Anthony Mirhaydari: CEO confidence indicates economic recovery, bull market

Extra7/21/2010 6:00 PM ET

Why are CEOs so cocky these days?

Things may look bleak to many of us, but company chiefs are growing more confident about the recovery. That's good news, because they've been right before.

By Anthony Mirhaydari
MSN Money

Do the CEOs know something we don't?

One year into the economic recovery, a lot of people remain scared and angry. Total unemployment is stuck near 17%. Housing is slipping again. Job growth is anemic. Taxes are set to rise. The stock market has been stalled for 10 months now. Retail sales are down. Consumer and investor confidence has plunged.

But things look brighter from the front office than from the cheap seats. Measures of confidence among chief executive officers have soared and remain high despite the recent debt turmoil in Europe and evidence the economy has hit a rough patch on the road to growth. Why? Cash flows are at record highs, adding to companies' already huge cash reserves. Earnings growth and profitability have been boosted by lower commodity prices and cheaper labor.

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This is just the sort of thing to get under the skin of the average American, who likely holds a low opinion of Wall Street bankers and corporate fat cats in general. But it could be a blessing in disguise: History shows that when CEOs' confidence differs from the public's, the CEOs tend to be right.

And right now, there is a huge disagreement on what the future holds. By one measure, the difference between CEO and consumer confidence has reached a record. Though it may be hard to believe, the conclusion is obvious: We're at the beginning of a long and prosperous economic expansion.

A big dose of confidence

The start of the second-quarter earnings season has deepened the differences in perspective between those sitting around their kitchen tables and those sitting in boardrooms. Profits continue to grow. And earnings calls are filled with optimistic ruminations about the future.

Aluminum giant Alcoa (AA, news, msgs) kicked off the second-quarter earnings season July 12 by reporting better-than-expected earnings and revenue.

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Alcoa
Graphical chart for AA
Intel
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Company executives expect customer demand to continue to improve in all of its end markets this quarter. They boosted their estimate of aluminum-demand growth as factories churn out planes, trains and automobiles at increasing rates.

Alcoa's good news was just the start. A wide swath of the economy is seeing reason for optimism.

In technology, Intel (INTC, news, msgs) beat estimates for profit and revenue as businesses ramped up spending to upgrade outdated computer systems. Executives noted that "PC and server segments are healthy and the demand for leading-edge technology will continue to increase for the foreseeable future."

In finance, the big banks, including JPMorgan Chase (JPM, news, msgs), Citigroup (C, news, msgs) and Bank of America (BAC, news, msgs), are reducing their reserves against loan losses as defaults and delinquencies drop. This is a big vote of confidence in the ability of borrowers to pay.

The list goes on.

Just look at the results from a recent Business Roundtable survey (.pdf file) based on the six-month economic expectations of 106 large-company CEOs. The survey was conducted between mid-May and mid-June, which came as the European debt crisis reached fever pitch and the U.S. economy showed signs of slowing growth.

Nevertheless, business leaders swelled with optimism. The index increased from 88.9 in the first quarter to 94.6 in the second -- the highest reading since mid-2006. The result is just under peak levels reached in the beginning of 2005 and up from a low of -5 reached in early 2009.

According to the results, 79% of respondents expected higher sales over the next six months, compared with 73% in the first quarter. As for hiring, 39% planned to increase payrolls versus. 29% in the first quarter. Though this may not seem like much, the measure stayed near 40% during the entire 2003-07 economic expansion. So this is great news for the job market.

Main Street worries

Yet at the same time, consumer confidence has sunk back to levels seen last summer. In June, The Conference Board's measure fell 9.8 points, or 15.6% -- a drop of a magnitude normally corresponding with an economic shock. Concerns over jobs and income dominate. For comparison, consumer confidence dropped by a smaller amount in the immediate aftermath of the Sept. 11, 2001, terrorist attacks.

Alternate measures of consumers, such as the Consumer Sentiment Index maintained by the University of Michigan and the polls conducted by Rasmussen, tell the same story. And it's a negative one.

Among investors, sentiment measures have fallen to levels not seen since stocks bottomed early last year. The Investors Intelligence Bull Ratio, which compares the number of bullish investment newsletter writers with bearish ones, has fallen to 48%, meaning a slight majority of writers are now on the negative side. Since newsletter publishers tend to be inherently bullish on stocks, this is a very subdued reading. Before the 2008-09 bear market, this metric fell below current levels on only three brief occasions, in 2001 and 2002.

Continued: Why the CEOs are right

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