When I was growing up, a “double-dip” was a good thing. It was the two enormous scoops of strawberry ice cream I enjoyed (for a dime, by the way) at the local drugstore soda fountain every Wednesday afternoon when my dad cashed his weekly payroll check. Alas, what a difference a few decades make.
In the parlance of modern financial markets, a different kind of “double-dip” is gaining increasing credence, and it is nowhere near as tasty. There is concern that the economy, having gone down and back up, will go down again before it gains significant momentum. This outcome can clearly be avoided and probably will be, but it is nonetheless a source of legitimate discussion. What ultimately happens depends on how we connect the dots. That’s right. The dips depend on the dots. Hang with me.
Generally speaking, the stock market and the economy move together. The correlation is certainly not perfect, but it is pretty tight—and with good reason. Fundamentally, when you strip away all the daily noise, stock prices reflect the present evaluation of the future prospects of firms (appropriately discounted for risk). This relationship may diverge from time to time, but ultimately the dots are always reconnected.
Because of the current crisis in corporate credibility spawned by numerous accounting scandals, things are completely discombobulated. The economic numbers have been fairly strong for several months, yet all of the major market indices and a vast majority of blue chip equity prices have plummeted by double-digit percentages (irrespective of whether they met their earnings targets).
As I have noted in prior editions and will not belabor here, the availability and reliability of information lies at the very core of the market. The point for this week is simply that the dots will indeed be connected again; it never fails. The only question is “how?”
There are essentially two ways to join them together. The preferable one is to create confidence in corporate performance, thus allowing the market to properly value and price growth prospects. If that happens, stocks will do very well. We are the most productive and efficient country on the planet and the opening of new global trading opportunities will only accelerate the potential for success. Progress is being made in that regard. New legislation has been enacted (not the strongest, but a good start); the “prep walks” of professional executives in designer suits and shoes and matching handcuffs make good theatre; and the need to vouch for financial statements by senior management is dragging a lot of skeletons out of the closet and creating an added incentive to get the numbers right (to say the least). At the same time, the market itself is meting out harsh punishment to those who would cheat.
The other way to connect the dots is less pleasant. A continuing credibility crisis and poor stock performance limits access to capital by major firms. The result is a lack of investment and a dampening effect on short and long-term prospects. The loss of wealth in individual portfolios also discourages the purchase of big-ticket consumer items. Such actions can become self-reinforcing and generate a second dip. A few recent statistics suggest that some of this type of response may be surfacing, thus leading to all the talk around Wall Street and more than a few kitchen tables.
Through effective leadership and market discipline, the dots can be connected in the right way. If that happens (and it should), growth will continue. Otherwise, we could be greeted with a second dip which bears no resemblance to strawberry ice cream (even the fat-free variety I’m forced to consume now). But make no mistake about it; the dots will be connected.