addition to fears about the Fed tightening monetary policy, some are nervous about the possibility that US profits to GDP are set to fall. But in the long run, profits to GDP falling and wages to GDP rising is surely good thing.
Even higher interest rates are a good thing, if higher rates are symptomatic of the economy returning to normal.

But higher interest rates will be bad news for those with high debts, and for that reason the UK and – more so – the Eurozone may lose out.

The FTSE 100 has not performed as well as US markets this year. Unlike the Dow, it never did pass its all-time high. And unlike the Dow, the FTSE 100 has now fallen to within a whisker of its start of year price. That is probably about right.

But at least the UK has its own central bank, free to print money and buy bonds via quantitative easing.

The countries of the indebted Eurozone do not have such a luxury, which is why Europe may yet be the biggest loser.

Image: Pig In Pen by Kim Newberg

© Investment & Business News 2013

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The data speaks for itself. In the final quarter of 2012 US corporate profits were 11.8 per cent of US GDP. To find the last time the ratio was so high you would have to rewind the clock all the way to the beginning of time.

Maybe, it would be more accurate to say you would have to rewind the clock to the date when data was first available, which an economist might say is indeed the same thing as the beginning of time. In fact quarter on quarter data only goes back to 1947. Year on year stats are available from 1929, however. As far as the data is concerned Q4 2012 was a record.

It may surprise you to learn that until just under ten years ago, the record for corporate profits to GDP belonged to 1929, with a ratio of 9.9 per cent. It is a shame the data does not go back further, because 1929 is an awkward year for a story to begin. It was, after all, the year when Wall Street crashed, and the point when the US Great Depression began. So had corporate profits surged just before 1929, and was the high level of this ratio a cause of the Great Depression, or was it normal for corporate profits to GDP to be so high back then? We can only really speculate.

What we can say, however, is that, according to data going back 80 or so years, the only two periods when US corporate profits to GDP approached 10 per cent or went over it, the US economy was either in, or about to enter one of its two worst periods of economic performance during that period. Is that a coincidence? Maybe it is, but there are good reasons to think this apparent correlation is not random.
Drilling into the numbers we find that the ratio of profits to GDP actually passed the 1929 record in Q4 2005, fell back in 2007 and 2008, hit a new record in Q4 2011, and has pretty much being going upwards ever since.

The downturn in the US has some odd things about it. Employment has been improving, but is still lower than we need it to be. GDP has been growing, but, just as is the case in the UK, households have been struggling. US median wages, on the other hand, have seen an awful performance. US median wages, relative to inflation, were lower last year than in 1995. As households have struggled, markets have soared, with the Dow and S&P 500 hitting all-time highs in the last few weeks.

Investors and corporate bosses may say: so what? They may say it is good that profits are rising, that an increase in profits will be followed by an increase in hiring. But that is not how it is panning out. Sure we are seeing a modest rise in M&A activity. Sure dividends and share buy-backs are increasing. But to a very large extent US companies are sitting on the cash, as indeed are large UK companies.

This cash sloshes around the banking system, and much of it finally ends up buying US and UK government bonds.

To grow, the US economy needs to see demand rise, and without seeing a corresponding increase in debt, demand can only rise if wages go up.
Without this rise in demand, sooner or later the surge in corporate profits will stop, and go into shuddering reverse.

It may seem counterintuitive, but the rise in the ratio of profits to GDP is not in the long term interests of companies. It is most certainly not in the interests of the people who work for them, and it is not what we need to create sustainable economic growth. So what is the solution? See: Will a rise in the minimum wage put an end to zombie companies? And: Is it time to increase the minimum wage?

©2013 Investment and Business News.

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