Dealing With the New Normal: Economic Situation, Market Outlook and Business Performance

8/14/2019 Dealing With the New Normal: Economic Situation, Market Outlook and Business Performance

1/29

Economy, Markets and Business:

Anticipating and Preparing for the New Normal

Llinlithgow [email protected]

January, 2010.

Economic Situation , Market Outlook and Business Performance Requirements

Economy +Geo-Politics

Industry

Business

Strategy

Operations
mailto:[email protected]:[email protected]


2/29

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System

both are improbable

Business is facing a decade of severe performance pressures .

. And its not clear that many are prepared or preparing!

y = 0.63x - 0.00

R2 = 0.62

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Output(YoY%)

Employment(Yo

Y

Employment vs GDP: 1960-2009

Real GDP growth of4.0% is required forbreakeven employmentgrowth of 2.5%.Expected growth of 2.5%leaves us short. Weneed 46 million jobs inthe next decade but willprobably get 20 millionat best.

Many businesses weresurprised by the depth ofthe downturn and not well-prepared.

Now they are struggling torecover.

Few are prepared orpreparing for a sustainedperiod of strains andchallenges.


3/29


both are improbable

The New Normal will not return to the old business-as-usual

Companies whose growth depends on the inclination and ability of the American consumer tospend are under pressure. Americans remain deeply pessimistic about the economy's currentstate, But consumers do not see themselves simply trimming on a temporary basis. One inthree (33 percent) strongly agree that changes to their lifestyles are most likely permanent. (GQRResearch. Fall, 2009).

How long will it take the unemployment rate to go back down to 5 percent? A rough estimate canbe obtained by looking at the rate of decline in the unemployment rate after recent recessions: ,or almost 7 years. (Mark Thoma, Economic professor. Dec.,2009)

We have not been on a sustainable economic track and that has to be changed. But thosechanges don't come overnight, they don't come in a quarter, they don't come in a year. You canbegin them but that is a process that takes time. (Paul Volcker, Der Spiegel. Dec., 2009).

Seven years later, what are the lasting lessons of Enron? There were two or three. This was a veryyoung and inexperienced management team, and I think both managementand possibly the

boardthought the good times could never end. That's one lesson: the good times do end. We'regoing through that right now. (William Powers, Enron CEO. Newsweek, October, 2009).

Plenty of lessons can be learned from the glut of businesses that have fallen under the swiftsword of a merciless recession. There are a number of mistakes being made, but the number onecause of failure is misguided strategynot sloppy execution, poor leadership, or bad luck. (PaulCaroll, Business@Emory. August, 2009).

Volatility is here to stay. What this does is force managers to harmonize two critical capabilities:on the one hand, strategic clarity and consistency; on the other, agility and resilience in

operations. This may seem counterintuitive, but organizations can handle extreme change onlywhen they can address it within a clear strategic framework. (C.K. Prahald, Businessweek.September, 2009).

Although it is true that most companies do not explicitly articulate an operations strategy, thedecisions made by operations executives ultimately produce or erode competitiveadvantage. Are you certain that your operations managers know the right choices to make orare they mindlessly pursuing best practices? (Tim Lasseter, BCG. December, 2009)
mailto:Business@Emorymailto:Business@Emory


4/29


both are improbable

Weve cycled thru a sequence of reactions, judgments and fears

and theres still a lot of confusion, uncertainty and doubts

Reading clockwisefrom the upper left

1.An already weak andslowing economy wastipped over into nearcollapse by thebreakdown of thefinancial and creditmarkets

2. Which resulted inwidespread panic which

was not out of line withpossible realities. It was anear-run thing

3. The collapse andconsequence was takenas the Death ofCapitalism but that wasexaggerated

4. If anything wevereturned prematurely tocomplacency with toolittle attention on deeprisks

5. And are facing a greatdeal of confusion andpuzzlement about whatsnext.


5/29


both are improbable

Two major sources of confusion assuming a calm economy isthe normal state and being surprised by storms.

- and not appreciating the underlying patterns!

The Economy follows the same recurrent patterns, driven by the same forces and

governed by the same relationships but the actual behavior varies considerably.

The challenge is to understand the structure and relationships and monitor the

changes in the forces to anticipate whats coming.


6/29


both are improbable

ConsumerConfidence

Consumer

Confidence

Consumer

Spending

EconomyBusinessInvestment

Hiring

Business

Business

Expectations

CREDIT

CREDIT

The GreatEconomic

Circle of Life

Consumer-led

Investment-driven

Policy-managed

Business Cycles:

Consumer-led Normal vs. Investment-driven Speculative

Economic Cycle

1. Any developed economy follows alinked cycle where the core engine is theConsumer driving the rest of theEconomy (65-70% in the US historically high).

2. Businesses respond by producing what

they can sell now and, IF demand isgrowing hiring more workers andinvesting in equipment and structures.

3. Part of their decision-making process isa multi-part Credit evaluation ofoutlooks, risks, financing andexpectations.

4. Going round consumers perform asimilar evaluation based on jobs, wages,expectations, uncertainties andasset/wealth & financing value

The last two bubbles were NOT based on

wage or job growth but were artificially

stimulated by leveraged asset-

appreciation

1. As the Economy moves around thecycle the result over time is a wave

pattern with repeating structures,relationships, timings, etc. that dependon how hard the wind is blowing

A Normal cycle is led by Consumer

spending

A Boom is driven by speculative

Investment (Tech, Real Estate)

When excesses correct the impact can be

years on the bottom without publicspending


7/29Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System

both are improbable

The economy has bottomed and is starting to recover

but employment lags and will lag for many reasons



both are improbable

The current state results from the links between the US andWorld economies, credit and equity markets and Housing

The LUV Outlook & Risks

1.The US Economy will have weakgrowth (U) and poor job creation

2. while Europe is facing a slower

and weaker outlook (L) and3. the developing countries are

likely to be more V-shaped with

4. some major structural challenges China in particular

China needs 6% growth for laborbreakeven and is

facing the structural change in an

export-led economy5. US Housing remains weak

6. Credit markets are self-repairingbut credit isnt flowing because ofbank balance sheet damage, lowerdemand and economic risks

Small businesses are vulnerable

Consumer demand is constrained

7. We think equity markets are over-valued on a $ carry trade and areexposed

PE Ratios are abnormally high

Economic growth will NOT be as

good as priced

Earnings outlooks optimistic

Likely priced beyond perfection



both are improbable

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1950-I 1955-I 1960-I 1965-I 1970-I 1975-I 1980-I 1985-I 1990-I 1995-I 2000-I 2005-I

GDP

PCE

GDPTrend

GDP and Consumption (yoy%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1980-I 1985-I 1990-I 1995-I 2000-I 2005-I

GDPx

PCE

Employ

GDP vs. Consumption vs Employme nt (yoy%)

Real economic data looks startlingly like the patterns weshowed . Telling us a lot about the future

1. GDP &Consumption havefollowed the cyclesince 1950

2. Both have turnedup but are still veryweak a post WW2record

3. Growth thisdecade was WEAK

4. The long-term

trend slowed andcliff-dove in theGreat Recession

1.GDP follows PCEbut Employmentfollows GDP

2. Employment hasNOT turned yet

3. It also shows asteady downtrendsince 1980.

4. Employmentgrowth was weakereach decade



both are improbable

In the short-run Retail Sales is a good high-frequencyindicator for the Consumer side of the economy

1. Both real andnominal salesabruptly fell off a cliff

in late 08, beenmarching long thebottom but now showsignificantimprovement.

2. They both remainnegative on a YoYbasis badly so.

1. Consumption tracksreal Sales thruout theentire business cycle.

2. The drop in thisdownturn was the worst

since 1960.3. Despite the upturn the

level remains very poor.

4. Growth in Sales (&Consumption) willdemand on Consumerdemand whichdepends on jobs andwages.

R2 = 87.3%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

RealNominalxAutoTrend

Retail Sales:(YoY%)

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

-6.0%

-4.0%

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2.0%

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8.0%

10.0%

12.0%Real Sales

GDPConsump

LT Economic Outlook:

GDP, Consumption, Real



both are improbable

-30%

-25%

-20%

-15%

-10%

-5 %

0%

5%

10 %

15 %

20 %

1993Q1 1995Q1 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1-5 %

-3 %

-1 %

1%

3%

5%

7%

9%

DGOrd

exAC

GDP

Capital Goods Orders vs Econo

Orders(xAC),Capex, Ind

-30.0%

-25.0%

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-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

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20.0%

1993Q1 1995Q1 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1

-15.0%

-10.0%

-5.0%

0.0%

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10.0%

xACOrds

Ca pe x

IndProd

Capital goods orders are encouraging though a directionalchange shouldnt disguise remaining weakness

1.Durable goods ordersand orders x-Aircraftsharply improved

tough still negativeand indicate betterpotential forinvestment spending

2. DG Orders and xACare still near 10%YoY. Things are muchless bad, not growing.

1.Economic activity(GDP) drivesIndustrial Productiondrives orders drivescapital spending in atypical cycle.

2. The order pickup is asign of improvingcapex potential.

3. BUT . Capex lagsas much or more asEmployment soequipment and techdemands are limited.



both are improbable

Residential Investment (new homes) are a critical driver ofgrowth . And remains in abysmal condition

1.YoY Changes in RImirror and drive GDPgrowth on a long

enough timeseries wefind that RI is aleading indicator.

2. RI is also turning upslightly on a YoYbasis, after reaching aterrible depth.

3. At 23% it remainsabysmal however.

1. RI has a steady-staterelationship around5% of total GDP foryears but was turnedinto a serious bubbleby financialengineering.

2. Relative to totalInvestment it isturning up more ameasure of reducedInvestment thanhealth.

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

1995-I 2000-I 2005-I

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

GDPx

RI

GDP vs. Residential Investment (yoy%)

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

1995-I 2000-I 2005-I

20.0%

22.0%

24.0%

26.0%

28.0%

30.0%

32.0%

34.0%

36.0%

38.0%

40.0%

RIGDP%

RIInvest

Residentia l Inve stmen t (RI) vs. GDP, Gross Inve



both are improbable

Housing has arrested its freefall but is a long way from healthy or even beginning to repair the sustained damage.

1. New Home Salesappear to be flatteningat a level at or below

the worst historicalone.

2. There is a worrisomegap between New &Existing Sales (existingsales dont contributeto growth)

1. The Inventory of NewHomes has improvedsignificantly butremains at very highlevels (comparable toprevious peaks).

2. Housing prices are at

more reasonable(affordable) levels butDO NOT appear tohave reset to priorlows leavingexposure.

3. THE goto source ofHousing is

CalculatedRisk.



both are improbable

60000

70000

80000

90000

100000

110000

120000

130000

140000

150000

1980Q1 1984Q1 1988Q1 1992Q1 1996Q1 2000Q1 2004Q1 2008Q1

Public

Private

Private Job Crea tion:1980-N

Net Private Job crea tion is ZERO since

LT Employment Tren

-14000

-12000

-10000

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-6000

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-2000

0

2000

4000

6000

8000

1980Q1 1984Q1 1988Q1 1992Q1 1996Q1 2000Q1 2004Q1 2008Q1

-3000

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0

500

1000

1500

AggNwJobs

NetNew Jobs

NewJobs

1.The US economyhas created ZEROprivate jobs in overa decade, since1999Q2.

2. It is the worstpost-war jobsperformance onrecord

The key to real growth, a healthy economy andfuture prosperity is JOBS, period.

1. Labor force growthmeans we need about150K/month +/- to stayeven.

2. Net New jobs is thedifference betweennew jobs and 150K.

3. A rolling total since1980 shows extremely

poor performance4. We entered the

Recession in the hole.

5. We are now 12.2million in the hole.

6. We estimate 46million jobs would beprosperity but

anticipate getting 20(BLS says 15!)



both are improbable

y = 0.63x - 0.00

R2 = 0.62

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Employment vs GDP: 1960-2009

y = 3.63x - 0.05R2 = 0.79

-25.0%

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-5.0%

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-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%

GDP (yoy)

Capex(yoy

Output vs Capex:1995-2009

y = 1.04x - 0.00

R2 = 0.74

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Consumption (yoy)

Output(y

Consumption vs GDP:1960-2009

y = 3.67x - 0.07R2 = 0.91

-25.0%

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-5.0%

0.0%

5.0%

10.0%

15.0%

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GDP (yoy)

Investment(yoy)

Output vs Investment:1995-2009

To understand the performance outlook follow clockwisearound the economic life cycle and read off the line

Consumption growth of 2.5-3.0% implies GDP growth of 2.0-2.5%, the outlook for next year. 2.5% GDP growthmeans Employment growth of


16/29

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management Systemboth are improbable

1. Demand (= YoY change in wages + employment) drives Consumption. Employment dropped but realwages went up as inflation fell due to falling oil prices. Now employment is flattening but labor marketpressures are causing wages to fall.

2. Continued weak labor markets will keep pressures on wages for the foreseeable future. The drop inDemand (on the monthly and quarterly) charts is worrisome and should be watched closely.

3. Economic growth becomes self-sustaining when organic demand leads to higher Employment and the

increase causes Investment to accelerate growth. The outlook is problematic for the decade.As it wasfor the last but no longer disguised by asset bubbles.

The single best indicator of demand is the change in real wages + employment and the critical question is whether the economy achieves takeoff velocitywhere growth becomes self-sustaining

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

J an -9 5 Jan -97 Jan -99 Jan -01 Ja n -03 Ja n -05 Jan -07 Jan -09

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%C o n s u mW+ E

Co n s u m p t i o n v s De

-4 .0%

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-1.0%

0.0%

1.0%

2.0%

3.0%

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J a n-9 5 J a n-9 6 Ja n-9 7 J a n-9 8 J a n-9 9 Ja n-0 0 J a n-0 1 J a n-0 2 J an-0 3 J a n-0 4 J an-0 5 J a n-0 6 J a n-0 7 J an-0 8 J a n-0 9-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

W +E W ag e s Em p lo

Future Dem and Com ponents:

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

19 65 Q1 19 70Q1 1 97 5Q1 198 0Q1 1 985 Q1 19 90Q1 19 95 Q1 20 00Q1 2 00 5Q1

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

GDP Co n W+E

LT Cycle Drivers: Consumption, Wages, Emplo

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

1 96 5Q 1 1 96 9 Q1 1 97 3 Q1 1 9 77 Q 1 1 9 81 Q1 1 9 85 Q 1 1 98 9Q 1 1 99 3 Q1 1 9 97 Q1 2 00 1Q 1 2 0 05 Q 1 2 0 09 Q1-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

W ag e s Em p lo y W +E( R)

Future Demand: Wa ges+ Employm

M th l i t th t i f lti t l


17/29


SPX: Nominal vs. Real

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

1400.0

1600.0

1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

SPX

SPXi

GDP vs. Profits

0

2000

4000

6000

8000

10000

12000

14000

16000

1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

GDP Profits

Profits vs. SPX

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

Profits

SPXi

Mythologies to the contrary economic performance ultimatelydrives profits, earnings and markets

1. These charts show normalizedrolling (cumulative) growth inthe SP500, Profits and GDPfrom 1960 thru 2009Q3.

2. That the markets went thru

two major aberrational bubblesin one decade is clear. Youhave to question whetheranother is possible.

3. Adjusted for inflation SPXperformance has not recovered(matching ~1998). More than aLost Decade.

Prior decades real performance

was not very good (looked at in

this framework)

50-68:UP, 70-85:DOWN,85-

95:UP, 95-09: Bubbles, Swings

and Range, 10-20: Range-

bound?

1. It is clear though that the SPXfollowed corporate profits-

more closely in the 60s/70s,diverging in the 80s, bubblingin the 90s and re-aligning inthe 00s.

2. It is even clearer that Profitsgrew with GDP, on the whole.Again very closely earlier.

3. ECONOMY PROFITSMARKETS

Economy

At t k t b i d i b lti l f t lti l


18/29


At any moment markets are being driven by multiple factors across multipletimeframes and have differential impacts on different asset classes.

1. A decision to invest in a particular asset isa bet on the four factors at the time youexecute explicit and deliberate or NOT.

2. The Four Factors are Structural,

Fundamental, Technical & Psychological Structural = long-term changes in basic

relationships (globalization, emerging

markets) Current: C/C-, better but jittery

Fundamental = business cycle phase and

asset performance (for equities business

performance) Current: C/C-, improving

Technical = are existing trends in the market

and (oddly) actually capture investorpsychology. Current: B/B-, deteriorating

Sentiment = investor perceptions, myths and

beliefs. Current: B/B-,dropping

1. The allocation among asset classes shouldreflect the state of the factors, the outlook,personal situation and shifts inunderstanding.

Too many US investors arent exposed long-

term to the right balance of foreign

investments

Allocations should be based on strategy.

Active management should see those adjusted

relatively frequently rather than held

constant.

Traditional weightings are 60/40

Income/Equity but a better strategy is risk

weighted

Structural Fundamental Technical Sentiment

Immediate

Short-term

Intermediate

Long-term

Structural Fundamental Technical Sentiment

Cash &Equivalents

Income Assets(Bonds)

- Domestic- Foreign

- Emerging

- ETFs

Equity Assets

Special Assets

- Real Estate

- Commodities

- Hedge/ PE

KeyFactor

AssetClass

Timeframe

KeyFactor


19/29


Markets have gone thru a lot of turbulence this year as last yearsdisruptions began to be stabilized, though were still not at normal

1. Markets went thru severalphases this year

Another near collapse as fears

of bank failure mounted

A relief rally as the Stress

Test and earnings rescinded

the argument

A flat market as the long-

term outlook was questioned

The beginnings of another,

milder rally based on a long

list of myths and a Dollar

carry trade funded by low Fed

rates

Another Flat market at the

end of the year

1. The question is what drovethings after August?

From August on the number

of arguments fromHyperinflation to China saves

us to Dollar collapse, to Gold,

and so on and so on were a

long list.

The Fed is maintaining

historically low rates which

means liquidity for

speculation is widely

available.

D ll G ld d E h t i i t


20/29


Dollar, Gold and Exchange rate comparisons in twotimeframes .

1. Gold (& Equity/Asset)Markets spent the entire yearlargely going up as the Dollarwent down and visa versa

The behavior was similar

across all markets that isthey are highly correlated.

Telling us fundamentals

arent driving.

There was a return flight to

the $ as sovereign debt fears

under-mined complacencies

1. The $ has had a longdowntrend this decade as theresult of trade imbalances and$ outflows.

This was interrupted by the

flight to quality fears last Fall

It was based on US consumers

borrowing abroad to continue

spending

As the world economy re-

balances and US consumersre-build their balance sheets

this will not continue

The $ will remain the

dominant reserve currency

for years or decades

Its probably reached the

bottom for now

D it ll th t th k t i i d t d


21/29


1. Markets were in a normal bearwhen the crisis hit, creatingchaos that almost collapsedthem last Fall.

2. And again this last Spring.Chaos is when things arecompletely unpredictable while

Turbulence can be analyzed butremains uncertain.

3. We are still in turbulentmarkets with serious riskfactors and an uncertaineconomic outlook

4. The recent rally has justtouched the upper bound on the

downtrend channel and hasalso retraced the 50% limit ofthe Fibonacci indicator from theOct07 highs to the Mar09 lows.

5. Were looking for a range-bound market with volatileswings for the rest of thedecade as misinterpretationstrump data & analysis.

6. Significant improvement fromhere will be based on

Upside surprises in the

Economy, especially

Employment

Continued trading and

speculative activity

Which depends on worldwide

Central Bank policy in general

and the Fed in particular

Despite all that the markets remain in a downtrend

The notion of a lost decade is widespread (now) but in fact weve been in a range-bound


22/29


both are improbable

The notion of a lost decade is widespread (now) but in fact we ve been in a range-boundmarket since 1997/1998 (which coincided with the topping out and relative flattening of GDPgrowth). Our outlook thru the decade is range-bound, wide-swing volatilities driven by moremythologies but reduced bubbles.

1. A Fibonacci indicator test

from the start of the 90sbubble to the 2007 peakshows us back at roughly the62% resistance level matching the intermediateterm analysis.

2. A horizontal resistance thattrims the 98/99/00 bubble alsotrims much of this last several

years and also definesanother source of resistancebeing approached. Thatcoincides with the Fib levels.

3. Taken all together weregoing to be in a range-boundTrading Market, are in onenow, and, if you believe theEconomic analysis, will be inone for a long-time.

4. Which puts a premium onanalyzing the factors drivingmarkets, assets, valuationsand performance.

5. And active investingstrategies and assetallocation management

There are two keys to understanding likely investment performance in this


23/29


both are improbable

There are two keys to understanding likely investment performance in thismarket: valuations and returns. Which define a 3rd the Margin of Safety, orthe difference between what you pay and what youre CERTAIN its worth.

1. From S&Ps long-runhistorical PE data (1936-2008)the avg. for 36-08 is 15.5 but

36-90 (pre-bubble) is 14.3 an8.4% difference.

2. From 36-99 the differencebetween the avg. and theactual tended to net out tozero, over the course of thebusiness cycle. As of 2008 itis as high as its ever been bya phenomenally large

proportion (2009 data NA).

3. Over almost any period oftime market returns arehighest when initial PEs arein the bottom decile. Implyingthat the likely returns at theselevels are poor, at best.

4. In a range-bound market

income investments (bonds)often out-perform equities.But there are market-cycleebbs and flows

5. An an active asset allocationand selection strategy iscalled for. Which requiresunderstanding theperformance outlook of the

asset.

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

Dec-36 Dec-46 Dec-56 Dec-66 Dec-76 Dec-86 Dec-96 Dec-06

PEAvg Av36-90Diff PETrendPEDiff Trend

LT Value Trends:PE Avg vsDifference

Diff is the difference between the 3MoMA of trailing PEand the 1936-1990 average.

Note that until this decade it was self-correcting but now has overshot significantly.


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both are improbable

Equity performance is driven by profits (and the economy) andneeds to be broken down into Finance and non-Finance industries.

1. GDP (lhs) vs. sector profitsshow Non-Fin & Finance (rhs)in $B from 1950 to 2009Q3.

2. Relative performance using a

rolling (cumulative)normalized scale shows Non-Fin tracking GDP until the late60s then lagging badly. It thensurged during the Tech boomand bubble this decade.

The NonFin bubble resulted from

restrained hiring, under-

investment and financial

engineering (buybacks) to maintainshort-term stock prices (bonus

consciousness?)

1. Finance growth was steadybut lagging until the late 70sbut, after a major drop,accelerated dramatically from83-00, largely as the result ofde-regulation. Beginning in 00

Finance profits bubbledspectacularly.

From 07 thru 08 the Finance

Industry destroyed the cumlative

profits back to approx. 1990.

Over half of those losses have been

recovered in the last three

quarters, largely on proprietary

trading.

Regulatory reform is not likely to

tolerate a continuation of excess

Finance profits.

GD P vs. Pro fits (no rm a

-100

0

100

200

300

400

500

600

700

19 50 Q119 55 Q119 60 Q119 65 Q119 70 Q119 75 Q119 80 Q119 85 Q119 90 Q119 95 Q120 00 Q120 05 Q1

-200.0

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

1400.0

1600.0

1800.0

GD P

NonFin

Fin

GDP vs. P rofi ts

0

2000

4000

6000

8000

10000

12000

14000

16000

19 50 Q119 55 Q119 60 Q119 65 Q119 70 Q119 75 Q119 80 Q119 85 Q119 90 Q119 95 Q120 00 Q120 05 Q1

0. 0

100.0

200.0

300.0

400.0

500.0

600.0

GDP

Fin

NonFin

BCG R h f d l j it f j ld id t i ht fl t


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both are improbable

BCG Research found a large majority of major worldwide enterprises were caught flat-footed by the downturn and protected profits by arbitrary cost-cutting. Recent researchindicates companies are still focused short-term.

1. Agile and resiliententerprises would anticipatethe downturn, act early andprepare to take advantage ofthe upturn.

Non-agile enterprises were slow to

react after being caught un-

prepared.

They also appear to be counting on

a vigorous upturn to avoid more

serious re-thinking of strategies and

operations.

Deeper restructurings require

improved controls and management

systems as well as new initiatives.1. The focus of cost-cutting has

largely been on short-termtrimming of existingoperations

Cost-cutting should NOT be evenly

spread across all operating

functions. Instead it should analyze

and weigh each function separately

and as part of the total enterprise.

Performance goals and cost and

investment decisions should be

based on the short- and long-term

performance potential of each

function.

1. In the business environmentwe will be facing there will bemajor profit and performancedifferences between

enterprises.

T t l R t E i (P fit ) X V l ti V l ti h ld1. Enterprise Performance


26/29


both are improbable

Total Returns = Earnings(Profits) X Valuation. Valuation shouldbe driven by Economic outlook. Profit IS driven by businessperformance in a difficult environment, which will persist!

te p se e o a cestarts with understanding thegaps between customerneeds and solution

Defines products and service

Business strategies and models

Operating strategies

Fundamental Value Proposition

1. It must be able to sell what itmakes as it Goes-to-Market(G2M).

Marketing is the process of

understanding the market and

making the market understand you

Sales is the process of direct contact

Service is the management and

delivery of an order

1. It must be able to Deliverwhat it promises whetherits making (Mfg), moving(Distributor) or Selling (Retail)

Operational effectiveness has

deteriorated more than any other

capability

Operations are NOT best practices

they are choosing the right ones,

running them efficiently (cost) and

effectively (enterprise value)

1. Management Systems aregenerally weak to extremelyweak

Establishing real goals with real

resources and measuring delivery

against plan is the heart of

performance.

Problem and

Value Focus

Key Operating Functions

Mfg, Logistics,

Procurement, etc.

Efficient locally

Effective

Linked x-function

Enterprise aligned

Marketing, Sales,

Service

Same Value message

x-linked

Efficient (operations)

Effective (business)

Management System

Budgeting

Operating Plan

Compensation

Infrastructure

VALUE

Op

erational

DeliveryG2M

Perform

ance

EXECU

TION

Enterprise

Performance

And

Value Delivery

A Business Enterprise exists to create and deliver value in the Market it must have the

right focus, strategy, ability to sell, deliver and execute to create value. And it must do so for

today and tomorrow simultaneously.


27/29


both are improbable

Initiatives & Focal Areas

Business performance improvement results from understand and assessing each

function by itself, in the context of the enterprise and balancing decisions across

functions based on overall performance contribution and potential

contribution.

StrategyMarkets & Products

Problem & Value

Profit/Business Model

Management SystemMetrics & Controls

Change Management

Environment & Culture

Communications + Incentives

OperationsMarketing & Sales

Customer Service

Procurement

Logistics

Core Operations

Product Management

Planning & Scheduling

Support Areas

TechnologyFinance

HR

Actions StatusResources

$ Staff Capital1 3 5 7 9Assessment

Each enterprise needs to 1) assess the current performance situation then 2) development a short-

term improvement plan based on that stress test. Next it needs to 3) develop a longer-term

strategic plan which 4) incorporates investments in new strategies and innovation initiatives. The

number of firms actually doing this would appear to be limited promising rather poor short-

term and long-term performance outlooks.

Magic is not in the shopping

list but in the blueprint

1. Knowing the functional

specifics

2. Knowing how to integrate

them for leverage

3. Orchestrating all the

moving parts into a whole

4. And in setting the right

goals realistically

5. And putting real

operating plans in place


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both are improbable

The key questions to ask of executive leadership are what is your

strategy and business plan and how are you going to deliver against

it? What should we look for in 10 months? 10 quarters? 10 years?

Initiatives & Focal Areas

StrategyMarkets & Products

Problem & Value

Profit/Business Model

Management SystemMetrics & Controls

Change Management

Environment & Culture

Communications + Incentives

OperationsMarketing & Sales

Customer Service

Procurement

Logistics

Core Operations

Product Management

Planning & Scheduling

Support Areas

TechnologyFinance

HR

Actions StatusResources

$ Staff CapitalPhase 1: Strategies & Objectives

Ope

ra tingPlan

Manag

ementSys tem

ActivityCo

ntrols

Strategic

&Business

Plan

Each stakeholder (employee, customer, supplier, business partner, investor) in any enterprise owes

it to themselves to understand what the current performance outlook is for every enterprise in

which they have an interest. They also need to understand how well that aligns with the

requirements of the New Normal, what the company is doing to meet those challenges, how it

plans to get from here to there and (most especially) how it plans to manage execution of thoseplans.

Every enterprise will face an extremely challenging environment and


29/29

Strategy without execution is fantasy Execution without Strategy is thrashing And without a Management System

Every enterprise will face an extremely challenging environment andneeds to prepare for it. Such preparation appears to be laggingrequirements.-Stakeholders should be asking key questions to test the performance outlook.

SUMMARY1.We are facing a weak recovery

Poor job creation

Weak demand growth

Rapidly developing economies dependenton export-growth will be especially

challenged

1.Markets appear to be anticipating animmaculate V-shaped recovery

Valuations are extremely high

Top PE decile returns are poor andbottom decile returns are the bestperformers

Investors need to adopt a more activeinvestment management and assetallocation strategy.

We are in a range-bound market and arelikely to be for the decade

1.Businesses are struggling to prepare

2.Investors need to focus on theperformance outlook

How do we m ake, deliver and support ?

Suppl iers ? How m any ? Manage ? C onnect ?

What mo ves ? Best way/mix ? S ervice Levels ?

Best layout ? Wo rkf low ? Skil ls ? Leanvs Bulk ?

Wh at features/funct ions for what markets ?

How do we synchronize the moving parts ?

OperationsProcurement

Logistics

CORE OPERATI ONSProduct Managemen t

Planning & Schedu l ing

Right Story to Right People Right Way ?

What targets ? Messages ? Methods ?

Find ? Prospect ? Develop ? Close ?

Order ? Pro cess ? Deliver ? Sett le ?

Support , Sustain and G row ?

Go-to-MarketMarket ing

Sales

Customer Service

What are we al l about ?What value do we create ?

Is i t sustainable or tempo rary ?

Wh o are we going to sell what ?

W h a ts it worth ?

How w i ll we make m oney ?Product, services, f inance ?

Subscript ion, Package, Per Ride ?

StrategyProblem & Value

Markets & Products

Prof i t /Business Mo del

Critical QuestionsKey A reas of Focus

How d o we m ake, deliver and supp ort ?

Suppl iers ? How m any ? Manage ? C onnect ?

What mo ves ? Best way/mix ? S ervice Levels ?

Best layout ? Wo rkf low ? Skil ls ? Leanvs Bulk ?

Wh at features/funct ions for what markets ?

How do we synchronize the moving parts ?

OperationsProcurement

Logistics

CORE OPERATI ONSProduct Managemen t

Planning & Schedu l ing

Right Story to Right People Right Way ?

What targets ? Messages ? Methods ?

Find ? Prospect ? Develop ? Close ?

Order ? Pro cess ? Deliver ? Sett le ?

Support , Sustain and G row ?

Go-to-MarketMarket ing

Sales

Customer Service

What are we al l about ?What value do we create ?

Is i t sustainable or tempo rary ?

Wh o are we going to sell what ?

W h a ts it worth ?

How w i ll we make m oney ?Product, services, f inance ?

Subscript ion, Package, Per Ride ?

StrategyProblem & Value

Markets & Products

Prof i t /Business Mo del

Critical QuestionsKey A reas of Focus

Dealing With the New Normal: Economic Situation, Market Outlook and Business Performance

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