Here is a perfect little encapsulation of the schizophrenic market environment we currently inhabit: with the earnings season in full swing 86% of S&P 500 companies reporting to date have beaten expectations, including a bevy of consumer heavyweights like Apple (as my colleague Masood Vojdani pointed out in his blog post earlier this week). At the same time the Conference Board’s consumer confidence index declined for a second straight month to 50.4, its lowest showing since February. Corporations are looking good, households are feeling glum. No wonder the market has been on this lurching path to nowhere for the past several months.
It would seem rather intuitive that corporate profits and confidence go hand in hand, or at least have a reasonably robust coefficient of correlation. It was Calvin Coolidge back in the 1920s who proclaimed that “what’s good for American business is good for America,” and that theme has become something akin to canonical law in this land since then. The post-World War II boom that lasted through to the early 1970s saw a massive expansion of household income, industrial output, exports, dynamic consumer markets and every other meaningful indicator of economic progress. The Great Growth Market of 1982-2000 likewise produced both record earnings for S&P 500 companies and increased household income (though also increased household debt, an ominous presage of things to come).
The relationship between confidence and earnings started to become less tenuous in the middle of the last decade. Corporate earnings seasons during the latter half of the 2003-2007 growth market were a continual-motion case of “can you top this?” Wall Street handily rewarded the record-busting earners, but meanwhile household incomes were flatlining, job creation was not keeping pace with natural population growth, and consumer confidence was tremulous – neither robust nor morose, but uncertain. Of course, the confidence and earnings trajectories reunited in 2008 in the other direction as both plummeted with the Great Recession.
The current disparity of low confidence and high profits may be only temporary, of course. But there is a plausible argument as to why that may not be the case, and here it is. American households are, by definition, American. They are made up of people who by and large live, work, raise children, shop, dine out, volunteer and pursue happiness in America. The corporations that make up the S&P 500, on the other hand, are AINOs: Americans In Name Only. Scour the income statements of the companies with the largest market caps and you will understand that these are truly citizens of the world. Their fortunes are only partly tied to the country where their home offices are legally registered, and less so with each passing quarter. When you travel overseas you see iPhone-toting teenagers in Moscow, GM-driving families pulling into KFC drive-in windows in Beijing, GE appliances adorning the bright modern kitchens of young urban couples in Kuala Lumpur.
But it is not just that our largest companies are selling to the world’s fastest-growing consumer markets. They are also employing the citizens of these countries in droves. Cisco recently invested over $1 billion to open a second headquarters in Bangalore, India. This high-tech town in the Indian state of Karnataka is also home to GE’s largest R&D center anywhere in the world. When you think of Indian citizens who work for US companies the image of the sari-clad woman in a small cubicle with headphone in ears, helping a caller from Cincinnati with questions about a mortgage payment, is woefully out of date. At these gleaming corporate centers smartly-dressed members of the burgeoning middle class – a global force reckoned at around 6 billion strong – are pursuing their professional aspirations the way that upwardly-mobile Americans have for many generations.
And there is still one more piece of the puzzle. In addition to consumer markets and production markets, the capital markets that fund US businesses are also relocating. For the 12 months ended in June 2010 the percentage (by volume) of global initial public offerings (IPOs) that took place in the US was a mere 10%. That means that the overwhelming flow of money into the “hot new things” that populate IPO markets flowed in other markets, facilitated by bankers, syndication experts and investors dispersed around the world.
What does this all mean? The principal conclusion I draw is that the economy’s long-term recovery, such that it may be, could bear very little resemblance in its impact on American households to the two previous macro growth environments of the 1950s-70s and 1980s-00s. Consumer, production and capital markets are global, increasingly frictionless and beginning to cluster in defined global regions like Southeast Asia. The one means of production component that remains rooted to domestic turf is the actual supply of labor – the people who get up and go to work somewhere less than 60 miles from home (usually, though certainly not without exception!). These people cannot simply pack up one night and reappear in Bangalore or Doha (Qatar) or Shanghai the next day.
So if the fortunes of American households and AINO corporations are indeed diverging, what does this mean for the economy, for the markets, for business-government relations, for the cohesiveness of our society? These are questions to be taken seriously. Expect to hear a great deal more from me and my colleagues in the weeks and months ahead.