Investing in the 21st Century stock market has not produced sustained equity valuation growth. The stock market has stuttered through three increasingly painful bubbles of high prices followed by collapses into valleys of even lower prices. Investors will not see sustained equity valuation increases in the stock market until our country fully embraces the principals of a sustainable economy. In this article I will outline the four sustainability challenges that investors ignore at their own peril. Tomorrow’s article proposes a new valuation analysis for identifying future stock values based upon a company’s ability to align value with values.
As of January 2010 here are four trends an investor cannot ignore:
Can’t fight the Fed
Economic analysis now points to government activism and massive cost cutting by businesses, rather than consumer driven revenue growth, as the foundation for the current stock valuation recovery from the 2008 financial crisis. The classic example on the power of monetary and fiscal power is the 1970’s defense of the dollar and successful fight against inflation achieved by raising interest rates into double digit ranges by Fed Chairman Paul Volker. The stock market had crashed in response to the 1974 oil embargo and resulting high oil prices (sound familiar?). Government efforts at reviving the economy through monetary and fiscal policy resulted in stagflation producing negligible economic growth and high price inflation. Volker solved inflation by raising interest rates to levels where quality corporate bonds paid 15-20 percent interest. Volker’s efforts contained inflation and this stability set the stage for President Reagan’s tax cuts that sparked the economic growth of the early 1980s. The price paid for Volker’s success were anemic stock and real estate markets. We are now again in a period of Federal Reserve activism. Monetary economics suggests interest rates must rise to mitigate the recent flood of money pumped into economy if we are to avoid double digit inflation. Invest at your own peril if you take your eye off the actions of our current activist Federal Reserve. (Tomorrow’s article proposes a methodology for differentiating between stock valuations benefiting from current government activism and sustainable stock valuations created by companies with a sustainable revenue growth path.)
Debt is The 800 pound gorilla
The United States has hit the wall on assuming more debt to finance a lifestyle dependent upon foreign oil and foreign manufacturing. Today’s consumers are finally saving more and borrowing less. Recent Federal Reserve reports point to consumer mortgage debt levels dropping 2 percent, to $10.8 trillion. Even more telling, consumer credit card debt fell 8.5% to $888 billion. The potential backsliding by consumers into their old debt-based lifestyles is being blocked by the banks through high credit-card interest rates and/or denial of credit. At some point the Federal government will also have to accept the reality that 2009’s $1.8 trillion debt financing is not sustainable as an annual budgeting practice. That point of time potentially arrives at the 2010 mid-year elections if the electorate does not see job creation as a benefit achieved from this deficit spending. Debt is now the 800 pound gorilla that can no longer be fed. This situation can be solved by either reducing debt or earning more. Given the size the problem the solution will entail doing both.
This is an emerging concept in sustainability as evidence grows that demand growth for our world’s resources is exceeding incremental growth in supply. The economic solution for reconciling supply and demand is price. We have already seen record high commodity prices over the last two years. As the world continues its emergence from 2008’s financial collapse, especially by resource hungry countries like China and India, the price for basic commodities will increase. This will place increased stress on the countries, industries and people who depend upon “peak everything” resources. Near-term this can create a downward pressure upon an economy like the U.S. that imports $650 billion of oil annually if oil prices soar again into the triple digits.
Unaffordable health care system
In America, it is our small businesses that create new jobs. Research by the Kauffman Foundation found that “from 1980–2005, nearly all net job creation in the United States occurred in firms less than five years old.” It is growing increasingly difficult for any business, most especially small businesses, to grow jobs that are tied to a health care system out of cost control. The size of health insurance costs upon employment cannot be mitigated by Federal job growth spending programs. Until either government policy and/or entrepreneurship produce a solution, our country faces a very uncertain employment future. And the size of this uncertain employment future is staggeringly large. David Smick, author of The World Is Curved, calculates that to achieve 5 percent unemployment by 2015 our country will need to create 250,000 new net jobs a month. From 1986 the average rate of monthly employment growth has been 90,000 jobs. At the height of monthly employment growth achieved in 2006 our country was adding 230,000 jobs a month. This job-creation mountain and the rewards it holds for future stock market valuation will never be scaled until we develop a sustainably priced health care system.
As an investor the above scenario is sobering. But one historical observation is that Warren Buffet began his investment firm in the down stock market of the 1970s by investing in stocks he felt had a sustainable revenue future. My book The Secret Green Sauce provides examples of companies large and small that today are developing the best practices for growing sustainable revenues. And tomorrow’s article will outline an investment path for finding and investing in such companies that are succeeding in growing revenues by aligning value with values.