Wall Street

Who Separates Wall Street From Main Street?

By David Stockman  |  August 2, 2019

Hey, pretty noisy Friday… Wall Street was already and is still chagrined by the Federal Reserve’s too-soft commitment to a rate-cutting cycle. The Tweeter-in-Chief, maybe an FOMC meeting or two away from demoting his Fed chair, has turned once more to his big bag of tariff tricks.

And, this morning, the Bureau of Labor Statistics reported that the U.S. economy created 164,000 jobs in July.

The Dow’s shed nearly 300 points just over an hour into the trading session, and the S&P 500 and the Nasdaq Composite are both off by more than 1%.

Will it be “BTFD!” again come Monday? We’ll see.

Our monetary central planners have created a mass of excess liquidity the likes of which financial markets have never seen.

It’s got to go somewhere, like “The Blob.”

Today, the Federal Reserve engulfs everything it touches. That’s Alan Greenspan’s gift to posterity. Right now, the Donald seems to be exploiting it to decent effect on his reelection bid. He can’t not be the center of attention.

All we lack now are the specifics of the scenario. But it’s increasingly apparent that the president of the United States will, eventually, tip the entire global system into a critical condition.

The Donald will, one way or another, fulfill his destiny and become the Great Disruptor.

Despite its apparent failure to properly succor Wall Street, we know, beyond any doubt, that the Fed is committed to nothing else like it is to “wealth effects.” It believes that rising share prices lift all boats, from the canyons of Lower Manhattan all the way to Main Street, just like that.

Maybe we see yet another bounce toward a new incremental “Peak Trump.” Recent experience says speculators and traders will once again fall back on the Powell Put/Empire Hedge and back up their trucks.

Roots Of A Bust

Evidence of easy-money-driven stock-buying abounds.

Take the massive spree of corporate buybacks over the past seven-odd years. S&P 500 companies repurchased $3.8 trillion of their own shares from 2012 through 2018, shrinking their share count by 10% and flattering their per-share earnings accordingly.

You also have the big corporate tax cut to 21%. That move reduced the average effective rate for the S&P 500 from about 27% to 19.8%. And it boosted reported net income by about 10%, or $15 per share.

That GOP-sponsored, Trump-signed piece of fiscal debauchery was funded on Uncle Sam’s credit card, of course. And it produced a one-time step-change in profits. There’s no recurring growth there that can be recapitalized at today’s bloated price-to-earnings ratios.

Wall Street’s ex-items flimflammery is making for wider and wider gaps from the profits reported based on Generally Accepted Accounting Principles and filed with the Securities and Exchange Commission upon penalty of jail time.

It’s about $18 per share on a trailing-12-month basis. It was $10 per share back in the first quarter of 2012. It hovered between $5 and $6 in the mid-1990s. And it was virtually $0 prior to 1990.

Those “extraordinary” “one-time” “non-recurring” items may well cause some lumpy reporting at the company level. But they do indeed represent destruction of corporate cash, whether its severance payments for workers or writeoffs for plant closures and/or “intangibles.”

At the aggregate level, they are certainly growing at an extraordinary rate.

Corporate profits are about as “great” as most other measures of U.S. economic fundamentals.

How To Eat The Seed Corn

None of it is sustainable.

Tax revenues from corporate profits declined by 31% in 2018, plunging from $297 billion in 2017 to just $204 billion. That’s fine in a vacuum. I do not object to cutting the corporate tax or even abolishing it entirely.

It’s just that any revenue loss must be paid for with either spending cuts or new, more benign revenue sources.

But that didn’t happen this time around. In fact, it never happens anymore. The entire $93 billion plunge in collections was charged to Uncle Sam’s credit card.

It’ll generate carry costs forever and no permanent economic gains at all. Based on the surge in 2018 buybacks, it’s obvious that most of it went to share repurchases, not enhanced capex or other productive investment.

That’s the prerogative of CEOs and CFOs and corporate boards, of course.

And that’s true even if this windfall benefits the top 10%, who own 85% of the stock… even if it’s a gift from monetary central planners and fiscal elites… even if there’s no sign of rising real wealth…

Aggregate operating cash flow before research and development (R&D) expenses and capital expenditures for the S&P 500 rose from $1.86 trillion at the 2007 pre-crisis peak to $3 trillion during 2018. That’s a 61.2% gain over the 11-year period.

But nominal U.S. gross domestic product (GDP) growth increased by just 41.8% during the same period. U.S. GDP grew from $14.45 trillion in 2007 to $20.43 trillion in 2018. Meanwhile, operating cash flow for the S&P 500 rose from 12.9% of GDP to 14.6%.

That was partly a function of the $11.5 trillion wave of consolidation via mergers and acquisitions (M&A) during the period. Corporate margins were also getting fatter due to rapidly falling carry costs.

Nevertheless, these gains did not go primarily into productive investment in the form of R&D and capex. In fact, the reflow to Wall Street in the form of buybacks, dividends, and cash-based M&A soared by 60%. It went from $1.15 trillion during the deal-making frenzy of 2007 to $1.85 trillion in 2018.

That $700 billion gain in the Wall Street take rate between 2007 and 2018 amounted to 11.6% of the entire $6.04 trillion gain in GDP during the period.

That’s right…

Nearly one dollar of each eight-dollar gain in U.S. GDP since 2007 has been cycled into the maws of Wall Street, where it’s fueled the greatest financial asset inflation in recorded history.

Net business investment after inflation and consumption of capital in current production has stagnated since the turn of the century. Real net capex of $493 billion in 2017 was still below its turn-of-the-century level. It’s been dead in the water for nearly two decades.

Low labor hours growth… low productivity growth…  and 2low investment growth in productive assets…

We haven’t even touched on the dual burdens on the American economy represented by the Welfare State and the Warfare State.

And then there’s Achilles Heel. That’s the $73 trillion of public and private debt held by Americans.

Nothing the Donald has done will accelerate sustainable U.S. economic growth. Most of it – Trade War, Border War, Fiscal Debauch, Ultra-Easy Money – will only decelerate it even further.

The trend real GDP growth rate has already fallen to 1.5%, and here we are, in month No. 121 of an old and weak expansion, on the brink of recession….

Do you still believe this is “The Greatest Economy Ever”?

Simple Sustenance

Desperate times call for… “common sense” measures.

And these are desperate times… Markets are corrupted by monetary central planning. They’re confused. And the road back is going to be treacherous.

We’re looking at a major re-pricing for all financial assets. And thousand-point intraday or day-to-day swings are part of that equation. Those can be frightening… for “buy and hold” investors.

I have a different approach, one that combines strategy and tactics into a plan flexible enough for you to survive and thrive amid the coming chaos. It’s called “The Stockman Model.”

All we’re after is a little stability, perhaps a chance to pocket a windfall when opportunity presents…

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR