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Cash rich yet subpar growth

I have been hoping that cash-rich US corporates will find new investment opportunities and help to drive the US economy into a “virtuous cycle” – positive corporate profits lead to improved employment and more labor income and more consumer confidence then more consumer demand.  But there are signs that maybe the opposite is more likely to happen.  Facing huge “unusual uncertainties” (Bernanke’s words), US firms, after completing their first inventory buildup, which has contributed to growth so far, now are unwilling to spend more on capital investment: they are looking at a prolonged unemployment scenario and consumer demand is likely to take very long time to recover.   What the US needs now is how to sell more to overseas – for that, the US needs a new export strategy (I will come back later for this topic).

Here is a piece from WSJ today discussing the uncertainties the US firms are facing:

Here’s a puzzler for investors: Although second-quarter economic growth figures look rather weak, corporate earnings are nevertheless coming in reasonably strong.

Specifically, about a third of S&P 500 companies have released their second-quarter earnings so far, and 78% of them have beaten analysts’ estimates, according to Thomson Reuters. On average, earnings per share are up 42% year-on-year, compared with the 27% growth expected.

[AOT]

Yet the market’s response so far has been lackluster. The S&P 500 is up only about 1.5% since the first earnings report July 12. It is hard to argue that such results were already priced in, as the market dropped by about 11% in the 10 weeks prior to earnings season. Why, then, the muted reaction?

Chalk it up to what Federal Reserve Chairman Ben Bernanke dubbed the “unusual uncertainty” over the economic outlook. For every upside surprise in corporate earnings, it seems there’s a disappointing piece of economic data.

The Commerce Department doesn’t release its tally of gross domestic product until this Friday, but it is expected to come in below the first quarter’s 2.7% annualized pace. Goldman Sachs economists last week cut their second-quarter GDP growth estimate to 2%, for example, and expect further slowing to 1.5% in the second half of this year. Moreover, they put the odds of another recession, or “double-dip,” at about one in four.

A double-dip would certainly wreak havoc on profits. But it increasingly looks as though the more likely outcome is that the U.S. economy muddles along for a while at roughly 2%, below the 3% average of the past two expansions. That doesn’t necessarily spell disaster for corporate profits.

For investors, the mixture of healthy, cash-rich corporate balance sheets but subpar growth “is not one we have a lot of experience with,” notes Credit Suisse U.S. Equity Strategist Douglas Cliggott. One likely outcome, he says, is that a higher share of total S&P 500 returns come from dividend yield as opposed to price appreciation over the next few years.

Indeed, companies like Procter & Gamble and McDonald’s may not be the most thrilling names on Wall Street. But with their above-3% dividend yields, they probably offer the best seat for investors to ride out the recovery.


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