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No Good Deed Goes Unpunished: How Google Is the Victim of Irrational Pessimism

Somehow, Google (GOOG)'s Q2 2010 earnings report last week was "bad" news because it missed its net income estimate. The company "only" made $1.8 billion in net income, a 24 percent increase from the previous year. The news helped drag down the entire market at one point as investors remain afraid we may enter a double-dip recession.

This seems like madness: How is it that a company adding $1.3 billion in extra ad revenues year to year, another 24 percent increase, is a harbinger of doom? Surely, the opposite is the case: Google -- as a massive player in the ad market and therefore a proxy for corporate marketing spending as a whole -- seems to be telling us that the economy is growing, not shrinking.

Yes, investors price in future growth and then sell if that growth isn't quite as massive as they'd hoped -- which is why Google's stock is down 17 percent over the last three months. But it's much more important to look at the big picture: If Google were any other company in the advertising business there would be a ticker-tape parade down Wall Street for these guys. If those revenue and profit gains, almost 90 percent of which come from advertising, had occurred at WPP (WPPGY) or Omnicom (OMC), we'd be cracking open the champagne -- happy days are here again!

By contrast, WPP's revenues were essentially flat in Q1 2010. Although it's the largest ad agency holding company on Earth, it pulled in only $3.2 billion in overall revenues. This is important because, like Google, WPP is big enough to be regarded as a proxy for the ad business as a whole. And the fate of the ad business tells us something about the likelihood of another impending recession: If businesses are not confident, they tend to pull back their adspend. Conversely, if they see their own sales growing in future, they'll spend more.

Google's results seem to indicate that in aggregate businesses expect to grow. WPP's Q2 results will thus be crucial. If they also show a growth in revenues, then a new recession is unlikely.

The other variable here, which advertisers are watching very closely, is whether President Obama and Congress will do what people want (rein in government spending) or what would actually be good for the economy (continue stimulus spending). Notice that WPP CEO Martin Sorrell is hoping the Tea Party loses this argument:

On the negative side, concerns still remain over when and how the fiscal and monetary stimuli will be withdrawn, particularly in the Western world. Too quickly and the recovery will falter, with unemployment rising. Too slowly, inflation and interest rates rise. Our bet is that the latter is more likely, as we live in political, not economic cycles and politicians are in business to be re-elected. Whichever way, economic growth in the West in particular is likely to be slow and a slog.