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As Dow sets records, stronger growth needed to sustain a bull market

By Peter Morici
web posted March 11, 2013

With the Dow Jones Industrial Average setting new records, it is important to recognize current stock prices are hardly extraordinary. Adjusted for inflation, stocks are still well below their January 2000 peak and may have a long way yet to run, but much stronger economic growth is needed to drive profits higher and sustain a bull market.

Stock prices are helped by the Federal Reserve's bond buying and thumb on interest rates, and by cash rich companies aggressively buying back stocks and boosting dividends. Simply, U.S. CEOs are flush with cash but don't have enough opportunities to invest in organic growth in a slow growing U.S. economy.

To date, corporate profits have been driven higher mostly by U.S. firms thinning employee ranks to accommodate slow growing domestic sales, and by big gains abroad—about half of the profits of S&P 500 companies are earned outside the United States.

Boosting worker productivity in slow growing markets has limits, and many companies may reach those in 2013. Repatriated foreign profits face stiff corporate taxes making future stock buy backs and boosting dividends more difficult.

In the end, a stronger U.S. economy is needed to sustain a bull market into 2014, and the fundamental competitiveness of the U.S. economy in global markets must be improved.

Consumer spending should strengthen with improvements in the housing market; however, reductions in federal spending and deficits and eventual Fed pull back from bond buying and higher mortgage rates policy portends only moderate growth in the combined contributions to aggregate demand from consumers, federal and state governments, and residential construction—those ultimately drive the remaining component of demand, business investments in structures, equipment, software and the like.

Too many consumer dollars go abroad for Middle East oil and Chinese goods that do not return to buy U.S. exports. Thursday, the Commerce Department is expected to report the January deficit on international trade in goods and services was $43 billion—about $500 billion annually.

Businesses, consequently, are pessimistic about future demand for U.S.-made goods and services. And bearing higher taxes, more burdensome regulations, and increased benefits costs mandated by Obama Care, they are reluctant to undertake major new investments in the United States and continue investing and hiring mostly abroad.

Imported oil and subsidized imports from China account for the entire trade gap. Development of new onshore reserves in the Lower 48, despite all the hype, have not delivered nearly enough new oil, and a full push on U.S. potential in the Gulf, off the Atlantic and Pacific coasts and in Alaska could cut U.S. imports in half, push U.S. growth well above three percent a year, and persistently push up U.S. stock prices.

The surge in natural gas production and accompanying lower prices substantially improves the international competitiveness of industries like petrochemicals, fertilizers, plastics, and primary metals—and important new investments have been announced. Investment opportunities are beginning to surface to deploy natural gas in place of oil in rail and coastal water transportation.

However, the Energy Department of Energy is reviewing licenses to boost exports of liquefied gas that would reduce the trade deficit and boost domestic demand, economic growth and corporate profits earned in the United States much less, than keeping the gas at home to boost energy-intensive manufacturing and alternatives to gasoline in transportation.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan through official intervention in currency markets and actions of state owned banks, which often evade calibration in their scope. Other Asian governments pursue similar strategies to stay competitive with the Middle Kingdom.

Economists across the ideological and political spectrum have offered strategies to offset the negative consequences of these mercantilist policies but the Obama Administration has refused to even acknowledge those options.
 
Cutting the trade deficit by $250 billion, through better domestic energy and trade policies, would ignite growth in the range of 5 percent a year—comparable to the economic recovery of the Reagan years—and fuel a bull market that would last until the end of the decade and take the Dow past 20,000. ESR

 Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist.

 

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