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February 20, 2006

What's Good for Corporate America Isn't Good for Main Street America
by Clif Droke

We've all heard the old saying, "What's good for General Motors is good for America." This is another way of saying that the fate of America's major corporations is inextricably tied to the economic health of the entire country. But is this necessarily so?

We've been hearing a lot lately in the news headlines how the economy is "back on track" and poised for another round of expansion. We've also been bombarded by a plethora of headlines cheering the huge increases in earnings from among America's largest multinational corporations. To show how far the earnings cheerleading has gone, one recent headline actually contained the phrase "earnings joy." The implication from the news media is that healthy corporate profits are a big plus for the economy. That's a "no-brainer,"right? But the problem with "no-brainers" is that they do most of their damage when people aren't using their heads.

Hewlett-Packard was one of the multinationals to make the headlines this week with increased earnings. Several earnings surprises have been announced in recent days, and each one cheered by the Wall Street press as a positive for the U.S. economic outlook. But what does it really mean to Main Street America when U.S. multinationals increase their earnings? My contention is that it actually represents a drain on the domestic economy since most of the dollars earned by the multinational concerns such as Wal-Mart and McDonalds will never see the light of day in America.

No, most of the dollars are transferred elsewhere where they are invested in the capital structures, and employee base, of their overseas operations. Whenever you hear that a U.S.-based multinational has recorded "record profits" you may as well be reading that those newly earned dollars have taken the first ship out to sea and won't be reappearing on these shores for a long time.

Another economic myth is that budget deficits are bearish for the economy while budget surpluses are positive. Last week a headline on the MSN news wire service read: "Government records budget surplus in January." This was the first time a surplus has been run in four years. What this supposedly good piece of news actually could mean is that the economy is on the verge of slowing down or perhaps even entering a recession of unknown magnitude and duration. If memory serves, the last time the government had a surplus was just before we entered the recession of 2000-2002. A statement by George Brockway in his seminal work, "The End of Economic Man" is worth repeating. Brockway wrote that whenever the government runs a budget surplus to watch out, for it usually means an economic slowdown is just around the corner.

Incoming Fed Chairman Bernanke recently stated his opinion that "it would be desirable for Americans to save more" and do their part to shrink the country's record trade deficit. He added that "saving is something that needs to be promoted." From the tone of his rhetoric it already sounds like Bernanke could turn out to be somewhat of a deflationist. His statements regarding the need for increased savings show where he is headed with fiscal policy and will likely end with an economic slowdown. A renewed focus on savings will have negative economic repercussions, at least short-term. This is exactly what I referred to in an article I wrote last year titled "Inflation and inhibition." The "inhibitionary" phase of the inflation-deflation-inflation cycle is being put into place and economic contraction to some degree is likely to result.

A reference to the great American producer Henry Ford would be in order here. It was always Ford's spoken belief that a heavy emphasis on national savings would do more to hard the U.S. economy than help the consumer. His company's advertising theme at one time was "Buy a Ford and *Spend* the Difference." In his autobiography, "My Life and Work," Ford wrote that the captains of finance and industry have an obligation to encourage a healthy consumer economy by doing their part to keep the price level as low as possible (which is something Ford both preached and practiced throughout his career as a producer). He denounced the manipulation of money supply and the key commodities (including oil and metals) as unpatriotic and destructive to the U.S. economy and American way of life. While he spoke of the necessity of savings for Americans, he felt that an undue emphasis on savings would snowball into a closed-minded "hoarder" mentality, which he rightly believed to be a cause of economic contraction.

With all the talk we're hearing today in the news media about savings, including from leading monetary officials, you can see where this is leading us along the expansion/contraction cycle. We're well into the "inhibitionary" phase of this cycle, which usually involves a period of discomfort until the desired adjustments have been made by the financial controllers.

Economists talk frequently of the yield curve and its usefulness in forecasting economic performance. But I've found a simpler and equally reliable tool, namely, the performance of the stock prices of Phelps Dodge (PD) and Freeport Copper & Gold (FCX). The price of FCX usually travels inversely to that of the 3-year annualized growth rate of the MZM money supply measurement. FCX reflects not only sensitivity to economically important metals prices but also inflationary/deflationary pressures (plus, FCX is an excellent leading indicator for the XAU mining index).

Breaks below the 30-week moving averages in PD and FCX for periods of at least four weeks or more are normally followed by bouts of economic weakness, with a lag time of approximately one year. This is especially true when the 30-week MA is downward trending (as it was heading into the 2001 recession). The 30-week MA in PD and FCX isn't downward trending now, so there's no reason to believe that any coming economic weakness will be particularly long-lasting or severe. But a period of economic softness can be expected to become apparent soon especially as we approach closer to the 8-year cycle bottom this fall.

Clif Droke
ClifDroke.com

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving internal momentum and moving average systems, as well as securities lending trends. He is also the author of numerous books, including "How to Read Chart Patterns for Greater Profits." For more information visit www.clifdroke.com.

Copyright © 2003-2008 Clif Droke

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