Ask someone about the state of the US economy. Chances are that you get one of the two following answers:
- America is at the beginning of a new economic renaissance.
- America is in the final stages of economic collapse.
So what's the right answer? I believe the 'renaissance' answer oversimplifies the current scenario.
Renaissance: Strong Corporate and Asset Performance
Judging by the performance of the S&P 500 (NYSEARCA:SPY) you'd think we're back to the roaring 2007s. The price level for the S&P 500 is nearing historical highs touched in 2000 and 2007. If you include dividends, the S&P 500 has done even better.
For the market to do well so must its component stocks. One look at Apple's (NASDAQ:AAPL) share price and you'd think the American consumer has money falling out of his pockets. iPads and iPhones aren't cheap, yet the company has roughly quadrupled revenues since the start of the 2008/2009 recession.
This story isn't restricted to Apple. Although analysts are forecasting a decline in S&P 500 earnings next quarter, the fact is that corporate profits have reached an all-time high! Tell that to the average person in the street who is still saying we are in a recession. They won't believe you.
The fact is American business is doing better than ever, and the 2007 high in corporate profits was surpassed long ago. Couple profit performance with the development of continental energy resources and the onshoring of manufacturing, and, to some, American businesses appear poised for a wave of growth. However, I don't believe this is the case.
Collapse: The Beginning of the End for the American Economy
So what's the problem?
It starts and ends with American businesses. Throughout the 2008/2009 near-collapse, American corporations slashed and burned overhead. With a new, lower cost structure companies quickly returned to profitability even with weak recoveries in top-line revenue.
The important lesson, however, that many businesses learned through the recession was that they could operate with less. Millions were laid off and business investment was slashed, yet profitability quickly returned to normal and continued to grow without a re-investment in people or machinery.
While this is a simplification of a complex issue (in other words, this doesn't consider the red tape small businesses - the engine of employment growth - must endure to hire people), it sums up the decision for many executives. Why hire people when they're not needed? Instead of investing in people or capital, and instead of returning cash to shareholders, executives are hoarding profits as cash on the books.
The chart below shows the massive growth in cash and short-term investments for index majors General Electric (NYSE:GE), Microsoft (NASDAQ:MSFT), Apple, Wal-Mart (NYSE:WMT), Coca-Cola (NYSE:KO) and Google (NASDAQ:GOOG).
So while many American businesses are performing beautifully, the wealth is not trickling through the economy. America has learned to operate with less, and nowhere is this more evident than in the employment-to-population ratio (chart below). Business profits are hitting record highs while the employment-to-population ratio has fallen to levels not seen since the early 1980s - a time when single-income families were far more prevalent.
This has grave implications for society, and reminds me of social issues first raised by folks like Karl Marx and Thomas Malthus. The battle between capital and labor, bourgeoisie and proletariat, becomes one-sided when labor is no longer needed. The middle class is hollowed out and labor is pushed down to a subsistence wage. Income disparities widen and society breaks down. Revolutions happen when the 99% has nothing to lose.
America is still far from the nightmare scenarios painted by Marx and Malthus. However, the positive post-war American trajectory has decidedly shifted. The dichotomy between rich and poor, capital and labor, the 1% and 99% is creating a new systemic risk for American assets. Things that American assets haven't had to price in for perhaps hundreds of years - rebellion, anarchy, mass social strife - are now becoming mainstream concerns. (I won't politicize this article, but the government's recent policy development actions show that the government too is concerned about these risks.)
[Making matters worse, this systemic risk simply adds to the pile of systemic risks already faced by America. America's prosperity is supported by a system that props up the losers (moral hazard), encourages excessive risk, relies on currency debasement and is dependent on credit to expedite forward expenditures. A growth imperative is endemic to this system, and a change in any of these characteristics could send the US economy into collapse.]
However, this disparity between capital and labor cannot continue forever. Most (all?) societies that have let the majority of its citizenry rot to concentrate wealth among a tiny minority have eventually succumbed to revolution.
As an investor, pay attention to the disparity between rich and poor and evaluate the attitudes of the masses, the 1% and government. For investing today is no longer simply about identifying undervalued assets - it is about protecting capital from all systemic risks: market and political.
Disclosure: I am long AAPL.
Additional disclosure: This is not advice. While the author makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.