Wednesday, August 12, 2009

High Corporate Profits AND High Unemployment : Recovery?

Good article on how our financial system has changed and is continuing to change in the new world economy.

According to Mr. Karbell, we are not out of the woods as many in the "know" say we are, especially the politicians and their cohorts in the financial markets. These New Socialists pundits want the markets to recover, if only temporarily so they can say the 'new thinking' is working because they want the New Marxist Socialist party to succeed. So at the first sign of anything that might resemble recovery, they proclaim success of their agenda.

Cooler heads say not so.

Keep the faith and powder dry, the battle has only begun.

Corporate Earnings Are No Sign of Recovery
AUGUST 10, 2009 WSJ
By ZACHARY KARABELLhttp://online.wsj.com/search/search_center.html?KEYWORDS=ZACHARY+KARABELL&ARTICLESEARCHQUERY_PARSER=bylineAND

Despite grim predictions, most major U.S. companies have reported positive earnings for the second quarter of 2009. Given how wrong past predictions have been, the fact that earnings have blown away expectations shouldn’t be so surprising. Still, the numbers are genuinely impressive: More than 73% of the companies that have reported so far have beaten earnings estimates—and stocks have rightly rallied.

Yes, profits are down sharply from a year ago, but this is in the context of an overall global economy that is shrinking. If a company made $30 million on $100 million in revenue a year ago, and made “only” $20 million this quarter, it’s accurate to have a headline that says its profits fell 33%. But making $20 million, or a 20% margin, in an economy that contracted is nonetheless startling, or should be.The same Wall Street culture that failed to anticipate the tipping point in the financial system is just as prone to a herd mentality of negativity.

Having overlooked the gaping fissures in the system last year, most analysts went to the other extreme in their analysis of what would happen this year. A similar process occurred in 2002 and 2003, as views whipsawed from unrealistic optimism to irrational pessimism.This time, the slew of better earnings has also led to the conviction that the worst of the economic travails are behind us.

As the stock market has soared, many have declared the recession either over or ending. These voices range from public officials at the Federal Reserve to notable pessimists such as New York University economist Nouriel Roubini. This rosy view assumes a connection between how listed companies are fairing and how the national economy will fair. That assumption is wrong.

The delinkage of the fate of corporate profits from that of the overall economy is not new. Beginning earlier in this decade, profits began to accelerate far in excess of either global or U.S. economic growth. In 2004, for instance, earnings for the S&P 500 grew 22%; in 2005 and 2006 they grew just under 20%. Those same years global growth barely exceeded 3%. As we now know, some of those elevated earnings were due to the leverage-fueled profits of the financial-service industry.

And there’s little doubt that mortgage-laced derivatives artificially elevated growth.

But even discounting those factors, the growth of corporate profits would have substantially exceeded the expansion of national economies. Then, in the second half of last year and the first months of this year, profits plunged along with U.S. and global economic activity. That gave succor to the belief that companies can only grow as much as the economies in which they function grow.

For years, most analysts argued that if there was too wide a variance between the two, something had to give. Either profits had to descend or national economic growth had to accelerate. As profits shrank over the past nine months, those who argued that a reversion to the mean was inevitable seemed to be vindicated. But that belief is wrong. Companies are increasingly less constrained by any national economy, and their success is no harbinger of national economic growth or sustained economic health for the United States.

First, companies have been profiting because they can cut costs aggressively. It’s not as if demand in the U.S. or Europe has picked up. Take Starbucks, which reported a surprising surge in profits. Little of that was due to American consumers suddenly becoming comfortable with $5 grande mocha lattes. Instead, it was because Starbucks—faced with weak demand and sluggish sales—closed stores and laid off workers. That has been a trend across industries.

Second, many larger companies have been profiting because they can focus on where the growth is around the globe. Companies such as Intel, Caterpillar, Microsoft and IBM now derive a majority of their revenues from outside the U.S., with the dynamic economies of the Asian rim and above all China assuming an ever-larger role. Companies are thriving in spite of economic activity in the U.S., not because of it. That suggests the connection between corporate profits and robust economic recovery in the U.S. is tenuous at best.

In fact, the financial crisis hastened the trend toward efficiencies, toward leaner inventories, and towards integrating both technology and global supply chains that has been taking place over the past decade. That has led to severe pressure on the American working class and eroding employment. As these companies profit from global expansion and greater efficiency, they have little or no reason to rehire fired workers, or to expand their work force in a U.S. that is barely growing.

If you are a global company, you want to hire and expand where the most dynamic growth is. Unfortunately for Americans, that’s not the U.S.

So we are facing a conundrum: Companies can grow by leaps and bounds—by double-digits—and yet unemployment can skyrocket and remain high. There is nothing on the horizon that would lead one to expect a turnaround in the employment picture. Job losses slowed slightly last month as the unemployment rate fell to 9.4% in July from 9.5% in June, but that’s a far cry from any sign of job creation.

The weight of more than 20 million marginally employed or unemployed, combined with the increasing pace of economic activity outside the U.S., presents the prospect of permanent change in the American economic landscape: high unemployment, moderate to weak growth, and soaring corporate profits.

The ability of companies—large ones especially, but even more modest ventures that assemble and source globally—to become more efficient and go where the growth is has never been greater. This is undoubtedly good for stocks and positive for investors, but it is also a challenge for American society that we have not even begun to confront.—

Mr. Karabell is president of River Twice Research. His new book, “Superfusion: How China and America Became One Economy and Why the World’s Prosperity Depends on It,” will be published by Simon & Schuster in October.Printed in The Wall Street Journal, page A11Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

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