"Reading the spreadsheets upside down"

by Rob Horning

17 December 2007


Last week, the Economist‘s Buttonwood columnist, who writes about Wall Street, had an interesting piece about falling corporate profits. With the credit crisis taking its economic toll, corporate profits were bound to start falling—don’t tell the analysts though.

The consensus is that earnings will grow by 14% in 2008, with every single sector managing an advance. In the first half of the year, when many economists think that America will be dicing with recession, analysts are forecasting that corporate profits will be growing at an annual rate of 9%.
Going by experience, profits start to fall when the annual rate of economic growth falls below 1.5%. “Consensus forecasts for next year’s US profit growth border on the hallucinatory,” says Tim Bond of Barclays Capital. “Even allowing for the typical bullish bias, the prevailing consensus suggests that equity analysts are collectively reading their spreadsheets upside down.”

Earnings are likely to fall because consumer spending is likely to drop. The article mentions the hit consumer discretionary sector (carmakers, retailers, etc.) taking a hit, a reflection of faltering consumer confidence. I’ll add the usual caveat here—I tend to root against consumer spending, particularly of the discretionary sort, because, paradoxically, I take it as a proxy for rote, thoughtless consumerism. Rather than exercising discretion or saving, consumers seem as though they are obliged to spend, going into debt to perpetuate their habits. But it’s probably not a good idea to extrapolate individuals’ psychology from these aggregate numbers; that’s why they conduct the confidence surveys, I suppose. Nonetheless, consumers cannot continue to overspend, no matter how convenient that is to companies’ bottom lines and to the economy as a whole. A story in BusinessWeek last week noted the rise in America’s credit-card debt, and the rise in delinquincy rates on payments—if this debt has been keeping consumer spending aloft, it seems in imminent jeopardy. And in the New York Times recession-forecast bonanza yesterday, economist Stephen S. Roach argues that

The current recession is all about the coming capitulation of the American consumer — whose spending now accounts for a record 72 percent of G.D.P. Consumers have no choice other than to retrench. Home prices are likely to fall for the nation as a whole in 2008, the first such occurrence since 1933. And access to home equity credit lines and mortgage refinancing — the means by which consumers have borrowed against their homes — is likely to be impaired by the aftershocks of the subprime crisis. Consumers will have to resort to spending and saving the old-fashioned way, relying on income rather than assets even as mounting layoffs will make income growth increasingly sluggish.

The inevitable retrenching will likely be painful, crimping the standards of living of even upper middle class families (those jumbo APR mortgages to buy those oversize homes don’t seem so smart anymore), but it presents an opportunity nonetheless to transform values toward a more conservational, spartan ethic. I glamorize spartanism (hypocritically no doubt) because it seems simpler and inherently a more creative way to live than letting consumerism supplant creativity (what is noxious to me about the term creativity is how it reifies the process, makes it into a commodity). But it is certainly inconvenient to live that way, and convenience is so easy to become accustomed to and celebrate as an end unto itself, or as a means to enable even more consumption.

Corporate profits have been unusually high for several years, and there are different explanations for this, as the Buttonwood column points out:

The optimists argued that profits could stay high because the balance of power had moved in favour of capital and away from labour, thanks to the globalisation of the workforce. But perhaps profits had been boosted by accommodating monetary policy, a credit boom and the associated surge in asset prices.

It’s funny how optimism equates to workers getting shafted. The idea is that outsourcing gives capital more leverage over workers, because they can draw from a much larger reserve army of the unemployed. This forces them to accept wages that are below the marginal product of their labor, meaning more profits accrue to the companies. That theory was influential enough to persuade Alan Greenspan (if we can believe his memoir) to keep interest rates low without fear of stimulating inflation—wages would remain tamped down, so the increase in the money supply would lead to capital investment rather than inflation and a more rapid circulation of funds. But then this logic leads to the other explanation for erstwhile surging profits. Interest rates were low, money was nearly free, and inflating house prices were making consumers feel flush, giving them access to equity lines of credit. So when wondering where the money went as homes are foreclosed and banks go under, those fat profit margins might be somewhere to start.

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