Did Washington Save the Economy? Part 1
A "jobful" rebound is unlikely to goose the recovery.
David Stockman was elected to U.S. House of Representatives for the 95th Congress and was reelected in two subsequent elections, serving from January 1977 until his resignation January 1981. He then became Director of the Office of Management and Budget under President Ronald Reagan, serving from 1981 until August 1985. He was the youngest cabinet member in the 20th century. After leaving government, Stockman joined Wall St. investment bank Salomon Bros. and later became a founding partner at New York-based private equity firm, The Blackstone Group. He left Blackstone in 1999 to start his own private equity fund, Heartland Industrial Partners, L.P., based in Greenwich, CT.
During its insouciant climb to1200 on the S&P, the market’s mantra has been clear: Buy stocks! Washington saved the economy. Surely that’s the penultimate whopper -- coming right after “the checks in the mail.” In the present case, the lie is that the $78 per share of current year S&P earnings alleged to be in the pipeline deserves to be capitalized at a historically normal 15x multiple. After all, the American body economic has been heavily medicated with an unprecedented regimen of experimental drugs -- $1.7 trillion of QE, 15 straight months of ZIRP, and trillions in willy-nilly fiscal “stimulus.” Can anyone possibly know at this early juncture whether the eventual withdrawal of these treatments will lead to a relapse, a coma, or a return to the pink?
For what it’s worth, the wisdom of the ages holds that extreme promiscuity in money-printing and government-borrowing -- of the kind we’ve undisputedly indulged in -- ends in macro-economic tears, not a sustained upward march of profits. At the very least, that risk suggests attaching a cautionary PE discount to near-term earnings until there’s more evidence on the experiment’s outcome. But today’s intrepid bulls insist that neither history nor traditional financial principles are relevant – it’s all about the flow of juice from Washington and extrapolating last week’s headline numbers into the future.
Needless to say, in the fall of 2007, these same seers opined that Goldilocks would reign forever because Bubbles Ben Bernanke was already lathering up the Fed and the then-current economic numbers -- like positive jobs prints -- were still flashing green. This sunny outlook, of course, was utterly oblivious to fundamental indicators of impending peril then in the public domain -- such as the gathering fissures in the insane edifice of housing prices, the economy’s need to take on $5 of incremental debt to acquire $1 of GDP, and Wall Street balance sheets reported at an incendiary 40x leverage ratio, to cite the obvious.
But burned once… well… here they go again. Hard upon the very first month of a positive jobs print, the mantra appears to have metastasized further. Load up the truck! A “jobful” recovery is just around the corner -- or so trumpets the bullish brass horns. Thus, leaping ahead to 2011, the $97 consensus EPS estimate is apparently deemed to be a no-brainer -- clocking in, as it does, at only 12x today’s market.
In fact, the 2011 estimate also computes to a 26% gain over this year’s hoped-for $78 per share, which itself is a 37% gain on actual 2009 operating earnings. Reaching back only slightly further, the 2011 estimate also weighs in at nearly triple the $37 per share of four-quarter operating profits recorded as recently as last June. So the current consensus outlook could be likened to leaping a tall economic building in a single bound. Then again, it might constitute yet another head-in-the-sand episode, like during the fall of 2007, when Wall Street bulls petulantly dismissed any sign of impending peril. Indeed, the possibility that they’ll experience a two-peat is strong, and is hinted at in recent key economic releases -- the March jobs report and the February income and spending survey. Lurking beneath their seemingly benign headline figures are some ominous trends suggesting that the economy may be heading for an ambush; an upset that could pulverize today’s rosy EPS estimates, as well as the naïve belief that a hot-house economy confected in Washington can be capitalized at historical rates.
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