Democrats Want To Destroy Our Consumer-Planned Economy

Source: AP Photo/Wilfredo Lee

Marx considered profits to be theft by capitalists from their workers. He believed labor alone creates value so workers should get all the profits from their labor and the capitalists should get none. His mind was too weak to grasp the idea that capital is stored labor.

The Democrat party hates profits, too. At least seven Democrat presidential candidates have proposed raising the corporate income tax rate and if the American people would let them, the party would tax away all profits. Non-profits are saintly in their fevered imagination; for-profit companies are the spawn of Satan.

Morgan Stanley says ride the raging bull

Morgan Stanley’s analysts suggest running with the bulls this week. They recently announced that they expect the S&P 500 to rise 15% in the next twelve months and possibly to reach 3,000, a gain of 27.4%. They wrote, 

Although optimism is a late cycle phenomenon, history tells us the best returns often come at the end."

Essentially, they are shouting “the end is near!” but “party while you can!” They credited President Trump for their optimism:

While acknowledging that the pro-business agenda of President Trump has awakened "animal spirits" in the economy, the Morgan Stanley strategists feel that Trump has simply "turbocharged" a global business recovery that already has been underway since the first quarter of 2016. They note that one of the worst economic contractions in 30 years, as measured by U.S. GDP, bottomed out a year ago. Since then, their favorite economic indicators have been accelerating, including those capturing business conditions, business outlook and global trade.

Creative destruction becoming less destructive

Investors should worry about productivity growth of the firms they invest in because it is one of the major determinants of profits and market share. Innovation should drive old technology firms out of business and improve productivity but that hasn’t been the case for half a century.

Productivity growth has been falling since about 1970 for many companies according to Andrew Haldane, Bank of England Chief Economist, in his speech “Productivity puzzles” at the London School of Economics last month in which he reported what’s happening to productivity in the UK and globally.

Haldane said the future is already here — it’s just not very evenly distributed. Some companies are highly innovative with rapidly growing productivity, but most lag far behind. There are broad differences in productivity growth between advanced economies and emerging market economies, between the US and other advanced economies, across industries and within industries. After providing the fruits of excellent research, however, Haldane offered an anticlimactic solution:

The Mayfield Commission aims to create an app which enables companies to measure their productivity and benchmark themselves against other companies operating in similar sectors and regions. By shining a light on companies’ relative performance, the aim is that this would serve as a catalyst for remedial action by company management.”

Trickle-down economics still doesn’t work

The Bureau of Economic Analysis elevated its estimate of third quarter GDP from 2.9% to 3.2% last week. They intend the decimal points to give an illusion of accuracy when they know there is a lot of slack in the numbers. Corporate profits rose in the third quarter on a year-over-year basis 2.8%, the first rise in profits in five quarters.

Tossed with expectations about Trump’s spending and tax cuts we should have a salad that promises improving health for the economy. It should end business cycles and bear markets, except for the fact that we have seen similar scenarios before. Mainstream economists gathered around the casket of the business cycle in the late 1990s, just before the recession of 2001. Bear markets are wedded to recessions for the most part, so the death of business cycles would mean the death of bears, too.

If that sounds too good to be true, then join me in looking into the numbers a little more closely. The Bureau of Economic Analysis (BEA) explains the jump in GDP this way:

The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, and federal government spending, that were partly offset by negative contributions from residential fixed investment and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased...

Considering job gains, wage increases and low debt levels, Bloomberg quoted Russell Price, senior economist at Ameriprise Financial Inc. in Detroit on the topic:

Growth is going to remain heavily reliant on the consumer, but consumers are in very good position to lead that charge...Overall, it’s an encouraging sign for the path ahead.

What the market has in common with Trump

Watching this market is like watching Trump’s candidacy. Everyone is waiting for both to crash and burn but they keep climbing to greater heights. Even Fox News appears to oppose Trump without much effect just as the stock market sets new records in the midst of gloomy economic news all around.

The market has set new records even as profits are expected to have fallen for the fourth consecutive quarter. Earnings season is upon us and we will soon understand how bad the damage in the second quarter was. Thomson Reuters has predicted that profits in Q2 will be down about 5% from the same quarter last year. Revenue will have fallen 0.8%. It blames oil prices, low interest rates, and a saturated cell phone market.

Trucking and profits drive off a cliff

Not long after the 2001 recession I took a job at a large long-haul flatbed trucking company as a rate analyst and one of the first things I noticed on the job was a graph of truck tons/mile. The line grew to the right at a steep grade as a result of Greenspan’s artificial expansion of the economy through money printing in the late 1990s. Then just before the recession, tons/mile drove off a cliff and dived for months until crashing.

Last week, the WSJ reported that “orders for new big rigs plunged and inventories of unsold trucks soared to their highest levels since just before the financial crisis, as uncertainty about future demand and a weak market for freight transportation weighed on truck manufacturers.”

Earnings stumble

Despite what mainstream finance and economics teach, the stock market is rational. Two things drive it - profits and risk tolerance, or as they say in finance, the discount rate. Both have advanced the stock market from its lows at the bottom of the latest recession to recent record highs as profit rates and risk tolerance soared so that investors have been willing to pay more for the same profits.

As of the writing of this post, the S&P 500 is down about 3% from its record set on March 2. Some of the selling could have come from profit taking or covering shorts, but much of it is due to concerns about future earnings. Last week I showed that profit rates are at record highs and reasonable investors would assume such rates are unsustainable based on the history. And that seems to be the case as Seeking Alpha's Brian Gilmartin wrote:

Looking at the first half of 2015, analysts are now projecting year-over-year declines in both earnings and revenues for both Q1 and Q2 '15, compared to expectations for earnings and revenue growth for both quarters back on December 31 '14.

2015 Q1 Forecast

The latest forecast from my model of the S&P 500 index for the first quarter of 2015 indicates that the market continues to outrun corporate profits. The pattern is similar to that of the late 1990s. When the market turns, it will fall below the level that profits would indicate as investors become pessimistic and afraid. It's likely that any January effect this next quarter will be small as the market corrects for profits.

When the market gets ahead of the forecast it means that the P/E ratio is expanding because investors are willing to pay more for the same level of profits. Some of that optimism comes from chasing yields as more bond holders grow weary of earning about one percent in real terms on bonds. Other buying comes from speculation about what the Fed will do.

Q4 2014 Forecast

Here is my latest forecast of the S&P 500 quarterly averages. The market is quite a bit above what profits would justify, which means the PE ratio is expanding, or to put it another way, people are so desperate for earnings that they're willing to take higher risks. The market is above the forecast as it was in the late 1990's bubble.

S&P 500 Forecast Q4 2014

Stock market forecast Q3 2014

Here is the latest forecast of the S&P 500 average for the fourth quarter this year. The market made a head fake lower last year so it may turn around again depending on how well profits for the first quarter of this year turn out. But from the looks of things we have probably hit the high for this year and maybe for the bull market. This is a good time to think about gold and silver or possibly emerging markets since they have fallen so low.

Debt Alert

The S&P 500 set a new record high today, April 2, 2014, which should make investors nervous. Here's a chart from my book Financial Bull Riding showing the close relationship between margin debt on the New York stock exchange and the S&P 500 through 2011. The data are monthly averages.

Presidential Returns

In honor of President's Day this week I decided to take a look at a popular cyclical candidate running to help you time the stock market - the presidential election cycle. Jeffrey Hirsch, chief market strategist at the Magnet Æ Fund and author of The Little Book of Stock Market Cycles wrote about the technique in "Using Seasonal and Cyclical Stock Market Patterns" in the June issue of AAII's Journal. Hirsch's Stock Trader's Almanac has followed this cycle for fifty years and found it profitable.

Here is his graph of the average returns for the Dow Jones Industrial Average in each year of the four-year cycle from 1833-2012:

 

Hirsch explains that, "In an effort to gain reelection, presidents tend to take care of most of their more painful initiatives in the first half of their term and 'prime the pump' in the second half so the electorate is most prosperous when they enter the voting booths. The 'making of presidents' is accompanied by an unsubtle manipulation of the economy...By Election Day, he will have danced his way into the wallets and hearts of the electorate and, it is hoped, will have choreographed four more years in the White House for his party."

After the election, reality asserts control:

The Great Stagnation Explained

A few economists are worried about the great stagnation, the apparent plateauing of wages and economic growth. Some attribute the malaise to rising inequality or technology having picked all of the low hanging fruit, or other causes. Any time someone identifies a problem every person with an ideology to promote offers their pet ideology as the cause or cure. Here is my take on it:

The industrial revolution caused per capita incomes in the West to rocket from $3/day in 1700 to as much as 130 times that amount today. A graph of incomes produces a “hockey stick” as this graph from the Atlantic that demonstrates:

Chicago economist Deirdre McCloskey’s explains in her book Bourgeois Dignity: Why Economics Can’t Explain the Modern World that the innovation caused the rapid take off in incomes, but innovation requires that society value business and innovation and adopt “bourgeois values.” She devotes a large portion of the book to slaying zombie explanations for the rise in incomes, including thrift, capital accumulation, greed, the Protestant ethic, colonialism, education, transportation, geography, energy, trade, slavery, exploitation, commercialization, genetics, institutions, and science.

How is it possible for innovation to benefit all of society and not just the inventor? After all, successful inventors become very wealthy. The answer is that innovators capture merely 2% of the total benefit of their inventions according to Yale economist William D. Nordhaus in his paper “Schumpeterian Profits in the American Economy: Theory and Measurement.” 

S&P 500 Forecast

Here is the latest forecast of the S&P 500 index through Q2 2014 base on my own model. The values are quarterly averages because the model uses profits to predict the market and profit data comes out quarterly.

Size Matters

Size matters in investing as much as in other human endeavors. Bigger is better for most activities; Goliath usually defeats David. But financial economists have known for decades that small is the new big: investing in smaller firms increases investor returns a great deal over investing in the Blue Chips. Eugene Fama had to add firm size and value investing, to the Capital Asset Pricing Model to make it work. 

Recently the journal of the American Association of Individual Investors carried an article in its January issue on the subject of firm size, “Exploiting the Relative Outperformance of Small-Cap Stocks” by John B. Davenport, Ph.D., and M. Fred Meissner. The conclusions are striking:

• Small caps outperformed large caps 51% of the time between 1926 and 2012, but realized a cumulative excess return of 253%.

• Investors have higher probabilities of capturing small-cap excess returns in times of economic expansion immediately following recessionary periods.

• Small-cap sectors realize higher returns than large-cap stocks when the large-cap sectors are in favor.

Slate Article Pays No Dividends

Slate magazine's business and economics correspondent, Matthew Yglesias, advertises his ignorance of investing in his latest rant against dividends: Dividends are Evil. Concerning GE and AT&T's increase in their dividends, Yglesias wrote,

The only problem is that dividends are terrible. Bad for the economy, bad for business, and surprisingly unfavorable to investors. A barbarous relic of a less financially sophisticated era, they’re also indelibly coated with misleading rhetoric that perpetuates sloppy thinking about business, profits, and investment.

 Yglesias then tells what companies should do:

 The impatient move that would benefit the economy would be for a cash-rich firm with an already high share price to invest. Hire more people and do more stuff, upgrade the training of your existing workforce, reward your better employees with raises and bonuses so they don’t go elsewhere, cut prices to build customer loyalty. That’s how profits lead to rising incomes, and how rising incomes lead to demand for the stuff businesses sell.  

Of course, the left does not understand what business is for. Businesses don't exist to "benefit the economy." They exist to make profits for their owners, the people who have invested their savings in the company. No one invests one's savings without the expectation of a decent return in the form of profits. Profits are to business owners what interest is to lenders: profits are repayment of the opportunity costs of giving up the use of one's money.

Fight the Fed or profit from its profligacy?

The Federal Reserve is a century old this year, but instead of cheering, good economists are lauding the apology in the Wall Street Journal by a Fed insider, Andrew Huszar, a senior fellow at Rutgers Business School and a former Morgan Stanley managing director. In 2009-10, Huszar managed the Fed’s $1.25 trillion agency mortgage-backed security purchase program.

It’s important to call the Fed out on bad monetary policy, but the few who do will not change the Fed because it has the support of mainstream economics. The Fed is only doing what mainstream econ teaches it should do, so until mainstream economics changes nothing will change at the Fed. Changing mainstream economics will be difficult to do because the professors have a lot invested in their paradigm. Cracks in the paradigm will not change their minds. Nothing short of a nuclear explosion will work.

S&P 500 Headed Up!

Here is the update to my forecast of the S&P500: