Good News Bad News
A man is at an economist’s office and the economist says “I have some good news and I have some bad news”.
That classic “doctor joke” opening line is pretty much how I see our current economic plight, but not nearly as funny. It’s more like – A horse walks into his 401K director’s office and the director says “Hey! What’s with the long face?”
As we proceed through another earnings season, so far the flurry of reports already made public give some hope that the worst is already behind us. Even though only a small fraction of companies set to report their quarterly earnings have reported thus far, a vast majority (71%) of those that did, beat Wall Street analyst’s expectations. That’s the good news.
But, now for the rest of the story.
The better than expected bottom lines are a direct result of businesses doing what businesses do during uncertain times, cut costs. Regardless of where the costs were or the benefit associated with the expense, cuts have been made across the board. Newspapers and television reporters are all too eager to expose some Wall Street investment CEO or Detroit automotive big wig that spent $20 grand on special toilet paper for his private potty, but the reality is that 99.99% of businesses have cut back on every conceivable expense from the CEO to mop bucket Joe.
The numbers being reflected are a direct result of this cost cutting. It has nothing to do with government stimulus or improving business conditions. The game has been whoever can cut the most cost out of their business wins. The problem is some of the costs cut will only help to delay or limit true recovery.
Historically it has been all about the bottom line. How much money a company makes defines its ability to not only stay in business but to grow as well. The numbers being reported so far, while encouraging on the bottom line, are still anemic at best on the top line. How much business is the business doing. You can cut until there is nothing left but the CEO and a security guard, but sales and production drive a company. And if the sales are still not there then neither is the recovery.
The problem we face today is that businesses have cut back so much that it may be next to impossible to recover without some form of debt relief. Operations that were designed to run with 250 employees are now running with 30. That not only means a dramatic reduction in output but also an equally dramatic reduction in cost effectiveness. Materials do not flow through a production facility operating with 15 to 20% of its work force. In manufacturing environments the cost per piece to produce a product has gone up due to this decrease in flow dampening profitability. Inventory levels of raw materials, reduced as part of the cost cutting, further hamper productivity thus diminishing profits. In order for these manufacturing facilities to join in the recovery they will need to increase production and inventory levels. But as current sales continue to lag the money necessary to bring back employees and to buy increased inventory simply isn’t available.
Businesses have historically depended on credit to help them increase production. They borrow money to help get things started and pay the loans back after the products are sold and paid for by their customers. But in today’s environment credit is tight at best and non-existent in many cases. While clueless media types are quick to blame banks, the reality is that banks want to lend money. That’s their business. But banks already have their loan portfolios filled with business loans that are in default or are carrying increased risk. In this environment banks are far more likely to hold their money to cover potential losses on loans already granted than to use it to make more loans. The only hope for many of these businesses unable to get new credit lines will be bankruptcy protection.
While bankruptcy has historically been viewed as a negative, in this case it just might be a sign that the recovery is actually upon us. It won’t be easy and it won’t be pretty. This scenario leaves the distinct possibility of a rash of bankruptcies shuddering though various market sectors. As one company files for protection it forces many of its creditors into a position to file as well.
It’s a phase we must pass through, but we will survive.
