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Why don’t we ask them to think? September 25, 2010

Posted by WillardWhyte in Economy, Politics, Wall Street.
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In the blizzard of lies, slanders, pledges and pure manure that this year is standing in as political discourse, anyone left still searching for a baseline of hard, unadulterated data from which to form an opinion on critical economic decisions before us is in a tough spot.

The zealots have the field and from their extreme vantages on the Red or Blue fringe they hurl their slogans, their spin-studies and prove their ridiculous contentions with a shard of a subset of numbers yanked free of the critical context that allows them to give some insight into what all is going on out there in a very complex and fluid economy.

I think my favorite actor remains Rep. John Boehner, the House minority leader and Speaker-in-Waiting, who continues to whine about the great uncertainty in the business community that is playing a huge role in holding the economy back. Business leaders won’t commit to hiring, reinvestment or new product launches because they can’t see over the horizon – at least, they can’t build into profit-loss models hard numbers for things like personal income tax rates, capital gains rates, health insurance costs or outlays for such things as pollution control gear, new product labeling or safety testing. They can’t do anything to grow their businesses because – alas poor Yorick – of the policies of President Obama and the Democrats.

Which, of course, is sophistry.

Most businesses already have built their best projections into budgeting for 2011, which is quite far along in most places, based on what they can see: The laws as they exist right now. Many – larger firms for sure – have multiple models for five years out, based on what they conclude from economic and political trends will be the way-of-the-world longer term. Rep. Boehner knows full well that the greatest element in any uncertainty out there results from the turmoil being created by the GOP, the tea party puppeteers (not the core folks) and the equal-whackos on the loopy left who simply ignore any resort to math as a matter of faith.

All of which extends into virtually any discussion of any specific government policy discussion on the table, or sitting on the shelf because the GOP refused to allow a vote on a particular bill (sensing a potential winning November issue), adamantly opposed a concept basic to a bill (a rare stand on core principle) or just blurted “no” from habit. All that stuff still hanging fire feeds any uncertainty out there, as government indecision will. But Rep. Boehner and the GOP are full partners in the forging of any and all uncertainty out there.

You could argue that Obama and Democrats are “to blame” because they offered “radical” ideas – like rolling the tax schedules back to where they were in 2001. Or nationalized Wall Street and the entire auto sector, instead of catching a flock of Humpty-Dumpties a foot or so from the pavement. Depends on your spin.

I go with the view shared by Jeffrey Immelt, the CEO of General Electric, and Alan Mulally, the C EO at Ford, who contend that the problem – the core long-term uncertainty – stems directly from the ying-yang of two parties at extreme loggerheads, with disruptive policy change every two or four years the only likely constant.

Whatever. That’s not going to change soon, for sure.

So with scant time I have today, I’m going to offer up some data that may help you come to your own conclusions on what the federal government should do – or not do – to enhance the current slow growth momentum in the U.S. economy. First this: I won’t even touch the notion of whether the government should “intervene” in the economy, for that assumes some sort of out-of-economy position for government to begin with, which also is sophistry. We’re talking about how the government’s role in the economy should be adjusted, in terms of revenues and expenditures, and in terms of its role as an economic policeman.

To start, I offer this summary which I ran into late last week. It’s a summary report of the monthly Morgan Stanley Business Conditions Index, a dipstick undertaken on behalf of investors by a firm I’ll boldly suggest is not part of the socialist conspiracy. I cut in verbatim the section on “uncertainties:”

Long list of policy uncertainties. In spite of various uncertainties that have weighed on economic growth over the past year, our analysts gave little indication that these headwinds had materially altered business conditions.

Among them:

Healthcare reform: Although only 30% definitively stated that uncertainty over the implementation of healthcare reform was not hindering their firms’ hiring, the percentage of survey respondents who advocated the contrary viewpoint remained in single-digits.

Financial regulatory reform: In a somewhat surprising development, only a third of analysts from the financials sector claimed that uncertainty over regulatory reform had affected their companies’ decisions to either lend or expand – the lowest such response since we began asking this question in February 2010.  This may reflect the growing clarity around regulations such as the just-released Basel III capital standards.

Taxes: On par with previous results, approximately 20% of respondents reported that uncertainty over potential tax increases was creating hesitation to invest or expand among companies under their coverage.

Market turmoil: For the first time since June, the majority of analysts indicated that firms under their coverage had not downgraded their assessments of business conditions.  Furthermore, fewer than 10% stated that the recent volatility in financial markets had been a major factor in their firms’ evaluations.

Excess corporate cash: In line with earlier responses, over 40% stated that firms intended to return their record high levels of cash holdings to shareholders in the form of dividends and stock buybacks, and another quarter of analysts believe that their companies will utilize this working capital to expand operations through mergers and acquisitions.  Interestingly, about 26% of survey respondents claimed that firms under their coverage had recently announced expansion plans and then been penalized by investors as a result.  Thus, a fear of possible shareholder retribution may be deterring firms from accelerating their pace of capital spending and hiring.  We see that as reinforcing capital discipline – a plus for margins.

Structural obstacles to hiring: As we have frequently noted, a mismatch between the skills that workers currently possess and those that firms are ideally seeking has long been an obstacle to hiring (see Employment Prospects and Policies to Improve Them, February 26, 2010, and Why Is US Employment So Weak? July 23, 2010).  The September canvass offered additional evidence to support this view.  Nearly a quarter of survey respondents reported that their firms had recently been unable to find new employees with the necessary skill sets.

New initiatives to aid the recovery: In light of President Obama’s recently announced initiatives to spur business investment, we asked our analysts to gauge the potential near-term impact of these policies on their companies.  With respect to the proposal to allow businesses to fully expense new equipment purchases through 2011, a little more than a third of respondents indicated that firms under their coverage would step up investment over the next 12 months.  However, fewer than 20% believed that their companies would increase investment in response to an expansion and permanent extension of the research and development tax credit.

Now, my thoughts:

Healthcare reforms: Only 30% said hiring was not being influenced by cost uncertainty related to the reforms. But note that the percentage who definitively said such uncertainty was making them hesitant to hire was “in the single digits.” So, if I plug in a generous 9% there, you have 61% in the “neutral” ground – not hindering/not not hindering. So I’d say “ObamaCare” in its first year is largely not an issue for hiring, based on this. Which makes sense, since most of the added costs right now resulting from the reform bill will be passed along in grandfathered-ERISA plans, adding only a point or three to higher annual costs in this category that businesses are very, very accustomed to come budgeting time.

Financial reform: Most banks and investment firms know what most of the new rules are, and either have adjusted or are well on their way to doing so. 67% say uncertainty here is not a factor in lending or investing. So any GOP “pledge” to undue any of this will only create uncertainty, not resolve any.

Taxes: Only 20% said uncertainty over future tax increases was entering into decisions on investment or expansion. Now this could mean any changes on the table – top-end personal income tax rates or capital gains – really are not significant enough to matter in their constellation (and this is a multi-national galaxy). Or it could suggest widespread confidence that tax rates will not be changed – either by Democrats or Republicans.

Excess corporate cash: We’ve all heard of the multitrillion cash pile corporate America is perched upon. This indicates the trend will go toward hiking dividends and buying back stock, both designed to boost the price of company shares. Indeed, 26% actually caught flak from shareholders (or fund managers who wear the shareholder pants) after announcing expansion plans, one would presume because money was being spent in a manner designed for longer term gains rather than to induce an immediate stock price bounce. To me, this shows how short the vision is right now in the investor mindset: It’s hard to even categorize these people as investors. They are short-term speculators – gamblers if you prefer, who have no true “stake” in a corporation’s health beyond the price of a share perhaps even a day or a week from now. In my view, they are renters and not owners, and their impact on the health of the property – and hence on the economy since the attitude is pervasive – will be much the same as the impact of a renter-vs-owner on a house or an automobile. Be that as it may, you must wonder long and hard about the utility of any across-the-board government tax incentive policy that claims to be stimulative, if all it does is allow corporations to keep more cash at the end of the year without hard evidence of a well-defined action. If, say, it allows for any and all equipment expenditures to be expensed 100% in the first year, all that may result is an after-tax gain for already scheduled purchases – a gain that odds are will go to a bigger dividend or a stock buyback. Unlikely to put anybody extra to work, or better position the company to compete down the road. That’s not a blanket criticism of such tax incentives, just a prediction of the effect of them in this environment, given what decisionmakers are telling Morgan Stanley.

Structural unemployment: I’ll have something to say on that in a day or so.

New initiatives: Based on the investor mindset I just mentioned, it’s not surprising that big company execs are not jumping to capitalize on R&D credits or full expensing. The owners might very well punish them if they do. And many remain focused on the expense side of the ledger because revenues are flat, so any hike in a budget line has a tall bar to clear, particularly if it is not linked to an immediate rise in a corresponding income line. This comes even as Wall Street’s scrutiny has shifted from the bottom line – earnings – to the top line – revenues and underlying unit sales.

So where does all of this lead? For me, to the conclusion that the real enemy – the real button that needs to be pushed – is the short-term focus. Remove that – with certainty – and I suspect a whole lot of corporate behavior changes. Perhaps, and I am tossing this up for comment and complete ridicule – long-term capital gains tax rates should come down to 10% and be defined as assets held for a considerably longer time than the current 1 year. Say the 5 years for small business stock gains. And tax dividends as straight income, just as interest income is taxed.

The impact of that probably would be small, for it would hit only individual actors in the markets, and not the large institutional actors – the pension, hedge, mutual fund managers, who are the folks who get on the phone to the CEO and chairman and howl at a silly move like an expansion that threatens even the quarterly fund return.

As for what should be done with the top-end income tax rate – that’s also for another day.

For my effort here, I ask only that you think – and force the party of your current preference to do the same and specify how they plan to take a “pledge” and turn it into concrete policy, with all of the above in mind.

So far, Rep. Boehner & Co. have opted not to go there.

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