Goldman's Deceptive Profit Growth

Say it ain’t so! The Dow Jones Industrial Average has slipped into the red for the day, year, decade and century…all in one day!

The Dow tumbled 213 points yesterday, dropping its performance for the New Year (and new decade) into negative territory. This decline also increased the Dow’s loss for the century-to-date to about -9%. “Stocks for the long haul” may still be a valid investment strategy, but the haul keeps growing longer.

Please don’t misunderstand us; we love stocks. But we love them less when they are richly priced or when underlying economic trends are sickly.

As it happens, stocks are richly priced AND underlying economic trends are sickly. That’s not ideal. Very few companies are reporting profit growth without also reporting expense reductions. In other words, they are “growing” by shrinking. Even Goldman Sachs, America’s greatest state-sponsored enterprise, is relying on expense reductions to boost reported profits.

Goldman did not merely utilize its government-subsidized financing to book record fourth-quarter profits, it also trimmed its bonus-pool payouts.

“In a surprising concession to the public outcry over big Wall Street bonuses,” The New York Times explains, “Goldman broke with the long-time industry practice of earmarking roughly half of its annual revenue for compensation. Indeed, the bank did the unthinkable for the final months of 2009: It subtracted about $500 million from its pay pool, rather than add more money to it, even though the bank earned a healthy $4.95 billion for the quarter, above Wall Street expectations.”

The Times’ report is factually correct, but misleading. Goldman’s record fourth-quarter profit was the direct result of trimming allocations to the bonus pool. If Goldman had added the “normal” amount to the pool, fourth quarter earnings would have been very disappointing.

Furthermore, Goldman’s “concession to the public outcry” still delivered a whopping 57% of net earnings to employees. “Normal,” as Goldman defines it, would have delivered 70% of the company’s net earning’s to employees…leaving only 30% for shareholders.

Wall Street’s very abnormal perception of normal has persisted for a long time. In fact, we highlighted this perverse condition three years ago. In a column entitled “Bonus Envy” we observed, “Karl Marx would be proud…sort of. The laborers of five major Wall Street firms will receive a much greater share of their companies’ 2006 profits than the owners of these five firms. Who could have imagined that the ultimate bastion of capitalism would strike a decisive victory for the laborers of the world?

“But it is true. Thanks to tens of billions of dollars of year-end bonuses, the laborers of five major Wall Street firms will receive twice the remuneration of the ‘capitalists’ who own these firms – i.e. the shareholders. In other words, employee compensation at Goldman Sachs, Merrill Lynch, Bear Stearns, Lehman Bros. and Morgan Stanley totaled $60 billion in 2006 – double the year’s earnings of the five firms. Almost half of this compensation arrives in the form of year-end bonuses…and the largest bonuses arrive in the bank accounts of a few privileged employees. So let’s call this process, ‘Marxism with a twist.’

“As fans of Das Kapital might recall, Marx argued that ‘capitalists’ deserve no ‘surplus value’ from their investments because the capitalists contribute no labor to the production process. Since labor, alone, contributes value to production, Marx asserted, the laborers deserve the profits of the enterprise. Wall Street’s major brokerage firms seem to agree.

“Wall Street’s biggest firms are in the process of doling out more than $24 billion of year-end bonuses to their employees – a figure that would soar above $35 billion if one included stock options and grants, as well as the bonuses of Citigroup, J.P. Morgan and Bank of America. Very few public companies reward their employees so lavishly.

“There may not be anything inherently wrong with Wall Street’s perverse part-time Marxism. But it just doesn’t feel right. These enormous bonuses may be perfectly appropriate and justified and ethical. But it feels quite the opposite.

“Perhaps we should not bother to examine the ethical aspects of unbridled capitalism. We are reminded of the expression: ‘Don’t try to teach ethics to a pig. It wastes your time and annoys the pig.’”

Forgive us the lengthy digression, dear reader…Where were we? Oh yeah, we were observing that pricey stocks and sluggish economies are not a great mix. Therefore, we’d become a much more confident buyer of stocks if the market were weaker for a while, or if the economy was stronger for a while, or both. But that’s not the case. The economy is still wandering around in the wilderness.

Workers aren’t working; homebuyers aren’t buying and consumers aren’t consuming. This condition punctuates a decade-long disappointment, as the chart below illustrates.

The “lost decade” continues to add days to its lifespan. Until the economy starts to find its way again, trade nimbly and invest selectively.