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June 28, 2009

Drugged Wallabies, Crop Circles and World Economies (Refreshes)

It's been quite a week for the data that was and the data that was reported, starting with a much more pessimistic World Bank Report leading, allegedly, to a major market drop that was entirely recovered by a slightly more optimistic OECD report that saw a "full" recovery along with some US domestic data, e.g. consumer income, spending and savings. For the record when you actually read what was written and dig into the headlines as usual were almost completely distortionate. We sound like, and are, a broken record on this topic but will keep replaying the old songs as long as no one else is despite a desire to moving on. The chart is a short-term look at only two data indicators - real personal consumption and real retail sales and makes one of our major, critical points: the rate of decline has stopped accelerating but is still about as bad as it's ever been. Abysmal to put a word on it that's both accurate and revealing, and ignored apparently. Rather than spend this whole post on digging thru the other data and re-repeating ourselves we'll point you to this downloadable PDF file of all the recent data on both a short- and long-term basis so you can see that ever series confirms this and how bad they all are in historical context: Recent Economic Data.

The Real World Economic Outlook

In the readings you'll find addresses and excerpts for both the World Bank and OECD reports as well as some news stories. In the Markets section you'll also find discussions on BNN regarding each of the BRICs specifically. This chart encapsulates what the OECD really said and shows maps of the '09 and '10 outlook as well as graphics for the BRICs and the major developed economies. What they really said was "weak recovery in sight but damage will be long-lasting". In fact if you do some more digging around the have an associated part of the report that ALSO says that long-term economic potential has been badly damaged and will result in anemic "growth" for a long-time to come. NOT what appeared in the headlines - adjusting for differences in weighting factors their outlook is identical to the Bank's as well as that of private forecasters (another one of the BNN vidclips). The sad fact is that this not what most are reporting, seeing or acting on. You'll find graphics with more details in the readings BTW.

Structural Changes: Reversing the Virtuous Cycle to a Vicious Cycle

The World Economy has undergone tremendous structural evolution, even abrupt re-structuring, in the last decade with the BRICs as a whole crossing thresholds into entirely new economies. Those changes will remain but they are both one time events that set the stage for new secular evolutions and will proceed at slower rates in the future. If everybody's ignoring the real data the implications of these shifts are even more neglected; that is they are not reflected in investors or business executives planning. A primary driver that's going to shift is that US consumers have been the driving engine of worldwide economic demand and they are shifting from dissavers to savers as they re-build their balance sheets. They are not the only ones that will be de-leveraging and re-building their balance sheets either - the entire worldwide financial system will as well. The devil's bargain that is unraveling in front of your eyes is that the developed economies borrowed from the rapidly developing ones who, in turn, built export based economies based on that demand and exported their "excess" savings as loans to finance the excess consumption of the world's grasshoppers (puns intended). Now that set of feedback loops will be running in reverse which means that Chinese growth, for example, will be lower in the future. By some estimates as much as 2-3% or more. That means that demand for commodities won't grow like it did, impacting countries like Brazil and Australia, nor will demand for the tools and equipment that made it workable, impacting Germany and Japan for another. One of the lessons of the last lost decade is that the markets went nowhere per se but certain anomolies did well for a time, e.g. real estate, emerging markets or commodities. If the point isn't clear the under-pinnings of those anomolies just got knocked out and will stay knocked out for a long time. But, because the "common wisdom" is looking for a return to old patterns we'll likely see a short-run effort to speculate on those patterns. Which explains the recent runups in emerging markets, oil and commodities. We won't repeat an earlier NYT chart on the implosion in world trade but here's the link so you can re-examine it as statistical evidence for how these cycles have reversed: World Trade Implosion.

Structural Changes and Strains

Which is not to say that the structural shifts in the world economy won't be continuing in some form, albeit at a lower level. Bridging back to the last post on the strategic outlook for the Auto Industry we borrow this chart from one of the reports we pointed to in our update on the industry outlook in the Rapidly Emerging Economies (REE). Our friends at Booz & Co also provide this more detailed prognostication: World Auto Demand Outlook.We think those outlooks are reasonable, fact-based and are representative of the huge shifts facing every industry. Shifts it's NOT at all clear they are preparing for or able to adapt to. At the same time we think that the actual levels will be reduced and the numbers will take longer to reach. That's on the assumption that the reductions in worldwide growth and the shift in demand don't strain the socio-political institutions of the BRICs to far. On that topic we'll point you to these discussions (G-20 Persepctives: How Well Do Bears Dance ?, Brave New World: the Emerging Balance, Pluralities, & Non-zero Sums, Existential Crisis Around the Agora II: New World Stories). The fundamental points here are that the development of the BRICs (or REEs) is fragile and dependent on the institutional framework. When Chinese growth drops to 8% they are under strain, if they drop to 5-6% that's more threatening to them than a sustained -6% would be for US.

Trade, Growth and Innovation: Choices About the Future

What's enabled and sustained all this change and growth is world trade. Trade is, on the whole, unambigously beneficial to all participants though certain sectors of the economy and segments of the population suffer serious adjustment impacts and costs. For example in the '90s everybody was  afraid of the Four Tigers after been afraid of Japan during the '80s. They missed the fact that what was going on was the shift of 15thC economies to 20thC ones with labor shifting from agriculture to manufacturing. China is playing out that adjustment on a ginormous scale. As a result they shifts will continue, if they are sustained for a long...long time. When you compare China's coastal areas to their interior you are in effect making a comparison across those years. The coast is a REE and the interior is just the opposite. We are faced with several alternative paths forward which depend on maintaing stability, the continuation of trade and economic growth and renewed innovation on the part of all parties. These chart tries to capture (too many) things but shows how the gains from trade effect wealth at a point in time, how each economy changes and what might happen depending on the paths we end up on. Almost needless to say the red and yellow lines are colored for a reason - on those paths like the possibilities of severe disruption. Even the blue path, a muddling thru, will see severe strains. It's the green path we need for things to all hold together. And that requires large-scale innovation.

Meanwhile the readings excerpts below contain a number of vidclip excerpts from BNN, the only financial news network aside from PBS' Nightly Business Report, worth listening to IOHO. The discussions on the world outlook and the investment climate are extended and worthwhile. The sections on each of the BRICs highlight the differences, though occasionally you need to watch out for someone talking their book, e.g. Russia. Also included in that section are some grahpic summaries of world markets worth looking at. By the way the "drugged wallabies" story is also in that section. It turns out they make the crop circles but also, at least to our mind, characterize how most observers are looking at the economic, investing and geo-political situations. For the record we stand by our own last two posts on the Economy (The Vast, Ignored Difference: Economic Bottoming vs Recovery) and the Markets (Time to Fold 'em (Updates): Market Outlook vs Investment Strategies), as well as our assessment of business performance (Beyond Specifics to Principles: Business Performance Principles & Outlooks). Each component is critical in its own right but what really drives things is the interaction between the three !

UPDATES: Oil, Corporate Bonds and Investor Reality Gasps (GraspNot ?)

In case you haven't been scrolling down onto the readings there was something on the strategic outlook for oil which resonates with our basic theme here of the consensus being a drugged walleby - to wit $250 oil is a pipe dream based on things as they were not as they're going to be. Well the IEA updated it's outlook recently and confirmed that; as well Iraq held its first major oil exploration and development auctions yesterday. You'll find some added readings in the markets section along with some more superb BNN vidclips as well as a couple on the corporate bond markets. The Mike Santolli (Barron's) interview is particularly interesting for what he has to say about the deep changes in investor's view things. Lo and behold it reinforces are theme. Wonder how that happened ? :)

International Economic Situation

World Bank Cuts 2009 Global Growth Forecast The World Bank has cut its 2009 global growth forecast, saying the world economy will shrink by 2.9 percent and warning that a drop in investment in developing countries will increase poverty. Global trade is expected to plunge by 9.7 percent this year, while total gross domestic product for high-income countries contracts by 4.2 percent, the bank said. It said economic growth in developing countries should slow to 1.2 percent -- but excluding relatively strong China and India, developing economies will contract by 1.6 percent. The bank's latest forecast is a sharp reduction from its March prediction of a 1.7 percent global contraction, which it said then would be the worst on record. Economic damage to developing countries "has been much deeper and broader than previous crises," warned the report, issued Sunday in Washington. The global economy should start to grow again in late 2009, but "the expected recovery is projected to be much less vigorous than normal," the report said. It said banks' ability to finance investment and consumer spending would be hampered by the overhang of unpaid loans and devalued assets. Eastern Europe and Central Asia have been hit hardest and the region's gross domestic product is expected to plunge by 4.7 percent this year, the bank said. It said growth should recover next year to 1.6 percent. GDP in Latin America and the Caribbean should shrink by 2.3 percent this year before rebounding to expand by 2 percent in 2010, the report said. In the Middle East and North Africa, growth is expected to fall by half this year to 3.1 percent, while that of sub-Saharan Africa will drop to 1 percent from an annual average of 5.7 percent over the past three years, the bank said. East Asia should post a 5 percent expansion, supported in part by China's stimulus-fueled growth, the bank said.

The Financial Crisis: Charting a Global Recovery New World Bank analysis of the global economy paints an unprecedented picture: global output falling by 2.9 percent and world trade by nearly 10 percent; accompanied by plummeting private capital flows, likely to decline from $707 billion in 2008 to an anticipated $363 billion in 2009. As the world enters what appears to be an era of markedly slower economic growth, the World Bank’s annual Global Development Finance (GDF) report, released today, updates the outlook for the global economy, and explores the broad approach that will be necessary to chart a worldwide recovery. “Extraordinary measures by governments around the world have helped save the global financial system from complete collapse, but the economic recession in the real sectors persists,” said the World Bank’s Justin Lin, Chief Economist and Senior Vice President, Development Economics. “To break the cycle, we need bold policy measures, including restoration of domestic lending and global capital flows.”

Weak recovery in sight but damage from crisis likely to be long-lasting, says OECD The slowdown in OECD economies is reaching the bottom following the deepest decline for more than 60 years, says the OECD’s latest Economic Outlook. But recovery is likely to be weak and fragile, and the economic and social damage caused by the crisis will be long-lasting. The latest edition of the Economic Outlook is the first in two years to see previous projections for economic growth revised upwards – most clearly for the large emerging economies and the United States – rather than downwards. But the prospects for the euro area this year have worsened and Japan’s have changed little since the OECD’s previous projections were published in March. US economic activity this year is expected to fall 2.8%, against the 4.0% decline projected in March. Growth in 2010 is now forecast at 0.9% compared with 0% previously. The trough in US activity is expected during the second half of this year but the Outlook warns that as the impact of the stimulus measures fades, increased savings by corporations and consumers to reduce their indebtedness will continue to hold back growth. The recovery will not be strong enough to stop unemployment rising to around 10% over the next two years.

BEYOND THE CRISIS: MEDIUM-TERM CHALLENGES (pdf) The economic crisis will cast a long shadow. The projections described in Chapters 1 and 2 imply that by the end of 2010, even though a recovery is under way, most OECD countries will still face severe macroeconomic imbalances including large output gaps, high unemployment, very low inflation or even deflation and wide fiscal deficits. This chapter considers how such macroeconomic imbalances might begin to be resolved over the medium term, as well as the main associated risks and uncertainties. Based on existing empirical studies it is likely that potential output will be significantly reduced as a result of the crisis. Estimates described in this chapter imply a downward revision to the level of OECD potential output in the wake of the current crisis of about 2% by the end of 2010. However, for some countries the revisions are much larger. In the medium term, the level of OECD potential output has been revised down by 2¾ percentage points compared to pre-crisis projections, although the long-term potential growth rate is unaffected. Two-thirds of the projected fall in near-term potential growth in the OECD revisions comes from the collapse in investment and the associated slower growth of capital input to production

Krugman Says Global Economy Isn't Showing Any Sign of `V-Shaped' Recovery  Nobel Prize-winning economist Paul Krugman said the world’s economy is showing “not a hint” of a “V-shaped” recovery marked by a swift decline and revival. The economy is “stabilizing, not recovering,” Krugman, an economics professor at Princeton University in New Jersey, said today at a conference in Dublin. “Things are getting worse more slowly.”  Data this month showed that the contraction in Europe’s manufacturing and service industries is easing and confidence in the economic outlook is rising. The U.S. lost fewer jobs in May than forecast, a report today showed. The International Monetary Fund says its forecast for global growth of 1.9 percent next year is based on the premise of a healthy financial system. “We have made the transition from sheer panic to chronic anxiety,” Krugman said, adding he’s has a “hard time” seeing what might drive a “full” economic recovery. U.S. payrolls fell by 345,000 in May, the smallest decrease in eight months, after a revised 504,000 loss in April, the Labor Department said today in Washington. The U.S. policy response to the economic crisis has been “extraordinarily aggressive,” Krugman said. “Unfortunately, it hasn’t been enough.” The country will need “some form of new taxes” to bring down its deficit, he added. Service industries in the U.S. shrank at a slower pace in May while job losses mounted, indicating that any economic recovery will be slow to develop. “The euro zone, like the United States, I fear, could be facing kind of a lost decade,” Krugman said.

  • The 21st Century Economy: A Beginner's Guide Mr. Eppping presents a how-to guide on surviving in today's global marketplace and downturn. The event is held with Steven Greenhouse, author of "The Big Squeeze" and was taped at the Carnegie Council in New York.

German central bank: economy to stagnate in 2010 Germany's economy will shrink by 6.2 percent this year and stagnate in 2010, the country's central bank said Friday, delivering a forecast more pessimistic than the government's. The Bundesbank said in its June monthly report that the new projection is "a reflection of the massive economic downturn" late last year and early this year. Gross domestic product shrank by 2.2 percent in last year's final quarter and by a massive 3.8 percent in this year's first quarter. "Downward pressure on the German economy is likely to ease during the course of 2009, although it does not look like there will be a significant upturn in the near future," the Bundesbank said in a summary of its monthly report. "With the gradual easing of tensions in the international financial markets, improved expectations, and with the support of extensive monetary and fiscal stimuli, the German economy could regain some ground in the third quarter," it added. The government forecast in late April that the country's economy, Europe's biggest, would contract by a post-World War II record of 6 percent this year but would return to growth -- albeit feeble -- of 0.5 percent next year. However, the Bundesbank, the national central bank, said it expects zero growth in 2010. "As things stand, economic activity is expected to remain at a subdued level in 2010, despite picking up slightly in the course of the year," the bank's report said. Germany's economy grew 1.3 percent in 2008, about half as much as the previous year. The country went into recession in last year's third quarter.

Structural Changes and Strategic Challenges

Stephen King: Good luck, not good providence, was at the core of happier times  We stand at a momentous point in macroeconomic policy thinking. A couple of years ago, it was possible to argue that monetary arrangements were good enough to avoid, or at least temper, nasty economic developments. We understood enough, apparently, to avoid the mistakes of the 1970s. We were living through the Great Moderation, the Great Stability or, as Mervyn King, the Governor of the Bank of England, once put it, the NICE (non-inflationary continuous expansion) decade. Two years later, after the onset of the biggest financial meltdown in living memory and the deepest, most synchronised, global downswing since the 1930s, it is no longer obvious that the Great Moderation amounted to much. Policymakers may have avoided a repeat of the 1970s, with its noxious mixture of high inflation and stagnant growth, but it is now difficult to talk with a straight face of Moderation, Stability or NICE-ness. The Great Moderation was a story about the reduced volatility of output and inflation and "no more boom and bust", which Gordon Brown probably wishes he had never uttered. There is no doubt that, for a while, economic developments were favourable. From the mid-1980s in the US and the mid-1990s in the UK, it appeared that economic life had become more stable. The question all along was whether this stemmed from structural changes in economic behaviour, from the impact of new, and improved, policy frameworks, or just good luck. James Stock and Mark Watson of the US National Bureau of Economic Research asked, "Has the business cycle changed and why?" Their conclusions were not as encouraging as those of Messrs Bernanke and King. Having examined all sorts of possible explanations for the Moderation – a shift from a manufacturing to a services-based economy, improved inventory management, a calmer housing market and smaller policy and price "shocks" – they concluded that "better" monetary policy could account for no more than 20 to 30 per cent of the reduction in economic volatility since the mid-1980s. Much more of the reduction was down to good luck. "We are left with the unsettling conclusion that the quiescence of the past 15 years could well be a hiatus before a return to more turbulent economic times."

Competitiveness: The U.S. and Europe Are Tops The global financial crisis seemingly shifted economic power away from hard-hit Western countries such as the U.S. and Britain to cash-rich emerging economies such as India and China. But while the West is limping along today, economic power may shift back when growth resumes. Why? Among the nations of the world, developed countries still enjoy considerable advantages in fundamental economic competitiveness—whether based on the quality of their infrastructure and educational systems or the sophistication of their business laws and bureaucracy. That's the conclusion of the 2009 World Competitiveness Yearbook, an annual report published by IMD business school in Lausanne, Switzerland. Based on a detailed analysis of economic output, government and business efficiency, skills, and infrastructure, the researchers ranked 57 of the world's economies to determine which are best placed to succeed in the 21st century economic race. Topping the list for the 16th consecutive year, unchanged from its No. 1 ranking in the 2008 report, was the U.S.—despite a tough economic situation and rising unemployment. With its world-class higher-education system, enormous and diverse economy, and powerful infrastructure, the U.S. continues to be the world's biggest economic engine and top destination for foreign direct investment. The U.S. shared top billing with plenty of other developed and competitive countries whose economies also are shaky these days. Among the top 20 on the list, only oil-rich Qatar, ranked 14, and China, ranked 20, can be considered emerging economies. What makes countries like Denmark and Japan more competitive than the likes of Slovakia and Brazil? Some of the credit goes to efficient domestic policies, ranging from the level of taxation to the time required to start a business. Though many top-ranked countries have labor market protections, relatively high taxes, and sizable bureaucracies, they are nevertheless more flexible and adaptable to the rapidly evolving global economy than many emerging countries. They also usually benefit from less corruption, more stable public finances, and generally better and more widely available education. Take Sweden. The Scandinavian country jumped from No. 14 in 2005 to No. 6 in this year's rankings. What gives this small state, with a population of just 9.2 million, an edge over India and its population of 1.1 billion? According to IMD's Garelli, Sweden's widespread social programs, combined with a strong education system and vibrant entrepreneurial scene, mean Sweden ranks among the top 10 countries in the world on more than half of IMD's competitiveness categories. In contrast, India, which is ranked No. 30 this year, scores high marks only for the size of its domestic economy and its low labor costs.

Surging American Savings Rate Reduces Dependence on China as Growth Slows  In the recession following a borrowing binge that sent consumer debt to the highest level ever, Americans are shutting their wallets and building their nest eggs at the fastest pace in 15 years. While the trend will put the country’s finances in better balance and reduce its dependence on Chinese investment, it may also restrain economic growth in 2010 and beyond, said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and a former Federal Reserve governor. “There’s been a fundamental change in people’s behavior,” he said. “It will affect the economy for years.”  Government data today showed that the household savings rate rose to 6.9 percent in May, the highest since December 1993, as personal spending increased less than incomes. The rate in April 2008 was zero. Most of the rise in income in May was due to one-time government stimulus payments to seniors, said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. Nouriel Roubini, an economics professor at New York University and chairman of RGE Monitor, forecasts that the savings rate will ultimately reach 10 percent to 11 percent. What’s critical, he said in a Bloomberg Television interview on June 24, is how quickly it increases. A rapid rise in the next year because of a collapse in consumption would push the economy, already in its deepest contraction in 50 years, further into recession, he said. If it occurs over a few years, the economy may grow. The bigger cash reserves will lessen U.S. dependence on investment by China and other foreign countries to finance economic growth, Gramley said. The current-account deficit, which includes trade in goods, services and income transfers, narrowed in the first quarter to its lowest since 2001 as Americans saved more and brought fewer imports. Edmund Phelps, winner of the Nobel Prize in economics in 2006 and a professor at Columbia University in New York, said it may take as long as 15 years for households to rebuild what they lost in the recession. “The only way we’re going to get a healthy, full recovery is over a long period of time, involving households rebuilding their balance sheets,” Phelps said in an interview on June 22 with Bloomberg TV. “There’s no silver bullet that’s going to get us into good shape quickly.”

China’s savings problem and the consumption constraint For the past decade until the onset of the 2007-08 crisis, the US has been growing quite rapidly. Powering this growth has been an even more rapid surge in consumption. When US consumption grows faster than GDP, two things must happen. 1. The US savings rate by definition declines 2. If the country is running a trade deficit, and consumption is growing faster than production (assuming that investment isn’t falling, or is at least not falling by more than the difference), then the country must run a growing trade deficit. If US consumption growth exceeds US growth in production (I am ignoring changes in investment because they are a relatively small part of this), then in China production must exceed consumption. This is just another way of saying that as the US savings rate declines and powers a surge in the trade deficit, the Chinese savings rate must rise and power an increase in the trade surplus. In fact this is what happened. What does this mean for China? Obviously the US trade deficit is contracting quickly. This means that China’s trade surplus must also be contracting quickly.  In fact China’s trade surplus has been growing, and this is where my simplification (the world consists of the US and China) runs into a problem. Although all trade surpluses are contracting, the fact that China’s trade surplus is rising indicates that other surplus countries are bearing more than 100% of their share of the global contraction. I don’t think this is sustainable and ultimately, perhaps even already, China’s trade surplus will decline. By the way the fact that China has been able to force at least part of its own adjustment onto trade competitors will likely lead to increasing anger with China, as it already seems to be doing especially on the part of Asian competitors, and will power a further rise in international trade tensions. So what does that mean for future Chinese growth? When China was growing at 11-13% a year, Chinese consumption was growing by 9% a year. The rapid reversal in the earlier decline in US savings might cause Chinese GDP growth to grow by at least 1-2% below consumption.  So if we assume that Chinese consumption continues growing at 9%, this initially suggests GDP growth rates of 7-8%. But hold on. If GDP growth rates of 11-13% translate into 9% consumption growth rates, is it reasonable to assume that GDP growth rates of 7-8% will still result in 9% growth rates in consumption? I doubt it. My guess is that the growth in Chinese consumption will also slow.  This suggests that while the US is adjusting, China’s annual growth rate must be significantly below 7-8%, perhaps 5-6%, or even lower. The key is the rate of Chinese and US fiscal expansion, in the former case to permit the rise in Chinese savings rates not to constrain domestic growth, and in the latter case to slow down the contraction of the US trade deficit.

So Much for the Cheap 'China Price' A growing number of companies are moving beyond the usual considerations of labor and raw material costs in deciding where to produce goods to calculate the "total cost of ownership." That means tallying expenses associated with things such as storage and delays. By this light, the so-called China price, which always seemed to be at least 40% below U.S. costs on everything from bedroom furniture to telecom gear, isn't so low. In fact, China's once-formidable edge in manufacturing has all but disappeared in some industries, according to a new study by Southfield (Mich.) firm AlixPartners, which researches and consults on outsourcing. AlixPartners studied five categories of machined products, ranging from large engine parts requiring significant labor to small plastic components that need little. The cost shift has been dramatic. In 2005, AlixPartners found that by the time the items had arrived at a U.S. port, Chinese-made parts were 22% cheaper on average than those produced in the U.S. By the end of 2008, however, the average price gap had dropped to 5.5%, which often isn't large enough to merit the hassle of manufacturing halfway around the world. Even more surprising is the cost comparison with Mexico. While the total cost of making goods in China was about 5% cheaper than in Mexico three years ago, manufacturing in China now is about 20% more expensive. Compared with the U.S., the savings in Mexico have widened to 25%, from 16%. "A couple of years ago outsourcing to China was a no-brainer," says Stephen T. Maurer, AlixPartners' managing director. No longer, he says. The biggest factors behind the sharp shift are currency fluctuations and labor costs. The yuan has appreciated by around 11% against the dollar since late 2005, and wages have risen 7% to 8% a year. To rein in polluting industries, furthermore, Beijing has stripped away tax breaks for exporters of some heavy industrial products.

Asia Challenges the U.S. for Green Tech Supremacy America was caught off guard in the 1950s when the Soviet Union suddenly launched its first Sputnik satellite. It looks like history may repeat itself, but this time the arena is more down to earth. In August, the leaders of Japan, China and Korea will hold a trilateral summit to discuss how they can pool their resources and expertise to develop and commercialize emerging green technologies. Who knows what world-beating products and processes will result from a successful collaboration? As it is, Japan has already sped ahead of the U.S. in hybrid car technology. China is emerging as a leader in electric cars, solar power and wind power. Korea is not yet known for anything environmentally friendly, but that is about to change. The Korean government is spending $31 billion to fund research into 27 green technologies, including non-silicon based solar cells, biomass fuels, and carbon collection, storage and processing. This unusual international collaboration is not solely aimed at reducing carbon emissions and husbanding the planet's resources, although hammering out a united front among Asia's top industrialized nations for the Copenhagen Climate Conference in December is one of the professed goals. It's really a hard-headed, shrewd initiative to marry Japanese and Korean high technology with China's manufacturing prowess, massive domestic market and bulging foreign currency reserves — thus creating a formidable player in a post-crisis, low-carbon world. What is becoming clear is that the fossil-fuel-fed industrial era is ending, and that the leading power of that age, the U.S., might not be able to maintain its economic dominance. New Energy Finance, a provider of information and analysis on low-carbon technologies, estimates that investment in clean energy in Europe last year reached nearly $50 billion. The figure for North America is a much lower $30 billion.

Red square blues NOT long ago, Russia proudly counted itself as one of the BRICs—with Brazil, India and China, the four emerging-market giants that were outgrowing the rich world. Yet it now makes more sense to talk of the BICs. With GDP shrinking by almost 10% in the year to the first quarter, Russia is in deep recession. This is upsetting and worrying for the country’s political masters in the Kremlin. Upsetting because, as late as last autumn, they dismissed the economic crisis as a Western problem that would leave Russia unscathed. But the collapse in the oil markets has shown just how much Russia still depends on getting a good price for its natural resources. Neither President Vladimir Putin in 2000-08 nor (since last May) President Dmitry Medvedev has done anything like enough to diversify the economy—indeed, it depends more on oil and gas now than it did. The government has utterly failed to create a legal and political infrastructure to support business and enterprise. The Kremlin may not care much about either of these shortcomings, especially now that oil once again costs $70 a barrel. Yet even at this price it must worry, for it can no longer honour its side of Mr Putin’s original bargain: that, in return for a guaranteed rise in living standards, ordinary Russians would accept curbs on the media, rigged elections and a slide into autocracy. The Russians are now lumbered with the second part of this deal without gaining the benefits of the first. Not since Mr Putin came to power have high inflation and shrinking GDP caused such a fall in real incomes (see article). Why has this not led to more protests? Partly because the Kremlin is firmly in charge and partly because many Russians built up savings in the boom years and have yet to feel the full impact of recession. Besides, faith in the “good tsar” and low expectations of government mean that few blame Mr Putin, now Mr Medvedev’s prime minister.

Oil at $250 Is Pipe Dream Without Chinese Boom: William Pesek  Green shoots could be great news for black gold. That is how some traders are reading signs that global growth is returning. They are bidding up the prices of oil and other key commodities, and there are two primary reasons: U.S. stimulus efforts and China. Optimists may be wrong on both accounts, particularly the latter. Expectations of a quick U.S. rebound cooled in the last 10 days. U.S. stocks slumped this week after Standard & Poor’s downgraded the credit ratings of 18 banks. Optimism is still coursing down Wall Street, though, that the worst is over. The more obvious area of misplaced cheer is Asia’s second- biggest economy. China bulls argue government largess will not only boost Chinese growth, but global demand, too. In this scenario, recent gains in commodity prices will be sustained over the next few years. Things may be more complex than that. “The reality is not so rosy,” says Jamie Dannhauser, an economist at Lombard Street Research in London. “Exports show no sign of life and the increase in domestic spending reflects a massive state-led program of raw material stockpiling -- hardly the foundations for sustained gains in domestic final demand in an export-dependent economy.” China’s ability to drive global growth is more limited than many investors realize. In a June 16 report, Albert Edwards, a London-based strategist at Societe Generale SA, argued that a “bubble of belief” in China’s outlook is likely to burst and end rallies in commodity prices and mining-company shocks. Without a snapback, especially in the U.S., China will be hard-pressed to grow at 6 percent or faster on a consistent basis. If it can, is that expansion rate in a $3.2 trillion economy enough to fill the global void? It’s simply not. And a U.S. recovery may be farther away than economists say. Policy makers won’t be spending much time in the short run retooling China’s lopsided economy. Without national safety nets for the unemployed, the household savings rate will remain absurdly high. The impediments to developing a stronger domestic economy are structural and formidable. China’s 4 trillion yuan ($585 billion) stimulus plan certainly helps, yet it’s not a long-term growth strategy. If global growth doesn’t return soon, today’s public spending may morph into tomorrow’s bad loans. A deflationary cycle may even hit China. It’s possible all that liquidity sloshing around the world will boost commodity prices. Those betting a Chinese boom will get us to $250 oil should get used to disappointment.

Unboxed: Can Governments Till the Fields of Innovation? INNOVATION — the tricky, many-step process by which ideas become products and services — has typically been seen, studied and celebrated at the micro level, as a pursuit for entrepreneurs and clever companies. But governments are increasingly wading into the innovation game, declaring innovation agendas and appointing senior innovation officials. The impetus comes from two fronts: daunting challenges in fields like energy, the environment and health care that require collaboration between the public and private sectors; and shortcomings of traditional economic development and industrial policies. Innovation policy, to be sure, is an emerging discipline. It lacks crisp definitions or metrics. The most explicit embrace of it has been outside the United States, though the Obama administration is taking some initial steps. The rising worldwide interest in innovation policy represents the search to answer an important question: What is the appropriate government role in creating industries and jobs in today’s high-technology, global economy? That central issue animated much of the discussion at an unusual gathering earlier this month at a lodge north of San Francisco. This invitation-only affair was organized and moderated by John Kao, a former professor at Harvard Business School and founder of the Large Scale Innovation. A few speakers covered big-think issues like climate-altering geoengineering and water-management technologies. But the main participants were innovation-policy practitioners from nine countries: Australia, Brazil, Britain, Chile, Colombia, Finland, India, Norway and Singapore. The meeting offered a window onto the state of innovation policy — how it is being defined, and what countries are doing. Above all, innovation policy is an attempt to bring some coordination to often disparate government initiatives in scientific research, education, business incentives, immigration and even intellectual property. In India, the government and industry have financed research into products and services that reverse the traditional pattern of innovation flowing gradually from wealthy nations to the rest of the world, said R. A. Mashelkar, chairman of the country’s National Innovation Foundation. Early evidence of the trend, he said, includes the $2,000 Nano automobile, and low-cost drugs for tuberculosis and psoriasis.

Market Situation

Stoned wallabies make crop circles The mystery of crop circles in poppy fields in Australia's southern island state of Tasmania has been solved -- stoned wallabies are eating the poppy heads and hopping around in circles. "We have a problem with wallabies entering poppy fields, getting as high as a kite and going around in circles," the state's top lawmaker Lara Giddings told local media on Thursday. "Then they crash. We see crop circles in the poppy industry from wallabies that are high," she said. Many people believe crop circles that mysteriously appear in fields around the world are created by aliens. Poppy producer Tasmanian Alkaloids said livestock which ate the poppies were known to "act weird" -- including deer and sheep in the state's highlands. "There have been many stories about sheep that have eaten some of the poppies after harvesting and they all walk around in circles," said field operations manager Rick Rockliff. Australia produces about 50 percent of the world's raw material for morphine and related opiates.

World Bank Report is Old News [06-23-09] BNN talks to Richard Kelly, international economist, TD Economics.

  • Strategy Session [06-24-09] Protecting your gains in this market can be difficult. BNN discuss strategies to take advantage of the current market conditions with Danielle Park, portfolio manager and president, Venable Park Investment Counsel.
  • Look Beyond the U.S. [06-26-09] The U.S. is undergoing a sea-change and U.S. equities will bump along the bottom for some time. Investors are better off looking to emerging markets for a decent return. BNN talks to T.J. Marta, chief market strategist, Marta on the Markets.
  • China's Recovery [06-22-09] China has just had its GDP forecast increased by the World Bank, the stock market is up 60% and the market is getting ready for the first IPO in nine months. BNN discusses China's recovery with Erik Nilsson, senior international economist, Scotiabank.

Brazil [06-22-09] Some unique features of Brazil's economy will leave it well-positioned when the world's economy turns around. Oscar Sanchez, senior Latin American economist, Scotiabank, explains.

  • Investing In Latin America [06-26-09] Amid talk Mexico could lose its investment grade rating, DBRS issues its latest report on the country. VP Fergus McCormick, who recently raised Colombia to investment grade, talks about his ratings for the region.

Russian Economy [06-23-09] Deleveraging is hitting Russia with a vengeance and the Russian government will burn through most of the cash it built up through the commodities bull run to support the economy. A look at the state of the economy with Paul Biszko, senior emerging markets strategist, RBC Capital Markets.

Indian Economy [06-24-09] A look at the Indian economy and strength of the consumer with Deepak Bhattasali, lead economist, South Asia, The World Bank.

  • Indian Equities [06-24-09] Indian equities continue to be among the best performers of the BRIC nations. Levi Folk, emerging market economist, Excel Funds, provides insight on where to find those growth opportunities.

Chinese Economy [06-25-09] The government is a huge player in the Chinese economy and the main reason growth, albeit at a slower pace, continues. Nick Consonery, associate, Eurasia Group, explains.

BRIC and EM ETFs [06-26-09] A look at the composition and performance of popular emerging market ETFs with Bradley Kay, ETF analyst, Morningstar.

UPDATES:

Corporate Bond Market

Oil and Commodities

Iraq Begins Major Oil and Gas Auction After a year in preparation, a much-heralded auction of licenses to develop Iraq’s huge oil reserves began Tuesday but seemed to run into difficulties when oil and gas companies demanded far more remuneration than the authorities were ready to pay. Symbolically, the sale, broadcast on television, coincided with the formal handover by American forces of security arrangements in urban areas to Iraqi forces — an economic counterpoint to the striving for political military independence underpinning the Iraqi takeover of patrolling Iraq’s restive cities. At the auction, each contender offered a sealed bid containing details of how much oil the developing company would produce and how much it expected to be paid for each barrel of oil produced.The auction has been billed as one of huge economic importance to Iraq, whose oil fields have been closed to foreigners for decades since they were nationalized. Iraq is seeking to increase its oil production after six years of war.

As Iraq Stabilizes, China Bids on Its Oil Fields

Posted by dblwyo at 08:27 AM | | Comments (0)

June 22, 2009

Detroitosaurus: Iconic Death vs. World Industry Futures (Updates)

Three weeks ago today GM filed for bankruptcy, taking an iconic company into a new chapter of its history along with its industry. GM wasn't just A company, or the world's largest manufacturer at one time. It was THE corporation. Following the filing everybody, and we mean everybody, published long and extended commentaries including the Economist, Business Week, the NYT and the WSJ. And they all said, despite being well-written, well-research and worth reading, the same thing: we saw it coming. The questions then become what lessons are to be learned ? The gist of all these commentaries was that we saw the natural, evolutionary consequences of decline and denial stretch out over decades. In some ways one of the best was the Charlie Rose interview, , where Paul Ingrassia (ex-WSJ Detroit Bureau Chief) along with Ed Altman (dean of bankruptcy) and John Stoll (of the WSJ) basically said, paraphrased, "it's a darn shame that the government had to do for Detroit what it couldn't do for itself". And further commented that the Auto Task Force did an exemplary job that was thorough, complete and rigorous and further highlighting the great irony that a Democratic Administration did what a good Private Equity firm is supposed to do.

More Great Ironies: Where Were the Naysayers When It Mattered?

We found most of the analysis to be spot on but were greatly amused at the "we saw it coming" argument that was part of all of them. Now there's been a great deal of critiscism of the of the industry for some time in the business press, to be fair. But nowhere do we recall the rather damming indictments about executive failure and the triumph of ostrich-thinking that we read. In some contrast we're on the public record for almost two years here and almost six years in writing that the Industry was on death watch. In fact we'd argue that the hand-writing has been glowing on the wall for over three decades even though Ingrassia himself wrote a book on Detroit's recovery and revival in the mid-'90s (Comeback: The Fall & Rise of the American Automobile Industry). The graphic will take you to a downloadable PDF file of all our prior blog posts plus selected readings and provide a great deal of background that we think is worth your time. In it we address market analysis and business strategy, the marketspace, product design and development, manufacturing and the industry management system as well as providing some integrated assessments of the overall status of the industry and individual players. Partly as back up but mostly to put all the machinery all in one place.

A Blueprint for Failure

Ten years ago was the height of the Tech/Telecom Bubble yet earlier this month Nortel also filed for BK. There are some real lessons beyond one company in GM's demise and the Telecom industry reinforces them. What we're seeing and saw was a failure across the board, partly thru a failure of executive leadership. If you were to take the major components of the accompanying graphic and rank the Detroiters from 1-10 for each one we think a 3 would be generous, at best. You could make a good case for much lower rankings. That's what makes GM's failure sad, poignant and a lesson. We've several friends who worked for GM and they thought this day would never come. They further objected to the idea that government had to do this - it was the companies and industry's responsibility. But they couldn't...and not because they weren't a lot of smart folks who didn't see this all coming for years. To quote Peter Drucker, who made his bones by channeling Alfred P. Sloan, in his magnum opus (Management: Tasks, Responsiblities and Practices) in his section on Managerial Organization, specifically in the chapter on "New Needs and New Approaches":

" Finally, GM has been a "managerial" rather than an "entrepreneurial" business. The strength of Sloan's approach lay in its ability to manage, and manage superbly, what was already there and known. GM has not been innovative - altogether the automotive industry has not been innovative since the days before WW1".

That was written in 1973, when the Japanese were first putting the glowing handwriting on the wall, next to the sales and marketshare reports showing the accelerating decline of the industry. The industry failed because of organizational sclerosis, or organosclerosis. It put satisfying internal political agenda ahead of the need to keep creating value and made its decisions in detachment from the marketplace. The Telecom Industry has been facing one perfect storm after another since 1999 and as a result Nortel, Lucent, Alcatel, et.al. are all in trouble and have been for decades; and for the same reasons. A failure to adapt because of the dominance of internally focused decision-making. THAT is the real lesson that should be drawn.

The Next Tsunami

And it's not over yet. In fact in some ways it may be just beginning. In the readings section you'll find some selected excerpts on GM's bankruptcy that's worth digging into in our opinion. And in the PDF file you'll find even more extensive readings excerpts that speak to each of the major components as well. The questions post-BK now become what's next ? Where are they going, how are they going to get there and who's going to lead the charges ? But a three-decade plus decline and denial thru a failure to adapt was against an old world. Also in the readings section you'll find other excerpts pointing to the next Tsunami that's beginning to build up, and has been building for years as well. That Tsuanami is a massive worldwide re-structuring of an industry that is vastly over-capacity and one facing rapidly accelerating capabilities in new, foreign competitors. Some years back we were walking thru the parking spaces after a concert and saw a Mercedes lined up, strangely in serial order, a Lexus, Honda and Hyundai. There was little or no difference in fit or finish, none discernible in functions and little in features. What happens when a foreign auto maker can deliver a quality car with all the bells and whistles for 1/2 the price ?

Lessons in Resilience and Adaptation

The lessons of GM, Detroit and the Telecoms are that you can't just focus on today's challenges or keep on doing what you've been doing. You've got to balance that with an eye toward the future. That is, each players in each line of business has to have an answer for the "Theory of the Case". In other words what are you going to do about strategy, business model, marketing and sales, manufacturing, infrastructure, logistics and product design and development now, in five months, in five years or in ten. Sadly, it's not clear that any of the domestic manufacturers has answers for any of those challenges.

More sadly it's not clear that many other industries or companies do either ! Therewith ended the sad and dangerous lesson for this post.

UPDATES:

 The world is full of surprises, synchronicities and serendipities. On the same day we put up this post Bloomberg covered a deep-seated re-thinking Toyota, Booz had a very thoughtful piece about long-term structural changes and we discovered another wonderful BCG piece on business response asking what happens after you apply the meat-axe to emergency cost costs; in other words it ain't working, now what do you do. Taken all together these three pieces, each deserving it's own discussion and dissection in separate posts, form a whole that reinforce the fundamental messages about enterprise resilience and leadership we're trying to communicate.

  1. Toyoda Asks How Many Times Toyota Errs Emulating GM Failures
  2. The Best Years of the Auto Industry Are Still to Come
  3. Collateral Damage: Function Focus—Leaders Have Made the Quick Cuts—Now What?  
If you have any interest or concern about enterprise performance we suggest they are must-reads, individually but especially collectively.

The Death of GM

A Saga of Decline and Denial Once, General Motors was Microsoft and Apple and Toyota all rolled into one. GM set the standard of how a company should be run, how utilitarian products could be made cool and how they should be sold. It helped win a world war, drive American prosperity and reinvigorate business-school curricula. "Nobody else could cover the whole range of the marketplace like GM, not Ford, not Chrysler," said Gerald Meyers, a former chief executive of American Motors Corp. and now a professor of business management at the University of Michigan. In the end, though, GM was a victim of its own success -- its path to bankruptcy paved with the very management, marketing and labor practices that made it the world's largest and most profitable company for much of the 20th century. Strategies that had once been deemed innovative "became a millstone on the whole company," said Mr. Meyers. At the beginning of 2005, GM's business began unraveling. Years of heavy sales incentives had gutted its profit margins, and the company warned a significant loss was likely that year. By March, there were signs that some people inside GM might be having doubts about the brand strategy. At a conference of financial analysts in New York, Mr. Lutz described Buick and Pontiac as "damaged brands" that had suffered as a result of too little investment in new models. GM ended up reporting a loss of $8.65 billion for 2005. In 2006, Mr. Wagoner faced off in a boardroom battle with billionaire Kirk Kerkorian and his adviser, Jerome B. York, who had publicly called on GM to eliminate some brands and for a time had a seat on GM's board. Mr. Wagoner eventually prevailed, and by the end of 2006 Mr. Kerkorian sold his stake and Mr. York left the board. GM's smaller brands, meanwhile, weren't gaining enough critical mass to generate returns. Between 2003 and 2007, Saturn, Saab and Hummer together averaged annual pretax losses of $1.1 billion a year.

How GM Wasted 'a Good Crisis' A great American institution has died. Mark June 1, 2009 as the tragic end of General Motors as a viable entity. Like a grade B movie wending toward its inevitable conclusion, 30 years of management insularity and incompetence at General Motors led to Monday's bankruptcy filing. GM will emerge from bankruptcy in some form, but it will never again be the king of the road that once produced one out of every two automobiles on American highways. Italian philosopher Niccolo Machiavelli once advised his followers, "Never waste the opportunities offered by a good crisis." For three decades General Motors management refused to face the reality that its autos were not competitive with foreign vehicles. This led to steady loss of market share, triggering a series of crises. The latter were always treated as short-term events to get through, rather than as opportunities to transform the company. Rather than acknowledge its mistakes, management preferred to blame external factors and hope that halfway measures, passage of time, or government protection could solve its problems. Avoiding reality never works. At the outset of a crisis, leaders have many options they can deploy to address their problems. Like the early spotting of a cancer tumor in one's body, early action to surgically remove the problem can enable the body to get healthy once again. Over time, the options narrow or wither away. Then management is forced to ask someone else to save it. In GM's case, management has frequently turned to the U.S. government when it needed help. On several occasions when GM faced difficulties, its executives boarded their company planes to lobby the U.S. government to help the company out. Past efforts included imposing import quotas on foreign-made vehicles, fighting against safety improvements such as seat belts and air bags, delaying federally mandated increases in fuel efficiency, or lobbying the government to take over its health care benefits. GM had powerful allies in these campaigns, including the United Auto Workers and Michigan politicians. The lessons from this tragedy are all too evident: leaders are paid to build healthy enterprises by facing reality and using crises to strengthen their competitive position. Three decades of GM leaders failed this basic test, and millions of lives are being negatively impacted.

Ingrassia: How GM Lost Its Way Decades of dumb decisions helped send General Motors to a bankruptcy court yesterday, but one stands out. The year was 1998, and the United Auto Workers was striking at two factories in Flint, Mich., that made components critical to every GM assembly plant in the country. The union was defending production quotas that workers could fill in five or six hours, after which they would get overtime pay or just, you know, go home. Most strikes are forbidden during the life of a labor contract, so to provide legal cover the union started filing grievances. GM lawyers contended the walkouts violated the contract anyway and drafted a lawsuit -- the first by the company against the UAW in more than 60 years. But GM's labor-relations department freaked out because the lawsuit would antagonize the union. Just think about that. The union had shut down virtually all of GM, costing the company and its shareholders billions of dollars, and yet the company's labor negotiators were afraid of giving offense. After heated internal arguments, the suit was filed and GM seemed on the verge of winning. But the company settled just before the judge ruled. UAW members marched victoriously through downtown Flint. GM executives who advocated a tougher stand got pushed out of the company. The picture of a heedless union and a feckless management says a lot about what went wrong at GM. There were many more mistakes, of course -- look-alike cars, lapses in quality, misguided acquisitions, and betting on big SUVs just before gas prices soared. They were all born of a uniquely insular corporate culture. By and large, Mr. Obama's automotive task force has done its job pretty well, forcing the companies and the UAW to make difficult decisions that they should have made themselves long ago. GM will shed four of its eight U.S. brands -- Saab, Saturn, Pontiac and Hummer -- thousands of dealers, 11 factories, and much of its debt. It is no small irony that a Democratic administration brought in a bunch of private-equity types to impose rational management on big business. That said, a couple of aspects of the GM and Chrysler bailouts could come back to haunt U.S. taxpayers and the Obama administration. The answer will depend on the success of GM, which in turn will hinge on whether the new company can cast off the culture of the old one. One encouraging sign is that, thanks to the labor contract amendments imposed by the Treasury's task force, UAW members will be required to work 40 hours a week before getting overtime pay. Less encouraging is that workers still will be allowed six unexcused absences before being fired. It doesn't take that many at a Honda plant. As for management, not long ago a group of executives was reviewing a prototype new Buick model, about the size of a BMW 3 Series, at GM's design studios. The sporty styling had been developed in China for sale both there and in the U.S. But the company's cautious product planners suggested conducting customer clinics to gauge reaction to the design and possibly changing both the front and back end. It would have delayed the project and cost tens of millions of dollars. CEO Fritz Henderson wisely said no. But the very next day the product planners were charging ahead with their clinic plans anyway, just in case the boss wanted to see the results of their research. Maybe the new Buick should be named the CYA. Neither billions in losses nor the brink of bankruptcy, it seems, have been enough to change many traditional ways of doing things at GM. Heaven only knows what will be enough. But a company with a cautious, slow-moving management and a union committed to defending ridiculous work rules won't have a chance of succeeding. Perhaps everyone remaining at the new GM will realize that. The rest of us can only hope for the best.

The Quagmire Ahead On Jan. 21, 1988, a General Motors executive named Elmer Johnson wrote a brave and prophetic memo. Its main point was contained in this sentence: “We have vastly underestimated how deeply ingrained are the organizational and cultural rigidities that hamper our ability to execute.”  On Jan. 26, 2009, Rob Kleinbaum, a former G.M. employee and consultant, wrote his own memo. Kleinbaum’s argument was eerily similar: “It is apparent that unless G.M.’s culture is fundamentally changed, especially in North America, its true heart, G.M. will likely be back at the public trough again and again.” These two memos, written by men devoted to the company, get to the heart of G.M.’s problems. Bureaucratic restructuring won’t fix the company. Clever financing schemes won’t fix the company. G.M.’s core problem is its corporate and workplace culture — the unquantifiable but essential attitudes, mind-sets and relationship patterns that are passed down, year after year. Over the last five decades, this company has progressively lost touch with car buyers, especially the educated car buyers who flock to European and Japanese brands. Over five decades, this company has tolerated labor practices that seem insane to outsiders. Over these decades, it has tolerated bureaucratic structures that repel top talent. It has evaded the relentless quality focus that has helped companies like Toyota prosper. As a result, G.M. has steadily lost U.S. market share, from 54 to 19 percent. Consumer Reports now recommends 70 percent of Ford’s vehicles, but only 19 percent of G.M.’s. The problems have not gone unrecognized and heroic measures have been undertaken, but technocratic reforms from within have not changed the culture.

The bankruptcy of General Motors SINCE the start of the year it had seemed probable, and for several weeks inevitable. General Motors’ application on June 1st for Chapter 11 protection from its creditors, triggering the biggest industrial bankruptcy in history, was nonetheless a momentous event. Yet as recently as the autumn of 2007 Mr Wagoner’s stock had been high. There was hope both inside GM and among industry commentators that after three years of huge losses and painful downsizing the carmaker was at last on the road to viability. In some ways, GM’s problems can be traced to its origins a century ago. Between 1908 and 1920, its founder, Billy Durant, bought 39 companies including Cadillac, Pontiac, Oldsmobile, Chevrolet and several parts-makers, but ran them as separate entities. In 1923, after narrowly avoiding bankruptcy, Alfred Sloan, a ball-bearing magnate, took over the running of GM. Sloan imposed tight financial controls and brought order to the chaotic model line-up. Yet even as GM expanded abroad, establishing factories in 15 countries and buying Vauxhall in Britain and Opel in Germany, Sloan made little attempt to forge a unified company at home. The different divisions were run almost as independent fiefs that fought among themselves and against any interference from the centre. By the early 1980s it had begun to dawn on GM that the Japanese could not only make better cars but also do so far more efficiently. A joint venture with Toyota to manufacture cars in California was an eye-opener. It convinced GM’s management that “lean” manufacturing was of the highest importance. Unfortunately, that meant still less attention being paid to the quality of the cars GM was turning out. Most were indistinguishable, badge-engineered nonentities. As the appeal of its products sank, so did the prices GM could ask. New ways had to be found to cut costs further, making the cars still less attractive to buyers. When GM emerges from bankruptcy, it will have shed some of its burdens, but the damage done by decades of mismanagement and union intransigence will still weigh heavily. The new GM will not be quite as new as either it or the government would like Americans to believe.

Detroitosaurus wrecks  THE demise of GM had been expected for so long that when it finally died there was barely a whimper. Wall Street was unmoved. Congress did not draw breath. America shrugged. Yet the indifference with which the news was received should not obscure its importance. A company which once sold half the cars in America, employed in its various guises as many people as the combined populations of Nevada and Delaware and was regarded as a model for managers all over the world has just gone under; and its collapse holds important lessons about management, about government and about the future of the car industry. The problem in the 1970s was not really the arrival of better, smaller, lighter Japanese cars; it was GM’s failure to respond in kind. Rather than hitting back with superior products, the company hid behind politicians who appeared to help it in the short term. Rules on fuel economy distorted the market because they had a loophole for pickups and other light trucks—a sop to farmers and tool-toting artisans. The American carmakers exploited that by producing squadrons of SUVs, while the government restricted the import of small, efficient Japanese cars. If Detroit had spent less time lobbying for government protection and more on improving its products it might have fared better. Sensible fuel taxes would have hurt for a while, but unlike market-distorting fuel-efficiency rules, they would have forced GM to evolve. As for the health and pension costs which have helped sink GM, the company and the government bear joint responsibility for those too. After the war GM rejected a mutual scheme that the unions wanted because it smacked of socialism; and around the same time, the company agreed to give retired workers full pensions and health care for life. But if successive administrations had dealt with America’s expensive and inadequate health care—a problem with which Barack Obama is now wrestling (see article)—the cost of those union demands would have been far lower. GM’s demise should not be read as a harbinger of doom for the car industry. All around the world people want wheels: a car tends to be the first big purchase a family makes once its income rises much above $5,000 a year, in purchasing-power terms. At the same time as people in developing countries are getting richer, more efficient factories and better designs are making cars more affordable. Yet although the long-term prospects for sales growth look excellent overall, the car industry has a problem: it needs to shrink dramatically. At present, there’s enough capacity globally to make 90m vehicles a year, but demand is little more than 60m in good economic times. Even as the big global manufacturers have been building new factories in emerging markets, governments in slow-growing rich-world markets have been bribing them to keep capacity open there. For all its peculiarities, the car industry is no dinosaur—Toyota, for instance, is a byword for manufacturing excellence. But the unevolved GM deserved extinction. Detroit employed so many people and figured so large in American culture that governments felt they had to protect it; but in doing so, they made it vulnerable to less-coddled competitors from abroad. By trying to keep their car industry big, America’s leaders ended up preventing it from becoming good. There is a lesson in that which all governments would do well to learn.

GM's dismantling opens doors for foreign carmakers Roger Penske is inventing a new business model on the ruins of General Motors Corp. The auto racing magnate and mega dealership owner is snapping up Saturn and opening his expanded sales network to foreign automakers looking to sell cars to Americans. The deal announced Friday is another example of how the cataclysm that hit Detroit's three carmakers is reshaping the global automotive landscape in profound ways, reducing their worldwide influence and -- if Saturn turns out as Penske envisions -- opening new markets to smaller companies. In the shake-up, well-known brands are changing flags quicker than an oil tanker in pirate-infested waters. Italy's Fiat SpA is waiting for U.S. courts to approve its acquisition of Chrysler LLC's assets. GM has worked deals to turn its German subsidiary Adam Opel GmbH over to a Canadian auto parts company with Russian backing. And Hummer may be going Chinese, although state media there reported Friday that the deal has hit regulatory hurdles. Yet industry experts are doubtful that the flurry of mergers and alliances will be any more durable than failed marriages of the past, proving to be just one big distraction from the underlying issue that made them so vulnerable in the first place: making more cars than people can buy. Still, Penske, who already runs Penske Automotive Group Inc., the second-largest U.S. dealer network, thinks his business model is different enough to be successful. GM and Penske expect to close the Saturn deal in the third quarter, with the wounded Detroit automaker continuing to build three models for Saturn to distribute. Key to its success, though, will be the ability to sign on other global manufacturers to make cars for Saturn, giving it a diverse portfolio of vehicles that will sell whether gasoline prices are high or low. But by opening the door to automakers not now in the U.S., such as France's Renault, Penske could alter the market here, allowing smaller automakers to compete against Detroit. For years, the U.S. auto manufacturing base has been too large for the market, forcing automakers to overproduce to keep plants running and flooding the market with vehicles. As a result, the Detroit Three especially have been forced to discount vehicles to sell burgeoning inventories. But Penske said the continued restructuring by Chrysler, GM and Ford Motor Co. should solve that problem, at least in the U.S.

Brief Incursion Into the Not-So-Big Two It is hard to recall an instance in which government officials have been as deeply involved in negotiating and, at key junctures, dictating the terms of a union contract or a company's business plan and financing scheme. Nor has so much taxpayer money ever been committed to assure the survival of two private firms. If this were happening in France or Venezuela, we wouldn't hesitate to call it nationalization. But this is not France, it is not Venezuela, and we have not embarked on a new course for American capitalism. This is simply an extraordinary intervention at an extraordinary moment driven by both economic and political necessity -- economic in the sense that the economy is in no shape to withstand the sudden collapse of General Motors, Chrysler and their supplier network, and political in the sense that their sudden demise would be a mortal blow to national pride and undermine other vital recovery efforts. Like Bush v. Gore, the auto bailout represents a distasteful policy decision that even its authors hope will set no precedent. As I suggested last year, a pre-cooked, accelerated bankruptcy process was the only realistic way to restructure companies that had been so badly mismanaged for so many years. As is appropriate in a capitalist system, shareholders have been wiped out and lenders forced to suffer for their bad judgment. It is the job of the bankruptcy court to ensure that these financial creditors receive at least as much from any restructuring plan as they would have from a long and messy liquidation -- and they will. But there is nothing in the bankruptcy law, or the common law, requiring a government volunteering to finance a bankruptcy restructuring to divide its largess evenly or fairly between bondholders and assembly-line workers. That is a political choice that properly rests with the government. In the coming months, the Obama administration will need to resist the temptation to use its newfound control over Chrysler and GM to try to solve the energy crisis, revive the Rust Belt economy and bring an end to income inequality. It will also need to find ways to insulate itself from taking responsibility for how every dollar is spent at the two companies, lest every bonus and first-class airline ticket be turned into a taxpayer scandal. As it has been up to this point, the Obama administration's role going forward is to be ruthless and impatient about the restructuring of these once-great American companies so they can emerge from the current recession profitable and competitive.

Ford's reversal of fortune For much of the last year, Ford Motor has been the strongest U.S.-based automaker. But with Chrysler already out of bankruptcy and General Motors possibly six weeks away from its own exit from bankruptcy, Ford could soon find itself in the weakest position of the traditional Big Three. The problem for Ford is that its strength was only relative to the greater problems at GM and Chrysler. Ford built its cash reserves not through profits, but by mortgaging most of the company's assets before the credit crisis of 2008 cut off funding for the other automakers. That pile of cash gave Ford (F, Fortune 500) the ability to ride out the sharp plunge in auto sales without turning to the government for help -- at least so far. But it also left Ford with about $32 billion in debt on its books at the end of the first quarter. With GM (GMGMQ) and Chrysler using the bankruptcy process to shed much of their own debt cheaply and quickly, Ford has gone from the automaker with the most cash on hand to the one with the most debt on its books. GM will have only about $17 billion in debt if it can follow its planned emergence from bankruptcy. Chrysler left bankruptcy with about $11 billion in debt, and a new partner, Italian automaker Fiat, it did not have previously have. Ford also hasn't been able to cut its manufacturing capacity or its bloated dealership network as Chrysler and GM through bankruptcy reorganization. Ford officials insist the company remains in a strong competitive position against its Big Three rivals -- despite all the help they got from the government and the bankruptcy courts.Other auto industry experts say that even if Ford can manage its debt level, it will soon find itself in need of a bailout or possibly bankruptcy if auto sales don't start to rebound in the next year. "Leverage is a concern, but it's not the primary concern. The greater concerns are low sales and underused capacity," said Gregg Lemos-Stein, credit analyst with ratings agency Standard & Poor's, which rates Ford's corporate credit as CCC+, deep into so-called "junk bond" status. Lemos-Stein said while the company still has a better cash position than its rivals, "they don't have an indefinite supply of cash, especially since we expect the outflows of cash to continue." Still, some experts believe Ford's future looks brighter than its rivals because it has a better lineup of vehicles in the showroom and its pipeline. While GM is busy shedding weaker brands and Chrysler is shifting away from trucks towards smaller cars, Ford has already adapted to changing demands from customers. "They've managed their product portfolio pretty well. That's very important," said Tom Libby, president of the Society of Automotive Analysts. Libby said that product development at GM and Chrysler took a hit as the companies rushed to slash costs in recent months. That could leave Ford with newer, more attractive products for at least a few years.

Fiat: restructuring of auto industry necessary Fiat, which has recently taken a controlling stake in Chrysler, called Thursday for a "serious restructuring" of the auto industry, saying the global crisis has worsened the problem of production overcapacity. Chief Executive Sergio Marchionne also laid out plans for car production in Italy, confirming no plants will be closed but that from 2011 one facility will switch from making autos to other types of production. Marchionne held a meeting with the Italian government and unions at the premier's office in Rome to illustrate the group's mid-term program. Premier Silvio Berlusconi attended the talks. Earlier in June Fiat took on most of Chrysler's assets in exchange for technology and management know-how. The alliance created the 6th largest automaker worldwide, according to Fiat. "The global crisis has further aggravated the problem of production overcapacity that has been plaguing the automotive industry for years," said a statement released by Fiat after the talks. "A serious restructuring of the automotive industry is now absolutely necessary if it is to be economically viable." Fiat officials said the restructuring would include measures to cut costs and increase efficiency. Fiat also said that "far-reaching strategic measures are necessary to achieve an adequate level of critical mass, increase volumes produced for each platform and expand geographic presence." It said the deal with Chrysler was part of that strategic approach. Marchionne said ecological incentives to stimulate demand and temporary layoff schemes were important tools.

China's Carmakers Are Gaining on Foreign Rivals Nissan (NSANY) skipped Detroit's North American International Auto Show last winter, and several companies are expected to stay home from the Tokyo show this fall. But no major automaker dared to miss April's auto fest in Shanghai. That's because global automakers see China as their best hope for growth this year.Yet, for GM and other global automakers, the optimism about China may be short-lived. True, the market is booming: It's on track to grow up to 10% this year, vs. an expected 23% plunge in the U.S. and a 15% decline in Europe, says London-based consultant Intelligence Automotive Asia. But local automakers are grabbing market share from their global rivals. In the first quarter of 2009, Chinese brands boosted their market share to 30%, from 26% during the same period in 2008.That represents a shift. Foreign carmakers have been China's market leaders ever since the government invited them to form ventures with local partners two decades ago. But increasingly, "Chinese automakers have the critical mass and momentum," says Ashvin Chotai, managing director of Intelligence Automotive Asia. One reason: Chinese brands benefit more than foreign competitors from new government tax incentives, which encourage consumers to purchase small, fuel-efficient cars. Chinese carmakers tend to make mainly small vehicles, while foreign companies dominate the larger end of the market. Local automakers are also winning customers by offering more features than before—at a still low price. That's why Xu Xingang, 32, a Beijing demolition worker, chose a $11,685 BYD Auto F3 with an automatic transmission over the Nissan Tiida, Honda Fit, and Hyundai Elantra Yuedong. The BYD wasn't luxurious, but the price was right. "The interior is anything but fine, but I'm satisfied," he says. "The BYD has the best cost performance."

Small Carmakers Benefit From Detroit’s Woes Many smaller automakers are gaining a bigger share of the market, most notably Hyundai and Kia.Together, the two Korean brands, which are both owned by Hyundai, hold 7.3 percent of the American market, the same as Nissan, which ranks sixth in American sales, behind G.M., Toyota, Ford, Honda and Chrysler. Last year, Hyundai and Kia had 5 percent of the market.Their gains appear to be a replay of what occurred four decades ago, when upstart automakers from Japan started selling cars in the United States. At the time, American carmakers dismissed them, but today they control nearly 40 percent of the American car market.Analysts see two main reasons that smaller companies are capitalizing on the auto industry’s downturn. One is that the shrinking of the overall market — the current selling rate is about 10 million vehicles a year, down 40 percent from two years ago — has created opportunities for carmakers that do not need to sell millions of cars to make money.Second, he said, buyers have become much less focused on brands and more on the quality of the vehicles themselves.“There are so many good cars out there to choose from. Everybody’s building a good car right now,” Mr. Pinelli said. “The average person who punches out of work and picks up some fast food and goes home to watch reality TV is oblivious to which auto brands are owned by which corporation.”

Posted by dblwyo at 10:19 AM | | Comments (0)

June 16, 2009

Time to Fold 'em (Updates): Market Outlook vs Investment Strategies

Well in the course of normal sequencing it is, and was, time to look at the markets and relate them to our prior take on the economy (The Vast, Ignored Difference: Economic Bottoming vs Recovery). Believe it or not we were all set to go over a week ago but when the god of timing fried our connectivity and we just got it fixed yesterday. And trying to blog, upload and link in graphics is a painful experience over the SBUX WiFi network for some reason. But, as my ex-girlfriends tried to tell me, timing is everything. What we have to say is what we were going to say and what we've been saying for about six weeks or so: this market is more than fully valued, it may run up on pure sentiment but its got nowhere to go from here. In fact based on our economic outlook its got nowhere to go for at least the next two years if not longer. That being the case if you have any profits it's time to take 'em off the table and get a drink. It's also time to re-think your investment strategies. But the involuntary delay works to our collective benefit since the markets might seem to confirm our argument so far this week, the commentariat is beginning to sound like us and today's econ data is more confirmation of sparse and wither prone green shoots. Just for the record Industrial Production was down YoY by -13.4% compared to last months -12.7%; in fact the rate of decline is still severe if slowing.

Market Assessment

Starting with the current market situation take a look at this chart composite. In the long-term (since 1990) chart you'll notice that we got two bubbles but the market has essentially gone nowhere for over a decade. It did bounce off the lower Fib level in '03 but busted it and climbed back up in the March Madness but would appear, on this scale to be failing at the next level of resistance. We're probably lucky it didn't bust the lowest level around 450. BtW S&P estimated as of early April that 2009 earnings would be $44.10 and $44.78. At a 10 PE, well you do the math...also notice that S&P is implying a zero growth in earnings as well !

the lower chart looks at the SPX since Jan08. In the first ten months we had a "normal" bear market followed by the panic in the Fall and a near total rout in March as it dawned on folks that various warnings about a very weak economic situation were indeed true. Nothing like a dose of reality to have the Bears come of their caves and the Bulls to run for cover. Thru last week we'd bubbled up a bit but so far this week that bubble has been largely erased. At best we're in a trading range. But valuations are pretty high and built on a recovery in corporate profits which is NOT in the offing at all. Like we keep saying this is going to be a long, drawn-out recovery that's a long way from getting started. The end of cliff-diving is NOT the beginnings of growth.

GDP vs Profits vs SPX

 Earlier we dissected (Beyond Specifics to Principles: Business Performance Principles & Outlooks) the relationship between aggregate/cumulative growth in the economy and corporate profits since 1950 and broke it down by Finance vs Non-Finance. The key finding was that there was a highly aberrational bubble in profits this decade, which drove apparent profits, but was due mostly to constrained hiring and investment. MUCH worse the aberrations turned out to be concentrated in Finance and had been far...far above trend since the mid-'80s (deregulation anyone ?). The bottom half of this composite reproduces the key chart on Profits vs GDP with Finance vs Non-finance broken out. The top half is the interesting one here. Interestingly, or strangely enough, we can see the two bubbles in the stock market we saw in the technical chart reproduced in this comparison of cumulative growth since 1950. Really stop and think about that for a minute....from 1950 to about 1995 GDP, Profits and the markets all grew synchronously until an investment-driven bubble pushed the markets (twice !) way over long-term trend. The markets are beginning to come back to trend but you have to wonder how far the excesses will lead to a corrective over-shoot. With a weak and jobless recovery likely to drag out over the next five years profits certainly won't be growing though they have yet to return to trend.

Long-term Valuations

We've pointed at Robert Shiller's work on long-term PE Ratios before as being the exemplar of a data-driven approach to looking at valuations. He found that PEs averaged 15.3 from about 1870 to now; and if you take his figures and net out the bubbles the average is about 14.9. By any measure the market is indeed fully valued. The last time we visited Prof. Shiller (Markets Manias: Thinking About the Year Ahead) we coupled that discussion with our favorite Graham-Dodd PE valuation formula of PE = (8.5 + 2*G) X 4.4/Y, where G is the earnings growth rate and Y the AAA corporate bond rate. That prior post reproduces our G-D tables where you'll find a 5% growth rate and a 6% interest rate yields a PE of 13.6; right in line with the other paths to enlightenment. BUT....but...but a 0-3% growth rate, which is reasonable given the economic outlook, and an 8% interest rate, which is reasonable given the downside risk factors to be properly priced, yields PEs in the range of 5-10, depending. Now look back at Shiller's chart and notice that a) we've had a tremendous bubble in PE Ratios as well as ALL the other indicators and b) every other time that's happened we've had a major corrective over-shoot. Lots and lots of different approaches seem to converge in roughly the same region, don't they ?

Re-Thinking Investment Strategies

The mantras that everybody has followed for the last three decades are buy-n-hold combined with asset allocation and those have been based on the "efficient markets hypothesis". In the readings you'll find several selections on the current market situation that (finally) raise exactly the questions you can find us raising about the markets about twice/month since at least January. MUCH more importantly are a key set of readings on the long-term strategic re-thinkings that are beginning to go on. These include two pieces from Mohammad El-Arrian of PIMCO plus another one from Bill Gross and a piece from Joe Nocera of the NYT pointing toward a growing set of challenges to the efficient markets concept. Markets may in fact be efficient if a) they're not distorted and b) all the information about them is available. When those assumptions fail so does the EMT (that's Efficient Markets Theory not emergency medical technician but one wonders). The accompanying graphic is our most recently updated assessment of the markets situation for the four fundamental factors we like to look at: Structure, Fundamentals, Technicals and Sentiment. Each category shows the immediate prior assessment compared to this one. For the record the immediate prior assessment was from Jun08 since the disequilibriums of the Fall and Winter swamped our concerns with updating them. If you'll click on the graphic what you'll actually pull up will be a downloadable PDF copy which we suggest you do dload, read AND think about. The two prior assessment summaries are here and here.

 Alternative Strategies

So what does that mean for your investing strategies ? We think several critical things that are going to be painful and a lot of hard work but less painful than continuing to worship dead shibboleths. For well over five years we've been suggesting that Buy-n-Hold was a dead strategy because we were in a low-return world and one where markets were, being polite, generating a lot of anomalies. Our 2004 take on re-thinking portfolio and asset class strategies against timeframes  is, IOHO, worth revisting for several reasons. (Portfolio Strategy:Mar04). Among those are the structure, timeframes and asset classes. Also among them are the things we got right and wrong, in retrospect, though we'd argue that there was more right than badly wrong and they were good guesses at the time. We took another pass at re-thinking strategies in Jan08 and dedicated a whole post to it. The resulting re-vamped portfolio strategy put a lot of emphasis on ETFs, particularly leveraged and inverse ETFs. (Portfolio Strategy:Jan08). We discussed the reasons and rationales extensively in this post:This One's for Jay: Investing Strategies for a Dicey Market.

Our bottomline is that you need to re-think and re-structure, be more active and look for anomolies and trends. Anybody who followed our Jan08 recommendations made a lot of money last year, and would still be making money. If we'd been all that smart way back when we'd have done better as well. This last decade was dominated by key trends: foreign markets, commodities and real estate to name some key ones. Now the question is what will they be in the future ?

A question for future investigation though right now with everybody wallowing in the same ditches nothing comes to mind. BUT repeating the same tactics that worked for the last set of inefficient anomolies won't work again. For example banking on emerging markets to be the great opportunity is, IOHO, a done and exhausted investment idea. The re-factoring of the BRICs is fully captured, with the disappearance of the US consumer the export-led growth model won't come back and that will decrease worldwide demand for commodities. All large and complex subjects. Made more so because there may be short-term opportunities to exploit everybody else's worshiping of the old shibboleths.

UPDATES:

Merrill Fund Managers Survey BNN talks to Gary Baker, co-head, international investment strategy, Banc of America Securities-Merrill Lynch.

STREET CRITIQUE - Todd Harrison TODD HARRISON, founder and CEO of Minyanville.com. Paul asks Todd about Wall Street's response to the Obama Administration's planned overhaul of the financial regulatory system. Todd also offers perspective on the current market environment.

White Paper No. 46: Is It Different This Time? During extraordinary market conditions of all kinds – good and bad – it is usual to hear people say, “It’s different this time.” Of course, every market environment is different from every other market environment, but what these people are saying is that market conditions today are so exceptional, so completely unprecedented, that investors will need to reassess everything they thought they knew about the investment process – or face serious consequences.

Market Situation

Market rally hits 3 months, raising questions Three months can feel like a long time on Wall Street.In the stock market, where news about companies and the economy dictate buy and sell decisions in a matter seconds, the market's powerful rally is getting pretty old to some experienced players. Traders have been laying down bets on modest signs that the economy is halting its slide. That optimism has lifted the Standard & Poor's 500 index, a benchmark for many investments like mutual funds, an enormous 39 percent from a 12-year low on March 9. Those kinds of gains might normally take four years to materialize. Some analysts are asking whether ebullient investors have been too quick to shed their caution. Another round of economic data this week could help determine whether the gains will hold."Are we getting ahead of ourselves in terms of market levels? I believe that we are and I think investors would be wise to take some profits off the table," said Walter Gerasimowicz, chairman and chief executive of Meditron Asset Management.The rally has added 2,220 points the Dow Jones industrial average to put it within a dozen points of being flat for the year. But the Dow is still down 5,400 points from its high of 14,164.53 in October 2007. Green arrows began popping up on stock screens three months ago this week as traders determined that the economy was likely to sidestep a ruinous fall marked by the Great Depression and instead muddle through the worst recession in decades. But some analysts contend that investors are in danger of setting expectations too high for how quickly the economy can recover from the recession that started in December 2007. "When the predictions become less dour I think that introduces the possibly of disappointment," said Jeff Knight, head of asset allocation at Putnam Investments. "You don't have any evidence yet that things have actually gotten any better."

Where Buffett's money is going now Although Berkshire Hathaway (BRK.A, news, msgs) made only modest changes to its substantial ($35 billion-plus) equity portfolio during the first quarter, based on data pulled from the company's latest 13-F filing with the Securities and Exchange Commission, we were encouraged to find more than a few five-star stocks in the company's holdings.In fact, of the 41 securities in Berkshire's equity portfolio at the end of the first quarter, there were 13 stocks that are currently rated five stars by Morningstar's analysts. Berkshire had fairly large positions in five of these securities, each of which accounted for 4% or more of the company's total equity portfolio. In one case, Berkshire's Warren Buffett and Charlie Munger were actually adding to a position they had trimmed substantially during the fourth quarter of last year. We'll delve more deeply into each of them as we discuss the moves Buffett and Munger made during the most recent quarter.

This Rally May Need a New Source of Fuel Traditionally, the price-to-earnings ratio has been the most commonly used measure for valuing the market. Yet there are several ways to calculate P/E’s — and current economic circumstances make some methods particularly hard to apply. For example, a classic technique takes the current price level of the S.& P. 500 and divides that by the earnings of the companies in the index over the preceding 12 months, using generally accepted accounting principles, or GAAP. Based on these figures, the S.& P. has had an average price-to-earnings ratio of 12.6 at the end of bear markets since 1938. But this is no ordinary downturn. Because corporate losses in the fourth quarter of 2008 equaled profits registered in the previous two quarters, the market’s overall P/E, based on GAAP earnings, now stands at more than 100. That’s pricey by any definition. Because profit growth can be so unreliable in a severe recession, some strategists prefer to gauge stock prices by using so-called operating earnings, which exclude one-time write-offs like the expenses associated with closing down a factory or a company division. Based on operating earnings, the P/E of the S.& P. 500 is a much more palatable 22 today. But that’s still considerably higher than the average of 19 for the past two decades. What’s more, there are concerns about how quickly the market’s P/E has grown. It’s not uncommon for market valuations to rise in the latter stages of a recession, because stock prices tend to move in anticipation of a recovery. That means prices — or the “P” in the P/E ratio — often recover before earnings do. But they don’t usually expand this fast. But even if that technique is the best to use, it still means that the mind-set on Wall Street has shifted. Instead of betting on stocks because of unbelievably cheap prices, many investors are counting on the economy to rebound strongly. In other words, instead of betting on the “P” in the P/E ratio, stock investors are banking on the “E.” But at today’s prices, says Mr. Inker at GMO, “You’re not getting paid a ton for taking on risk.”

Is This Bull Cyclical or Secular? Many investors are now calling the rebound in stocks since early March the start of a new bull market. But it could be only a temporary respite from a longer-term bear market dating back to the beginning of this decade. If the market is poised for a multiyear run, investors can be more aggressive about diving into stocks. If the bear market will regain its grip on stocks and send prices lower again, investors need to be cautious. Historical data and the still struggling economy seem to point to the latter case, called a cyclical bull market in a secular bear market. For now, stocks are fully in bull-market territory, even if it doesn't feel that way given the losses that many investors are still nursing. "We have some very substantial headwinds on the economic front," says David Pedowitz, a senior portfolio manager at Neuberger Berman. Consumer spending is strained and there is significant excess capacity in the manufacturing economy, he says. Against that backdrop, expectations may be building for a bigger rebound in profits than will be possible, says Mr. Pedowitz. In late 2001, Ned Davis Research, a market analysis and money-management firm, raised the idea that stocks had entered a secular bear market, a long period of flat or declining stocks. That idea gained traction last autumn as stocks fell below levels of a decade ago. Ned Davis considers this the fourth secular bear market since 1900. The last one, from 1966 to 1982, ended when the Federal Reserve moved to aggressively crush inflation. These "secular" cycles run for long periods; secular bull markets have lasted from six to 24 years and bear markets 13 to 16 years. Within those cycles are many more cyclical bulls and bears -- nearly three dozen of each since 1900. (Ned Davis uses its own criteria for a cyclical bull or bear market, based largely on 30% moves.) During a secular bull market, the cyclical, or shorter, bull markets within them gained 110% on average and lasted nearly three years. Within secular bear markets, however, the gains in cyclical bull markets averaged 64% and generally were over within a year and a half. Long-term Bull vs Bear Graphic, Recent Cyclical Bear Graphic

Strategic Concerns

‘To Do’ List Is Getting Longer Today’s financial crisis is producing ever higher unemployment, investment losses, and home foreclosures. People now recognize that the unthinkable is thinkable, be it in the banking system or in the real economy. Yet some major structural changes, that are about to play out, have not as yet attracted sufficient attention – including the upcoming shrinkage and consolidation of the industry that provides investment management services to individuals, companies, pensions, and governments around the world. Two distinct yet inter-related drivers are at work. First, collateral damage from the largely self-inflicted war within the banking system which, as I noted in an earlier FT column, is gradually transforming banks into “utilities”. Second, the desire by governments to impose a peace by de-risking and re-regulating finance, lest today’s crisis morphs again – and this time into a global depression that would negate the progress that the world has made in the last ten years to improve living standards and alleviate poverty.These factors will inadvertently result in a major but uneven shrinkage of the investment management industry during 2009 and 2010. This unintended consequence will be felt most intensely in the levered (or “alternative”) space dominated by hedge funds and private equity firms. But it will spread well beyond that to traditional investment managers, particularly in the equity space and among those that are part of declining banking conglomerates. The alternative sector faces a perfect storm. These once prominent pools of capital are finding it harder to secure financing lines from banks. It is also proving harder for them to raise longer-term funds through bond issuance and initial public offerings.

The Future of Investing: Evolution or Revolution? The future of the global economy will likely be dominated by delevering, deglobalization, and reregulating, yet if so, it is important to state at the outset that we do not envision a mean reversion, cyclically oriented future, but instead a new world where players assume different roles, and models relying on bell-shaped/thin-tailed outcomes based on historical data are less relevant. Historical models look backward while modern-day finance is being fast forwarded and reconstituted almost as we speak. Whether evolution or revolution it is important to recognize that the aftermath of an economic and investment bubble transitioning from levering to delevering, globalization to deglobalization and lax regulation to reregulation leads to an across-the-board rise in risk premiums, higher volatility and therefore lower asset prices for a majority of asset classes. The journey to a new stasis is a destructive one insofar as it affects previously assumed wealth. Rough estimates suggest that as much as 40% of global wealth has been destroyed since the beginning of this delevering process. In essence, asset prices, which are really only the discounted future value of wealth creation, go down – not only because that wealth creation slows down but because it becomes more uncertain. In such an environment, equity interests in the form of stocks, real estate or even high yield bonds become re-rated. In turn, investor preferences towards risk taking, even when correctly calculated and modeled must be considered. In short, our stereotyped conceptions of what makes money are being challenged. As Bernstein says, there is no predestined rate of return. And a PIMCO corollary would counsel that future rates of return will be dependent on the beginning price and future growth rates and risk preferences that cannot necessarily be derived from historical models. Another way to summarize our caution would be to quote a recent comment by Barton Biggs. “I am a child of the bull market,” he said which upon further elaboration meant that he bought on cyclical dips with the expectation of riding mean reversion to an upward sloping trend line of prosperity and ultimately higher peaks. In a sense, we are all children of the bull market, although some of us are more mature than others – a bull market of free-enterprise productivity and innovation, yes, but one fostered by a bull market in leverage, deregulation and globalization that proved unsustainable in its excesses. We now must view ourselves as chastened adults, forced into acknowledging a new reality that is dependent upon bear-market delevering and debt liquidation to deliver us to our new and ultimate restructured destination – wherever it lies.

Poking Holes in a Theory on Markets For some months now, Jeremy Grantham, a respected market strategist with GMO, an institutional asset management company, has been railing about — of all things — the efficient market hypothesis. You know what the efficient market hypothesis is, don’t you? It’s a theory that grew out of the University of Chicago’s finance department, and long held sway in academic circles, that the stock market can’t be beaten on any consistent basis because all available information is already built into stock prices. The stock market, in other words, is rational. In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of Chicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices — meaning that perhaps the market isn’t quite so efficient after all. Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod erat demonstrandum. These days, you would be hard-pressed to find anybody, even on the University of Chicago campus, who would claim that the market is perfectly efficient. Yet Mr. Grantham, who was a critic of the efficient market hypothesis long before such criticism was in vogue, has hardly been mollified by its decline. In his view, it did a lot of damage in its heyday — damage that we’re still dealing with. How much damage? In Mr. Grantham’s view, the efficient market hypothesis is more or less directly responsible for the financial crisis. “In their desire for mathematical order and elegant models,” he wrote in his firm’s quarterly letter to clients earlier this year, “the economic establishment played down the role of bad behavior” — not to mention “flat-out bursts of irrationality.” He continued: “The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. ‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.” But as much as I’ve admired Mr. Grantham’s writings over the years, I think the truth, in this case, is a little more subtle. Given the long history of bubbles, I suspect this crisis would have taken place with or without the aid of the efficient market hypothesis. People thought “it’s different this time” in the 1920s, long before anyone was writing about efficient markets. And over the course of history, professional money managers have been just as fearful of bucking the trend as they were during the Internet bubble. Mr. Fox sees it somewhat differently. On the one hand, he says, the efficient market theoreticians always assumed that smart market participants would force stock prices to become rational. How? By doing exactly what they don’t do in real life: take the other side of trades if prices get out of whack. Their ivory tower view reflected an idealized market that simply doesn’t exist. On the other hand, Mr. Fox says, what was truly pernicious about the efficient market hypothesis is the way it allowed us to put asset prices on a pedestal that they never deserved.

Investment Outlook: 2 + 2 = 4 Through my years here at PIMCO there have been numerous demarcation points where Baruch’s whispers almost turned into screams. Two plus two screamed four in September of 1981 with long-term Treasury yields approaching 15%, and two plus two boomed four in 2000 when the Dot Coms rose to prices that discounted the hereafter instead of the next 30 years. Similarly, 2007 was a screaming mimi with the subprimes – if only because the liar loans and no-money-down financing were reminiscent of a shell game, Ponzi scheme, or some other type of wizardry that was bound to lead to tears. 2009 is a similar demarcation point because it represents the beginning of government policy counterpunching, a period when the public with government as its proxy decided that private market, laissez-faire, free market capitalism was history and that a “private/public” partnership yet to gestate and evolve would be the model for years to come. How does one invest during such a transition? Investors should recognize that this grassroots trend signals – most importantly – an increasing uncertainty of cash flows from financial assets. Not only will redistribution and reregulation lead to slower economic growth, but the financial flows from it will be haircutted and “burden shared” by stakeholders. In turn, the present value of those flows should reflect an increasing risk premium and a diminishing multiple of annual receipts. This Outlook is not to bemoan this transition, but to recognize it. Slower growth can be a public good if it avoids the cataclysmic effects of double-digit unemployment, escalating foreclosures, and fear of financial insecurity. But the Obama cannon shot will have financial consequences. Do not be deceived by the euphoric sightings of “green shoots” and the claims for new bull markets in a multitude of asset classes. Stable and secure income is still the order of the day. Shaking hands with the new government is still the prescribed strategy, although it should be done at a senior level of the balance sheet. If the government indeed becomes your investment partner,  you should keep the big Uncle in clear sight and without back turned. Risk will not likely be rewarded until the global economy stabilizes and the Obama rules of order are more clearly defined.

Economic Recovery: Will Corporate Profits Recoup?  I keep thinking of something I heard Mohamed El-Erian, CEO of bond-investing giant Pimco, say at a conference in April: "We are so focused on whether recovery will be at the end of this year or the beginning of the next that we lose sight of the more important question. It's not whether the recession will be over; it's, What does the new normal look like?" It's a question with lots of facets. What will consumer spending look like? What will government deficits look like? What will my hair look like? But some of the most crucial unknowns have to do with corporate profits. Profits are, after all, what stock prices are supposed to be based on. Stocks have skyrocketed since early March, providing the earliest and strongest signal that the recession might ebb soon. One could even argue that rising stock prices brought optimism that has since begun to show up in real economic data, although if you think too hard about such feedback loops it will just make your head hurt. In any case, the future path of corporate profits should eventually determine whether the stock market will keep rising, whether companies will start hiring again, whether this recovery will feel like much of a recovery or not. And while Wall Street's analysts are all making (for the most part increasingly optimistic) estimates of what those profits will be, they really have no idea. That's because the mostly rising corporate profits of the past 35 years have been in large part the product of a long, long rise in indebtedness, especially consumer indebtedness. That rise in indebtedness is now giving way to what looks to be a long slide. At least, it had better be; if consumers start piling on debt again, we'll just have another, bigger credit crisis in a few years. But if they keep increasing their savings rate and reducing their debt loads, that's bad news for corporate profits, not just bank profits. Anybody who makes things that in recent years were bought on credit, from houses to washing machines to cars, is likely to be affected. So are stock prices.

Posted by dblwyo at 07:44 PM | | Comments (0)

June 05, 2009

The Vast, Ignored Difference: Economic Bottoming vs Recovery

The readings contain sections on the current situation and purported outlook, largely from Paul Kasriel of Northern Trust, recent Consumption and Employment data, the outlook for recovery in the US and worldwide (with an illustrative reading on Germany) plus Krugman's most recent take on the non-V recovery and a potential lost decade and the credit and policy situation with Janet Yellen of the SFO Fed's assessment that the "Great Moderation" of the last two/three decades is likely gone forever. Brave New World indeed ! There are several bottomlines here that are incredibly important, not least for the fact that they are being completely ignored.

1. There is a vast difference between a bottoming process and the beginnings of recovery. The economy is stabilizing in that a panicked cliff-dive has stopped (Western Civilization is saved) but recovery won't begin until we start creating jobs again and won't be sustainable until both employment and investment begin growing significantly, if ever.

2. Consumption data on a YoY basis as well as Employment data continued to drop. Worse, the decline in job losses, is more due to really dangerous structural factors than moderation; the Employment:Population Ratio is cliff-diving as badly as it has done in three decades, indicating huge downward employment pressures, reflected in Hours Worked and the beginnings of Real Wage declines.

3. The commentariat, punditocracy, allegedly responsible economic forecasters, the investment community and business leadership (to some extent) is reacting month-to-month to the headlines, missing the vast difference, ignoring the underlying realities on trends and patterns and generally setting itself and us up for some serious disappointments. For which, worse, nobody will be prepared again.

The chart is a snapshot of some of Kasriel's latest key outlook assessment showing the Leading Indicators are bottoming, that New Orders are not shrinking anywhere near as fast, that Monetary policy is apparently very stimulative and the credit markets are self-repairing. Paul is one of only two economists in the forecasting business who's largely gotten it right (the other being Roubini), which is not to ignore Summers, Feldstein or Krugman who comment more than regularly publish assessments (and not to neglect CalculatedRisk nor ourselves who have been accurate as well). That said we think his outlook for a Q4 upturn is optimistic but in any case, as he admits, will see a drawn-out and very weak recovery that will feel more like a recession.

Employment

Let's show you why by considering the Employment situation now that we have today's latest figures which, as the top sub-chart shows, is still cliff-diving on a YoY basis having dropped in the last four quarters -0.4,-1.6, -3.1 and -3.8%. That latter number certainly doesn't indicate much of an improving situation being that much larger than Q1 - though admittedly Employment is a lagging indicator. In the second sub-chart though you can see where the pressures are really showing up with an over 6% drop in Hours Worked and the YoY change in Unemployment nearing -70% !!! That's not a typo - the YoY% change for the last four quarters in Unemployment is 30,44, 63 and 70% ! Doesn't get any worse than that - well actually it might. Our e-friend and blogging colleague CalculatedRisk dives into the Employment:Population Ratio to look at the worst consequence - the number of folks being driven out of the Labor Force. His set of posts are linked in the readings are as his charts. Read 'em and weep but start paying attention. Our approach to the long-term structural consequences is to look at New Jobs, Net New Jobs (> 150K/month breakeven) and the cumulative creation of jobs. In the third sub-chart the redline tracks the latter and there are two points. The one we've made and keep making - how incredibly weak a job-creating "recovery" this was - and a new one that's really scary. New job creation has gone as badly in the tank as it has since we can apply this approach, and not be a little big either. In the last four quarters we went from being -5.2 to -6.9 to -9.4 to, now, -11.2 million jobs in the hole. 11.2 million jobs in the hole, we repeat; what do you say ? OMG seems grossly insufficient, doesn't it ? What kind of recovery is going to create 11.2 million jobs just to get back to breakeven ? And how long will it take ? And what will growth look like while we struggle with just getting back to that point ? Oh, btw, if the US consumer was the engine of worldwide growth over the last three decades and is going to go in retreat for the next decade to repair the damages what replaces them ? Where does demand for the BRICS come from ?

A High-Frequency Snapshot

Let's dial up the granularity and dive into our collection of monthly data that serves as our dashboard of the detailed current situation, starting with current Consumption and Investment. In the top sub-chart YoY Personal Consumption and Retail Sales continue to decrease though the rate of decline is leveling off (remember our first key finding !) with Consumption down about -2.0% and Sales down over -10%. Key thing to note - both dropped these last couple of months ! Investment wise new capital goods orders are truly cliff-diving, being down almost -25% YoY, Industrial Production (which is more coincident than lagging) following though the scale reduces the drop and Residential real estate improving only if you consider a change from -40% to -33% a vast positive sign. Good luck on that. The two things that drive a recovery in more normal circumstances are Consumption and Residential Investment. The former is going to be incredibly weak for a long time while the latter has enormous accumulated damage to repair. We'd say a long, drawn-out and very weak recovery is the best we can hope for.

Shifting gears what about that possible growth in future demand ? Well that's where we come full-circle. What drives Consumption is consumers ability to spend which depends on wages and employment plus their ability to borrow against their assets. At this point we hope everybody is clear that the late '90s stock bubble is never coming back and the Housing ATM that sustained spending, and the US and world economies, is likewise one with the Dodo. In fact given the state of bio-genetic research we consider it more likely that historical recovery and cloning of Dodo DNA is more likely to see the birth of new Dodos than seeing serious jumps in consumer spending for a long time. THE KEY INDICATOR is the YoY change in Real Wages plus Employment. That showed a steady drop as both weakened until Fall08 when the sudden drop in commodity-driven inflation drove up wages. Now W+E is dropping again and rather seriously. Part of that's due to the Employment pressures, which will worsen significantly over the next 18 months or so and continue to pressure spending. Worse the bad Employment situation, really coming full-circle now, is beginning to drive down Real Wages.

So now we've linked the macro-outlook to the long-term structural and secular trend picture and then to the immediate high-frequency indicators. We're in for a weak, U-shaped, recovery at best with the problems in Employment keeping the risk of an L-shaped recovery very real.

And NONE of this is being factored into any outlook or market advisories that we can see !

Economic Situation

No Growth Yet, But the Worst is Over Real GDP contracted at annualized rates of 6.3% and 6.1%, respectively in Q4:2008 and Q1:2009. These rates of contraction would appear to be the largest that are likely to occur before real economic growth commences in Q4:2009. After having contracted in the second half of 2008, real personal consumption expenditures grew at an annual rate of 2.2% in Q1:2009. Although we expect that real consumption will resume its contraction in the second and third quarters of this year before posting growth again in the fourth quarter, the worst seems to be over for consumer spending. While overall nominal retail sales declined by 0.4% in April, total nominal chain store sales increased by 0.6%. With more autos and trucks being scrapped than new ones being produced, it is highly likely that the bottom of motor vehicle sales has been reached. Perhaps the best summarizing statistic for the economic outlook is the index of Leading Economic Indicators (LEI). The year-over-year percent change in this index does a good job of identifying turning points in the overall economy. As Chart 9 shows, the year-over-year change in the LEI appears to have reversed from a declining to a rising trend. Again, the message is that although an outright economic recovery still lies ahead, the worst of the recession is likely behind us.

CONSUMPTION

More on Consumption in April PCE declined sharply in Q3 and Q4 2008, and rebounded slightly in Q1 2009. Q2 2009 is off to a weak start, with PCE in April below the levels of Q1. Although it is possible that PCE will pick up in May and June, it seems likely that PCE will be negative in Q2 (although not the cliff diving of the 2nd half of 2008). Usually PCE and Residential Investment (RI) lead the economy out of recession, and right now both remain weak. As households increase their savings rate to repair their balance sheets, it seems unlikely that PCE will increase significantly any time soon. Just a reminder - the end to cliff diving is not the same thing as "green shoots".

  • Graphs: Auto Sales in May May was the best month of 2009 (on seasonally adjusted basis), but sales are still on pace to be the worst since 1967. The second graph shows light vehicle sales since the BEA started keeping data in 1967. The small increase in May hardly shows up on the graph. In 1967 there were 103 million drivers; now there are about twice that many (205.7 million licensed drivers in 2007). Compared to the number of drivers, the current sales rate is the lowest since the BEA started tracking auto sales.
  • U.S. Autos Rebound: Too Little, Too Late Edition
  • ISM Manufacturing Shows Contraction in May As noted, any reading below 50 shows contraction, although the pace of contraction has slowed.
  • Construction Spending in April Private residential construction spending is 63.2% below the peak of early 2006. Private non-residential construction spending is 4.4% below the peak of last September. Nonresidential spending is essentially flat on a year-over-year basis, and will turn strongly negative as projects are completed. Residential construction spending is still declining YoY, although the YoY change is starting to be less negative. As I've noted before, these will probably be two key stories for 2009: the collapse in private non-residential construction, and the probable bottom for residential construction spending. Both stories are just developing ...
  • Many U.S. Retailers’ Sales Miss Expectations Shoppers searched for bargains and basics in May, leading many retailers to miss sales expectations on Thursday even though the bar was set pretty low for most chains. While there have been early signs of stabilization such as improving consumer confidence, issues such as unemployment and the troubled housing market have led many Americans to take on a thriftier attitude. Upscale department stores posted some of the steepest drops in sales at stores open at least a year, or same-store sales.

EMPLOYMENT

Job Losses in U.S. Slow More Than Estimated in Sign Recession Is Abating The U.S. lost fewer jobs than forecast in May, reinforcing signs that the deepest recession in half a century is starting to abate. Payrolls fell by 345,000, the least in eight months, after a revised 504,000 loss in April, the Labor Department said today in Washington. The jobless rate increased to 9.4 percent, the highest since 1983, in part as more people joined the labor force to look for work. “The recession is very close to an end,” said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts, whose payrolls forecast matched the closest estimate in a Bloomberg News survey. “The labor market is still pretty awful, but vastly better than it was.” The dollar rallied and Treasuries fell as optimism grew that the economy’s slump will soon end. Still, figures showing a drop in hours worked and slowdown in earnings indicate any recovery will be muted. Americans are spending less and saving more as home values fall and companies from American Express Co. to General Motors Corp. continue to cut back workforces. Another report showed consumer borrowing dropped by $15.7 billion in April, the second-biggest decline on record, as unemployment surged and loans remained difficult to get. Consumer credit fell at a 7.4 percent annual rate to $2.52 trillion, the Federal Reserve reported. Revisions added 82,000 to payroll figures previously reported for April and March, the Labor report said.

  • Employment Report: 345K Jobs Lost, 9.4% Unemployment Rate The unemployment rate rose to 9.4 percent; the highest level since 1983. Year over year employment is strongly negative (there were 5.4 million fewer Americans employed in May 2009 than in May 2008). For the current recession, employment peaked in December 2007, and this recession was a slow starter (in terms of job losses and declines in GDP). However job losses have really picked up over the last 8 months (4.6 million jobs lost, red line cliff diving on the graph), and the current recession is now one of the worst recessions since WWII in percentage terms - although not in terms of the unemployment rate. This is another weak employment report ... % Job Losses Since Peak in Post WW2 Recessions
  • Unemployment Compared to Stress Test Scenarios, and Diffusion Index This graph shows the unemployment rate compared to the stress test economic scenarios on a quarterly basis as provided by the regulators to the banks (no link). This is a quarterly forecast: in Q1 the unemployment rate was higher than the "more adverse" scenario. The Unemployment Rate in Q2 (only two months) is already higher than the "more adverse" scenario, and will probably rise further in June. Note also that the unemployment rate has already exceeded the peak of the "baseline scenario".
  • Employment-Population Ratio and Part Time Workers This graph shows the employment-population ratio; this is the ratio of employed Americans to the adult population. The general upward trend from the early '60s was mostly due to women entering the workforce. As an example, in 1964 women were about 32% of the workforce, today the percentage is close to 50%. This measure is at the lowest level since the early '80s and shows the weak recovery following the 2001 recession - and the current cliff diving! Not only has the unemployment rate risen sharply to 9.4%, but the number of workers only able to find part time jobs (or have had their hours cut for economic reasons) is now at a record 9.1 million. Part-time for Economic Reasons

Recovery ???

Bernanke: Recovery Will Be Slow Data suggest the economic contraction may be slowing, but the economy is hardly out of the woods, Federal Reserve Chairman Ben Bernanke told lawmakers on Wednesday. "A number of factors are likely to continue to weigh on consumer spending, among them the weak labor market, the declines in equity and housing wealth that households have experienced over the past two years, and still-tight credit conditions," Bernanke said. Bernanke said he still anticipates that the economy will start its recovery later this year, but cautioned that "recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring and the unemployment rate is likely to rise for a time, even after economic growth resumes." The Federal Reserve expects that the growth in inflation this year will be less than it was in 2008.

Krugman Says Global Economy Isn't Showing Any Sign of `V-Shaped' Recovery  Nobel Prize-winning economist Paul Krugman said the world’s economy is showing “not a hint” of a “V-shaped” recovery marked by a swift decline and revival. The economy is “stabilizing, not recovering,” Krugman, an economics professor at Princeton University in New Jersey, said today at a conference in Dublin. “Things are getting worse more slowly.”  Data this month showed that the contraction in Europe’s manufacturing and service industries is easing and confidence in the economic outlook is rising. The U.S. lost fewer jobs in May than forecast, a report today showed. The International Monetary Fund says its forecast for global growth of 1.9 percent next year is based on the premise of a healthy financial system. “We have made the transition from sheer panic to chronic anxiety,” Krugman said, adding he’s has a “hard time” seeing what might drive a “full” economic recovery. U.S. payrolls fell by 345,000 in May, the smallest decrease in eight months, after a revised 504,000 loss in April, the Labor Department said today in Washington. The U.S. policy response to the economic crisis has been “extraordinarily aggressive,” Krugman said. “Unfortunately, it hasn’t been enough.” The country will need “some form of new taxes” to bring down its deficit, he added. Service industries in the U.S. shrank at a slower pace in May while job losses mounted, indicating that any economic recovery will be slow to develop. “The euro zone, like the United States, I fear, could be facing kind of a lost decade,” Krugman said.

German central bank: economy to stagnate in 2010 Germany's economy will shrink by 6.2 percent this year and stagnate in 2010, the country's central bank said Friday, delivering a forecast more pessimistic than the government's. The Bundesbank said in its June monthly report that the new projection is "a reflection of the massive economic downturn" late last year and early this year. Gross domestic product shrank by 2.2 percent in last year's final quarter and by a massive 3.8 percent in this year's first quarter. "Downward pressure on the German economy is likely to ease during the course of 2009, although it does not look like there will be a significant upturn in the near future," the Bundesbank said in a summary of its monthly report. "With the gradual easing of tensions in the international financial markets, improved expectations, and with the support of extensive monetary and fiscal stimuli, the German economy could regain some ground in the third quarter," it added. The government forecast in late April that the country's economy, Europe's biggest, would contract by a post-World War II record of 6 percent this year but would return to growth -- albeit feeble -- of 0.5 percent next year. However, the Bundesbank, the national central bank, said it expects zero growth in 2010. "As things stand, economic activity is expected to remain at a subdued level in 2010, despite picking up slightly in the course of the year," the bank's report said. Germany's economy grew 1.3 percent in 2008, about half as much as the previous year. The country went into recession in last year's third quarter.

Credit and Policy Dilemmas

Fed's Yellen Says Treasuries May Reflect `Disconcerting' Inflation Worries  Federal Reserve Bank of San Francisco President Janet Yellen said that policy makers need to be prepared for “substantial shocks” and that rising Treasury yields may be a “disconcerting” signal of inflation fears. “Recent experience raises the possibility that the Great Moderation is behind us, so we must be prepared for substantial shocks,” Yellen said today during a panel discussion hosted by the Fed Board of Governors in Washington. “Great Moderation” is a term used to describe the comparative economic stability seen in the U.S. and other major industrial countries, except Japan, since the mid-1980s. Yellen’s comments on yields go beyond remarks made two days ago by Fed Chairman Ben S. Bernanke, who said in congressional testimony that the increases may reflect rising optimism about the economy and concerns about large federal deficits. Fed officials are starting to discuss how and when they will need to start tightening credit and pulling back the record injections of liquidity into the financial system. The central bank has more than doubled the assets on its balance sheet over the past year to $2.1 trillion to revive lending and end the recession. “We do not yet have good estimates of the quantitative impact of such interventions,” she said. “We simply must understand better, and ultimately develop reliable models of, the extraordinary financial and macro linkages that produced the current crisis.”  In addition, calculating the costs and benefits of leaving the benchmark U.S. interest rate near zero needs “to incorporate greater volatility than experienced over the past quarter century,” Yellen said. Yellen reiterated her view that she sees a stronger case for using Fed monetary policy to prick asset price bubbles that may lead to an economic crisis.

“Truly, we are sailing in uncharted waters, marking our maps with every bit of information along the way,” she said.

U.S. Consumer Credit Had Second-Biggest Drop on Record in April, Fed Says  Borrowing by U.S. consumers had the second-biggest drop on record in April as the jobless rate reached its highest in a quarter century and accessing loans remained difficult.

Consumer credit fell $15.7 billion, or 7.4 percent at an annual rate, to $2.52 trillion, according to a Federal Reserve report released today in Washington. Credit decreased by a record $16.6 billion in March, more than previously estimated. Spending by consumers declined for a second consecutive month in April as the unemployment rate increased to 8.9 percent, a level not seen since 1983. The number of people collecting jobless benefits broke records for 17 weeks before the end of May, causing Americans to put off purchases out of fear they might lose their jobs or take longer to find new ones.

Posted by dblwyo at 09:23 PM | | Comments (0)

June 02, 2009

Beyond Specifics to Principles: Business Performance Principles & Outlooks

Maybe an alternative and less exalted title would be value, focus, clarity, execution and integrity; all the virtues that a business enterprise should possess and few have repeatedly demonstrated during the drunken debaucheries of the last three decades. Case in point of course being GM's BK declaration with the accompany diagnostic litanies of the accumulated consequences of denial, avoidance, missteps and pretending the wolf is NOT at the door. Sadly when business executives fail this miserably the collateral damage for employees, communities, suppliers, lenders, investors and society as a whole are serious. Last post we waltzed thru several key industries so serve as examples of bad and good performance, aside from the current easy target of Finance, to remind us that these issues aren't limited to Wall St. nor Detroit. They are widespread and endemic. The questions, as always, boil down to who's swimming naked and who's a good swimmer. Now we're going to focus on some of the general requirements and principles starting with the classic - know when there's a rip tide and learn to deal with it. Put another way - don't ignore or deny economic realities. With Fri's GDP update verses Mon's startling market rally we'd have to say denial is currently the triumphant sentiment. Just to set the stage the chart shows YoY% changes in real GDP vs annualized QtQ changes. The latter is what the headlines report but the former is what you should be looking at to understand the trends, patterns and turning points. The headlines told us the Q4 GDP change was -6.3% and Q1 was -5.8%. Wow, let's party. The YoY numbers were -0.9 and -2.5%, respectively. Hmmm, let's not and batten down the hatches instead.

Facing Realities: Brave New Worlds

One of the more fascinating surveys that floated around was the readership of the business and financial news over the last couple of years. The "trade" press covered this evolving crisis fairly well yet, by and large, nobody paid any attention. Last week David Brooks the NYT OpEd columnist devoted a column to the kind of CEO's we're going to need in this new environment with David Brooks: In Praise of Dullness.Now as it happens we don't agree with all his points but that he covers it at all is noteworthy and that he's fairly accurate is important. What we need from CEOs is not flash but execution. What we'd add is that that execution cannot be the repeated execution of what's no longer working but has to be what will work in the new world we're facing. Yesterday the BEA also updated it's data on corporate profits and we extended our recent look see at the nature of profits as a result. For decades they rose in lockstep with GDP until the leverage deliriums of this decade. When you break it down it turns out that the real economy companies had a "slight" proft bubble as they curtailed hiring and capital investing but the real "magic", stretching back to the beginnings of de-regulation, was in the Finance Industry. That tells us two major things on the deepest structural level. First, the Finance Industry of the future will look nothing like that of the last three decades. Second, the regular OpCos (operating companies) need to re-think how they run themselves just about as badly. The question is will they ? We'll take up Finance some other time and focus now on "real business" performance challenges.

Key Principles Re-visited

We've spent some time comparing our approach to Buffett's and Drucker's as well as inventorying, from time-to-time, the headline exemplars of good, indifferent and bad performance. From that work we point back to this chart that combines Drucker's Fundamental Principles and the Theory of the Case. The readings section covers stories on the environment, key functions, leadership failures, human resource development and leadership changes for the future. Paul McCulley of PIMCO points out that things aren't going to get much better until 2010 and Jeff Immelt looks ahead to a business environment where performance will be challenged for many years to come; as we've just said and been saying. In the HR section we particularly want to point you a recent HBR article by our friend Bob Sutton on "How to Be a Good Boss in a Bad Economy". Superb article on the attributes in a crisis of excellent leadership - with which we have two major quibbles. Bob's checklist of ToDo's are representative of what these guys should have been doing all along, not just in a crisis they contributed to. But worse, the need to "Cowboy UP" is going to be with us for a long time. In the section on continuing leadership failures you'll find some evidence on how likely that is while in the final section you'll find some countervailing evidence of "green shoots" that may be the first indicators of the revival of management practices as we'd like to know them. You might want to pay attention to the review of Jim Collins' new book wherein he says, "hubris born of success; undisciplined pursuit of more; denial of risk and peril; grasping for salvation with a quick, big solution; and capitulation to irrelevance or death — offer a kind of instant autopsy for an economy on the stretcher. He writes that he’s come to see institutional decline as a “staged disease” The points being that the companies you're looking for are the ones who have answers instead of question marks.

Devil's Details: From Function to Synergy

We'll also point back to a simple chart that provides a conceptual illustration of how all the piece parts of the enterprise need to work together. When Michael Lewis wrote Moneyball: The Art of Winning an Unfair Game he not only documented a revolution in sports management that finally took the BoSox to two World Series titles after a multi-decade drought he started a conversation on performance management in general that's still going on. In discussion and theory, if not in actual practice. The graphic actually speaks to several of those key points: 1) it inventories each of the major functions that are essential for performance then 2) illustrates the linkages between them and their order (first basemen play first base and need those skills after all but also need to have the rest of the infield to work with) and 3) the performance of the whole enterprise is NOT just paying to much for each function, or not enough as the case may be. It IS about making all the pieces work together in the context of the whole.

In the readings you'll find selected stories on:

1) understanding how to think about telling the marketplace and your customers the right story, illustrated here by the lizard-brain messages implicit in various choices, but more broadly illustrative of the need to think about telling a true, accurate, honest story that represents real capabilities and puts the customer's needs and wants at the center of go-to-market strategies.

2) understanding and managing the realities of core operational capabilities, here illustrated with a discussion of the realities of manufacturing but also intended to make the point that core functional excellence is central to long-term business performance. Whether you make software, build cars (ahem), run retail stores or deliver packages real performance for real requirements is at the center of who and what you are. A notion that's been lost and neglected for a long time but one that the prosperers will see return to center stage in the future.

3) making sure the critical operating support functions, logistics and supply chain managment for example, meet and exceed to the requirements of the core, whether it's plants, stores or distribution operations. For almost four decades these functions have been the most sadly neglected of all yet they offer the most strategic promise for improvement. It's as if the Celtics got themselves a great center, two outstanding guards, a decent power forward and then, having spent their available salary budget decided to cut corners and recruit a junoir college player who was competent but not the kind of resource needed for the rest of the team to play up to their full potentials. Like we said and will keep repeating - performance is a team result, not a collection of individual players. There's a reason the US Men's basketball team got it's butts kicked in Athens and did so well in Beijing.

4) and another trip to the cesspit of technology management wherein the perennial lament of a continuing gap between IT and business receives yet more confirmation. Aside from logistics IT is the one major function of the enterprise that touches all others and influences their individual performance and also controls their ability to integrate with the other key functions as well as adapt to the future. Yet for decade after decade this same lament keeps getting repeated with not end in sight. We think there are two fundamental problems - Tech guys are fascinated by bright shiny things and tend to trap themselves in their silos. On the other hand Business guys are even more responsible because they're repeatedly failed to step up and provide the necessary adult supervision. The companies who have figured out how to bridge that gap are the same list of usual suspects from WMT to Fedex to Scwab who keep getting cited as strategic users of IT. Now where's the rest of the world ?

To try and pull this all together we're arguing that times are going to stay challenging for a long time, that effective responses to these challenges still seem to be all to missing in action and there's a checklist, a blueprint, of what to look for in potentially high-performing enterprises.

AND those are the ones you want to be on the lookout for !


Strategic Environment

McCulley Says No Significant Recovery Until 2010 Pacific Investment Management Co.’s Paul McCulley said the U.S. economy won’t show a significant recovery until 2010 as jobs are eventually created. “I really don’t see recovery worthy of the name until sometime in 2010,” McCulley, a partner and fund manager at Pimco, said in a Bloomberg Television interview from Newport Beach, California. “A recovery, to be self-sustaining, has to have job creation with it in order to get personal income and therefore consumption.” The number of people collecting unemployment insurance rose to a record in the week ended May 16 for the 17th straight time, reflecting restrained hiring, according to Labor Department figures released yesterday in Washington. The Commerce Department said today that the U.S. economy shrank at a 5.7 percent annual pace in the first quarter, capping its worst six- month performance in five decades. Pimco, the world’s biggest bond fund manager, expects long- term global growth rates to slow from historical levels as household and business balance sheets shrink.

David Brooks: In Praise of Dullness Should C.E.O.’s read novels? The question seems to answer itself. After all, C.E.O.’s work with people all day. Novel-reading should give them greater psychological insight, a feel for human relationships, a greater sensitivity toward their own emotional chords. Sadly, though, most of the recent research suggests that these are not the most important talents for a person who is trying to run a company. Steven Kaplan, Mark Klebanov and Morten Sorensen recently completed a study called “Which C.E.O. Characteristics and Abilities Matter?” They relied on detailed personality assessments of 316 C.E.O.’s and measured their companies’ performances. They found that strong people skills correlate loosely or not at all with being a good C.E.O. Traits like being a good listener, a good team builder, an enthusiastic colleague, a great communicator do not seem to be very important when it comes to leading successful companies. What mattered, it turned out, were execution and organizational skills. The traits that correlated most powerfully with success were attention to detail, persistence, efficiency, analytic thoroughness and the ability to work long hours. In other words, warm, flexible, team-oriented and empathetic people are less likely to thrive as C.E.O.’s. Organized, dogged, anal-retentive and slightly boring people are more likely to thrive. These sorts of dogged but diffident traits do not correlate well with education levels. C.E.O.’s with law or M.B.A. degrees do not perform better than C.E.O.’s with college degrees. These traits do not correlate with salary or compensation packages. Nor do they correlate with fame and recognition. On the contrary, a study by Ulrike Malmendier and Geoffrey Tate found that C.E.O.’s get less effective as they become more famous and receive more awards. What these traits do add up to is a certain ideal personality type. The C.E.O.’s that are most likely to succeed are humble, diffident, relentless and a bit unidimensional. They are often not the most exciting people to be around. For this reason, people in the literary, academic and media worlds rarely understand business. It is nearly impossible to think of a novel that accurately portrays business success. That’s because the virtues that writers tend to admire — those involving self-expression and self-exploration — are not the ones that lead to corporate excellence.

GE's Immelt says to get harder to achieve growth General Electric Co's (NYSE:GE - News) growth will be "harder to come by" in coming years given the prospect the global economy may grow at a slower pace once it emerges from recession, the company's chief executive said. Jeff Immelt said he would look to shift more of GE's resources to China and other emerging markets set to play a larger role in driving economic growth as tighter credit forces the U.S. consumer to rein in spending. "The basic engine of global growth for a long period of time -- maybe 25 years -- has been the U.S. consumer," Immelt said in a speech to clients, business partners and media in Tokyo. "The U.S. consumer is finally going to have to save." The global economy could settle at a slower growth rate once the recession runs its course, making it more difficult for the world's largest maker of jet engines and electricity-producing turbines to expand its business, Immelt said. "As consumers around the world get more conservative, we think that overall economic growth -- not just for a year or two but even post the recession -- overall economic growth may be slower," Immelt said. "Our focus on research and development, our focus on globalization, our focus on customer service and customers has to be increased... in an even more substantial way because growth will be harder to come by and we are going to have to work harder to get it."

Surviving the slump This special report will make several arguments. The pain will eventually end. American business will regain its shine. Many firms will die, but the survivors will emerge leaner and stronger than before. The financial sector’s share of the economy will shrink, and stay shrunk for years to come. The importance of non-financial firms will accordingly rise, along with their ability to attract the best talent. America will remain the best place on earth to do business, so long as Barack Obama and the Democrats in Congress resist the temptation to meddle too much, and so long as organised labour does not overplay its hand. The crisis will prove hugely disruptive, however. Bad management techniques will be exposed. Necessity will force the swift adoption of more efficient ones. At the same time, technological innovation will barely pause for breath, and two big political changes loom. In the next couple of years the businesses that thrive will be those that are miserly with costs, wary of debt, cautious with cashflow and obsessively attentive to what customers want. They will include plenty of names no one has yet heard of.Times change, and corporations change with them.

Critical Functions: Marketing, Operations, Supply Chain, IT & Innovation

Message in What We Buy, but Nobody’s Listening Why does a diploma from Harvard cost $100,000 more than a similar piece of paper from City College? Why might a BMW cost $25,000 more than a Subaru WRX with equally fast acceleration? Why do “sophisticated” consumers demand 16-gigabyte iPhones and “fair trade” coffee from Starbucks? If you ask market researchers or advertising executives, you might hear about the difference between “rational” and “emotional” buying decisions, or about products falling into categories like “hedonic” or “utilitarian” or “positional.” But Geoffrey Miller, an evolutionary psychologist at the University of New Mexico, says that even the slickest minds on Madison Avenue are still in the prescientific dark ages. Instead of running focus groups and spinning theories, he says, marketers could learn more by administering scientifically calibrated tests of intelligence and personality traits. If marketers (or their customers) understood biologists’ new calculations about animals’ “costly signaling,” Dr. Miller says, they’d see that Harvard diplomas and iPhones send the same kind of signal as the ornate tail of a peacock. Suppose, during a date, you casually say, “The sugar maples in Harvard Yard were so beautiful every fall term.” Here’s what you’re signaling, as translated by Dr. Miller: “My S.A.T. scores were sufficiently high (roughly 720 out of 800) that I could get admitted, so my I.Q. is above 135, and I had sufficient conscientiousness, emotional stability and intellectual openness to pass my classes. Plus, I can recognize a tree.” Most of us will insist there are other reasons for going to Harvard or buying a BMW or an iPhone — and there are, of course. The education and the products can yield many kinds of rewards. But Dr. Miller says that much of the pleasure we derive from products stems from the unconscious instinct that they will either enhance or signal our fitness by demonstrating intelligence or some of the Big Five personality traits: openness, conscientiousness, agreeableness, stability and extraversion.

  • Is marketing an art or a science? It's both, and that's the problem.Some marketers are scientists. They test and measure. They do the math. They understand the impact of that spend in that market at that time with that message. They can understand the analytics and find the truth.This sort of marketing works when it works, but it usually doesn't. That's because we're dealing with humans, the wild card in the system.The other marketers are artists. They inspire and challenge and connect. These marketers are starting from scratch, creating movements, telling jokes and surprising people. Scientists aren't good at that.

  • Re-building Corporate Reputations As governments respond to the financial crisis and its reverberations in the real economy, a company’s reputation has begun to matter more now than it has in decades. Companies and industries with reputation problems are more likely to incur the wrath of legislators, regulators, and the public. What’s more, the credibility of the private sector will influence its ability to weigh in on contentious issues, such as protectionism, that have serious implications for the global economy’s future.Senior executives are acutely aware of how serious today’s reputational challenge is. Most recognize the perception that some companies in certain sectors (particularly financial services) have violated their social contract with consumers, shareholders, regulators, and taxpayers. They also know that this perception seems to have spilled over to business more broadly. In a March 2009 McKinsey Quarterly survey of senior executives around the world, 85 and 72 percent of them, respectively, said that public trust in business and commitment to free markets had deteriorated.

The myth of US industry's demise Despite headlines about low-wage workers in China and our factory jobs going to India -- which has happened to some degree -- the U.S. is still far and away the biggest manufacturer in the world. U.S. workers produce 21% of all factory goods made globally, or about $1.7 trillion worth per year. That's significantly lower than the peak of 28% in 1985 but only slightly below the long-term average of 23% for 1970 through 2006. China, the second-biggest global producer, doesn't even come close. It makes just 13% of the world's stuff, or $1 trillion worth. Japan is next with 11%. And Germany, the vaunted workshop of Europe, comes in fourth with a paltry 7.4%. OK, so these numbers are from 2006, the latest data from the United Nations, which keeps track of these things. But China, the hottest contender for factory jobs, has been grabbing jobs from other Asian countries for the most part and not from the United States, says economist David Huether of the National Association of Manufacturers. So the U.S. lead over China in factory jobs may not have changed much since 2006. Here's other evidence of the strength of the U.S. manufacturing base: During the previous economic boom, manufacturing contributed more to U.S. growth than any other sector, Huether says. Though lots of factory workers have lost their jobs in the recession, U.S. manufacturing still employed 12.1 million people as of the end of April. Factory workers' daily toil contributed to 11.5% of the United States' product last year. Many U.S. factory workers are big earners, which lets them consume more, contributing more to growth. They made an average of $71,000 in 2007, or 20% more than the average of all other workers combined. States with the most factory jobs are California, Texas and New York.

Clarity Is Missing Link in Supply Chain The world's complex "just in time" manufacturing supply chains are making it increasingly tough for Zoran, and any other single link in the chain, to know what's going on just a few links away. Sometimes, Zoran itself doesn't even know how its own chips are used: One batch it thought was destined for DVD players instead turned up in digital picture frames. The recession has exposed a harsh side effect of the supply-chain system. Because modern industry rewards suppliers with the leanest inventories and fastest reaction times, when economic crisis struck, tech companies up and down the line contracted as sharply as possible in hopes of being the ones to survive. Forced to guess at demand for their products in a plummeting market, everyone hit the brakes, hard. An examination of the electronics supply chain -- from retailers all the way back to makers of factory machinery -- shows that, at almost every stage, companies were flying blind as they cut. The cumulative result: The tech pullback may have been overdone. In March, Best Buy Co. said it could have sold more electronics equipment in the three months ended Feb. 28, but its suppliers' deep cuts made it tough to keep shelves stocked. Suppliers "all decided to build a lot less," says Best Buy merchandizing chief Michael Vitelli. As the contraction raced down the supply chain, its effects became amplified. Rick Tsai, CEO of chip manufacturer Taiwan Semiconductor Manufacturing Co., has said that, in last year's final quarter, consumer purchases of electronics gear in the U.S. fell 8% from the prior year. But product shipments fell 10%, and shipments of the chips that go into the gear dropped 20%. The speed of the cuts are a big change from previous economic slumps. As recently as the early 2000s, companies compiled orders only monthly or quarterly; now they often do it every week. Their quicker reflexes this time kept their inventories from swelling dangerously, as happened last time, supply-chain experts say. This has consequences for economic recovery. Although U.S. gross domestic product fell 6.1%, on an annual basis, in the first quarter, nearly half of that was due to inventory reductions. Since consumer spending actually grew 2.2%, some factories might need to increase output, economists say.

IT Management Slideshow: Dirty Dozen: Inside 12 IT Disasters Learning from your mistakes is good. Learning from others’ mistakes is even better. We looked at 12 major IT failures to learn more about how and why they happened. Each example is unique, but they all have something in common: a chain reaction of pain that rippled through the entire business or organization. Whatever the specifics, breakdowns within the IT organization are rarely contained. They can lose a business customers, they can cause lawsuits, and in some instances they can even shut a business down.

Who Says Innovation Belongs to the Small? FOR more than a decade, the prevailing view of innovation has been that little guys had the edge. Innovation bubbled up from the bottom, from upstarts and insurgents. Big companies didn’t innovate, and government got in the way. In the dominant innovation narrative, venture-backed start-up companies were cast as the nimble winners and large corporations as the sluggish losers. There was a rich vein of business-school research supporting the notion that innovation comes most naturally from small-scale outsiders. That was the headline point that a generation of business people, venture investors and policy makers took away from Clayton M. Christensen’s 1997 classic, “The Innovator’s Dilemma,” which examined the process of disruptive change. But a shift in thinking is under way, driven by altered circumstances. In the United States and abroad, the biggest economic and social challenges — and potential business opportunities — are problems in multifaceted fields like the environment, energy and health care that rely on complex systems. Solutions won’t come from the next new gadget or clever software, though such innovations will help. Instead, they must plug into a larger network of change shaped by economics, regulation and policy. Progress, experts say, will depend on people in a wide range of disciplines, and collaboration across the public and private sectors. Today, Mr. Arthur said, the unfolding “digitization of the economy” is in some ways a modern rerun of past technology waves, from steam power to electricity. “It’s not individual inventions that matter so much, but when large bodies of technology come together and have an impact across the economy,” he said. “That’s what we’re seeing now.” In computing, some technological frontiers require size and deep pockets.

Executive Leadership (NOT)

 Shell Investors Revolt Over Pay Plan Royal Dutch Shell PLC, Europe's largest oil company, suffered a stunning rebuke Tuesday when investors shot down its executive-compensation plan, in the latest display of shareholder anger over big paychecks and boardroom excesses amid the economic crisis. Shell is the largest among a growing group of British companies whose shareholders have voted down compensation plans in advisory votes, including Royal Bank of Scotland Group, Bellway PLC and Provident Financial PLC. Large numbers of shareholders, though not a majority, voted against compensation plans at miner Xstrata PLC, oil major BP PLC, and Pearson, owner of the Financial Times. The Shell vote, although nonbinding, shows how the economic downturn has inspired a new activism among shareholders, particularly in Europe, and a greater willingness to challenge board decisions, especially those perceived as rewarding failure. In a charged meeting at Shell's headquarters in The Hague, which was broadcast live in London to U.K.-based shareholders, a succession of investors lined up to excoriate the board of the Anglo-Dutch company for awarding performance-based shares to executives despite the company's failure to reach its own internal targets. Investors gasped in disbelief when results of the vote were displayed. European investors are angry over bonuses that are relatively modest by U.S. standards. At Exxon Mobil Corp., the largest U.S. oil company, Chief Executive Rex Tillerson received a 2008 compensation package valued at $23.9 million, including $1.87 million in salary, a $4 million bonus and stock grants initially valued at $17.6 million, according to the company's latest proxy. Executives were supposed to get the performance-based shares only if Shell placed in the top three of its peers in a ranking of total shareholder return, based on its share price and dividend payouts. Shell placed fourth, but the board's remuneration committee decided to exercise its discretion and award the bonuses. Shareholders in London's financial district were met by protesters holding banners and handing out leaflets accusing Shell of human rights abuses in the oil-rich Niger Delta region of Nigeria. Stony-faced board members also heard strident criticism of Shell's investments in Canadian oil sands, which green groups have condemned as polluting, carbon-intensive and damaging to the environment. There was also strong disapproval of Shell's decision to back away from investments in renewables such as solar and wind energy.

CEOs Should Stop Spinning, Start Thinking Forget the charisma and the polished speeches. Those may have been the qualities top executives were judged on this past year, when every other chief executive was publishing a book, appearing on prime-time television or socializing on Facebook.com. But today, with everyone predicting a more volatile year ahead, business executives are going to be graded more heavily on whether the decisions they make on everything from strategy to talent help their companies grow. They have to stop becoming experts on giving a positive spin to economic warnings and start analyzing the data at hand. This is particularly the case in banking and on Wall Street, as the subprime-mortgage troubles continue to unravel. It's also true in the media and entertainment industries, where the rapid growth of the Internet is upending traditional media; and in pharmaceuticals, where the expiration of patents threatens old giants. In a bumpy business landscape where there are so many demands on executives' time, leaders must determine what's critical to their companies so they can mobilize their people to take action. And they can't assume that just because a rival is succeeding with a certain strategy, they will, too. That's the mistake many finance executives made in recent months. "What led to the subprime meltdown was a manic denial of good judgment because there were warning signs everywhere," says Mr. Bennis.

Human Resources Development

The Hubble: Real Men at Work It becomes easy to forget that most people go to work each day to succeed, not fail. Still, it was startling last week to catch sight on TV of men floating in space. This was Servicing Mission 4, NASA's long-scheduled flight to fix the space-based Hubble telescope. It was pure success. Anyone able to avert their eyes the past week from Speaker of the House Pelosi swimming in her own marinade of failure could have watched a team of Americans doing miracles in space for days. he Hubble telescope has become the Washington Monument of U.S. science -- beautiful, beloved and important. One of the astronauts who went up to fix it, astronomer John Grunsfeld, this week called it "arguably the most important scientific instrument ever created." Hubble's good now for at least another five years. Then, once and for all, it will fall apart. On departing the telescope, astronaut Grunsfeld called the week a "tour de force of tools and human ingenuity." And as well of training and raw smarts in the service of, hard to believe just now, nothing but human progress. Lessons abound in what one witnessed during the 11-day mission to restore the legendary Hubble, which ends tomorrow when the astronauts land in Florida. Here's one: Like the Hubble team, try to be lucky enough once in life to be part of a great project worked by great people -- the early Microsoft or Genentech, the Manhattan Project, the 1927 New York Yankees, many now-gone Wall Street financial "shops" at the top of their game, or the Iraq surge. It's an ethos of team-driven possibility caught in the famous title of a book, "The Soul of a New Machine." The mortal enemy of all this is bureaucracy. The Hubble project's struggle not to be strangled by bureaucracy was conveyed last year in a stirring history, and cautionary tale, by Robert Zimmerman -- "The Universe in a Mirror: The Saga of the Hubble Space Telescope and the Visionaries Who Built It." Worth a read. Across 20 years, several thousand very smart people worked on the Hubble project which, easy to forget, was always a line-item in the federal budget. As one of Mr. Zimmerman's reviewers noted, if the Hubble itself hadn't been so compelling, the political system would have killed it. Men broke themselves, their friends and families to get that thing into space.

Free PDF of "How to Be a Good Boss in a Bad Economy" to 98 Readers It’s not easy being the boss during a downturn. Your natural impulse is to focus on your own well-justified concerns, but your people are watching your every move for clues to their fate. • You need to rethink your responsibilities in terms of what your people may lack most in unsettling times: predictability, understanding, control, and compassion. • By making tough times less traumatic, you’ll equip your organization to thrive when conditions improve—and earn the loyalty of individuals who will remain in your network for years to come. Some years ago Robert Sutton led a workshopwith the senior managers of Procter & Gamble that touched on the importance of providing workers with predictability, understanding, control, and compassion. It turned out that his framework aligned with what they’d already learned in the context of plant closings. John E. Pepper, Jr., who was then P&G’s chairman, explained an internal analysis of the effects that management’s actions had on productivity, retention of employees who were offered jobs elsewhere in the company, and sales in the cities where the closings occurred. Plant closings did far less damage when leaders: 1. Announced the closing date and key milestones well in advance and described how events would unfold both for employees and for members of the affected community. 2. Explained in detail to employees and the community the business case for closing the plant. 3. Gave affected employees options for finding other jobs inside the company or resources to job hunt outside. 4. Expressed human concern—in public and in private—to affected employees and community officials. In other words, P&G executives saw the value of predictability, understanding, control, and compassion in times of distressing organizational change.

Leadership for/of the Future ???

For This Guru, No Question Is Too Big Within the sprawling and overpopulated world of self-styled gurus dispensing advice on management and leadership, Mr. Collins is in rare company. His last two books — “Built to Last” and “Good to Great” — were breakout hits, selling about seven million copies combined. Rather than presenting silver-bullet formulas that are easily forgotten, Mr. Collins’s books offer tangible frameworks for understanding why organizations succeed. His winning streak is about to be tested with his just-released book, which takes a turn, as he says, to the “dark side,” focusing on why companies fail. At any other time, it would seem a long shot, in that it lacks the upbeat message of his previous books. But his timing, given the number of once-great companies now in ruin, couldn’t have been better. Now the stages of decline that he maps out in the book — hubris born of success; undisciplined pursuit of more; denial of risk and peril; grasping for salvation with a quick, big solution; and capitulation to irrelevance or death — offer a kind of instant autopsy for an economy on the stretcher. He writes that he’s come to see institutional decline as a “staged disease” — harder to detect but easier to cure in the early stages — which is likely to foster a sense of corporate hypochondria in many readers. His new book, “How the Mighty Fall,” grew out of a discussion he led in the fall of 2004 at West Point, with 12 Army generals, 12 chief executives and 12 leaders of nonprofit organizations. Mr. Collins put this question on the table: “Is America renewing its greatness, or is America dangerously on the cusp of falling from great to good?” At a break, one C.E.O. pulled him aside and asked him a question that boiled down to, “How would you know if your successful company is on a path to decline?”

In a Word, He Wants Simplicity Q. What is the most important leadership lesson you’ve learned? A. Walking the talk is the most important lesson I’ve learned. There’s nothing that destroys credibility more than not being able to look someone in the eye and have them know that they can trust you. Leadership is about trust. It’s about being able to get people to go to places they never thought they could go. They can’t do that if they don’t trust you. Q. What have you learned to do more of, or less of, over time? A. I read something early on when I was in my first or second management role that you can accomplish almost anything in life if you do not care who takes credit for it. So I’ve tried to do more of that. And I’ve tried to do less of the things that make business more complex. I really like simplicity. At the end of the day, retailing - but you could apply this to many other businesses - is not as complicated as we would like to make it. It is pretty logical and simple, if you think about the way that you yourself would act, or do act, as a customer. Q. So you find that people make business more complicated than it is? A. No doubt about it. I think that all of us read far too many business books. I’ve worked 30 years now in management roles, and a number of times I’ve seen a new C.E.O. come in, and the first act is typically to get the leadership team to an offsite. And you get a consultant - because you can’t do it without a consultant - and the consultant then helps the team design a vision. And then you’ve got all these words, and several thousand dollars and a couple of days of golf later, you go back to the company to actually try to communicate that vision throughout the organization. So you hire another consultant to do that. It shouldn’t be like that. We have a very clear view of what we do for consumers around the world. And we can describe our complete strategy in 10 words. And that makes it very easy to get everybody energized and aligned. Q. So what do you think the process should be? A. I think the best source of strategy is your customer and the people who work for you. I’m not saying there’s no room for a vision statement or anything like that. I’m just saying that we tend to spend too much time on that and not enough on the more practical, down-to-earth requirements that drive business.

Tough Courage "Courage is going from failure to failure without losing enthusiasm," Winston Churchill said. He did not give in to defeatists. Instead he inspired a nation and its allies to greater sacrifice and eventual victory. A recession is like a war in that its effects dig deep into the fabric of a nation, and this time the world. This is our first serious world recession. Poor credit and bad investments circle the world like storm clouds. The earth has become one economic organism, like it or not. Churchill's admonition emphasizes enthusiasm, and that means taking dares. The only way we can count on ourselves is to be willing to embrace some level of pain. The natural reaction to bad times is to cut back. Trim the sails, hunker down, and wait for the wind to abate. But, as any sailor knows, taking charge in a storm means a lot more than hunkering down. It can mean steering in a precise direction to avoid a catastrophic breach. In a recession, every one should be on the bridge and not in the ship's bar. Regaining balance will be the result of combined courageous actions at command stations.

A Promise to Be Ethical in an Era of Immorality When a new crop of future business leaders graduates from the Harvard Business School next week, many of them will be taking a new oath that says, in effect, greed is not good. Nearly 20 percent of the graduating class have signed “The M.B.A. Oath,” a voluntary student-led pledge that the goal of a business manager is to “serve the greater good.” It promises that Harvard M.B.A.’s will act responsibly, ethically and refrain from advancing their “own narrow ambitions” at the expense of others. What happened to making money? That, of course, is still at the heart of the Harvard curriculum. But at Harvard and other top business schools, there has been an explosion of interest in ethics courses and in student activities — clubs, lectures, conferences — about personal and corporate responsibility and on how to view business as more than a money-making enterprise, but part of a large social community. Part of this has emerged by the beating that Wall Street and financiers have taken in the current economic crisis, which can set the stage for reform, Harvard students say. “There is the feeling that we want our lives to mean something more and to run organizations for the greater good,” said Max Anderson, one of the pledge’s organizers who is about to leave Harvard and take a job at Bridgewater Associates, a money management firm.

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