What the "profits to earnings ratio" tells us

The other day President Obama talked of the “profit to earnings ratio” as he was trying to convince people that the time to invest in the stock market might be here.

Quite a switch from his talk a few weeks ago of a “recession that never ends.” It would be a welcome switch but for one small thing. As most know, there is no term in the investment world called “profit to earning ratio.” This “Bush-like” gaff unfortunately is symptomatic of President Obama’s relative economic ignorance. The gaff itself has no lasting significance. However, tragically the ignorance is reflected in the Obama economic plan and will have significant negative impact on us all.

What are some of the elements of the Obama plan? The plan calls for increasing taxes on every man, woman, and child by enacting a carbon tax that will increase the cost of everything we purchase. A general tax increase, last tried during the first Great Depression, will only make the economy drop further and faster. The plan tells wealthy people, i.e., those who have the money to invest, that he will increase their taxes starting in 2011; just about the time when new investments might have a chance to pay off. This means people will be less likely to make job creating investments. If that were not enough, the plan tells people that their capital gains (i.e., money earned on job creating investments) will be taxed at a 33% higher rate. This also means people will be less likely to make job creating investments. These are just some of the plan elements that will work to further damage our economy.

But you don’t just have to take my word for it. We have some objective measurements we can look at. Time after time studies have shown the best indicators of future economic performance are measures of current stock market performance (measures such as the S&P 500, Dow Jones Industrial Average, or the very broadly based Wilshire Index of 5000 stocks). Why are these measures an accurate predictor of future economic activity? Investors want to make money from their investments. They evaluate potential investments based on what they believe they will make over the next few years if they make a given investment. That look-forward element is what makes these valuable indicators of future economic performance.

So what has the investment community told us since Obama was elected? The Dow Jones Industrials Average, has dropped over 3,000 points since Obama was elected. The S&P 500 is now under 700; a level not seen for over a decade. And, the measures continue to drop day-by-day.

The investment community is not a political community. They invest not on the politics of a corporation, but rather on the investment potential of an enterprise. Collectively they are telling us that the programs Obama is putting into place will be bad for our economy. Some in Congress are beginning to understand the risks posed by Obama’s confused and counterproductive plans. Let’s hope sufficient numbers develop that understanding before it is too late.