Growth Through Contraction?? That’s Rich.

CAT (Catepillar) epitomises what ‘s been happening in the overall market.  Today CAT had its earnings call.  The message is that earnings improved but revenues were flat.  So how do earnings improve without expanding production? Well you fire 8000 employees, you deliver a dividend and you buy back shares.  So all the improvement is due to financial statement engineering and not from expansion of operations (i.e. real growth).  CAT stock traded to a 52 week high on this news.  The problem is that demand is flat or shrinking and so financial engineering of the financial statements is all they can do to project an image of growth.  But growth of profits through contracting operations and contracting share float is not sustainable and it is not a positive indicator.  The market has this wrong but will eventually get this right.

I want to be clear that I fully understand on a short term microeconomic basis these firms are doing what they see as maximizing shareholder value.  That I agree with.  The problem I see is that if these very large cap firms are cutting capex by more than 50% and instead using that cash in way that does not support future operations then it means they do not have much confidence in the future US economy.  And I also agree with that.  So in the short term (and they’ve been doing this for a few years so short term duration is near) this has been an appropriate take by firms, however, on a medium to long term basis these firms will continue to shrink as their future capacity is reduced.  The reduction in capacity will be necessary because of reduced demand, however, the demand will permanently decline because the overall market is cutting jobs and cutting capex.  So on a micro level, in the short term, they are logically allocating funds.  However, when many companies do that on a micro level it creates an unsustainable macro environment whereby disposable income drops to such a degree that it destroys future demand.

Thank you CAT for giving such a perfect example of the serious and very complex problem that is taking hold in America today.  This all leads back to our conversations on narrowing income distribution and the resulting implications.

The attached chart shows the S&P Earnings vs Revs.  This is not a sustainable trend.