Stocks, they are a’ tumbling…again. Asian markets plummeted overnight, after the Dow Jones Industrial Average closed down 3.7% Thursday. The question on everyone’s mind: is this really the start of a new recession, or is the market oversold?
The fact is, even the world’s savviest investors don’t seem to know how to play the latest bout of market gloom. They’ve spent the last few weeks trying to untangle the market’s mixed up wiring and recover from shocking events (the downgrade of the U.S.’s AAA credit rating, coupled with an ironic flight into, rather than out of, U.S. debt). But now, as the dust begins to settle, what’s on the horizon looks even more bleak.
The Federal Reserve’s promise to keep interest rates low until mid-2013 – a move meant to coax consumers and businesses to lend and spend – failed to juice markets. That sent confused investors into a tug-of-war between those who think global growth will tank and those who see stocks as a bargain. One camp thinks low Fed rates will depress the value of the falling dollar, which could boost growth-driving exports and shave billions off our debts to foreigners, which are mostly priced in dollars. But the bulk of the market is more concerned about what that means abroad and how companies back home will be affected: rising inflation in emerging markets, crunched foreign consumers, and pricier imports for us.
All those factors bode poorly for U.S. company profits, which increasingly rely on consumers abroad. As this Council on Foreign Relations graphic points out, companies’ expected earnings growth is at its lowest level in 25 years. While some of this can be chalked up to sheer panic, the rest has to do with cold, hard numbers. Even though corporate profit margins are near all-time highs, those are just percentages that don’t reflect firms’ real potential. Companies are still – on the whole – bringing in less revenue than they were in 2008.
Indeed, until now, higher profit margins have essentially been an illusion, the result of cutting costs. But squeezing more product out of fewer workers and shifting operations abroad can only do so much when it comes to driving growth. What businesses lack is willing consumers. U.S. consumer spending is in the dumps (it has only risen by 2% in the past year), while consumer confidence is at a 30-year low. And the outlook abroad is getting even dicier. Manufacturing output in China is hitting rock bottom levels, which could put even more pressure on the wages of rising Chinese consumers. Deutsche Bank now thinks a slowdown or recession in the U.S. or Europe is “the single most important shock to the Chinese economy” and could slow its GDP growth to 7%. And of course, debt-soaked governments – plagued by the threat of ratings downgrades – have no more room to step in to boost consumer demand.
As Reuters’ James Saft notes:
Mathematically, that profits could be maintained at current levels or rise in the face of declining government spending would be for households to save less or borrow more. That isn’t happening: households are saving more than they did a few years ago, but less than they ought to given the poor performance of their assets and wages and the lousy state of their personal balance sheets.
So the fall in the stock market is rational. There will be some mixture of falling corporate profits and slow to negative growth in the medium term.
The bottom line? We are entering an age of austerity, and no one – not the Fed, not China, not a unified Europe – seems able to save us from that fact. But at the end of the day, there may be a silver lining. If profits keep falling, the stock market will take an even bigger hit, and that will wreak havoc on Americans’ 401Ks. But then, a profit dive might be the only way to persuade corporations to put their buckets of cash to work. Because eventually, investing that cash into jobs and wages will become their only hope.