Recent Earnings Reflect A Troubling Trend
When it comes to the international finance industry, I have conflicting influences and have to be careful to keep an open mind. I made a living in dealing rooms for nearly twenty years, and, to a certain extent still depend on the industry in my role as a writer. That time on the inside, however, also gave me some insight into the moral and ethical questions that arise when a business makes nothing but money. I try, therefore, to be neither a consistent critic of Wall Street, nor a consistent cheerleader for finance.
This morning, as I look at the major companies reporting earnings, the financial industry and its role in the economy trouble me. IBM (IBM), General Electric (GE) and Blackrock (BLK) have all reported since Wednesday’s close. This is admittedly a small, unscientific sample, but the relative performance of these three giants of tech, industry and finance demonstrate a problem for the economy of the U.S. and maybe even the world.
IBM roughly met expectations when they released their numbers after yesterday’s close, but earnings and revenue were down 15% and 4% respectively on a year to year basis. GE, who reported this morning, also saw both revenues and profits decline in comparison to last year. Blackrock’s numbers, released this morning, showed a 9% increase in revenues and a whopping 21% growth in adjusted EPS.
Two major corporations that are both in the business of making things lost ground. The money manager that makes only money continued a run of strong growth. This could, of course, be specific to those individual companies, but it is hard not to extrapolate a pattern. Companies that make things are struggling, while the financial industry is booming.
The growth in investment managers is understandable in many ways. The Fed’s actions over the last few years have given an enormous boost to equity markets, and therefore to companies whose revenue is derived from a percentage of the money they manage. Obviously, if the stock market goes up, then so does the number of dollars managed by Blackrock, and therefore their revenue. Higher markets weren’t the only thing that drove Blackrock’s performance though; they also saw net inflows of $14 billion into their funds. Some of this could be won from competitors due to great performance, but money invested in mutual funds is notoriously sticky, so a large percentage of “new” money is likely.
It is an old cliché of traders in any market that the dumb money coming in is a sign that the top has been reached. I hate to break it to you, but “dumb money” in this context means you and me, the retail investors. Bear in mind that the earnings released by BLK this morning are for the last three months, and the volatility of the last few weeks begins to look less like passing turbulence and more like a sign of trouble to come.
Increased inflows into mutual funds do not, in and of themselves, indicate trouble for the market is imminent. There is some demographic inevitability to it as baby boomers approach retirement. Analysts have been saying for a while that there was still an enormous amount of cash sitting on the sidelines following the recession, and this could be just the beginning of that money’s return to action. When that inflow is combined with a jittery market and weak performance from large, multi-nationals, however, it doesn’t bode well for the next few weeks or months.
In the longer term, this imbalance between making things and making money could have other undesirable consequences. Markets are about the allocation of capital and resources. The more of those that are directed to the profitable but unproductive business of managing money, the less there is for the basic manufacturing that all economies need.
Until now, I have seen the last few weeks of volatility as merely a rebalancing between growth and value and a much needed correction in certain areas where valuations had begun to outstrip reality. If this pattern continues, of retail inflows into the markets just as demand weakens then I will revise that view and become a lot more bearish. I am not talking about selling everything; history shows us that that is usually a foolish thing to do. A reduction in exposure to stocks and a general reduction in risk, however, would be a wise move.