Much has been made of the divergence in
the United States among households, the federal
government, the economy and corporate profits. Yet
the pieces of the puzzle are rarely assembled to
form the fractured image that is emerging.
Lately, a tale of two states has come to
define the flow of macro-data. Late last month we
learned of runaway producer inflation (the largest
one-month increase in the Producer Price Index in
decades [1]) and a slight reversal of the decline
in housing starts on the same day - within a few
hours. [2] New and existing home sales improved in
November as well. Strangely, consumer
confidence, as measured by the
Michigan Sentiment Index, went up. All these data
were refigured by market pundits as good - if not
great - news. The Producer Price Index and housing
news events of December 19 are not of enduring
significance, except as market metaphor. The
parting of the ways in data and in national
fortunes demands great concern and discussion. So
far, it has received neither. It is there that I
seek to turn your attention.
It has been
an unusually robust run for America's
corporations. Profit rates, numbers and earnings
as a percentage of gross domestic product (GDP)
have scaled new heights. Average S&P 500
earnings growth has risen at a more than 10% pace
for almost five years - 19 quarters and counting.
This has left S&P 500 corporations with well
over a half-trillion dollars in cash on balance
sheets. This cash is funding stock buy-backs,
acquisitions and interest earnings, all of which
have pushed share prices up.
Between 2003
and today the wages and salaries component of
national income - unadjusted for inflation - has
risen 18%. Over the same period, there was a 67%
increase in corporate profits with inventory
valuation and capital consumption adjustment. [3]
Corporate profits are increasing at 3.7 times the
rate of earnings in the US economy. The broad
measures include these corporate earnings and are
thus more laggard than traditional side-by-side
measures suggest. Profits are a bright spot, as
are corporate fortunes. The US is now defined by
the tandem rise of federal and personal debt,
current-account imbalance, stagnant wages and
soaring profits. Corporate earnings growth
inflates lackluster macro-performance and leaves
many overly optimistic about the health of the
national economy.
We see slowing GDP
growth and quickening dollar pressure as signals
that the drag of international imbalance and flat
wage growth has increased. The challenge of the
year ahead is to reconcile the experience of firm
bottom lines with the overall macroeconomic
conditions. The new Congress will face pressures
on this front, and so will business.
Housing weakness is taking a welcome
breather of late but is far from over. The wind
always dies down in the eye of the storm. We
believe we are experiencing the false confidence
of rough weather passed in the eye of the
residential investment hurricane. Interest-rate
pressures are similarly on pause. Dollar
conditions will push for higher rates even as
economic weakness suggests lower rates. We see a
stuck Federal Reserve moving cautiously to address
these two mutual opposed concerns. The divergent
states of households and firms will complicate
this process as the Fed fears recession and a
public riding a debt-service razor's edge.
Despite all this, there is reason to
believe that after an overdue retreat in the first
half of 2007, firm profits and bargains will allow
for bright spots in US and foreign equity markets.
Expect rising volatility and discussion of foreign
outperformance to creep into the recent buoyant
attitude. Even before adjustment for the dollar's
slide, much of Europe, developing East Asia and
parts of South Asia widely outran US indices in
2006.
Firms with foreign operations have
moved into an enviable position where weakening
dollars and stellar corporate earnings combine
with still fairly robust consumer spending and
minimal tax exposure to create strength in
earnings. One of the standard risks from deflating
dollars - rising import costs - has lately been
offset by retreats in energy prices, dollar-pegged
Asian currency in production inputs, and
dollar-priced commodities that serve to limit the
exposure to weakening dollars on the input cost
front.
Here again, we see a tale of two
states of exposure to globalization. US labor -
indeed, developed-world labor - is restrained in
wage and benefit demands by intense global
competition. This competition is led by
established Western and Japanese firms growing
offshore and using cheap input components. States
also compete for capital investment and strain to
maintain globalization as opposition throughout
the world raises security costs and requires
action on far-flung instability. Again, this
entails a parting of ways among states, employees
and leading firms. We assume this will continue in
2007, and the way in which it is slowly recognized
and reactions to it take shape will define the
investment and business climate this year and
beyond.
There must be some reversion of
mean performance by the various elements of the
macroeconomy. This can take place slowly and in an
orderly fashion or rather more violently through
instability and outcry - economic and political.
The form and speed of adjustment to sustainable
balance among firms, states and labor is the great
challenge and risk of 2007.
Notes 1. The 2.1% November
PPI increase was the largest since
1974. 2. December 19 saw a 6.7% November
increase in Housing
Starts as measured by the National
Association of Home Builders. 3. BEA press
release: Gross domestic product and
corporate profits, November 29, 2006.
Max Fraad Wolff is a doctoral
candidate in economics at the University of
Massachusetts, Amherst and managing director of
GlobalMacroScope.
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