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Robert Reich: The Wall Street Rally: Watch Your Wallets

July 24, 2009

Been Down So Long It Seems Like Up To Me, the precocious 1966 novel by the late Richard Farina, defined the late 1960s counterculture. The stock market rally that’s pushed the Dow Jones Industrial Average back above 9000 for the first time since early January could be given the same title, and it might well come to define the much-wished-for financial recovery.

What’s pushing the stock market upward? Mainly, unexpectedly positive second-quarter corporate profits. But those profits aren’t being powered by consumers who have suddenly found themselves with a lot more money in their pockets. The profits are coming from dramatic cost-cutting — including, most notably, payroll cuts. If a firm cuts its costs enough, it can show a profit even if its sales are still in the basement.

Better-than-expected” is Wall Street’s euphemism these days for “we’re happier than we thought we’d be.”

The problem here is twofold. First, such profits can’t be maintained. There’s a limit to how much can be cut without a business eventually disappearing — becoming, in effect, a balance sheet in space. Secondly, when businesses slash payrolls to show profits, consumers end up with even less money in their pockets to buy the things businesses produce. Even if they hold on to their jobs, they’re likely to fear that they won’t have the jobs for long, which causes them to retreat even further from the malls.

Most companies that have reported earnings so far have surpassed analyst’s estimates, but that only means that earnings have been less bad than analysts had feared. According to the chief investment officer at BNY Mellon Wealth Management, if the companies that haven’t yet reported earnings show the same pattern a the companies that have reported so far, overall corporate earnings will have dropped 25 percent over the past year. That may not be as much of a drop as analysts had expected, but it’s still awful. Operating income for companies in the S&P 500 that have reported so far has been almost 29 percent lower than last year, more than 80 percent lower than 2007, according to Standard and Poors. Ouch.

“Better-than-expected” is Wall Street’s euphemism these days for “we’re happier than we thought we’d be.” But Wall Street is in the business of cheer leading, even when there’s really nothing to cheer about. It wants investors to think positively, on the assumption that positive thinking can be a self-fulfilling prophesy: If investors begin putting more money into the market, then the market will automatically rise, leading more investors to put in more money — until, that is, the rally ends because nothing has fundamentally changed in the real economy.

Keep your eye on the real economy, where unemployment and underemployment keep rising. It’s not as much fun as cheering and investing right now, but it’s far safer.

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Robert Reich.JPGRobert B. Reich is Professor of Public Policy at the Goldman School of Public Policy at the University of California at Berkeley. He has served in three national administrations, most recently as secretary of labor under President Bill Clinton. He has written eleven books (including his most recent, Supercapitalism, which is now out in paperback). Mr. Reich is co-founding editor of The American Prospect magazine. His weekly commentaries on public radio’s “Marketplace” are heard by nearly five million people. This entry appeared on his blog.

Copyright 2009 Robert B. Reich

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