Today, economists were way off on the non-farm payroll report, which stated that job growth for May was only 54,000 - versus a predicted 175,000. In addition, the national unemployment rate rose from 9.0% to 9.1%.
As a result of this gross underestimation, equity markets opened down over 1% and bond markets rallied. To add to the disappointment in job growth, House Republicans have publicly declared that "Obamanomics" has not worked, and employers' confidence has depleted due to the uncertainty in the U.S. Government being able to control the budget deficit.
I've always been in the camp to question everything that a politician says. However, I think they may be onto something with the statement about confidence. At the end of the day, CEOs in the United States have a tough job (for those who create real value outside the financial services industry) and I believe they generally have the proper skills, background and incentives in place to lead their firm going forward.
With that being said - assuming I'm correct about my assumption that we have excellent CEOs in non-financial firms - why would CEOs want to risk their firm's liquid assets into projects that have a much greater degree of uncertainty than ever before? Assuming a smart decision maker, who were to invest in a project requiring a 5-year wait for a return on investment, and may anticipate (a) a slowing in consumer spending, (b) an increase in the savings rate, (c) increasingly massive government debt (d) a bloated Fed balance sheet, (e) a potential corporate tax rate hikes and (f) the Board of Directors not rewarding managers & CEOs for taking risk like they did in the past, why would any smart business leader want to hire someone when the risk/reward profile is not in balance?
If incentive structures were properly set up to compensate managers to take on additional risk in search of further growth & innovation, then perhaps more firms would hire.
The major problem can be described using Game Theory 101. Back in business school, I learned simple yet powerful concepts on the theory of decisions and payoffs.
Currently, CEOs collectively have two major choices: (A) they can take risks, increase capital expenditures - hire employees, increase outsourced work, invest in technology, etc. - or (B) they can invest in the bare minimum to appease the shareholders and board of directors.
Now, an important component on the decision is the payoff. For example, say the CEO chooses A and if the project succeeds, the payoff will be X and if the project fails, the payoff will be Y.
In addition, assuming the CEO chooses B and, if competitor's projects succeed, the payoff will be M and if the competitor's project fails, the payoff will be N.
The CEO's current dilemma is to decide whether or not to increase investment of their firm's capital. In today's environment, the difference between Y and N (if the project fails), is not even close enough to warrant the ensuing risk to the CEO's job or career. Even if the difference is relatively great between X and M (if the project succeeds), the dramatic difference to the downside is what causes the CEO's to not take the risk.
The key is to decrease the gap between case Y and N.
To take this one step further: since most, if not all, senior managers are taking the conservative approach, the risk/reward profile will not improve. The increase in investing and hiring needs to get to a Tipping Point before other CEOs feel that they better start to put their firm's assets to work before the shareholders and board of directors lose patience and fire them.
Currently this is not the case and CEOs collectively sit on the sidelines. It's a question of who will be the first brave enough to jump in, and then others feeling they have to follow suit.
If only our government - federal, state, and local - could inspire confidence among businesses of all sizes. Otherwise this "great recession" will only prolong itself even further.
Take care & Avenge!
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