Stock-market investors have suffered through a big fat headache
this year. And with so many investors today, the market decline has become a
Economists, meanwhile, continue to talk about the so-called
disconnect between the rising economy and the falling stock market. They say
corporate corruption, accounting fraud, domestic security threats and now a
growing likelihood of military-induced regime change in Iraq are the root
causes of the stock slump. Even the Fed has gotten into the act, blaming
sluggish growth and falling stocks on "heightened geopolitical risks."
But you know what? The disconnect between the economy and stocks
is not so large.
The speed of economic recovery is pathetically slow. In this
stalled environment, businesses have no pricing power and very weak top-line
revenue growth. Since they can't raise prices, and sales revenues are
scarce, they can't make money. Without money, or profits, share prices keep
falling day in and day out.
Christian G. Koch, the top technology analyst for the $50
billion investment firm Trusco Capital Management, writes in that "in a
low-trajectory GDP growth environment, acceleration in tech top-line sales
should be difficult to achieve." This proposition is essentially inarguable.
Perp-walking CEOs and special-force commandos heading to Iraq are not at the
root of our pain. But a business slump is.
Koch points out that yearly revenue changes in all the high-tech
sectors -- including semiconductors, computer hardware, software, connectors
and networking equipment -- are registering negative numbers. Revenue from
the whole tech universe sank from 20 percent growth at the peak of the boom
in March 2000 to a 20 percent decline-rate at the end of last year. Halfway
through 2002, revenues were still falling at a 10 percent pace.
So there you have it. There's no way the technology-based Nasdaq
is going to awaken from the dead until those revenues start rocketing
And if the revenue story isn't bad enough, the pricing situation
adds considerably more insult to the injury. Prices for
information-processing equipment are deflating at a 4 percent rate. Software
prices are dropping by nearly 1 percent annually. Computer prices are
sinking at a 15 percent to 20 percent pace. Outside of technology,
industrial equipment prices are falling slightly and industrial commodity
prices are also dropping.
Falling prices plus declining revenues equals no profits and
plunging stocks. This is called deflation.
So the question is: What happened to the economic recovery?
Well, it's not really a recovery at all. Statistically, gross domestic
profit has been rising 3 percent to 4 percent since the end of last year's
recession. But this is only about half the normal recovery rate.
Retired New York Fed economist Leon Korobow writes in to say
that today's GDP increases are "the equivalent of zero to 1 percent growth
10 years ago. Why? Because productivity growth has taken a quantum leap
forward as a result of the investment boom of the '90s and, consequently,
the economy's full potential is advancing well ahead of 3 to 4 percent
Think of it as a modern jetliner flying 65 miles per hour when
it wasn't built to fly below 135 miles per hour and can cruise at 500 miles
per hour. If demand in the economy increases by only 3 percent or 4 percent,
and profit margins remain slim, then business investment will no longer fly,
technology will fall below the radar screen, and the productivity miracle
Like modern aircraft, modern economies cannot stay aloft if they
are piloted at sub-optimal speeds. All the excess capacity in the technology
sector will evaporate unless economic demand rises at a sufficiently rapid
pace. Only economic growth can fill up that excess. And without sufficient
growth, the supply-side breakthroughs of business investment and
productivity will rot away. Gone with it will be any hopes of regaining full
employment in the labor force -- which includes hard-hit Wall Street.
Federal policymakers don't seem to understand this. The Bush
administration has given up on pushing investor tax cuts. Congress, rather
than accelerating the income-tax cuts it passed a year ago, is focused on
the mechanics of the midterm election battle. And rather than curbing
deflation and raising demand by turning the cash spigots wide open, the
Federal Reserve is busy pondering the Iraq factor.
Meanwhile, Wall Street runs a special election every day, and
each stock-market decline is another overwhelming vote by investors who are
fed up with poor economic leadership and a slow-flying economy. There's
really no need to wait until November. The vote tally is in. It's a
landslide message of no confidence.