I am simply amazed at the stock market and its ability to keep rising. But I predict things will be very different by the end of this year.
It doesn't get much attention, but companies have been buying back their own stocks at a record pace these past few years. The rules of supply and demand tell us that this company-generated demand has kept stock prices higher than they would have been. But it is looking like that hoard of corporate cash is drying up.
Cash Flows May Be Drying Up
Firms' Earning Pace Might Not Back Surge In Share Buybacks
April 14, 2007
Wall Street Journal
But the underlying assumption that companies remain awash in cash may be eroding, and without many investors realizing it. The most recent flow-of-funds data released by the Federal Reserve shows that free cash flow in the nonfinancial corporate sector plummeted late last year, according to Dominic Konstam, head of rates research at Credit Suisse. As credit spreads show signs of inching upward, a ramping up of corporate leverage at a time when cash is flowing to share buybacks could send bond spreads surging higher.
Free cash flow, calculated as internal funds less capital spending and buybacks, typically runs slightly negative and at most reaches about 2% of gross domestic product, according to Mr. Konstam. In the most recent flow of funds report, however, that figure plummeted to minus 5% of GDP, about as low as Mr. Konstam said he has ever seen it.
"I think it's alarming, and I think a lot of people are unaware," Mr. Konstam said.
Inflation also appears to be a factor. As a head of household, I never understood why food and energy are excluded from the inflation index. After all, I spend money to buy both of those necessities. My home heating bill doubles this past year due to the cost of natural gas. Similarly, my gasoline bill went way up. And we still need to eat - food prices are higher too. Only incomes have stayed fairly flat and that means less money to go around for households.
Higher Prices Weigh on Consumers
April 14, 2007
Wall Street Journal
Economic reports released Friday supported the widely held view that the U.S. economy is sputtering while inflation is picking up, an unpleasant combination that is weighing on consumer sentiment.
And the third leg of the stool is the housing sector. If house market flattens, and those ARM's kick in, the magic house ATM machine is going to stop printing money. This will be a painful correction for people as they have to face the real limits of what they can afford.
Subprime Pullback May Crimp Consumer Spending
April 2, 2007
Wall Street Journal
With subprime mortgage lenders pulling back, some working-class Americans are already finding it harder to buy a new home or refinance the one they already own. The big question now for the nation's economy: Will it also get harder for these consumers to buy cars, shop at the mall and dine out?
All three of these factors together tells me that corporate profits are going to slow because consumer spending is going to slow. Other analysts have written that businesses have been buying back stock instead of investing in their own infrastructure. On one hand, this means business spending will not pick up the slack from falling consumer spending. On the other hand, I wonder if this lack of investment is because businesses too foresee a slowdown and dont want to invest in new factories that will sit idle.
Business-Investment Drop Stirs Worries
March 29, 2007
Wall Street Journal
A key measure of business investment declined in February for the second consecutive month, igniting fears that businesses are becoming more pessimistic about the economy and have pared back their plans to expand and modernize.
"Businesses are worried [about] where the economy is heading, and they're being very cautious about buying equipment," says Patrick Newport, a U.S. economist at consulting firm Global Insight.
"It's looking like capital expenditures aren't going to be able to offset housing and autos with respect to investment," says Joseph Brusuelas, chief U.S. economist for IDEAglobal, an economic-consulting firm in New York.
And dont forget President Bush's record setting pace of borrowing and the increased payment on his federal deficits as well as the costs of Social Security and health care as the boomers age. These factors imply a future of higher income taxes.
Times have been good thanks to Alan Greenspan's policy of cheap cash but like all good parties, the hangover that next day is a bitch. I hope he lives long enough to share it with the rest of us.
