U.S. corporate profits rose 56% in the first half of 2002, yet stock prices have plunged. The problem is not corporate governance, it’s political governance
Contrary to popular opinion, most of America’s CEOs are doing a fabulous job. On the heels of a 50% profit plunge in 2001 — a plunge caused primarily by policies in Washington — top executives in the United States have boosted profits by 56% in the first half of 2002 compared to the level earned in the last half of 2001. Profits have risen by 13% in the past three quarters compared to the prior three — and in 2003 they’re likely to be 20% to 25% higher than this year’s level. At the same time, long-term interest rates in the United States have declined significantly — by more than a percentage point since the year began.
Profits and interest rates are the two most important of the “traditional” fundamentals undergirding stock prices. Historically, stocks have risen in anticipation of profit revivals. Moreover, both stock prices and price-earnings multiples have tended to increase amid large declines in interest rates — the discount factors used to assign present values to future profits. Yet stock prices in the United States — and in most major equity markets — have plunged this year, while stock price multiples have contracted. What explains this seeming disconnect? Is it yet more evidence of the widespread view that markets don’t reflect fundamentals?
Not at all. A plunge in stock prices, despite an improvement in traditional fundamentals, provides strong evidence that market pricing is being undermined by destructive government policies. Washington has been very effective at waging war in the past year — on the U.S. dollar, on business, on CEOs and on trading partners — but not, as yet, on one of the seven terror-sponsoring nations on the U.S. State Department’s list. The traditional fundamentals are being overshadowed and offset by war — that is, by a badly conducted war on terror regimes, by a regulatory war against U.S. business and by a protectionist trade war against U.S. allies. Rising profits and declining interest rates can’t boost stock prices when producers fear for their lives and their livelihoods — not only by threats of terrorist attacks from abroad, but also by repeated regulatory attacks from Washington.
When investors fear for their lives — let alone for their investment portfolios — it should be no mystery that the stock market performs badly. This is a failure of political governance, not corporate governance. Prosperity requires the freedom to make contracts and do business without government interference; it also requires security of life, limb and property — fundamentals that run far deeper than profits and interest rates.
It’s been more than a year since Sept. 11 and the U.S. government has done virtually nothing to protect the country against further terrorist attacks. Scores of terror-sponsoring regimes still exist and operate freely. Terror groups haven’t been expunged — they’ve simply been allowed to disperse to other havens. Even in Afghanistan, which some consider to be a “victory” in the war, groups like al-Qaeda have been returning; last month they nearly succeeded in assassinating that country’s newly appointed leader.
Instead of vanquishing terror-sponsoring regimes, it has become official U.S. policy to sponsor and create yet another one — a Palestinian State, to be headed by a terrorist like Yasser Arafat. Meanwhile, the United States has surrendered its sovereignty by asking for UN “permission” to eradicate threats to U.S. security — even though the UN itself has scores of terror-sponsoring states as voting members. Thus, not only have U.S. officials failed to eradicate known terrorist groups (like al-Qaeda or Hamas), it has failed to eradicate regimes (like Iraq and Iran) that are known to sponsor such groups — and it genuflects before a corrupt international body (the UN) which itself sponsors terror-sponsoring regimes. All of this is bearish.
Market-makers are not stupid; they know a policy of appeasement when they see it. And they know history, too; they know that appeasement of evil only brings more evil — and in more virulent forms. In the past year market-makers have seen that the United States and the UN are not serious about fighting terrorism — that both sponsor terror regimes and condemn Israel whenever it properly and forthrightly fights terror.
Markets would be suffering if they faced the risk of a U.S. government that refused to fight in a just war. But markets also observe the same government waging an unjust war on businesses and trading partners. Last March, the United States raised its protectionist tariffs on imported steel and on imports of softwood lumber from Canada. Regulatory witch-hunts also persist. U.S. officials are rounding up and persecuting scapegoats — essentially innocent CEOs, CFOs, accountants, analysts and bankers — in order to deflect attention away from the massive (US$8-trillion) destruction in market capitalization of U.S. firms that’s been caused by government officials. The same thing happened in the 1930s and 1970s: Government policy inflicted damage, but business and trading partners were blamed for it — and punished accordingly.
Many analysts claim that stock prices have plunged — while oil and gold prices have risen — because of a potential war against Iraq. Not so. Prices have moved in this pattern because the United States has failed to wage war in the Middle East — and because it has chosen instead to wage war against domestic innocents. In the five months after Iraq invaded Kuwait in early August, 1990, oil and gold prices increased similarly –amid declining stock prices. Like recent months, that was a period of inaction, foot-dragging and “coalition building.” But once the United States and its “allies” did act in January, 1991 — and won the war in a few weeks — commodity prices plummeted and stock prices sky-rocketed. The oil price fell from US$40/barrel to under US$20/barrel, even though Iraq sabotaged oil fields in the waning days of the war and even though, in the next decade, its oil output declined to 15% of its 1990 level. These bullish results would recur if the United States acted militarily — especially if it acted unilaterally, without permission from the terror-sponsoring UN.
In short, the U.S. equity market is currently “spring-loaded.” That is, it is poised to perform well, based on traditional fundamentals like profits and interest rates. But far deeper fundamentals are weighing it down. The necessary catalysts for rising stock prices include a strong-dollar policy, freer trade, deregulation and — above all — a swift, well-executed war to eradicate a few terror-sponsoring regimes. Improvement in these four areas — especially in the last one — would free the market from today’s wealth-destroying burdens and uncertainties.
It is difficult to judge when government policies will improve. Government officials are primarily to blame for the market plunge; but they merely enact policies supported by the media, the intellectuals and the general populace. Today there is enormous envy and resentment of the successful — especially of those who are successful economically, and especially of CEOs, businessmen and those who work on Wall Street. Most people say they want to see economic recovery, but won’t admit that only the economic giants (CEOs) can really make it happen. People say they want to see more production, but they applaud the persecution of producers. People worry about losing their jobs, but condemn the “greed” of job-creators.
The problem in the West today is that its leaders either reject — or apologize for — its virtues: reason, science, technology, self-reliance, greed, individualism and money-making. They believe selfless service and sacrifice for others is “noble.” Some — like Prime Minister Jean Chr