The thinnest string: Finances today
The markets in the past week have been volatile, to say the least. We have seen the Dow go from its lowest mark in five years to its largest percentage gain over four days-13 percent-since 1933 according to the Wall Street Journal. The large four-day rally has many people wondering if this is the beginning of a turn around for the markets and the economy as a whole. Although the changes in market trends tend to precede changes in the overall economy, certain economic factors indicate that this past rally is not actually a turnaround in the economy.
If the economy were truly recovering then companies would be expanding. However, in today's market we hear stories about how companies cutting costs. Furthermore analysts would not be praising companies that had good earnings because they were able to cut their costs. Earning reports published by companies beat expectations not because of an unexpected rise in business, but due to the companies' ability to cut costs among waning business. For instance, IBM beat analysts' expectations for the third quarter by maintaining current operations and cutting costs further. The point here is that if the economy were truly recovering then companies would be holding on, so to speak, but succeeding instead.
On Wednesday, to many people's dismay, the rally ended with the Dow dropping 2.7 percent. However, what is even more daunting than the woes in the market is overcapacity that still exists in today's economy. According to the Wall Street Journal 41.7 percent of all United States manufacturers are operating at less than 75 percent if their capacity. What this implies, is that manufacturers do not have the business to operate at full or near full capacity. This has the same implications as before. The economy seems to be hanging on the edge of a cliff.
Another related problem currently plaguing the U.S. economy is that capital investment (money spent on new equipment) was down five percent last year and is expected to be down another five percent this year. The lack of capital investment is obviously the result of overcapacity, which in turn is the result of extreme capital investment during the late 90s. However, the more troubling news is that companies that actually need to expand, despite the woes in the market, are purchasing used equipment instead of investing in new equipment in attempts to cut costs. Other companies, instead of building new plants, are simply revamping their current plants. Although this does solve problems of overcapacity, which is good, it also takes away from capital investment.
The aspect about these economic factors that bothers me is not that the factors imply that markets will not change, but that the economy most likely has not seen the worst yet. If companies are hanging on, then how long can they hold on for before letting go? Many firms are hoping for a turnaround in the market in the final quarter since the fourth quarter is usually filled with better economic times due to the holiday season and other seasonal trends. If the economy does not improve in the fourth quarter then this could be disastrous for many companies who are holding on by a thin string.
Furthermore, the economy tends to slump in January due to its own seasonal trends. In my opinion, it seems like it is a now or never situation for the economy. Either the economy starts to pick up now, or it is going to get a whole lot worse in the next couple of months as the thin string many companies are holding on to breaks.