Edgelings

Scared CEOs Hamper Economic Recovery

By Rich Karlgaard

Monday’s sharp pullback in stocks was attributed to weaker-than-really-reported bank earnings. Andrew Sorkin of The New York Times scorches four big banks for their tricky accounting:

Another day, another attempt by a Wall Street bank to pull a bunny out of the hat, showing off an earnings report that it hopes will elicit oohs and aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of America all tried to wow their audiences with what appeared to be–presto!–better-than-expected numbers.

But in each case, investors spotted the attempts at sleight of hand, and didn’t buy it for a second.

Then again, maybe Monday’s pullback was just the inevitable technical correction. So predicted Doug Kass on Monday morning, presciently once more, just before the market’s open. Kass looks like a wizard these days. He was bearish from late 2007 to March 9, 2009, when he pronounced the market had reached a “generational low.” Kass has been spot-on.

A third explanation for Monday’s pullback:  Investors sense that the economy is at a crossroads. A political crossroads.

Here is what I mean. The U.S. economy has turned the corner. Not dramatically, but enough to notice that things are better than they were six weeks ago. Where do we go from here? If the president and Congress and regulators would just leave matters alone–go on a long vacation, say–the economy would show positive growth by the second half of this year. Call me nuts, but I think a second-quarter positive surprise would be possible.

The Fed has done it’s job. (Maybe too well, but that’s another story for another day.) Consumer sentiment and spending has ticked up. The headwinds that remain have less to do with bank stress tests, and more to do with CEO sentiment. The Business Roundtable reports “record low” CEO confidence as of early April:

* 71% of CEOs plan more layoffs in next six months.

* Most see declines in capital spending.

* CEO Economic Outlook Index negative for first time.

Let me say this again. The yield curve predicts growth. Check. Consumer sentiment is ticking up. Check. But CEO confidence is lousy, and CEOs are (not) spending accordingly. Whoops. This begs the question: Why are CEOs in such a low mood?

Answer: If you are a CEO in financial services, manufacturing, energy production and health care, you are going to be more regulated. Period, end of story. Your response to forthcoming regulation of yet-to-be-determined complexity will be to hunker down. Keep your name out of the news, improve the balance sheet and hold tight.

This is why the U.S. economy, which wants to turn the corner, is still stuck in the intersection as it decides which way to go.

In her book The Forgotten Man, Amity Shlaes (now a Forbes columnist) wrote that the 1937-38 “depression within a depression” occurred when “capital went on strike.” President Roosevelt’s willingness to “try anything”–including retroactive taxation, laws against discount pricing and an attempted Supreme Court packing–had businesses and their backers so confused about Roosevelt’s rules that they simply withdrew.

This is the risk of Obama’s willingness to “do what it takes.” The words sound positive and action-oriented. But in practice, “do what it takes” really means “anything can happen.” Tearing up of legal contracts … that can happen. Limits to salary and travel … that can happen. Bullying by the Environmental Protection Agency … that can happen. Nationalization of General Motors and Citigroup … that can happen. Nobody knows for sure. Government is sorting it out, day by day.

The yield curve predicts good news. Consumers are bored with the recession and are ready to come back. But CEOs are nervous about deploying capital, and for good reason.

Thus the U.S. economy is not sharply turning the corner toward recovery, as it should be doing at this point in the cycle. It is turning, but very tentatively. That’s why the recovery will be modest, lumpy and disappointing.