The broadcast media loves a good, tight narrative. Here is the narrative for the stock market downturn for the recent events happening on Wall Street.
Congress squabbles over debt ceiling, Tea Party was obstinate about debt and deficit, we came close to default, S&P drops rating, stock market reacts. Package that up with some pundits, repeat over and over and it becomes fact. Next story.
Only part of this is true.
Here is what I think is happening with the stock market. It is about as simple as the narrative, but admits that human behavior is behind all the numbers so that is always scary territory for economists. But we’ll give it a go anyway.
In 2008, the economy came to a grinding halt. Millions of people lost their jobs, many were on their way to losing their homes and since poor people don’t spend money, millions of businesses quit stocking inventories.
Corporations shed jobs and cut expenses and immediately became more productive and profitable just in the way we measure these things. When the economy started growing slowly, they did not re-hire people; they replaced them with technology that shows up every day, do not need a medical plan and will never saddle the corporation with a pension plan. Investors like that so they buy more of that company’s stock. And they bought a lot in the past two years, pushing stock prices higher. Investors were getting richer.
But you can not cut your way to long-term profitability. The life span of a “cost-cutting to profitability” plan is about 18-24 months. After that, if you are not growing revenues, your profitability will start to decline. Business knows that but they also know that the average “dip” between recessions is about 18-24 months. After that, people get tired of austerity, they start spending, jobs get created and the economy kick-starts itself into gear.
Investors also know this, but they never know exactly when they should be selling the stock. But the smart ones know they will sell the stock eventually because companies will start hiring based on product/service demand and their stocks will take a hit before going back up. Investors hate when companies hire; it means lower short-term profitability and long-term obligations. They like to sell before that “hit” happens.
The underlying reason businesses are not hiring is because they have no need to hire. There are few customers on the horizon. Regardless of what the GOP spins about tax cuts and regulations, the number one — and only reason — businesses are not hiring is because they do not see any customers. Period.
Taxes and regulations are things to either comply with or figure out how to get around when you really, really want to get to the dollars on the other side. To date, I have not met a businessperson who does not believe that in his/her heart. Have you?
We are at about the 24 month mark when the economy should be swinging upward. Only it isn’t and the only organization with the will and means to spend money to get things kick-started — the US Federal Government — is now in a Tea Party-forced cost-cutting frenzy. Even if the President were to introduce a jobs bill, he could never get it funded. What the market heard during the debt ceiling debate and Mitch McConnell’s comments afterwards is the government is going to keep cutting way past the 18-24 month window. Way, way, way past.
“Holy crap!” think investors who are looking at history and know they are at or near the end of the “cost-cutting to profitability” plan of most corporations. “I’m not going to lose my butt in the private sector. I’m going to buy the most secure stuff that exists; US Treasuries.”
Standard & Poor’s did the only thing they knew how to do; lowered the rating for the US Government. Not entirely the best strategy, but they could do little else. S&P also gave a narrative as to why they did something, anything. But neither side heard the rationale. I’m not a fan of S&P as they have been wrong more often than right, but this time, I think they got it right, even if their math was off.
The problem does not lie in the math; it lies in the human assumptions behind the math.
And that is exactly what is going on, regardless of what rating Standard & Poor’s gives the US Government.
Now, all we need to do is package that in a nine-second sound byte.