The Press vs The Economy

In recent months we have written about the press’s misconception that the economies of the West are extremely sick. In fact, contrary to most press reports all news is not bad; indeed in corporate results it is not bad at all!

Recent reporting of economic news has focused predominantly on the negative and tends to look for negative interpretations at the expense of covering the wider range of developments in household and corporate sectors in a more balanced way.

A good example was the reporting of the Federal Reserve Open Market statement which was widely reported as "Bernanke sees significant downside risk in economic outlook" 

After pointing to the expansion of business investment in equipment and software the Committee went on to say:

"The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets."*

The press’s reporting was a very negative interpretation of what is more a qualification of the Committee's view. The point we would make is not that the economic recovery is picking up (that prediction is as unreliable as any economic prediction) rather, there is little or no acknowledgment of what are unquestionably positive developments.

It’s worth re-iterating our comments in recent months about the strength of corporate balance sheets and the rate of growth in corporate profits - with a qualification of the requirement for re-capitalisation of European banks as a result of problem loans to peripheral Europe. 

It is significant to point out that corporate profit growth in Australia and the US has been strong and is well above pre-GFC levels - The US Commerce Department figures indicate that corporate profits are now approximately 25% above their pre-GFC highs. Bernanke’s comment about expanding corporate investment we would regard as very positive and a significant development.

The other point we would make is that while Governments will have to go through a process of debt reduction this has already occurred in corporations and is underway in the household sector. Not only have balance sheets been de-leveraged but market pricing of stocks has been very significantly reduced.

In the US, investors are paying 50 times earnings for a 10 year bond as opposed to 13 times for high quality corporate earnings streams (that have doubled over the last 10 years).

In Australia, the contrast is not as stark but it's also pretty lopsided - Investors pay 25 times earnings for 10 year Government bonds (a 4% yield is 25 times annual earnings from a 10 year bond) against corporate income streams of 10-15 times earnings, and if you are a pension fund you get the corporate tax back as well, so arguably you should use the pre-tax earnings multiple (7 to 10 times).

*The full Fed statement which is little more than a page can be seen at: 
http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm

Hugh MacNally, November 2011

More Short Papers