July 29, 2013
Have you ever been in a situation where a family member is sick and some savant in the family goes off on a riff about the competence of the doctor rather than the health of the patient?
It can be a strange experience when the afflicted person’s health is deteriorating and the focus of the conversation is about the ability of the doctor who might treat him.
It has only happened to me once, but I will never forget it as an exercise in futility, wishful thinking and misappropriate concern. Sure, some surgeons might be better than others, but their ability to work unique magic while operating in the same system, with the same drugs with the same checks and balances must surely be broadly similar.
What matters is the health of the patient rather than the ability of the surgeon who can only do the best with what is presented to him or her and yet, hushed conversations about the quality of the doctor are happening all over the country today, when the determining factor is the health and strength of the patient which is often overlooked at critical moments.
Maybe it’s just human nature, but it has always struck me as a bit odd.
Watching developments in the global economy this week, I was reminded of the doctor and patient conversation again. In the world economy case, the doctors are the central banks who are trying to treat the patient, which is the ailing economy.
Right now, the global financial markets and politicians of every hue appear to have enormous confidence in the ability of the world’s central banks to engineer all sorts of conflicting objectives. In the US, the central bankers have to facilitate a recovery, yet in China, they have to achieve the opposite – a soft landing.
The most powerful doctor in the financial world – Ben Bernanke – is about to retire, and the resulting vacancy has the financial press jammed with stories about who may get the plum job. Much of the focus this week has been on the quality of the next surgeon general rather than the health of the patient.
This focus on the doctor rather than the patient has created a weird dilemma in global financial markets which is that, as the economy gets weaker, the sick markets rally. This makes no sense. Global stock markets should be driven by the underlying strength of the economy, which should drive company profits. So how come weaker data causes the markets to rally? How come bad news has become good news?
It’s because the worse the news, the more the doctors increase the dosage of monetary drugs – money printing – and the higher the stock markets go as a result. This is great news for banks and financial casinos, but it tells us little about the global economy other than that it is getting more fragile.
In order to find out what’s going on in the real economy, a good place to start is in the results of large companies. This evidence is usually much more timely and detailed than the general economic data that’s published and can be characterised by all sorts of measuring problems best left to statisticians.
Economic forecasting is fraught, but usually the more information you have and the wider you cast your net, the more likely you are to have a handle on what the future might look like in a world that is not only uncertain, but is obviously impossible to predict.
Last week, the evidence from companies made interesting reading. Caterpillar, the global truckmaker for construction and generally for moving big stuff from A to B – the staple of traditional economic activity – reported a 45 per cent fall in profits in the three months to July. If the world economy is recovering, Caterpillar should be seeing it.
But forget the old economy: surely the new economy is flying, isn’t it? Well, not really. Consider these technology companies – all of which have a significant presence in Ireland.
Google Q2 profits were up 16 per cent, but this was well short of forecasts. Then we had eBay, the online retailer, reporting profits down 7.5 per cent. Wall Street had estimated Microsoft profits of 75 cents per share, but the computer giant reported 66 cents per share profit.
And what about two of Ireland’s computer giants, IBM and Intel? Intel’s profits were down 29 per cent in the three months between March and end of June while IBM’s were 17 per cent down.
Now contrast the world’s big tech and traditional industrial companies with the banks and financial casinos.
Goldman Sachs’ net income rose to $1.86 billion from $927 million a year earlier. Citigroup saw a massive 41 per cent increase in quarterly profit. Meanwhile, Wells Fargo posted a 19 per cent increase in second-quarter profit.
You can see what is happening. The doctors apply the drugs because the patient is still weak, but this drives up stock markets because there is so much free cash about looking for a home. This is reflected in surging profits of the banks that make the money from the financial casino.
Now here is the truly worrying thing. Investors see share prices going up, they then plough more money into the frothy stock market thinking things are getting better.
But what if things are not getting better, but worse?
What if the stock markets are playing tricks on investors because while share prices are going up, the underlying profits of the companies – as we have just witnessed – are going down?
What if rising stock markets are a signal that the economies are contracting, not expanding; and the worse the contraction is, the more the doctors apply drugs giving the temporary impression that the patient is recovering when the signs of life are simply the response to stronger and stronger drugs?
If this is the case, it is a recipe for the most monumental financial markets’ crash, as stock prices fall back down to where company profits actually are.
This outcome is not in any way guaranteed, but when the world focuses on the doctor rather than the patient, there may be nasty surprises.
Something has to give, because you can’t have rising bank profits, rising stock markets and falling profits in the companies whose share prices are actually going up. This inconsistency doesn’t work, no matter how brilliant your doctors are.