Time to Sell on Strength? Friday, November 29, 2002
Age can turn a man bearish. For the greater part of the past half-century Wall Street financier Leon Levy has been an optimist. Levy believed that the US economy would, through a succession of business cycles, reignite and spark the higher profits that are the fuel of rising share prices.
Today, at 77, worn but worth a cool US$750 million and still active as an investor, he is more pessimistic about the US economy and stock market than ever before in his adult life.
"The outlook for profits is disappointing," Levy says. "It's very hard to tell how bad the economy will be. Still I feel it will be worse than any time since World War II."
Levy's newfound bearishness is the result of lessons learned as a young man from his economist father, Jerome Levy. Levy senior used basic economic statistics to predict the direction of the stock market.
Levy says he does not pay too much attention to earnings, dividends and the "story" of a stock. Indeed, he urges investors to ignore all recommendations by stock analysts. The underlying reason: big securities firms have an ingrown bias for "overly optimistic forecasts" whatever the true climate for investment.
Now, his economy-centric viewpoint tells him that despite the recent rally, there are big problems ahead for the US economy.
"Look carefully at the economy, and you will see that the main props for growing profits are not going to be here," Levy says.
Take capital expenditures first. From a peak of US$1.34 trillion (annualized rate) in August 2000, corporate spending on new plant and equipment had shriveled by 11.9% to US$1.18 trillion by last May. "It means less money invested in building factories and other commercial enterprises that will pass through to other companies and the consumer and be translated into profits," Levy says. It foreshadows, he adds, weaker profits for companies in the years to come.
Levy also views the US' record current account deficit - US$520 billion on an annualized basis in the second quarter - as an inevitable drag on US companies' profits. The largest chunk of this deficit is in trade in goods and services, at US$110.6 billion for the quarter, up from US$88.9 billion the same quarter a year earlier.
Another piece of the deficit has to do with the fact that the US pays more to foreigners in profits, royalties and interest than we receive from them. In other words, a growing fraction of the returns to capital is going to foreign suppliers of capital and not to the bottom line of U.S. companies. (The last item in the current account has to do with government spending.)
To be sure, trade - and foreign investment in US factories - makes US consumers better off. You benefit when Honda offers terrific cars at low prices, even if you end up in a Chevrolet priced to compete with an Accord. But the presence of Honda is bad news either way for your General Motors dividends.
Third, and here Levy cannot be too emphatic: "Nothing is in short supply. I keep asking that question of everyone. And they have no answers." He rattles off consumer products in excess--"autos, fiber optic cable, computers, cell phones, trucks, airplanes, steel, even food."
"It won't get back to the way it was," he says darkly. "If nothing is in short supply then how can profits rise?" More supply than demand triggers a deflationary spiral of lower prices and profits. He doesn't see a replacement source of higher profits on the horizon to break the spiral.
"Where is the compelling force for growing profits?" he asks. The consumer not only lacks for nothing, but also is paying down debt or building up personal savings. Wealth is shifting from corporate savings (i.e., profits after taxes and dividends) to households, he emphasizes.
”When the savings rate rises, my father observed, corporate profits fall," he writes. Each 1% rise in savings will cut profits by 11%, he predicts. And savings rates in the U.S. must rise, he argues, because Americans have taken on too much debt.
"As Americans' financial situation collides with reality, the savings rate will rise and profits will fall. Those who think we are in a recovery will be disappointed," he concludes.
