Be careful what you hear in the media regarding the stock market and economic data. Almost without exception, they aren’t giving you the entire story. They’re counting on you not to look past the headlines.
Beware The Claims Of Cash-Hoarding
At the end of the third quarter, cash held by 419 nonfinancial companies in the Standard & Poor’s 500 list was up 49% from three years ago—before the start of the recession—while total debt was up a more modest 14%, according to an analysis by The Wall Street Journal.
Sounds good, right?
Then explain this:
That’s equity value divided by (tangible assets less debt), all from The Fed Z1.
It doesn’t lie folks.
Cash is a tangible asset.
So what’s really going on here? We have the market crooners – again – ignoring deterioration in asset values across Corporate America. We’re again trading on hype and claims that are true but materially misleading in that they omit the other parts of the equation. And while cash has gone up, the value of property, plant and equipment has plummeted much faster, leading the current leverage index to nearly triple since the recession began.
If corporations spend their cash they will drive this ratio even higher (more unfavorable), and so will further increases in stock prices.
As I have repeatedly pointed out, an unfavorable Corporate Leverage Index does not mean the market cannot go up. It is, however, a very clear measure of risk. It represents the number of dollars you must spend on a common stock in order to get one dollar of tangible liquidation asset – whether that asset be property, plant, equipment, or cash.
Normally recessions lead to material declines in this ratio as corporate leverage comes out of the system during a recession as a consequence of bankruptcies, reorganizations and stock price declines.
This time the exact opposite thing happened, and the change was not small.
This is what happens when you produce a claimed “economic recovery” on lies.
Nobody Needs To Clean Anymore!
“The economic environment in the second quarter has remained challenging,” Chief Executive Officer Don Knauss said in the statement.
When you cut back on the bleach and Pine Sol, you know things are bad.
The cause? My belief is that it all comes down to the abuse of leverage and input costs.
Again, watch that corporate leverage index.
This is a chicken that will eventually come home to roost, and my expectation is that the margin story starts to show up this quarter, which earnings due to start up here shortly.
ISM: First Mess Of The Year – 57.0
(Tempe, Arizona) — Economic activity in the manufacturing sector expanded in December for the 17th consecutive month, and the overall economy grew for the 20th consecutive month, say the nation’s supply executives in the latest Manufacturing ISM Report On Business®.
The problem in the report is prices paid. This is the same problem I’ve been highlighting for months now – and there’s no way this escapes having an impact on corporate earnings.
Oh, the crooners will try to discount it, but it won’t work. Sure, the market is up ~2% on the Russell and Nasdaq today, and the DOW is up 100 – but most of it was before the number release.
The brown-nose media at least mentioned the prices paid problem this time around – it only took them six months to come to the conclusion that there might be a problem there.
The issue remains this – pick your poison, they’re both bad. Either margins compress or consumer purchasing power gets trashed. In a world where labor is instantly arbitraged overseas there is no way to couple price increases back to wages for the vast majority of Americans.
As such the premise that we can “inflate away the debt” and it will all be ok is idiotic. It simply cannot happen as the average American does not possess any way to leverage these price increases back into their economic situation and thus grow their purchasing power at least as quickly as prices go up. This makes it impossible for manufacturers to pass through the increase in materials cost.
As I noted in my 2011 Ticker I believe this will be the story of 2011 that nobody, thus far, has talked about to any material degree. Yet it is what matters in the end when it comes to the final outcome for the economy.
I wish I could find a way to be bullish on a forward basis, even if it was to come up with some sort of nonsense scenario that took leverage out of the economy by “inflating debt away” as so many have claimed we will do.
Unfortunately the numbers say otherwise – that the premise that we’ve all been operating on for the two years has been a false God – hard assets have continued to decline in value even though their carried price has remained in the idiot zone from 2007 when everything smelled like a rose.
Remember, in 2007 there was nothing that anyone could do that was wrong. M&A was booming, we had “Merger Monday” every week, Downey Savings and Loan was going to $100 and then $120, Countrywide was going to own the mortgage business and the stock market was going to go up another 15-20% next year.
Instead it all came apart because leverage had built in the system and despite the machinations of The Fed, who tried like hell starting in August of 2007 to stop it, they could not keep the truth from being realized.
We’re in the same place today but with corporate leverage at three times the level it was in 2007, unemployment vastly higher which makes it even more impossible to couple price increases back into wages, a budget deficit more than double where it was in 2007 and prices paid are ramping once again.
I wish we were not in this position, and if we had done the right things then we wouldn’t be – but we are.
Margin compression – or if you prefer, collapse – will be the buzzword this year.
You heard it here first, starting in the early fall of 2010.
It becomes realized in 2011.