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Wednesday, September 14, 2011

Forget the Maestro, is There a Composer in the House?

Then and Now. Since September of 2001, the S&P has appreciated at a paltry annual rate of 0.5% despite corporate earnings expanding at an annual rate exceeding 11.5%. Even so, since 1900, the stock market has averaged six percent growth per year, excluding dividends.

A decade ago the US was in the midst of an economic slowdown, as S&P earnings fell from $53.70 in September 2000 to $24.69 by December 2001. The Fed, under Greenspan’s baton, lowered interest rates a dozen times, from 5.75% to 1.25%. By July of 2003 the unemployment rate began to subside from its 6.3% high. A year later, earnings finally bested the 2000 peak.

Following the score which reads, “In a slowdown, lower interest rates help stimulate the economy,” worked, earning Greenspan his famous “Maestro” moniker. Unfortunately the music has yet to be written for today’s show. Can Bernanke be both composer and maestro?

Today is not 2001. Earnings, rising since December 2009, are now within a few percent of the 2007 peak. Though stubbornly high, unemployment has been receding at a (what used to be called) glacial pace, since reaching 10.1% in October 2009.

What music might liven this sluggish economy? Or is this a problem of perception, where a slow patch gets all the publicity though a recovery is actually in place? Who is trumpeting the just reported quarter where earnings grew 14% on 10% higher sales?

QE2 bond buying kept short-term interest rates at zero and brought long-term rates from 4.5% to under 3.5%. But what was actually done for the economy? Credit card rates are north of 19% and small business loans are still hard to get. Corporations won’t put cash to work where there is little demand for products—meaning in the US or Europe. Pushing long-term rates from 3.5% to 2.5% may not change that equation much. Unemployed and under-employed cannot be expected to increase demand.

A chunk of the “stimulus” went toward balancing states’ budgets. Another chunk has yet to be spent. It was recently reported that balancing the Texas budget required Federal stimulus funds— to the tune of forty percent of their budget. Texas is not alone or the biggest recipient. The average state budget was balanced with 15% Federal assistance. With 1% GDP growth and the end of stimulus, states are going to be in dire straits for another few years.

The Fed can help set the stage for recovery by moderating interest rates. But low interest rates alone may not be enough. Another $500 billion infusion, even if passed by Congress, might do little more than help states’ balance their budgets again. It may be time for Keynesians to show some creativity.