18 November 2014

Stock Valuations Outrunning Profits Growth - And the Band Played On

"We are still amazed by the chart [below], but it summarises the problem for those seeking to short stocks with fundamental weaknesses. In the last three years, the MSCI World Index has risen by 38% (11% per annum) whilst reported profits have risen by just 3% (that’s just 1% per annum!). As the events of last month attest, central bank actions–not profits–are driving equities forward."

Andrew Lapthorne, Societe General

This quote is in reference to the first chart below that shows stock prices are outrunning profit growth.   The second chart is the Shiller PE 10 Ratio for US stocks.

Beside the corrupting influence of Big Money on politics and academics, the other pervasive problem in our society is really quite banal, that is, mindlessly managing to the numbers.

Although incentives have always been an issue, in the last thirty years it has become quite fashionable in modern management theory to set a few relatively narrow metrics and judge the performance and rewards of a manager by them and them alone.

While this is not wrong in and of it self, such a philosophy provides a source of great mischief if the metrics are excessively narrow, and therefore obscure the bigger picture and the health of an organization, a company, or even a nation.

I think we are all familiar with how incentives badly designed can drive counter-productive, short term behavior that can actually be destructive of the values of an organization.  I cannot think of a better recent example, other than the widespread fraud and corruption on Wall Street, than the manner in which the Central Banks and their governments are managing The Recovery™.

If employment is a metric, let us foster an economy in which a large number of jobs are created, that are low paying and part time, in order to address the metric of unemployment.  Never mind that this ignores the real reason for concern, ie, the lack of jobs at living wages which will spur aggregate demand.   If unemployment is the only concern, why not just bring back indentured servitude and give everyone a job at below subsistence wages.  Not far off the Japan model at that.

If inflation is a metric, let us follow policies of money printing in order to raise the prices of goods.  Unfortunately this will have price inflation running ahead of the ability of the broad public to pay for the things that they need through wage and income growth.  

See, there is no deflation.  It doesn't matter to the model that the growth in prices is not only artificial, but is in fact increasing the misery of the people by diluting their already reduced incomes with which to purchase necessities.

Now, this would seem to insult common sense.  But in fact if you are a bureaucrat under pressure to please a powerful constituency, and are driven to pursue policies that really do not make sense by any reasonable estimation of 'the public good,' it is tempting to stand fast on your models, and insist that one cannot prove that you are not doing a good job of it. 
And it is all so easy to claim well intentioned ignorance, or a lack of relevancy to your responsibilities.  There were executives at Enron who were so incapable, who knew and did so little, that it was a marvel that they were not in nursing homes.

When pressed you can always use discredited theories and perception management to quell those who are calling out the contrariness, at times to the point of madness, of your policy actions.  Prove to me it is a bubble!  Prove to me that people are not just lazy, or incapable of doing useful work!  Prove to me that giving trillions to the Banks is not sound monetary policy.
What does it matter, if your bosses are happy, and the perks and prestige, and all important access to the halls of power, are ensured.  At times your conscience may be troubled by the thought that in some of your actions you may have gone too far, and committed acts that could be considered outside of the law.  But you have done it for the good of the system, after all. 

And in that you are above the law, a law maker, not a follower.  A bonus or promotion, or some other visible reward or recognition, may quiet your conscience and concerns.  You are only doing what must be done, as demanded by those who deserve to be followed and obeyed. 
You see the excesses, by the really bad ones, but you are not like them.  Some day when you have the power you will set things right, but you must stay within the system to obtain that power.  So you must steel yourself, and be practical, and do what must be done. 
And that is easier to do, when there is no metric for human misery and suffering.  The unfortunate are easy to ignore.  No one wishes to see them, or hear them.  And they have little power.

You work hard, and are only human after all.  And for this you are a very important person, well regarded in the Capitol.  You are making money for yourself and your friends, the people who really count.  You are a success!  And all is right with your world.
"When virtue is lost, benevolence appears, when benevolence is lost right conduct appears, when right conduct is lost, expediency appears. Expediency is the mere shadow of right and truth; it is the beginning of disorder."

Lao Tzu
No one sits down one day and decides, 'I shall become a monster, and do monstrous things.'
And the band played on.