We are in the heart of the current earnings season and it's interesting to observe, as one of our recent US presidential candidates once opined, that "corporations are people, too". That remark has never been more typified than by what we see coming out of analyst's reports and forecasts today. Like you, corporations are in pare-down mode, hoarding more cash, and loathe to spend indiscriminately.
Not
that the opposite has always been true.
In fact, corporations, just like you, try to live within their means;
deliver an on-time profitable budget; and have an obligation to invest wisely
on behalf of their stakeholders, hopefully to deliver even more value.
But
the comparisons end there when assessing the current spate of data. Indeed, while one must concede that the
engine of commerce is beginning to ignite, the changes in how business is being
done have serious and long-lasting consequences for how the economy and the
financial markets are to be quantified in the future.
One
important distinction is that the primary nexus of capital savings is not in
consumer's hands, but in treasuries, banks, and corporate coffers. This would imply that what you or I do, what you and I might spend, pales in comparison to the
significance of institutional capital expenditures and their impact upon
sustaining future economic development.
Gross Domestic Product (GDP) now emanates from a substantially different
source than in the past.
This
sits in diametric opposition to a consumer-led expansion in which business
takes its direction from demand we, the people, might create. Instead, capital today sits, figuratively, in
drawers and vaults that, at the end of the day, are micro-managed with
potentially self destructive implications, over which the consumer markets have
relatively little control.
The
second example of a new paradigm in earnings emerges from the centralization of
natural resources into fewer and fewer global sources. If, for
example, there were to be an interruption in the flow of vital commodities
(food, water, energy, e.g.), the global economy would respond immediately with
a high velocity inflation in prices which remarkably today sit pent-up, in
abeyance. The potential impact of sudden
commodities price spikes upon corporate profitability and consumer savings
would be catastrophic, many might speculate.
The
good news is that we do not expect a material disruption at this juncture,
although current events in the Middle East and Ukraine bring the sensitivity of
these facts into clearer focus. However, earnings reports, and market
behavior, seem to anticipate the potential for price increases "at the
source" and are making the necessary adjustments with savings and cut
backs as a part of the nomenclature, just in case.
Too
late....
From
an investment standpoint, these data force us to look at commodities prices,
basic materials, utilities, and price sensitive equities as direct
beneficiaries of this uncertainty.
Another
effect I see coming out of the current releases is a stagnation both in breadth
and enthusiasm for financial securities.
To be sure, the markets are toying with making "new highs" and
investors are eager to speculate in future price advances, but while global
economic activity is accelerating, it certainly doesn't feel like it in many homes. The most compelling argument for consumer
disassociation from the financial markets is that the downside seems more scary
than the upside seems enticing. While Friday's volatility was
disconcerting, it doesn't appear to have stopped the risk-takers who chase
after a 5 year recovery with great zeal.
Even if investors haven’t yet lowered their threshold about hoping for
the best, their tolerance for yet another market collapse has nearly evaporated. Not a good combination of odds, in this
reviewer's opinion. Markets work best
when risk and reward are evenly correlated, and work even better when risk is
at "absolute zero". Present
conditions are nowhere near approximating either the former or the latter.
The
data is good, the forecasts are better, but the emotional conviction has
justifiably been tame.
We
need to ratchet down the "chase
instinct" just a notch and realize
that contractions are part of growing, growth implies future revision, and planning for those ebbs and flows is
instrumental in helping to reduce the effect of risk upon portfolio allocation
strategies.
Demand
generates income and profitability for corporations. That is the sequence I believe in, and upon
which I predicate my market analysis. Therefore, the wealth centers have to
step up, participate more aggressively, and allow that potential to be
released.
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