While reading a carefully-hedged article arguing (I think) that the performance of the stock market is a useful guide to investors’ assessments of the U.S. economy’s long-term prospects, I was reminded of a Zachary Karabell article from the summer of 2010:
Stocks are no longer mirrors of national economies; they are not — as is so commonly said — magical forecasting mechanisms. They are small slices of ownership in specific companies, and today, those companies have less connection to any one national economy than ever before.
As a result, stocks are not proxies for the U.S. economy, or that of the European Union or China, and markets are deeply unreliable gauges of anything but the underlying strength of the companies they represent and the schizophrenic mind-set of the traders who buy and sell the shares. There has always been a question about just how much of a forecasting mechanism markets are. Hence the saying that stocks have correctly predicted 15 of the past nine recessions. At times, stocks soar as the economy sours (in 1975, for instance) or sour when the economy soars (as with China’s stock market, the Shanghai stock exchange, in the past year).
At other times, stocks have tracked or even anticipated a nation’s economic strength — but that happened in an era when a strong relationship existed between the companies that traded on a particular exchange (American companies on the New York Stock Exchange, British companies in London) and the country in which they traded. For many years, American companies did most of their business in the U.S., so their results could be expected to parallel the larger economy.
But since the turn of the millennium, business and capital have gone truly global. The companies of the S&P 500 now make about half of their sales outside the U.S., and if you remove geography-bound utilities and railroads, regional banks and a fair number of retailers, the percentage is higher. Tech and industrial firms such as 3M, Hewlett-Packard and Intel derive two-thirds or more of their sales beyond the U.S. That means that even if the U.S. economy is a total wash, they can access other markets to maintain their growth. The same might be said of a German conglomerate like Siemens, a Dutch powerhouse like Philips or a Korean company like Samsung.
Though I find Karabell’s argument largely persuasive, it could be that he is overplaying his hand. Perhaps the performance of the U.S. stock market is a better indicator of investors’ assessments of America’s economic strength than he suggests. But for the sake of argument, let’s pursue the idea that the stock market might flourish because investors assume that publicly-traded companies will flourish even as the broader economy performs poorly.
One can imagine a scenario in which incumbent firms benefit from regulations and subsidies that make entry into various sectors very challenging. These entrepreneurial firms might introduce productivity-enhancing business model innovations that would benefit the broader economy, yet high barriers to entry see to it that they do not materialize.
We have a clear example of this phenomenon in Mexico, our neighbor to the south. Ruchir Sharma’s Breakout Nations provides a helpful look at Mexican political economy:
The top-ten business families control almost every industry, from telephones to media, which allows them to extract high prices without much effort and to enjoy unusually high profit margins. That explains why Mexico has had one of the hottest stock markets and one of the most sluggish economies in the emerging world. Over the last ten years the Mexican stock market increased by more than 200 percent in dollar terms, while in the United States the S&P 500 was essentially flat, even though Mexico’s economy did not grow much faster than that of its northern neighbor. This perverse disconnect between the stock market and the economy is unusual in the current global environment. In Mexico it reflects, to a large degree, the power of oligopolies.
While big Mexican companies use their fat profits at home to become major multinationals, Mexico itself has fallen behind. Cornered markets mean the oligopolists have little incentive to invest and innovate: domestic productivity growth has been virtually stagnant since the financial crisis of 1994, when excessive government borrowing led to an 80 percent drop in the value of the peso. The economy has been expanding at an average rate of barely 3 percent for the last decade, and it barely accelerated through the great boom from 2003 to 2007. With a population of 105 million, Mexico was once the richest country in Latin America, but in recent years it has been surpassed by its largest regional rivals. Mexico now has a per capita income of $11,000, lower than both Brazil’s ($12,000) and Chile’s ($13,000).
Mexico’s roaring stock market reflects, at least in part, an oligopolistic structure that has had problematic consequences for Mexican consumers, e.g.:
Phones, services, soft drinks, and many foodstuffs cost more in Mexico than in the United States, where per capita income is five times higher. As U.S. corporations streamline operations and lay off workers in the wake of the Great Recession of 2008, American corporate profits are becoming politically controversial as they consume a growing share of the economic pie, and now represent about 12 percent of GDP. But Mexican corporations are taking an even larger share of the Mexican pie—about 25 percent of GDP.
This is not to say that the U.S. economy has somehow transformed into the Mexican economy. But there are a number of discouraging signs. It is true, for example, that the relative position of the largest financial institutions has strengthened considerably in recent years while not a single de novo bank was chartered in the United States in 2011. A number of large industrial firms have received significant infusions of public sector capital, disadvantaging their domestic and foreign rivals. And though the World Economic Forum’s Global Competitiveness Report is hardly a definitive guide, its survey should give American readers pause:
The business community continues to be critical toward public and private institutions (41st). In particular, its trust in politicians is not strong (54th), perhaps not surprising in light of recent political disputes that threaten to push the country back into recession through automatic spending cuts. Business leaders also remain concerned about the government’s ability to maintain arms-length relationships with the private sector (59th), and consider that the government spends its resources relatively wastefully (76th). A lack of macroeconomic stability continues to be the country’s greatest area of weakness (111th, down from 90th last year).
The most relevant indicator might be concerns regarding “the government’s ability to maintain arms-length relationships with the private sector.” Note that individual firms, and indeed a collection of large firms, might benefit from this development while the broader economy does not.
I should stress that this argument could be overblown. After all, though U.S. firms do sell their wares to customers overseas, they tend to rely heavily on their domestic market. But improving prospects in the domestic market for a given firm could also reflect a predatory dynamic, in which particular firms gain pricing power — recall our discussion of Warren Buffett, Carlos Slim, and the uses of pricing power.