Sunday, January 5, 2014

Did Someone Say “Crash”?

America's Missing Investors

Guess who’s investing in America’s future?

Nobody, that’s who.

Just check out this excerpt from an article by Rex Nutting at Marketwatch and you’ll see what I mean. The article is titled “No one is investing in tomorrow’s economy”:
“The U.S. economy simply isn’t investing enough to ensure that there will be enough good paying jobs for our children and our children’s children. Net investment — the amount of capital added to our stock — remains at the lowest levels since the Great Depression. …

Net investment…measures the additional stock of buildings, factories, houses, equipment, software, and research and development — above and beyond the replacement of worn-out capital. In 2012, net fixed investment totaled $485 billion, only about half of the $1.1 trillion invested in 2006…

If businesses, consumers and governments were investing for the future at usual rate, the economy would be at least 3% larger, employing millions more people. That’s a huge hole in the economy that can’t be filled by heavily indebted consumers, especially at a time when government is handcuffed by forces of austerity.” (“No one is investing in tomorrow’s economy”, Rex Nutting, Marketwatch)

Now the author seems to believe that the lack of net investment is just a temporary phenom that will work itself out in the years ahead. But he could be wrong about that. After all, why would a company build up its capital stock for the future when the future is so uncertain? Certainly, there’s nothing in the data that would suggest that the US economy is about to shake off its five year post-recession funk and shift into high-gear again, is there? No, of course not. In fact, it looks like the economy has reset at a lower level of activity that will only get worse as the impact of budget cuts and stagnation are felt. That will further curtail consumer spending which, to this point, had been the primary driver of growth.

Bottom line: Net investment is down because there’s no demand. And there’s no demand because unemployment is high, wages are flat, incomes are falling, and households are still digging out from the Crash of ’08. At the same time, the US Congress and Team Obama continue to slash public spending wherever possible which is further dampening activity and perpetuating the low-growth, weak demand, perma-slump.

So, tell me: Why would a businessman invest in an economy where people are too broke to buy his products? He’d be better off issuing dividends to his shareholders or buying back shares in his own company to push stock prices higher.

And, guess what? That’s exactly what CEOs are doing. Check this out in the Washington Post:
“Battered by months of dis­appointing sales, networking giant Cisco needed a way to give its shareholders a pick-me-up. So the San Jose-based firm did what has become routine for many big U.S. companies in a slow-growing economy: It announced last month that it was buying back shares of its stock…..

This is what U.S. multinationals do now with their cash. Rather than tout big new investments, raise worker wages or hire more employees, companies are more likely to set aside funds to reward shareholders — a trend that took a dip during the recession but has roared back during the recovery.

The 30 companies listed on the Dow Jones industrial average have authorized $211 billion in buybacks in 2013, according to data from ­Birinyi Associates, helping to lift the benchmark stock index to heights not seen since the tech boom of the late 1990s. By comparison, the amount is nearly three times what the group spent on research and development last year, according to data from S&P Capital IQ.

Why spend so much on stock repurchasing?

When the number of shares outstanding falls, the value of each one goes up, instantly rewarding shareholders.” (“Companies turning again to stock buybacks to reward shareholders”, Washington Post)

Corporations don’t care about the future. What they care about is maximizing shareholder value, that’s the name of the game; profits. If that means boosting net fixed investment then, okay, that’s what they’ll do. But if the Fed creates incentives to do something else, like gaming the system with stock buybacks, then they can make the adjustment. And that’s what the Fed’s zero rate policy does. It’s incentivizes businesses to use their capital in a way that’s damaging to the real economy. Here’s more from the same article:
“Helping to fuel the stock market’s meteoric rise is the Federal Reserve’s stimulus program designed to lower borrowing costs. Companies are taking advantage, often by borrowing money at low rates to repurchase shares, although it’s unclear how much of the debt is being used to pay for buybacks.

“It somehow feels scarier if they borrowed the money to buy back stock than if they had some investment opportunities,” Inker said. “That somehow seems more sustainable than just levering up to reduce the share count.”

Some analysts say companies are better off repurchasing shares than pouring money into investments promising dubious payoffs, especially in a slow-growing economy.” (“Companies turning again to stock buybacks to reward shareholders”, Washington Post)

There you have it; instead of investing in R&D, factories or new technologies, (all of which produce more high-paying jobs) companies are taking advantage of the Fed’s cheap money, goosing stock prices and raking in hefty profits. That’s just the way the policy works. The only way change the outcome, is to change the incentives. But the Fed doesn’t want to do that, and neither does the Congress because, at present, they have working people right where they want them, under their bootheel.

If you are looking for proof that workers are getting shafted, just look at the condition of the US consumer who is still on the ropes 5 years after the recession ended. Now, according to the latest Fed’s Flow of Funds report, “Household net worth rose by $1.9 trillion in the last quarter” which means that everything should be hunky dory, right? It means the long period of deleveraging should be over and consumers should be ready to go on another madcap spending spree like they did up-until 2007. Unfortunately, the Fed’s report is a bunch of baloney. The $1.9 trillion merely accounts for rising asset prices that have been reflated by Bernanke’s quantitative easing boondoggle. While working people have seen some uptick in housing prices, the bulk of the gains have gone to stock and bond speculators who’ve made out like bandits. As for consumers, well, they’re still stuck in the doldrums as economist Stephen S. Roach points out in this article at Project Syndicate. Here’s a clip:
“In the 22 quarters since early 2008, real personal-consumption expenditure… has grown at an average annual rate of just 1.1%, easily the weakest period of consumer demand in the post-World War II era.” (It’s also a) “massive slowdown from the pre-crisis pace of 3.6% annual real consumption growth from 1996 to 2007.” (“Occupy QE“, Stephen S. Roach, Project Syndicate)

So, personal consumption has dropped from 3.6% to 1.1%?!?

Yep. No wonder there’s no recovery. And, keep in mind, this is no short-term deal either, mainly because Democrats and Republicans are equally committed to future budget cuts which means it will be more difficult for households to get out of the red and resume spending. More austerity means more retrenchment and hard times for consumers, households and workers. Economist William R. Emmons provides a good summary of what’s-in-store for consumers in a recent post titled “Don’t Expect Consumer Spending To Be the Engine of Economic Growth It Once Was”. Here’s a clip from the article:
“Lower wealth: First and foremost, U.S. household wealth took a beating during the Great Recession. …., the loss of significant amounts of wealth and the severe pressure in some households to deleverage their balance sheets (reduce debt) are likely to contribute to restrained consumer spending for some time.

Stagnant incomes: The economic recovery under way since mid-2009 has been mediocre, at best. Job growth barely matches population growth, while incomes of the typical worker are barely keeping up with inflation. …, most of the overall gains in income appear to be flowing to high-income workers.

Tight credit: Consumer lenders either have disappeared altogether or are offering credit on a much more restricted basis than before the downturn.. …

Fragile confidence: Major consumer-confidence indexes have rebounded from their lowest levels during 2009 in the immediate aftermath of the recession, but they remain below the levels that prevailed just as the recession began in late 2008 …

Looming reversal of stimulus: The Federal Reserve has explored options to “exit” its extraordinarily accommodative monetary policy, while Congress and the president agree that budget consolidation is necessary in the not-too-distant future. In both cases, a tightening of policy measures represents a withdrawal of support for household incomes and wealth and, therefore, consumer spending.”

Individually, any of the five obstacles noted above might be surmountable. But combined, these contractionary forces make the outlook for broad-based consumer spending growth challenging. To be sure, some households weathered the economic and financial storms well, but we can’t count on these fortunate few to step up their spending sufficiently to offset the lost spending caused by declines in wealth, income, access to credit, confidence and government support.” (“Don’t Expect Consumer Spending To Be the Engine of Economic Growth It Once Was”, William R. Emmons, The Regional Economist |via The Big Picture

Emmons offers a bleak, but realistic assessment of our present predicament. There’s really no way the US economy can rebound without a dramatic reversal in the current fiscal policy. Most Americans appear to grasp this point which is why survey after survey show that the majority think the country is “on the wrong track”. The public’s frustration with Congress -(whose public approval rating is at all-time lows) is reflected in growing pessimism which is affecting their spending habits. This is completely normal, given that most middle income working people do not expect their financial situation to improve in the next year. Lower expectations mean more penny pinching, fewer job openings, skimpy net investment, and sluggish growth. That’s the future in a nutshell.

It’s worth noting that the investor class will also pay a heavy price for the current misguided policy. Stocks have had an impressive 4-year run, but there are signs that the day of reckoning is fast approaching. Get a load of this from USA Today:
“A potential warning to stock investors: the fourth-quarter earnings pre-announcement season is shaping up to be the most negative on record. In what seems like a major disconnect, the number of profit warnings relative to upbeat guidance is the widest it has ever been — at a time when the U.S. stock market is trading near record territory. The Standard & Poor’s 500 index notched a new closing high of 1809 Monday.

For every 10 companies warning of weaker-than-expected earnings for the October-through-December period, only one has said it will top forecasts, says earnings-tracker Thomson Reuters I/B/E/S. The actual 10.4-to-1 negative-to-positive pre-announcement ratio is on track to eclipse the prior record of 6.8 warnings for every positive one back in the first quarter of 2001. The long-term ratio is 2.3 warnings for each positive one.

“This is off the charts, I’ve never seen it this high,” says Gregory Harrison, analyst at Thomson Reuters.” (“As stocks hit record highs, so do profit warnings”, USA Today)

So why is Wall Street taking such dire warnings in their stride, you ask?

It’s because investors no longer pay attention to the fundamentals. Demand doesn’t matter. Earnings don’t matter. What matters is the Fed and the Fed alone. “Is Bernanke going to keep pumping trillions in liquidity into the financial markets or not?” That’s the policy upon which all investment decisions are made.

So when Bernanke announces his plan to “taper” his asset purchases (scale-back QE), equities will adjust accordingly.

Did somebody say “crash”?

The Year of the Great Redistribution

One of the worst epithets that can be leveled at a politician these days is to call him a “redistributionist.” Yet 2013 marked one of the biggest redistributions in recent American history. It was a redistribution upward, from average working people to the owners of America.
The stock market ended 2013 at an all-time high — giving stockholders their biggest annual gain in almost two decades. Most Americans didn’t share in those gains, however, because most people haven’t been able to save enough to invest in the stock market. More than two-thirds of Americans live from paycheck to paycheck.

Even if you include the value of IRA’s, most shares of stock are owned by the very wealthy. The richest 1 percent of Americans owns 35 percent of the value of American-owned shares. The richest 10 percent owns over 80 percent. So in the bull market of 2013, America’s rich hit the jackpot.

What does this have to do with redistribution? Some might argue the stock market is just a giant casino. Since it’s owned mostly by the wealthy, a rise in stock prices simply reflects a transfer of wealth from some of the rich (who cashed in their shares too early) to others of the rich (who bought shares early enough and held on to them long enough to reap the big gains).

But this neglects the fact that stock prices track corporate profits. The relationship isn’t exact, and price-earnings ratios move up and down in the short term. Yet over the slightly longer term, share prices do correlate with profits. And 2013 was a banner year for profits.

Where did those profits come from? Here’s where redistribution comes in. American corporations didn’t make most of their money from increased sales (although their foreign sales did increase). They made their big bucks mostly by reducing their costs — especially their biggest single cost: wages.

They push wages down because most workers no longer have any bargaining power when it comes to determining pay. The continuing high rate of unemployment — including a record number of long-term jobless, and a large number who have given up looking for work altogether — has allowed employers to set the terms.

For years, the bargaining power of American workers has also been eroding due to ever-more efficient means of outsourcing abroad, new computer software that can replace almost any routine job, and an ongoing shift of full-time to part-time and contract work. And unions have been decimated. In the 1950s, over a third of private-sector workers were members of labor unions. Now, fewer than 7 percent are unionized.

All this helps explain why corporate profits have been increasing throughout this recovery (they grew over 18 percent in 2013 alone) while wages have been dropping. Corporate earnings now represent the largest share of the gross domestic product — and wages the smallest share of GDP — than at any time since records have been kept.

Hence, the Great Redistribution.

Some might say this doesn’t really amount to a “redistribution” as we normally define that term, because government isn’t redistributing anything. By this view, the declining wages, higher profits, and the surging bull market simply reflect the workings of the free market.

But this overlooks the fact that government sets the rules of the game. Federal and state budgets have been cut, for example — thereby reducing overall demand and keeping unemployment higher than otherwise. Congress has repeatedly rejected tax incentives designed to encourage more hiring. States have adopted “right-to-work” laws that undercut unions. And so on.

If all this weren’t enough, the tax system is rigged in favor of the owners of wealth, and against people whose income comes from wages. Wealth is taxed at a lower rate than labor.
Capital gains, dividends, and debt all get favorable treatment in the tax code – which is why Mitt Romney, Warren Buffet, and other billionaires and multimillionaires continue to pay around 12 percent of their income in taxes each year, while most of the rest of us pay at least twice that rate.

Among the biggest winners are top executives and Wall Street traders whose year-end bonuses are tied to the stock market, and hedge-fund and private-equity managers whose special “carried interest” tax loophole allows their income to be treated as capital gains. The wild bull market of 2013 has given them all fabulous after-tax windfalls.

America has been redistributing upward for some time – after all, “trickle-down” economics turned out to be trickle up — but we outdid ourselves in 2013. At a time of record inequality and decreasing mobility, America conducted a Great Redistribution upward.