All That Glitters / Egypt? It's a concern but I'm rushing to an important meeting
Business leaders at the annual World Economic Forum in Davos, which ended last week, were visibly happy with climbing corporate profits; no word of Egypt.
The body language and facial expressions of business leaders at the annual World Economic Forum in Davos, which ended last week, was telling: Business is good, great even.
The clues were abundant. For one, everyone came. No one likes to turn up at the big conclave, swarming with customers and competitors, bearing bad news or disappointing financial reports. The fact that the top execs came, rather than opting out or sending underlings, said it all.
The second clue was that while some honchos managed to exude confidence without spelling anything out, others couldn't contain themselves. When JP Morgan Chase CEO Jamie Dimon, considered the world's most influential banker, exclaims in the midst of a party, "The boom is back!," everyone in the room gets the point. The big banks know how their customers are doing, and what they're doing now is terrific.
Third clue: Throughout the conference, the top executives were seldom seen at panel discussions, moving along the corridors or whispering to each other in the lounges. They simply didn't have time: They were too busy making deals in private meetings.
Many executives reported scheduling 10 or 20 meetings a day - the best proof possible of the global business sector's great self-confidence. Even in the forum's last two days, which coincided with the onset of protests in the Middle East, their body language said "Egypt? The images on the news are disturbing but I don't have time to discuss it, I'm too busy meeting with important customers."
The sagging bond market gladdens execs' hearts
But one needn't spend $70,000 to attend Davos to learn that the big corporations are in excellent shape. In Israel the flood of 2010 financial reports won't start until March, but half of U.S. companies have already released their results. The Economist reports an average rise in profits of 17% so far, over 2009, without banks and finance companies, which would make the curve even steeper.
There are solid reasons for the climbing corporate profits, from three years of belt-tightening, in particular through staff and salary cutbacks, to operational and sales expansion in the Far East and Latin America. The latter has taken up a lot of the slack from lackluster sales in Europe and the United States in 2010.
These measures brought about a strong surge in profits, a rise in corporate cash reserves and reduced corporate price-earnings ratios, an indicator of the attractiveness of shares. The average P/E ratio in the United States is below 15, compared with 22 at the time of the Dow Jones Industrial Average pre-crash all-time high.
Almost all market forecasters agree that the U.S. economy has moved from recession into healthy expansion. Since U.S. companies are more efficient as ever, much of the anticipated rise in revenues should go directly to the bottom line - the one showing profits. And nothing energizes the markets like the expectation of rising profits.
But eye-catching prices aren't enough to send stock prices soaring. What's needed is hard cash, pulled out of whatever investment channel it's in and put into stocks. And there is a channel that is bleeding money: the bond market, especially government-issued debt.
In the past 90 days the price of long-term U.S. bonds dove 10%, while prices for shorter term treasury debt fell 7% and corporate bond prices dropped by 5%. The only debt whose price hasn't dropped in this period is high-yield "junk" bonds, which in any case often behave like stocks.
The reason is fear of inflation, as well as the long-term effect of the deficit and the U.S. government printing money. These concerns make sense because commodity prices, especially oil, keep rising and make goods more expensive. The improving economy will exert inflationary pressure on wages. Inflation has long threatened economic stability in places like China and India, with annual rates of 5% and 13%, respectively. In Davos these two economies were marked as the likely hotspots for the next round of financial problems.
But the major fear in the bond markets is that economic recovery and growth could end the Federal Reserve's bond-buying program, known as QE2, and that the largest buyer in the market will disappear. In February 2011 the term "government bonds" is almost a profanity: The only question isn't whether their prices will drop, but by how much.
Some of the funds leaving the bond market are flowing into the stock market. This is ultimately the main reason for the high spirits of the 2,000 senior business executives attending the Davos conference. With all the factors for the stock market's continuing climb seeming to line up nicely, they are confident they'll receive more pay, more bonuses, more profits from their stock options, more respect and more influence in the upcoming year.