1929 wasn’t a good year for the global economy, and it was especially tough on the US. This morning we have noticed two different theories emerge, looking at the economy from quite different perspectives, but both drawing parallels with that awful year.
First there’s US corporate profits. Recently Fortune Magazine’s Justin Fox wrote one of those seminal articles – which seems to have set alight a blog fire- where an increasing number of web sites have suddenly leapt on the article to proclaim economic doom.
Mr Fox’s article revealed disturbing news, like a black hole, when all around are shining stars of economic promise.
The US markets are soaring, the Dow Jones Industrial Average has been breaking all time records with such regularity that it’s no longer making headlines. The NASDAQ has passed its five and a half year high, but can it continue? Supporters of theories of economic gravity think it must end – saying the rises can’t go on forever. The counter argument is many fold, and has been rehearsed here many times. But here are two key reasons why markets may continue to boom. Firstly, gravity is not as yet stretched – don’t forget we are only seeing the Dow hit levels, which are around 700 points or so up on the highs reached on January 14 2000. In percentage terms, that’s a tiny increase of around 5.8 percent, so compare today’s levels with the scores seen in the late ’90s and early few weeks of this millennium, then the rises have hardly been the stuff of gravity defying leaps.
Then there’s the ratio between profitability and valuation. Forward pe ratios, are, so it is understood, around their lowest levels seen this decade. So despite the big jump in equities seen since markets hit their lows three years ago, market valuations as a function of projected profitability are quite modest.
Bear in mind the rate of interest is, in historical terms, quite modest. If rates are low, you would have thought pe ratios would be high, – after all, the ratio of profitability to valuation should really be to the equity investor what the rate of interest is to a bond investor. Since equity investment and bond investment are in competition, the current phenomenon of low pe ratios is at odds with the continued economic environment of a low rate of interest.
But, according to Justin Fox, corporate profits (that’s after paying tax) are now running at 10.1 percent of US GDP. The ratio has never been so high – at least Commerce Department’s data, which goes back 87 years, have never recorded it so high. But it did come close to the current level once before; back in 1929 the ratio of profits to GDP hit 8.9 percent.
Quite ironic that, when you think about it. Corporate profits rise – suggesting healthy economic fundamentals, and fears grow of a 1929 style depression.
The other theory doing the rounds at the moment lies in the idea of peak debt. If you were to track debt as a percentage of GDP, you would see extraordinary rises over the last decade or so. If you believe that this has to come to an end, and US consumers are going to have to cut debt and save more, then we are approaching a peak. According to blog producer, Jas Jain, who describes himself as the prophet of doom, the last time we saw peak debt was in 1929.
But, we don’t want to leave these nasty parallels with 1929 in your heads over the Christmas period.
Even if there is a lot of truth in these miserable comparisons, it is worth recalling that there is one big difference today. Back in 1929, not only was the US the world’s biggest economy, in a way it was a developing economy too. The US was also the engine of global growth.
Today, the global economy seems to rotate around many axis, and the emergence of China, and in its wake India, as global economic powers, could mean that this time it’s different, and that factors that in the past spelt disaster ahead, may only have a muted effect this time.
Bear in mind also, that technology has helped promote a productivity boom of unprecedented proportions. This, in part, helps explain the high level of profitability, while high debt is perhaps more manageable given relatively modest interest rates.
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© Investment & Business News 2013