My notes as I explore various business and financial topics


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Monday, May 10, 2010

The Artifical Economy - When Will it Crash?














In resolving to be more diligent in reviewing my 401K, I'm puzzling over the conflicting financial news.  On one hand, I keep hearing that the economy will grow slowly, take years to recover and  be a jobless recovery.

On the other hand, despite an anemic 3% growth, job loss has tapered off, corporations were reporting record profits and the stock market is at its 2 year high.

The stock market crash last week, just adds to the confusion. I had just concluded that the market would continue to rise until the latter half of 2010 when Wall Street imploded. The Greek debt crisis and a glitch in the computer order of a major trader caused the stock market to plunge over 900 points during the day.

Where are corporate profits coming from?

Where are those profits coming from while we are at a 9.9% unemployment?

Banks - no secret here.  With the government bailout, banks are getting virtually free money.  Its easy to make record profits when you can borrow money from the government for almost 0% interest then lend it out in the form of credit card interest rate of 23%.  Or, the banks can simply purchase government bonds and earn 3% - 4% interest on their free money.

Auto makers - had some of their best sales figures in three years. I attribute this to the cash for clunkers program which artificially drives auto sales, much as the government tax credit for home buyers fueled the huge home sales numbers.

Corporate Profits - this number didn't make any sense at all. With the record profits some companies were reporting, our economy should be humming!  A closer look shows that much of the profits came from two areas: the savings from cost cutting measures, such as reduction in workforce; and an increase in overseas sales.  Here are some examples:

Caterpillar

Earned $233 million, or 36 cents a share, up from a $112 million lost a year earlier. Chairman and CEO Jim Owens attributes the strong numbers in this light.

"The main driver behind our improved outlook is robust growth in Asia/Pacific and Latin America and continued improvement in mining and energy globally," - source Marketwatch.com


Whirlpool

Shares now trade at $112.42, near it 52-week high of $118.44.  Contrast that to a low of $37.24 last year.  The company credits the more than doubling of its first quarter to the $300 million rebate program offered as part of the government stimulus bill. - source Cleveland and Ohio Business News

Also, the company's press release shows that while North American sales (2.3 billion) and European sales (739 million) rose just 7% and 6%, while Latin American sales (1.1 billion) rose by 65%! - source Whirlpool company press release.


Summary

I believe that the best summary for this post is a quote at the second annual Los Angeles Economic Forecast Conference from Christopher Thornberg, a co-founder of Beacon Economics,

Although the economy appears to be on a rebound,  "but unfortunately it is not due to fundamentals, it is due to government intervention."

The question now is how to weather the current economic climate?  And how should I redistribute my 401?

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