It was only about a month back that I penned a piece for these pages entitled “The Tale Of Two Economies”. That discussion looked at the glaring disparity, especially relative to historical experience, of large company CFO and CEO confidence survey optimism versus what we see at the small business level. In short, the large company CFOs and CEOs were feeling pretty darn good about life. But small company optimism remained at recession lows at best, current levels being below any recession low of the last few decades at least. The question I posed at that time was, just how will this reconcile ahead? Will small companies start to feel a bit better as we move forward, or will large companies be a bit less cheery as we head into the end of the year. As per the latest surveys of the big boys and girls occupying the corner offices in the sky, we may now have our answer. The charts tell the stories, so I’ll make this brief.
Quick tangent before we get to the current pictures of life. The second more recent theme also tied into the "tale of two economies" theme I have been discussing has been the question of whether the macro is about to meet up with the micro. Specifically, due to the fact that year over year productivity has reached and is now falling from historic heights as year over year unit labor costs have reached historic lows, have large companies already picked all of the low hanging fruit of cost cutting (particularly labor costs)? In a world where lack of aggregate demand is THE key issue bearing down on both the domestic and global economies, reported corporate earnings have held up so far due specifically to margin enhancing cost cutting. But if that's over, then the investment decision making spotlight will now fall meaningfully on the character of the top line ahead. Small companies continue to struggle and their optimism levels of the moment are much more consistent with recession than not, but until recently large companies have been pretty darn upbeat. And THE key issue of change we are seeing right now is the "until recently" part.
To the point, the Conference Board CEO confidence survey hit the tape a few weeks back and as you'll see below, we saw a 12 point drop in confidence back to the 50 level. Again, being a diffusion-oriented survey, 50 is the academic demarcation line between thoughts of economic expansion and contraction. As you'll see below, periods of US economic expansion have been characterized by survey response levels remaining for the most part above the 50 level and certainly recessions have seen it drop well below 50. Important point? As with the CFO survey, the Conference Board CEO survey has been an excellent historical leading indicator. You can see clearly in the bottom clip of the chart the high level of directional correlation between the year over year change in GDP and the CEO survey.
At the time I wrote about the "tale of two economies" theme, the question implicitly was, just how will the massive dichotomy between positive large company optimism and deeply negative small company optimism ultimately resolve itself in the current economic cycle? Are we now getting our answer with the large drop in current period confidence we are seeing with the CEOs, while small company optimism up to this point has not recovered? It's starting to look that way, now isn't it? The drop in current period CEO optimism also suggest to us these folks literally on the front lines of corporate business are seeing pressure ahead. Is that the same pressure the small business community has consistently singled out as their number one concern for a year and one half now - the pressure on top line sales, or lack thereof to be more to the point? Again, it's a pressure for the large companies that might have been there all along, but was masked when looking only at the bottom line by unprecedented cost cutting that boosted margins up to this point. With labor related cost cutting largely behind us, it's a good bet the CFO's and CEO's know the focus will now shift to the character of the top line. Does this all tie together? I think so, but of course the reality will be told as we move forward.
Next up? It's our old friend the Duke/Fuqua CFO optimism survey. Or, at least as per the message of the current report, lack of optimism. THE big issue of the moment is the very marked deterioration in the level of CFO optimism for the 3Q 2010 report. In fact, it's the type of thing we see right in front of meaningful domestic economic downturns. Marked are the current optimism level with the dotted black line in the chart below. Only in late '07 and early '08, and then again in late '08 and the first quarter of '09 did we see levels below what we see now. Remember, the CFO's have had a simply great track record of "catching" GDP inflection points over the short history of this survey, as has the CEO survey above. They are telling us the risks of recession have risen markedly. Sounds crazy when the equity markets have gone vertical with Fed POMO’s over the last six weeks or so, right? Hasn’t someone told these folks Fed money printing solves all? Maybe not.
So are we now getting our answer? Is it the large companies that are now coming to see the same set of circumstances as their small company brethren have been seeing all along? I’m certainly not expecting the world to come to an end, but the CEO and CFO surveys have been key leading indicators for quite some time now, so until proven otherwise at least need to be factored into decision making.
Final real world anecdote that may be supportive of the comments above. Yet another divergence that has gone unresolved until recently is the small business outlook for sales relative to the headline ISM new orders component of the manufacturing index. The divergence up until recently has been meaningfully glaring because of the very important directional correlation between these two over time. And current period resolution is? Exactly what you see below. The large company driven ISM new orders outlook is converging with the small company sales expectations outlook.
You get the picture. At least for now, the somber tones of small company outlook have stood in stark divergence to large company outlooks. It has been the tale of two economies. Seems that’s no longer the case, now doesn’t it? And the path of reconciliation could not be more clear.
Briefly, while on the subject of confidence, just a few more anecdotal real world watch points I hope will be important and useful in intermediate term decision making as we head into the end of this year and beginning of next. Let's face it, and as I have discussed at length as of late, what is moving financial asset prices (as well as commodities) right now is investor focus on here and now Fed money printing (the POMO's) as well as the anticipation of a lot more printing to come in terms of QE. Although monetary madness can clearly be a dominant driver of short term asset price outcomes, economic and company specific fundamentals will ultimately support asset prices longer term, or otherwise. And the reason I believe this is very important to keep ever present in our thinking and decision making of the moment is that if the next guaranteed round of QE fails to positively and sustainably influence the real economy (exactly as was the case with QE I) then I can assure you that the next popular thematic buzz words to hit the Street will then become "liquidity trap". Mark my words if you choose, failed QE2 will precipitate liquidity trap as being dominant investment perception. I promise you it will not be the beneficent characterization currently associated with quantitative easing. But that's a story to anticipate for the tomorrows of our lives. For now, it’s all about the weight and movement of money. Or at least what we think of as money.
