3 Crises Weighing Down Stocks

10/13/2011 12:17 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Chronically weak consumer demand in the US, overbuilding in China, and austerity in Europe are likely to cap the recent rally, writes MoneyShow.com senior editor Igor Greenwald.

It was a nice run for stocks, and I’m sure in the fullness of time, there will be nicer runs still, bull markets and new highs and all that jazz. That’s the natural order of things, since capital expects and tends to get a positive return, a lot of which gets reinvested.

The pickings have been especially good for listed companies enjoying record-low borrowing costs, economies of scale, and technology smaller rivals lack, as well as the unprecedented opportunity to exploit a vast pool of underemployed and increasingly desperate labor.

Yet here we are, with stocks valued at 12 times the past year’s profits, despite the stated plans of most companies to profit much more handsomely next year.

Recession fears are to blame, of course, but they exist in the first place because real household income has been falling for years, and because the spending adjustments made by the hardest-hit households have more than offset all the excesses of conspicuous consumption at the other end of the scale.

No one can know for sure whether and how much income inequality has contributed to the disappointing economic performance. Even the great liberal economist Paul Krugman writes that, hypothetically, 100% of the labor pool could be employed producing luxury goods for the top 1%.

But common sense suggests that an economy can’t thrive if most consumers feel they’re making no headway, and a sizable minority has lost a big chunk of income.

As PIMCO’s Bill Gross writes, “If Main Street is unemployed and undercompensated, capital can only travel so far down Prosperity Road.” And Main Street is increasingly resigned to that fate, after a decade of fruitless competition with vast and growing pools of cheaper foreign labor.

Gross fingers this as the chief obstacle to growth and the main depressant of market multiples and asset prices, and he’s right to do so.

Eventually, the disparity in labor costs might even out. Eventually, the grossly inefficient US healthcare system that so inflates labor costs might be reformed. But in the meantime, chronic economic underperformance is feeding fears that the entire capitalist edifice is in crisis.

It’s hollowed out its home base and imposed huge external costs that are tallied not on corporate profit statements, but on the public budgets, where missing taxes are no longer available to cover the growing tab for food stamps and other income supports.

This is an existential threat that won’t go away no matter how many extra pennies per share IBM (IBM) delivers this quarter. In fact, there’s a good chance that those extra pennies will have been earned by letting attrition shrink the US workforce while hiring aggressively (and more cheaply) abroad. That’s great for IBM, but a lot less so for the US economy.

Meanwhile, China, which has benefited hugely from the outsourcing of US jobs and the transfer of US technology, funneled much of the benefit into a huge construction boom that could give way to a property bust at any moment. Chinese trade statistics released overnight showed exports and imports down from this summer’s levels, with the slowdown in demand from Europe driving much of the export downturn.

More generally, China’s inefficient and corrupt capital allocation plan has “sinned” enough to merit a lot of pain. If the export surpluses dry up, the day of reckoning will arrive that much sooner.

Meanwhile, there’s a black hole at the core of Europe, where the banks lack the capital to handle the string of sovereign defaults growing more likely by the day as a result of fiscal austerity. In Germany, a conclave of the leading economic forecasters has just cut next year’s expected growth by more than half, to 0.8%, and said the debt crisis will make it hard to dodge a recession.

Is it any wonder the stock market has been a volatile as it’s been, given that recent earnings have been so good but also that an investor can take almost nothing for granted?

Those inevitable records will have to wait until the systemic crises on three continents have been resolved. And we’re very far from that happy occasion.

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