Thursday, July 16, 2009

The Stock Surge and the Profits Paradox

Stocks are roaring this week. A 6 percent surge is being fueled by better-than-expected earnings — profits that make capitalism go. Earlier this morning, on the heels of stellar results from Goldman Sachs and Intel, JPMorgan Chase announced record net revenues that easily beat analyst estimates. The bank’s second-quarter profits rose 36 percent from a year earlier.

Profits remain the mother’s milk of stocks, business, and the economy. Even though profits may be a dirty word in Washington these days, this is the golden rule on Wall Street.

Here’s an unconventional capitalist thought: Businesses are slashing jobs, hours worked, production, and inventories — big-time. Unfortunately, this is driving up unemployment and creating skepticism about a real economic recovery. However, at the same time, these cost-cutting measures are contributing to better earnings and profit margins. This, in turn, is driving up stocks.

I call this the profits paradox. Bad economic news can be good profits news, at least for awhile, as businesses take corrective measures. And from this business discipline comes a big surge in productivity, which ultimately drives us into recovery.

This is all part of the self-correcting nature of free-market capitalism.

Second point: I was right one time in a row about this bank-stock rally. Financials have soared this week. So let me repeat: Borrowing at near-zero interest rates and lending much higher is so profitable that even bankers can do it right. The steep, upward-sloping Treasury yield curve, which has gotten even steeper, is the best bailout for banks. They are earning their way out of their toxic problems.