On my way into work this morning I was thinking to myself how our country - politically and economically - has seemed so broken over the past few years - even today government still cannot function smoothly - and yet the markets continue to reach new highs.
I then reflected that these market highs are due primarily to the great job corporate America has done managing businesses through some incredibly turbulent waters, and I decided to jot down a few thoughts on the current state of Corporate Business and the Business of Government.
It's always easy to be a Monday morning quarterback, so let's glance at the rear view mirror for just a moment. Recall what CEOs and managers of businesses recently faced - negative impairment that would hinder both growth and profitability of business. And by and large, they responded with common sense.
Let me explain what I mean. From a corporate leader's perspective, you wake up one morning and find a world economically falling apart. Due to greed and bad political decisions, the bank industry is about to collapse. The press is screaming that the world is about to end. Politicians are going into panic mode every time a TV camera gets near them.
Your first thoughts at this point are to protect your business. You immediately cut capital expenditures and discretionary spending, you freeze new hires, and you review carefully any growth plans that are built into your long and short term budgets.
Then of course you focus on inventory management, because, from a business perspective, a recession is essentially an excess of inventory that needs to be worked off. You scrutinize expenses, and you solidify your cash position in order to fight another day.
In a nutshell, that is what Corporate America did - a common sense, back-to-the-basics approach. (If you would like to read more about this topic, let me recommend that you read "Memos from the Chairman" by Ace Greenberg; it's an easy read, highly insightful and often humorous.)
And as a result of that common sense reaction, corporate balance sheets are now looking pretty good. Earnings have surpassed expectations, inventories are under control, and cash positions are strong. Valuations look reasonably fair, and consequently the markets are surging.
In fairness, I should add that, from a macro perspective, Washington helped, at least initially. Some may disagree, but TARP was truly a thing of beauty - it saved the banking industry, and credit needs to be given where credit is due. The outcome was actually quite profitable to taxpayers, with the notable exceptions of GM (GM) and Chrysler.
But then came an avalanche of new rules and regulations, along with new business taxes and fees, intended to insure that "this will never happen again." Government and politicians frequently overreact, and ours were no exception. The new restrictions often hindered banks from lending money. Additional regulation made it more difficult for start-up businesses to open their doors, thereby stunting job creation.
And of course we have also had to deal with cliffs, gorges, can kicking and punting, together with a 2000-page healthcare act, which is going to keep corporate America in its defensive cash hoarding mode a while longer. By no means am I denying the need for healthcare reform - everyone knows changes need to be made there, but we will save that topic for another day.
Nonetheless, over time, the pendulum will swing away from overreaction, and things will stabilize, and growth will once again pick up, at least until the next economic catastrophe.
Recently I was on a local radio show in North Carolina, and one of the government's budgeting practices came up in the discussion. It's worth mentioning at this point. Did you know each agency or subset of government is given a budget each year, a lot like your business or even your household? But there's one big difference at the end of the year - as a government manager, if you have not spent your entire budget, the following year your budget is cut by the amount you did not use. There is no incentive to end the year with a budget surplus - the goal is to have no "leftovers."
So, near the end of the budgetary year, government managers go on a shopping spree. What would corporate leaders do with a department head who made that kind of decision? We all know the answer to that question, don't we? And a department head who came in under budget would probably merit a reward, right? Meanwhile, the press wonders why we have problems with our debt.
What does all this mean for the investment horizon? You may have seen a commercial where the guy is made of cash and driving the motorcycle. As he drives down the road we see the wind blowing cash in every direction. I liken that guy to corporate America. Instead of taking that cash and spending it on capital expenditures, employment and outright full expansion of their businesses domestically, they are very likely to increase dividends and implement large share buy backs.
The markets as a whole look pretty good to me and this "dividend increases and share buyback" theme should work for some time to come ... or at least until the Federal Reserve starts causing interest rates to rise and takes the punch bowl away. Like most cycles, until the yield curve inverts, and short term rates exceed long term rates, we should be pretty much fully invested. Be on the lookout for those companies flush with cash and little debt. They will be the candidates most likely to participate in the theme described above.
It's a shame the common sense approach to managing business cannot be implemented in Washington. There's no incentive to make it work there. Maybe someday. But in the meantime, hats off to you, Corporate America, for a job well done.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.