A New Normal? Or Just More ‘New Era’ Thinking?

“Laissez-faire is dead…The all-powerful market that always knows best is dead.” (September 2008, Nicholas Sarkozy)

This is not a recovery, this is an “emotional, social, and economic reset.” (November 6, 2008, Jeffrey Immelt)

“…a nagging fear that America’s decline is inevitable…the next generation must lower its sights.” (January 20, 2009, Barack Obama,)

“The bubble has burst…this is a once-in-a-lifetime economic event…a fundamental economic reset.” (February 2009, Steven Ballmer)

“the new normal” and “potent cocktail – a self-reinforcing mix of De-leveraging, De-globalization, and Re-regulation… that disrupt the normal functioning of markets and the global economy.” (May 2009, Mohamed El-Erian)

On their face, recent events would seem to confirm what these eminent seers declared back in 2008 and 2009: capitalism, particularly in the developed economies, has descended into a “new normal” considerably less appealing that the buoyancy of the 50 years following World War II. Some straws in the wind:

· The 2010 book, The Great Reset, by Richard Florida is a prominent expression of the view that we are in a “new normal.” In essence, he argues that the Global Financial Crisis has triggered a reaction to the pervious era of unbridled consumerism, aggressive use of debt financing, winner-take-all corporate management, and so on. Though Florida does not court embarrassment by making an economic forecast on which an investor could act, he does argue that this reaction will be a long period of austerity not unlike the Great Depression (1931-1940) or the Long Depression (1873-1896) in American History.

· Prominent economists such as Robert Gordon, Tyler Cowen, Carmen Reinhart, and Kenneth Rogoff suggest that America may be in for a long slog of slow growth—I summarized their messages in a recent blog post.

· John Boehner, Speaker of the House, gave a speech last week in which he mourned the “new normal” economy that America faces and advocated every business and person to create wealth.

· At the other end of the political spectrum, Senator Bernie Sanders decried the “new normal” and wrote in the Guardian that “We must not be content with an economic reality in which the middle class of this country continues to disappear, poverty is near an all-time high and the gap between the very rich and everyone else grows wider and wider.”

· Trustees of pension plans and charitable endowments foresee mid-single digit returns on a diversified portfolio of investments in the future. This prompts them to propose cutting the typical investment draw rate, 4.5%, to something much lower, saying “get used to it; it’s a new normal.”

· The following graph shows the mentions of “new normal” in periodicals in recent years. Plainly, “new normal” is a meme, an idea that appeared with the collapse of the Internet bubble in 2001 and really surged in 2009. By now, it is an idea firmly rooted in the public consciousness.


Readers of this blog have seen my agreement that our recovery from the Great Recession will be slow. We are likely to return to higher employment that we experienced before the Global Financial Crisis only in the latter part of this decade. Certainly, our slow recovery to date is consistent with Richard Florida’s forecast in 2009.

I don’t have a crystal ball; and anyone who claims to have a crystal ball is lying. I do worry a bit when there is so much unanimity in a diverse population. Perhaps the unanimity is proof of “new era” thinking and a signal that conditions are about to change.

In a recent post, I highlighted “new era” thinking as a very important foundation of a market bubble—we can generalize “new era” thinking to be an attribute of major economic turning points, in the opposite direction. Research documents the tendency of markets to “overshoot” or overreact to changes in the economic fundamentals. For instance, retail investors tend to sell out well after the “smart money” and after prices have subsided to a level consistent with rational valuation; this added selling causes markets to “undershoot,” driving prices below levels consistent with a realistic outlook. There is a similar tendency for retail investors to buy in during the late stages of an economic expansion.

I wonder whether the ubiquity and persistence of the “new normal” meme signal a “market top” for this idea. In recent years, Jeremy Grantham, a iconic investment manager, has been almost Cassandra-like in warning about the perils of the “new normal.” But in his most recent investment letter, he acknowledges “two trends that might just save our bacon.” His dour letter won’t prompt dancing in the streets, but it certainly suggests a sea-change.

What are business leaders and investors to do with the concept of the “new normal”? Here are some suggestions:

First, challenge anyone who uses the phrase (your chief of forecasting, perhaps) to define it in any rigorous way. I’ve tried this with a cross-section of business practitioners and gotten some pretty mushy replies. Here’s the best I can say: a “reset” embodies the consciousness that this time it really is “different.” The “new normal” as triggered by a “reset” is a downward step-change in welfare, outlook, and self-confidence. A “reset” is transformational: big, costly, enduring, pervasive, and unanticipated.

The power of “new normal” and “reset” may be their usefulness to leaders in mobilizing constituencies at both ends of the political spectrum. The Left has harnessed this meme to motivate a stimulus funding program, health care reform, and re-regulation of the financial services sector. On the Right, the meme underpins a spirit of regime change displayed by Tea Party and Libertarian candidates who argue that most of what the government does is unaffordable now and in the years ahead. Thus, the meme has influence in the way that Humpty-Dumpty told Alice in Through the Looking-Glass:

‘When I use a word,’ Humpty Dumpty said, in a rather scornful tone,’ it means just what I choose it to mean, neither more nor less.’

‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’

‘The question is,’ said Humpty Dumpty, ‘which is to be master – that’s all.’

Next, it is worth asking, “Is this it? Are we in a “reset”?” Without a rigorous definition, how can we tell? The proponents argue that we are in a reset because it started with a bank panic, like other resets. It is global in scope. There is clear job destruction. The recovery is slow and is accompanied with a big transformation in various industries, such as housing and finance.

But on the other side are some possible objections. We have seen many bank panics and relatively few “resets.” The appearance of a panic in 2008 is not a perfect predictor of the next reset. Though the Global Financial Crisis rippled around the world, some regions (China, India, Brazil) remained buoyant for a considerable time. Though housing and finance were badly damaged in the crisis, sectors of the economy such as energy and health care showed relatively little harm. Though unemployment is worse than in many previous recessions, it remains a matter of considerable debate as to whether the unemployment is structural in nature, or purely cyclical. Deleveraging always occurs after a financial crisis. Anyway, when hasn’t the U.S. economy been in some stage of transformation?

Third, one should ask, “Is this “reset” like other resets?” The following table offers a profile that so far does not look much like the Great Depression, Long Depression, or the depression of the 1890s. The recent crisis and recession stand out for the very slow recovery, but not for the depth of the damage.



It’s a stretch to imply that the present “new normal” compares to earlier depressions. The current situation lacks the pervasiveness of antecedents. Nevada and the city of Detroit are devastated; Utah and Washington D.C. are not. Greece, Iceland, and Ireland are plainly in deep distress, but China and India have been relatively buoyant. Industries such as housing, financial services, and print media were hurting, but oil & gas, health care, agribusiness, and information technology barely broke stride.

The present social and political environment doesn’t compare well to historical examples. We have had rallies in Washington, Occupy Wall Street, and Tea Party populism, but have yet to see a populist presidential hopeful on the order of William Jennings Bryan (1896), the demagoguery of Huey Long and Father Coughlin (1930s), Coxey’s Army (1894), the Bonus Army (1932), the violence of the steel and Pullman strikes (1894) or the Molly Maguires (1875), and long bread lines of the Great Depression. Such kinds of events may yet appear in this cycle, but until they do, how can one be certain that we are now in “reset”? Pundits hopefully suggest that a political regime change is imminent in 2014 or 2016, though such is not unusual for the second term of a Presidential administration.

To be sure, the present high unemployment, low growth, fragility of the recovery, and fiscal deficits of the U.S. are serious, unsustainable, and unacceptable. They could unravel into another correction and serious social unrest if not reversed soon. In this sense, perhaps the events of 2007-2010 could better be labeled a “preset,” a precursor to a much bigger realignment that awaits the U.S. economy if fundamental problems remain unaddressed.

Fourth, one should ask, “If we are in a “new normal” triggered by a “reset,” when did it start? Most pundits reply that the “new normal” was triggered by the Global Financial Crisis of 2008-2009. But there are very plausible alternatives:

o 2001? Internet bubble pops, Enron, 9/11.

o 1989? Collapse of Soviet sphere; “end of history.”

o 1973? First oil shock.

o 1971? Abandonment of Bretton Woods system.

Economic historians some years from now will earn their pay trying to parse the actual onset of the “new normal” from the alternatives. Suffice it to say, if we can’t pinpoint the beginning, how can we be so sure of the ending, or even the very existence of the “new normal”?

Finally, one should fight acceptance of the “new normal.” Some folks I’ve met express a weariness with the slowness of the recovery: “New normal? So be it.” But this is defeatism. It is in no one’s interest for America to sustain the “new normal” for very long. James Pethokoukis argued this in a blog :

So what to do? One option is acceptance. Accept that we will never fully close the growth gap or income gap or jobs gap. Accept that unemployment will never return to the levels of the Bush and Clinton years. It’s time to move on and be grateful that America avoided an outright depression and isn’t suffering recessionary relapse as Europe is. The Dow and S&P 500 are making records, and home prices are again rising. Slow and steady is better than bubbles and busts, right? Forward!

The other option is defiance. Refuse to embrace the “new normal” reality. Refuse to lower expectations of what America can be. As Larry Kudlow likes to say, “Growth, growth, growth!”

Next November 14 and 15, Darden will host the sixth annual University of Virginia Investing Conference. The theme of the conference is “Finding Opportunity in an Unpredictable World”—this confronts the mentality of the “new normal.” Where can asset managers find attractive returns?

Industry experts from around the world, hosted by Darden’s faculty, will probe innovations and investment ideas that could help the decision-maker respond proactively to current conditions.


Speakers include:

Registrations for the conference may now be made. Reserve your seat today and gain some insights to deal with the “new normal.”

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A New Bubble? An Old Meme?

“A meme (pron.: /_’miːm/; meem) is “an idea, behavior, or style that spreads from person to person within a culture.”A meme acts as a unit for carrying cultural ideas, symbols, or practices that can be transmitted from one mind to another through writing, speech, gestures, rituals, or other imitable phenomena. Supporters of the concept regard memes as cultural analogues to genes in that they self-replicate, mutate, and respond to selective pressures.”

- Wikipedia

As my last couple of posts on the subject of a “market bubble” suggest, I harbor doubts about the justification for the buoyant markets (see this)—and at the same time, I emphasize that the definition of “bubble” is murky (see this); thus, how would we know a bubble when we see it?

I’m in New York today and convened a roundtable discussion of investment management professionals for Darden’s new Center for Asset Management. There, the attendees discounted the notion that the U.S. markets are in the early stage of a bubble. They pointed out that the correlation between GDP growth and the stock market has never been high, that the price/earnings multiples remain at a reasonable level, and that investors are still “under-risked” as indicated by the historically high percentage of assets held in the form of cash. The problem is that the world is awash in liquidity and returns are low because of financial repression by the central banks.

If this is true, then why is the concept of a “market bubble” on anyone’s mind? My guess is that it has been burned into our collective consciousness by recent experience. Mind you, the notion of a “market bubble” has been around since at least 1637 and the bursting of the Tulip Mania, or since 1720, and the collapse of the South Sea Bubble and the Mississippi Bubble. The longer history of bubbles is recounted in Charles Kindleberger’s book, Mania Panics, and Crashes and in Charles Mackay’s book, Extraordinary Popular Delusions and the Madness of Crowds—these are worthy readings for professionals in finance and investing.

But for much of the post-World War II era, the fear of market bubbles disappeared. Then, at the end of the 20th Century, the “market bubble” re-entered the collective consciousness. The following graph depicts the number of mentions per year of either of two phrases, “market bubble” or “economic bubble” as they appeared in newspapers and periodicals.


These data are drawn from Factiva with the help of Darden’s Reference Librarian, Susan Norrissey.

Note that the volume of references was virtually nil from 1978 to 1991. Then the number rose in the wake of the Tequila Crisis (1994), the Asian Financial Crisis (1997), the Russian Flu (1998), and the dot-com bubble (1997-2000) and its bust (2000). It is not surprising to see the lag between these events and subsequent increases in the number of mentions; as I have discussed in previous posts, it is difficult to make sense of a bubble and writers will continue to try as long as it sells copy. What is remarkable is that the concept of “market bubble” has remained an object of strong interest for so long.

My point is to suggest that “market bubble” is not just a financial concept. It has attained the status of a meme, “a unit for carrying cultural ideas, symbols, or practices…” And the graph suggests that it gained that status well before the Global Financial Crisis. We are a society that carries bubbles in our heads. And for good reason: the cascade of financial crises and panics over the past 20 years has taught us painful lessons.

These are uncertain times for investors. The forthcoming University of Virginia Investing Conference, November 14-15, 2013 at Darden will consider “Finding Opportunity in an Unpredictable World.” See the list of provocative speakers and sessions. Mark your calendar.

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My advice at Graduation 2013: Hang on, hang in, and make a difference

[Here are my remarks for Darden’s 2013 graduation ceremony. I foreshortened my talk a bit to help avoid some approaching rain. What follows is the full message.]

“Never confuse movement with action.” – Ernest Hemingway

Today’s ceremony is an historic event in that we honor the first graduating class of Darden’s Global Executive MBA program. These students traveled far to come to Darden; they traveled far during the program; and they will travel far as new MBA graduates. This prompts the following reflection.

This graduation season, the media will report a range of speeches by famous people, one common theme of which will be to exhort the graduating students to “move out, move away, and move on”—the notion being that they’ve had enough time with the cloistered academic life and that more growth awaits them out in the real world. It’s hard to argue with that—except that “move out, move away, move on” too easily becomes the mantra for professional life in general. Therefore, I choose to take the contrary view this season, and urge you to embark on a professional life where you “hang on, hang in there, and make a difference.” Let me tell you why.

The evidence is growing that professional life in business is not just mobile, it is getting a bit footloose:

  • It is said that today’s MBA graduates are more like entrepreneurs than true employees, and that they are more transactional than relational and therefore more prone to move around frequently. There’s an urban legend that the tenure of the MBA’s job with his or her first employer is short, about 18 months. I haven’t found any rigorous research to support this, but conversations with corporate recruiters seem to affirm this urban legend. You are not much wiser after 18 months than you were after your day of graduation. Nor are you much more valuable to the business community. In one of my blogs, I urged MBA students to think about making a commitment to stay awhile with their first employer—I called it the “five-year hitch.” I’m pleased to say that Darden graduates do stay longer with their first employer: only 17 percent of Darden graduates changed employers within 18 months. [1] And 41 percent of Darden graduates stay with their first employer for five years or more.
  • The behavior of many other MBA graduates mirrors the broader society. Surveys find that 61% of all employees are open to or are actively searching for a new job. And the median tenure of all job-holders is 4.4 years.
  • The median tenure of CEOs of the S&P 500 companies is even shorter: 4 years. In most industries, that’s a fraction of the time it will take to make a beneficial impact. And it’s barely enough time to learn the nuances of a complicated position, such as leader or general manager.
  • Then there is the statistic from census data in the U.S. that 13% of all households change address each year. Such mobility is even greater among 25 to 34 year-olds: 21% per year—this means that one out of five of you will move each year. Compared internationally, these rates of movement are high. America is an extraordinarily mobile society. Such movement is costly to communities, businesses, and charitable organizations, not least because your leadership is needed to tackle the problems and seize the opportunities that society faces. This contributes to a decline in social capital described by Robert Putnam in his book, Bowling Alone. Putnam wrote,

    “Television, two-career families, suburban sprawl, generational changes in values–these and other changes in American society have meant that fewer and fewer of us find that the League of Women Voters, or the United Way, or the Shriners, or the monthly bridge club, or even a Sunday picnic with friends fits the way we have come to live. Our growing social-capital deficit threatens educational performance, safe neighborhoods, equitable tax collection, democratic responsiveness, everyday honesty, and even our health and happiness.”

All of this movement is not lost on humorists. A journalist friend of mine, Bill Henry, once wrote a farewell column as he was leaving Boston to go to New York to take up a job with a big magazine. He said something to the effect of “When you’re young and in your twenties, you should live in Boston and pretend you’re still a student. When you’re in your thirties, you should live in New York and prove that you can make it in the big time. When you’re in your forties, you should move to Washington D.C. and pay your dues to society. And when you’re in your fifties, you should move to Los Angeles and pretend you’re a student all over again.”

Consider the alternative. George David, Darden MBA Class of 1967, worked for United Technologies Corporation for 23 years. He served as UTC’s CEO for 14 years. The year he retired, he came to Darden and spoke to our community. His message was that commitment to an enterprise and continuity of leadership are hugely valuable—they produce high levels of domain knowledge, which becomes the foundation for high performance. If domain knowledge matters, then keeping planted in one sphere is very important.

In contrast, George David’s chief competitor was Jack Welch, CEO of General Electric. Welch believed in the theory of the “best available athlete” as the criterion to fill any managerial position. For instance, in picking someone to run GE’s locomotive business, Welch might pick one who had been running operations in the light bulbs or medical equipment. His presumption was that if you’ve seen one operation, you’ve seen ‘em all.

George David had a different view. He believed in appointing managers who knew the business best. For him, that meant recruiting managerial talent carefully and then growing it over long periods in whatever business the candidates might be, such as helicopters, air conditioners, or elevators. The interesting thing is that Jack Welch’s successor, Jeffrey Immelt, has since disavowed the “best available athlete” theory.

Among Darden’s alums, I see some great examples of what it means to “Hang on, hang in, and make a difference.”

  • Paul Hamaguchi (Darden MBA 1970) lives in Tokyo, Japan, and is CEO of Higetu Shoyu Company, Ltd., a 400-year old producer of soy sauce. Paul has worked with that company since 1979.
  • Gordon Crawford (Darden MBA 1971) lives in Los Angeles where he has worked as a securities analyst and portfolio manager for Capital Research and Management for 40 years. Gordy rose to be a top expert in media and entertainment. He served as Chairman of Southern California Public Radio and Vice-Chairman of the Nature Conservancy.
  • Lem Lewis MBA 1971, was the first African American to graduate from Darden. He rose to EVP and CFO Landmark Communications in Norfolk and worked for nearly three decades with the company. Today he serves the community with his leadership. He’s on various charitable boards, including the Darden School Foundation. And he chaired the board of the Federal Reserve Bank of Richmond.
  • Elizabeth Lynch, MBA 1984, worked for Morgan Stanley for 22 years, eventually retiring as Global Chief Operating Officer of their Equities Research business. She has been a wonderful supporter of Darden and told the students in General Managers Taking Action, “Do new MBAs get it? I want to see commitment to culture, loyalty, and learning. Always be wary of the person who’s had three jobs in five years.”

My point is that these people had huge impact in their work and lives through long-term dedication to one organization. They hung on, hung in, and had an impact. Their ability to gain senior leadership probably had something to do with hanging on. About two-thirds of all CEOs of the S&P 500 companies were internal appointments; and on average, they spent 12.8 years with their company before being appointed.

So continuity matters; domain knowledge matters; and persistence matters. You can’t have much impact on the world around you if you are constantly on the move. Therefore, my advice is not “move out, move away, move on.” Rather it is “hang on, hang in, and make a difference.” Dive in to the challenges faced in your community. Make an in-depth study of your industry and your company’s products and services. Volunteer to help with anything. And invest deeply in building relationships within your firm—and not just with your bosses or peers; but start with the humblest employee in your space—this could be the person who delivers packages, or picks up trash, or serves your coffee.

I want to be clear that it may make a great deal of sense to “move out, move away, and move on” if you distrust the leadership of an organization, or if its ethics and treatment of people don’t meet your standard, or if you simply feel called into a different line of work. But even then, it may make sense to stand and fight for what you think is right. The distinguished economist, Albert O. Hirschman argued that “exit” is not always the desirable or rational response to a disagreement with an organization. What matters is the “voice” you can find and your depth of loyalty to the mission and values of the organization.

It may seem ironic that I’m standing here today to help you “move out, move away, and move on” and yet I’m giving you this message to “hang on, hang in, and make a difference.” Please understand, I’m not suggesting that you stay at Darden beyond today; but I am urging you to find your calling and do so with loyalty to your values and vision for society—and this will entail persevering to build the organizations on which society depends. That’s how you will have an impact with your career and how you will find fulfillment.

Please accept my best wishes to you all on your ability to “hang on, hang in, and make a difference.”

  1. Here are some results from our All Alumni Survey of 2012, which had over 2200 respondents from across the alumni population. (Note that the Classes of ‘08-’12 are not included as 5 years had not yet passed; this cohort shows 68% still in their first job.)
    image []
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A New Bubble? What New Era?

Are the markets going mad? That is a question many investors might have asked in recent weeks, as stocks in the UK, eurozone and US have soared – even as bond spreads decline.

* Gillian Tett, “Markets Insight: Phoney QE peace masks rising risk of instability


The public discussion of bubble-like conditions in the financial markets is missing the forest for the trees. Gillian Tett and others focus on data patterns, index movements, and other market metrics while ignoring the larger question of what is driving this behavior. Her title implies that it’s all about QE (quantitative easing) by central banks. The financial repression induced by QE is quite influential in the markets, but a “bubble” is motivated by much more, which I outlined in my just-previous post. As the radio commentator, Paul Harvey, used to say, “there’s the rest of the story.”

A key driver of a bubble is “new era” thinking, the belief in a new paradigm, the conviction that the rules have changed permanently, in some fundamental way. As Sir John Templeton once said, “The four most dangerous words in investing are ‘This time it’s different.’” Those words prompted the title of the iconic book on financial crises by Carmen Reinhart and Kenneth Rogoff.

“New era” thinking has preceded every one of the major market busts in recent memory. Leading up to the Panic of 2008 was the belief that housing prices could only rise and that demand for housing was practically unlimited. Leading up to the bust of 2001 was the Internet boom and the belief that new information technology would radically and rapidly change all business models (that may happen, but not at the speed believed in 1998-99). Financial crises of the 1990s in Russia, East Asia, and Latin America were brewed in visions of long-term rapid economic growth and the ability of those regions to handle massive inflows of “hot money.” I could go on at some length, but you get the picture.

If we are in the onset of a new “bubble” today, where is the “new era” thinking, and on what is it predicated? Consider these possibilities:

· Shale gas, fracking, and permanently lower energy prices for the developed economies. I can find no one who thinks this isn’t a big deal. Some of the analyses I’ve seen suggest that the economic impact of shale gas will be huge. But in the media it is hard to separate the rigorous analysis from the buoyancy and bloviation of “new era” thinking .

· Austerity works. Government actually reduces its debts and deficits without triggering revolutions or social unrest among the long-term unemployed and under-employed. Economies grow. Bondholders rejoice, as will Tea Partiers and Libertarians. This “new era” vision could be a long shot, as Keynesians will be the first to argue. But some radio talk show hosts make it seem just around the corner.

· New technology redux. Last week, I heard Jeffrey Immelt, CEO of GE, extoll the rise of the Industrial Internet, in which machines talking to one another will dramatically improve manufacturing efficiency and profitability. For instance, he says that such improvements have reduced the labor content of GE’s jet engines to only 5% of the total cost per engine. In Immelt’s view, enhancements in new technology will drive manufacturing back to America. This may be good for corporate profits, but what about employment and consumer spending?

And if you hang around a university long enough, you’ll hear late-night student bull sessions spin out many more possibilities. The three “new era” visions I mentioned are plausible; over time, any one of them could turn out to be true. But they sure warrant critical reflection. As Yogi Berra said, “It’s tough to make predictions, especially about the future.”

Critical reflection on the “new era” sentiments is how analysts and pundits could usefully shed some light. In particular, four dimensions beg for attention:

· Profitability. Bigger is not better. Better is better. The realization of more economic activity is useless if it does not generate benefits in excess of the costs to produce those benefits. How profitable will be the “new era”?

· Timing. How soon will the net benefits of the “new era” arrive? How long will those benefits last?

· Growth. Will the net benefits change over time? With they grow? Will they decay? How fast?

· Investment. What’s the outlay necessary to realize this future?

These four factors are the underpinning for valuing just about any asset and should prompt a host of probing questions about any of the “new era” scenarios.

In my experience, it is good questions, rather than fervent opinions, that mark the successful investor. I don’t think that the popular conversation is asking enough questions about the fundamentals that might possibly underpin the current market conditions.

Whether we’re in the early stage of a bubble or not, investors are well-served by critical thinking about firms and market conditions. You’ll find plenty of it at the forthcoming University of Virginia Investing Conference, November 14-15, 2013 at Darden. The theme of the conference is “Finding Opportunity in an Unpredictable World.” We already have a line-up of impressive speakers and stimulating sessions. Mark your calendar.

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A New Bubble?

“Recession-Plagued Nation Demands New Bubble to Invest In”

- The Onion, July 14, 2008.

‘When I use a word,’ Humpty Dumpty said, in a rather scornful tone,’ it means just what I choose it to mean, neither more nor less.’

‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’

- Lewis Carroll, Through the Looking-Glass

This kind of news is hard to make up: The Dow Jones Industrial Index topped 15,000 two weeks ago, setting a new all-time high and encouraging one writer to envision a Dow of 116,200. One journalist wrote, “You know it’s a big bull market when even some of the most disliked stocks muster huge rallies.” The VIX index (the so-called “fear index) is at a five-year low point, suggesting to some observers that investors must be throwing caution to the wind. I visited Miami recently and was told that boom-like conditions had returned to the market in condos there. Housing prices have risen over 12% nationally over the past year, prompting some analysts to mark the reappearance of a housing bubble. Stock market pundits acknowledge “animal spirits” at large in the markets but argue that the bull market still has a long way to run—yet other pundits say that the bull market in commodities and bonds has ended. Funds raised through Initial Public Offerings (IPOs) are up 50% over last year. Mergers-and-acquisitions volume is also up—along with a return to lofty pricing and with prominent contests for control affirming more animal spirits (viz: the bidding war for Sprint Nextel by Softbank and Dish Network; the buyout of Dell Inc. by Michael Dell and Silver Lake Partners at $21.3 billion; US Airways combining with American Airlines; Delta Air Lines buying 49% of Virgin Atlantic; Berkshire Hathaway and 3G Partners buying H.J. Heinz for $27.3 billion). Yahoo! paid $30 million for a news aggregation cell phone app designed by a 17-year old boy. Apple, Google, and Amazon recently spent huge sums on tech acquisitions. High-yield (lower quality) lending by banks has also increased sharply, prompting the Fed to wring its hands over the possible deterioration in lending standards and controls. Research suggests that the zeal of investors to buy the high-yieldclip_image002 paper is a direct result of the financial repression by the Fed: with interest rates at all-time lows (driven by the Fed’s quantitative easing) investors are reaching into riskier segments of the investment spectrum. By printing money, the Fed produces a cycle that distorts prices and leads to bad decisions by consumers, investors, and business leaders. With a yield to maturity on 10-year Treasury bonds of 1.9 percent and consumer prices rising at about 2.2 percent, lenders to the U.S. government are accepting a negative real return.

What is weird about these conditions is that neither the U.S. nor global economies are roaring along. Expected growth in cash flows is the #1 driver of asset prices. But GDP growth in Japan and Europe is at or below zero. The U.S. is shuffling along at about 2% per year, hardly fast enough to stimulate job creation or capital spending that would justify lofty asset prices. It would seem that “the falcon cannot hear the falconer”: prices are detached from reality.

Accordingly, we’ve seen the concept of an economic “bubble” return to talk shows, market commentaries, and dinner-table conversations. This is significantly a 21st Century phenomenon. A quick check of Google NGram Viewer shows that the mentions of “market bubble” really only took off in the late 1990s and peaked in 2008.

Are we there yet?

Certainly, recent conditions warrant heightened attention by regulators and investors. But whether conditions warrant more extreme defensive actions depends on two things: a) more clarity about boom-and-bust cycles, and b) greater definition of “bubble.”

Cycles. The reality is that booms and busts occur irregularly—but there is little or nothing we can do to prevent them. Market economies don’t grow smoothly. The long-term trend is composed of cycles that oscillate between expansion and recession. Bubbles are associated with expansive episodes, though not all expansions have bubbles. The key points are that there will be another financial bubble in the United States some day and that it will be difficult for regulators to recognize, much less forestall.

In our book, The Panic of 1907, Sean Carr and I outlined[i] the attributes of market “tops” that are associated with bubbles:

  • Relatively high and rising indebtedness of households, businesses, and governments. Carmen Reinhart and Kenneth Rogoff highlighted this attribute prominently in their book, This Time Is Different.
  • Dramatic rise in prices reflected in aggressively high valuation multiples and transactions.
  • Buoyant demand for the assets: oversubscribed initial public offerings in equities, numerous participants in auctions for companies, natural resources, and real estate.
  • Optimism about the sustainability of future price increases.
  • Entry into the market by naïve, inexperienced, and unsophisticated investors. Bernard Baruch sold his stocks in early 1929 when he started receiving unsolicited stock tips from his shoeshine boy.
  • Talk of a “new paradigm” rendering long-standing investment maxims invalid. Such was the case during the Internet boom. “This time it’s different” is one of the most dangerous attitudes in investing.
  • Jumbo M&A deals and Initial Public Offerings. These deals change the competitive landscape and/or frame of reference for investors. Travelers Insurance acquired Citicorp in 1998, signaling the end of the regulatory ban on universal banking. The audacity of jumbo deals serves to reinforce “new paradigm” thinking.
  • Innovations in deal design, new securities, technology, and goods and services. Leading up to 1907 were the creation of trusts, new national consumer-branded products, and the spread of the telephone, automobile, and household electricity. Leading up to the panic of 2008 was the aggressive creation of exotic asset-backed securities. Joseph Schumpeter heavily emphasized the role of the inventor and entrepreneur in triggering new phases in economic cycles.
  • Aggressive financing. Banks lower their credit standards to the benefit of borrowers who lots of cheap credit.
  • Regulators and other watchdogs relax their monitoring of financial intermediaries and investor behavior.
  • Positive economic news. A recent stretch of growth.
  • Media hype and considerable popular interest. Rising prices, huge profits, jumbo deals, often to the benefit of Everyman and Everywoman, garner front-page stories.

Judged against these criteria, it just doesn’t seem that the U.S. or global economies are in bubble-like conditions. Sure, if current trends advance aggressively, we could be in bubble-land.

Definition. Robert Shiller defined “speculative bubble” as “a situation in which temporarily high prices are sustained largely by investors’ enthusiasm rather than by consistent estimation of real value.”[ii] Shiller added, “The traditional notion of a speculative bubble is, I think, a period when investors are attracted to an investment irrationally because rising prices encourage them to expect, at some level of consciousness at least, more price increases. A feedback develops—as people become more and more attracted, there are more and more price increases. The bubble comes to an end when people no longer expect the price to increase, and so the demand falls and the market crashes.”[iii] The problem is that it is impossible to translate the textbook definitions of “bubble” into an operational or actionable concept. Peter Garber notes “bubble …is a fuzzy word filled with import but lacking a solid operational definition….if we have a serious misforecast of asset prices we might then say that there is a bubble. This is no more than saying that there is something happening that we cannot explain, which we normally call a random disturbance. In asset pricing studies, we give it a name—bubble—and appeal to unverifiable psychological stories.”[iv] Some economists, such as Allan Meltzer[v] and Olivier Blanchard[vi], allow that some deviations from fundamentals may be rational, as for instance, where a market price depends on its own expected rate of change. That is, perhaps the changes in asset prices will be self-fulfilling. Meltzer has written, “Bubble phenomena are what remain unexplained by [some rational hypothesis]. In this sense, bubbles are a name assigned to phenomena that may be explained by an alternative hypothesis….”bubble” is a name we assign to events that we cannot explain with standard hypotheses.”[vii]

At the core of the concept of a bubble is a sense of psychological instability. Alan Greenspan, chairman of the U.S. Federal Reserve Board expressed the concern on December 5, 1996 coined the phrase, “irrational exuberance” in suggesting that prices in the stock market might not be reflecting economic fundamentals.[viii] After the stock market had risen considerably further, on February 23, 1999, Greenspan was asked whether he still thought the market displayed irrational exuberance. He replied that irrationality is “something you can only know after the fact.”

The basic problem is that not all explosive movements in prices are bubbles, manias, or evidence of irrational exuberance. As Alan Meltzer has pointed out, asset prices exploded in Germany in the 1920s in response to the Reichsbank’s monetary expansion.[ix] Popular usage of “bubble” has been sloppy and perhaps self-serving. Humpty-Dumpty is instructive: “bubble” probably means whatever the writer or speaker wants it to mean.


It may be true that The Onion got it right, that investors are starting to build a new bubble. Certainly, that could be the consequence of a very expansive monetary policy. But I think that it’s just too early to tell and the whole concept of a “bubble” remains fuzzy. However, anxieties aren’t unwarranted. Maladroit unwinding of the Fed’s program of quantitative easing could trigger a sharp reversal of investor expectations, which might look like the bursting of a bubble.

[i] We developed this list from field observation and Shiller (2000), Kindleberger and Aliber (2005), Lowenstein (2004), Hunter, Kaufman, and Pomerleano (2003), and Caverley (2004). Caverley (page 13) offers his own abbreviated list. See the bibliography in Panic of 1907 for details on these sources.

[ii] Robert Shiller, Irrational Exuberance, Princeton: Princeton University Press, 2000, page xii.

[iii] Robert Shiller, “Diverse Views on Asset Bubbles,” chapter 4 in Asset Price Bubbles: The Implications for Monetary, Regulatory, and International Policies, W. C. Hunter, G. G. Kaufman, and M. Pomerleano eds. Cambridge, MIT Press, 2003, page 35.

[iv] Peter M. Garber, Famous first Bubbles: The Fundamentals of Early Manias, Cambridge: The MIT Press, 2001, page 4.

[v] Allan H. Meltzer, “Rational and Nonrational Bubbles” Chapter 3, in Asset Price Bubbles: The Implications for Monetary, Regulatory, and International Policies, W. C. Hunter, G . G. Kaufman, and M. Pomerleano eds. Cambridge, MIT Press, 2003.

[vi] See, for instance, Olivier Blanchard, (1979) “Speculative Bubbles, crashes and rational expectations,” Economic Letters 3, 387-389, and O. J. Blanchard and M. W. Watson, (1982) “Bubbles, rational expectations and speculative markets,” in Crisis in Economic and Financial Structure: bubbles, Bursts, and Shocks, P. Wachtel, editor (Lexington Boos, Lexington, MA).

[vii] Allan H. Meltzer, “Rational and Nonrational Bubbles” Chapter 3, in Asset Price Bubbles: The Implications for Monetary, Regulatory, and International Policies, W. C. Hunter, G . G. Kaufman, and M. Pomerleano eds. Cambridge, MIT Press, 2003, page 24.

[viii] Alan Greenspan’s speech is worth reading in full, and may be found at http://www.federalreserve.gov/BoardDocs/speeches/1996/19961205.htm.

[ix] Allan H. Meltzer, “Rational and Nonrational Bubbles” Chapter 3, in Asset Price Bubbles: The Implications for Monetary, Regulatory, and International Policies, W. C. Hunter, G . G. Kaufman, and M. Pomerleano eds. Cambridge, MIT Press, 2003, pages 23 and 27.

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Career advice: Go where the competition isn’t

This week I am in Shanghai, China, visiting with alumni of Darden, business leaders, government officials, and interesting companies. It’s refreshing to plunge into the business ecosystem here because of its buoyancy and optimism. Sure, there is frustration with state-owned enterprises, bureaucracy, air pollution, corruption, and government restrictions on freedom of speech. Yet this country is a magnet for global talent. Is it rational to reach for great career opportunities despite local frustrations?

The answer is “yes…if:” you envision opportunities unobtainable in more liberal and pleasant environments and you harbor the great passion to pursue those opportunities. In brief, you must be an entrepreneur, a go-getter, and quite persistent.

Jimmy Wei, (Darden MBA 2002) gave me a personal example of this spirit. A breakfast meeting with our alumni leadership here brimmed with expressions of the opportunities that drew Darden graduates here. Jimmy explained that at graduation from Darden, he accepted a job with McKinsey and Company in the U.S. Eventually, he decided to return to his homeland, China, where he held some general management positions with local companies before ultimately becoming a venture capitalist, investing in promising young companies.

Jimmy reminded me that on the final day of my courses I used to distribute to students an excerpt from a book by John Train, Preserving Capital and Making it Grow. Train pursued a remarkable career as investment advisor, government official, and writer. This particular book, published in 1983, is long out of print but is relevant today not least for its final chapter. The previous chapters give sage advice about investing one’s nest egg; in the final chapter, Train in effect asks, “if the previous advice bored you and you want to do better than the average investor, where should you go?” His reply has little to say about investing one’s money, and a lot to say about investing one’s time.

The final chapter is entitled, “For the Adventurous Few: How to Get Rich.” At Darden, we believe that business is about a lot more than getting rich; creating value is important, but business is also about treating others with respect, living according to one’s values, lifting society through one’s work and so on. If you allow for the distance of 30 years and allow richness to include Darden’s broader range of values, you will see in Train’s chapter a strong response to the question, “where should I work?” His answer resonates well among entrepreneurs, risk investors, and many MBA students: in effect, he says, “go where the competition isn’t.” This is sound and intuitive advice, delivered with flair and a bit of romanticism. The following excerpt catches much of the spirit that I detect among Darden’s entrepreneurs in East Asia.

* * *

(Excerpt from pages 191-197)

The first step is to stop thinking the way people do who don’t get rich. Almost none of my “successful” friends in the East are getting rich: They either started out that way or else just have good jobs, as law partners, bankers, company vice-presidents (plus a few presidents), or whatever. These friends of mine become respectable, but they don’t get rich, not the way people did in the old days or still do out West or in places like Mexico, Brazil, Spain, the Middle East, or Taiwan, with palaces in town, yachts, ranches here and there, and collections they eventually give to museums…

You can still get rich, although, as I say, you have to change your thinking. All these successful but non-rich friends of mine have modest, conventional points of view. They went to the right schools and colleges, they joined the right law firms, brokerage houses, or banks; they appear in the right clubs; they have deliberately turned themselves into professionals or corporate functionaires…The worst of it is that the lawyer or brokerage house vice-president knows that he isn’t needed…

So step number one is to abandon the entire Eastern respectable point of view, which prizes a safe seat in the shadow of the throne more than the magnificent reality. You have to think like an Elizabethan, an adventurer; like the American of a century ago, not his clerkish descendant of today. You must think as a builder, a conqueror.

Second, you must ask yourself: Where am I needed enough so that I can really get paid for it if I’m able to stand some risk and discomfort? The answer is, in the developing countries with idle resources–specifically, the ones that have sufficiently overcome their political hangups to be able to welcome capital and entrepreneurship for what it’s worth to them…Much of the world’s surface is lying fallow, useless to its population, for lack of entrepreneurs. If you are clever and energetic enough to make the grade in a good law firm, you probably have multiples of what it takes to play a role in building up a developing country. Never fear, the countries themselves know the score–they have investment codes, tax rates, and labor unions, not to speak of anti-free enterprise intellectuals; but the needs and opportunities are still so great that a trained and able person can reasonably expect to build an interest in something really valuable during his or her career.

In such places, it is taken for granted that one works hard, takes risks, creates something, and is well-rewarded for it, not an almost lost idea in the respectable Eastern Seaboard circles, where “new money” is mentioned in whispers. Young friends of mine have developed a minerals empire in British Columbia; created the principal agricultural-equipment distribution company in Central America; organized the Hong Kong television station; started a bottling company in Thailand; developed a large petrochemical venture in the south of Spain; organized a major investment bank in Madrid; put together a fertilizer complex in Korea; organized vineyards in Australia; I can cite dozens of such cases. Most of these people live magnificently, with swarms of servants who are delighted to have the work….

Let me describe the actual process. In the first place, you will have a much easier time if you know something valuable before you set off. A good grasp of investment banking (more precisely, the “deal business”) would suffice, or a degree in engineering plus a few years operating in a manufacturing company, or field and money-raising experience in oil or hard-rock geology, or a thorough knowledge of some aspect of finance, such as consumer credit or leasing, or of a consumer business, such as bottling or mail order sales. You must have a business sense and entrepreneurial flair. Ask a seasoned friend how he sizes you up. You also need six months’ or a year’s eating money, preferably borrowed from old family members. After you arrive in Vancouver or Caracas or Sao Paolo or Lisbon or Sydney or Denver or Singapore (one hopes that the place has been chosen rationally, a high growth rate being indispensable), ask around about the young Americans who are doing interesting things. Visit them. Call on a couple of banks and lawyers (preferably with letters of introduction from your own) and take soundings…Then visit the local development banker and whatever the ministry of development is called, and then the people who run the local and the U.S. Chambers of Commerce.

If you push right along, following up leads, within a couple of months you will have found three or four projects in search of an entrepreneur, including with luck, one or two where your expertise is applicable…In a month, you will have five telephone calls waiting for you each time you get back to your hotel, and after three months you can decide to work on two or three of these projects for a piece of the action and expenses–but no salary.

If you are always honest, energetic, and careful, then even if the first project doesn’t score, you will get a reputation for being serious, and after a while the solid groups will seek you out with something really worthwhile….

Why can’t all this be done in the States? It can, but the competition is much tougher. Any number of large corporations are constantly sifting through stacks of self-generated expansion possibilities. There are hundreds of competent deal makers in even provincial centers, and the real G.N.P. growth in sectors where individual entrepreneurs can function is more limited. In the United States you haven’t got the comfortable margin for error that you have in the developing country, where you have more opportunities, less competing talent, and a chance to look up the answers in the back of the book, so to speak, by bringing in foreign know-how….I am not talking about putting money into foreign ventures without going there. It will be lost. I am talking about going and staying, of committing your working life to a place that needs your energy, talent, and knowledge of a more advanced economy and will reward it. I can’t guarantee that this prescription will make you rich, but it probably won’t happen any other way.

Learned Hand put it better, as usual, “…in establishing a business, or in excavating an ancient city, or in rearing a family, or in writing a play, or in observing an epidemic, or in splitting up an atom, or in learning the nature of space, or even in divining the structure of this giddy universe, in all chosen jobs, the craftsman must be at work, and the craftsman, as Stevenson says, gets his hire as he goes…If it be selfishness to work on the job one likes, because one likes it and for no other end, let us accept the odium.


Why do we need academic degrees?

I regularly get cornered at a reception or dinner by an intense person who feels an urge to unload some unsolicited advice (N.B. see my earlier post, “The Advice We need.”) Usually the advice is idiosyncratic. But over the past few months, such advice has taken on a disquieting sameness, something like this:

It’s time to ditch degrees as the focus of higher education. “Know-how,” not book-knowledge, matters to employers and society. MOOCs, Khan Academy, and many other digital outposts enable the learner to tailor his or her learning to the acquisition of specific competences, such as bookkeeping, building spreadsheet models, or estimating an economic order quantity. Such tailoring democratizes learning by putting decisions about education in the hands of the learner. You learn what you want or need without all the extra stuff that some expert supposes you should learn. Credentials, such as bachelors and masters degrees, are authoritarian: someone else judges what’s right for your learning and tells you what to study. There are too many hoops to jump through to get the typical college degree; most of these have nothing to do with being useful or making a living. University degrees dominate society today. They suppress innovation and the flow of talent to where it’s needed. The revolution of competencies is coming. It will overthrow the credentialization of society and the institutions that promote it. Digital education is the spearhead of this revolution. Bring it on!

Uh…no. I doubt that we’ll see the eclipse of diplomas and degree programs any time soon. Society still needs them. This blog post explains why.

“Credential” derives from a Latin word, meaning to warrant creditworthiness, confidence, authority, status, or special rights and privileges. The Oxford English Dictionary defines it as “a qualification, achievement, quality, or aspect of a person’s background, especially when used to indicate their suitability for something…a document proving a person’s identity or qualifications.” A credential is typically a written document, for instance, a university degree. In modern business practice today, the term has a slightly archaic aroma. I can’t remember the last time someone asked me for my “credentials” though I’m regularly asked for “some I.D.,” a passport, a credit card, or a membership card.

Those who don’t like academic degrees focus on “competence” instead. The Business Dictionary defines it as:

“A cluster of related abilities, commitments, knowledge, and skills that enable a person (or an organization) to act effectively in a job or situation…a sufficiency of knowledge and skills that enable someone to act in a wide variety of situations. Because each level of responsibility has its own requirements, competence can occur in any period of a person’s life or at any stage of his or her career.”

The concept of “competence” is one of the cornerstones of human resources management today: it defines the requisites for employment promotion, raise in compensation, and skills development. And since “competent” is better than “incompetent,” it is the basis for hiring or terminating employees. All of this supposes that competences are measurable, an assumption that is the wellspring of the employee assessment field. A focus on competences is so pragmatic, but fraught with issues. How was the competence defined? Who measured it? How? What are the standards for distinguishing “just OK” from “very good?” Does the competence you acquired in New York mean the same to an employer in Shanghai? Can the specifications for a competence be scaled across a large organization without losing their relevance for a particular job or individual?

The problem with the opening sentiments is that they do not contrast competence from incompetence, but from credentials that are university degrees. But competences and credentials are not mutually exclusive. A valuable university degree probably requires the demonstration of a number of competences, such as written and oral communication.

And a valuable university degree entails so much more. Consider that a great educational experience envisions growth in three dimensions:

· Knowledge: names, dates, formulas, mechanics of how things work. This is the “know what” stuff of education. It is incredibly valuable because it frames the context for how one interprets one’s experience.

· Skills: public speaking, selling, negotiating, organizing a team, driving a car, fixing a leaky faucet. This is the “know how” stuff of education and is the main focus of vocational schools.

· Attributes of character: empathy, emotional intelligence, social awareness, work ethic, or personal integrity. This is the “know why” stuff of education.

Know what. Know how. Know why. The common definition of “competence” is so vague that it’s hard to pin down into just one area; but I would say that it is mainly about skills (know how) and less about context (know what) or character (know why).

Mastery of context and growth in character matter enormously in what it means to be an educated person. Knowledge is the foundation for pattern recognition, problem assessment and recommendation, and critical thinking. Consider the saying, “To a child with a hammer, every thing looks like a nail”—the child has a competence (hammering) but an inability to interpret her context in ways that discriminate actual nails from, say, a china vase.

Character is the foundation for action-taking. One might suppose that human trafficking is a competence, but is it a worthy activity? We want people who understand the moral and social consequences of their competences and take actions that are ethical.

Ultimately, a credential helps to define what it means to be a professional. Fields such as engineering and medicine require a formal credential, a license, to practice. The license is based on passing entry exams and completing university degrees. Business is less formalized though graduate degrees (the MBA) and specialized field certifications (accounting with it’s CPA and investing with its CFA) help to distinguish a higher level of professionalism for those who hold them. The business degrees and certifications are no guarantee against incompetence or unprofessional conduct, but they do suggest a higher level of achievement, mastery, and confidence in the individual.

My point is this: it’s not either credentials or competences; it’s “both…and.” We want people to be both competent and worthy. To focus exclusively on competences is to focus a way of doing. Academic degrees embrace the doing and they promote a way of thinking about the world and even a way of being in it: know what, know how, and know why.

The current rage about competences is especially relevant to business schools. Some would argue that b-schools could save a lot of time, money, and effort by distilling their instruction into a few “how to do it” modules. But focusing on competences and ignoring context or wisdom is one of the root causes of Enron’s collapse and the Global Financial Crisis. The world will be a better place if business leaders are broadly developed, and not just trained in a bunch of tools. Sure, the world needs people who are competent in the use of tools. But it also needs so much more. Don’t settle only for competences; get a degree.


Why Companies Transform: Standing Still Is Not An Option

It is not the strongest of the species that survives, nor the most intelligent, but the one most adaptable to change.

- Charles Darwin

A few days ago, Bill Utt, (Darden MBA 1984) dropped by to teach a class. Bill is the CEO of KBR, the Fortune 300 engineering, construction, and military contracting firm. Appointed CEO in 2006 as KBR was spun off from Halliburton, he encountered three distinct challenges as he prepared the company for life as a stand-alone company. It had an organization structure with levels of accountability that were too broad and undefined. He wanted to implement a clear and understandable culture of risk awareness. And he sought to create management information systems that would permit greater transparency, cost awareness, and financial discipline. Bill wrote to the students that “I expected that it would take two years to complete the three challenges…one thing I have learned over my career is that it is easy to develop a strategy and to find the organization’s deficiencies; however, the hard part is in the implementation and having the focus, determination and stamina to see these successfully through.” During his class session Bill described no fewer than three organization structures of senior leadership at KBR that he implemented between 2006 and 2013.

These visits got me thinking: why do businesses reorganize? And why are they such a prominent and recurring feature on the corporate landscape? New senior leaders are appointed. Lines of reporting are changed. Administrative procedures and information systems are updated. Boxes are moved around on the organization chart. Critics claim that this is all terribly distracting and of doubtful value. A Dilbert coffee mug says, “Change—What We Do To Give The Illusion of Progress.” If, as the critics allege, reorganizations are so bad, why do they remain such a regular and prominent feature of business life? Possible answers are the subject of this post.

Transformations, Restructurings, Reorganizations

Anecdotally, we know that businesses restructure or reorganize operations rather frequently to accomplish many possible ends: focus, diversify, save money, meet a crisis, and/or exploit an opportunity. A restructuring program at General Mills spanned two decades and consisted of many discrete transactions.[i] The restructuring of Thorn-EMI lasted 13 years.[ii] Walter Isaacson’s biography of Steve Jobs recounts how Apple Computer restructured repeatedly to stay ahead of changes in computing technology. And perhaps the most prominent example of corporate reinvention is Corning Glass, which renewed its organization several times over decades in response to changes in products, technology, and competition.


Seeking the Positive Motive for Reorganizations

Reorganizations and restructurings are a response to strategic threats and opportunities. Competition, technological change, and the product life-cycle can bring a challenging new phase of the firm’s existence—and reorganizations are a typical response. For instance, the economist, Joseph Schumpeter, wrote,

“The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process…The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization, that capitalist enterprise creates…The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. …Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction.”[iii]


Schumpeter’s explanation hints at a number of specific reasons why a firm might reorganize:

· Seize leadership, improve response time, or simply regain its mojo. The iconic business leader, Lou Gerstner wrote that the reorganizations that really matter are transformations that are “really fundamentally changing the way the organization thinks, the way it responds, the way it leads. It’s a lot more than just playing with boxes.”

· Sharpen strategic focus. A “transformation” can bring a portfolio of unrelated business activities into focus. A portfolio of disparate businesses requires senior management to master a wide variety of industrial concepts. But a portfolio organized around a focused strategy can exploit executive expertise in neighboring businesses. This motive proved to be decisive in the dismantling of conglomerate firms in the late 20th Century. And it helps to explain the reorganizations of multinational corporations, as they shifted among a structure based on countries or regions, a structure based on products or industries, or a matrix structure. How you organize the firm explains what you think is important.

· Improve accountability. A reorganization can help to align authority with responsibility, and ultimately, with results. Having a manager who wakes up every day to ask how to advance the firm in a strategically important area—and empowering that manager to do something about it—are key to gaining good results.

· Strengthen managerial incentives. A new structure can focus management attention on the efficiency of the business and align their interests more tightly with the success of that unit.

· Improve transparency. Often, a restructuring is associated with the implementation of new forms of reporting and measuring results of a business unit. This produces better feedback to managers and faster decision-making.

· Allocate scarce resources more effectively. Better accountability, incentives, and transparency often result in the better use of time, talent and treasure: fewer wasted meetings, a greater sense of personal impact on the enterprise, and wiser allocation of capital.

· Bring “fresh eyes” to bear on a persistent problem or new opportunity. When the game changes, it may be necessary to bring in leaders who will be more effective under the new rules. When the Internet stole classified advertising away from newspapers, publishers awakened to the fact that they did not know much about online advertising. And the availability of “big data” meant that news organizations would need to develop new talent to tease insights out of new data sources. These kinds of changes produced significant changes in management and organization structure.

Thinking Critically about Reorganizations

Some firms reorganize, but for the wrong reason. For instance, in Deals from Hell, I wrote about Tyco International. In January 2002, Dennis Kozlowski, CEO of Tyco, announced a radical restructuring plan for the firm that would break Tyco into four segments. The transaction would entail three spin-offs. Kozlowski argued that the firm would be worth 50 percent more after the restructuring.[iv] Securities analysts were mystified by the announcement. Tyco had been the target of SEC accounting investigations. An analyst said, “To me, it smells a little bit fishy. If you are a public company and people are pointing the finger at you, I wouldn’t think your first reaction would be to split up and make things confusing for investors. Here is a clear effort to break up one company and make it a more complicated company.”[v] The spin-off announcement triggered a 58 percent decline in the firm’s share price. But this was only the beginning of a dramatic unraveling of Tyco’s strategy of growth by acquisition. Kozlowski was fired and later indicted on grounds that he looted $170 million from Tyco in unauthorized compensation and $430 million in fraudulent stock sales. The indictment accused him and another executive of running a “criminal enterprise.”

Some research[vi] suggests that restructurings, reorganizations, and transformations are associated with better financial performance. However, the practitioner should scrutinize blanket assertions about the value of these actions. The example of Dennis Kozlowski and Tyco International reminds us to think critically about any proposed reorganization. There are at least four tests to keep in mind:

1. Is it motivated by the purpose, mission, and vision of the organization? This first question helps to fight the evils of sheer impulse and opportunism. If you don’t know where you’re going, any road will take you there. Using reorganizations just to solve tactical problems is the bad road; the good road is to use reorganizations to advance the mission of the firm.

2. Does the proposed structure follow the strategy? Structure should follow strategy—this was the lesson of one of the most influential business books of the 20th Century, Alfred Chandler’s, Strategy and Structure: Chapters in the History of the Industrial Enterprise.

3. Will the implementation of the reorganization bring out the “better” in people? This question addresses the “how” of restructurings and should raise considerations about communication, engagement, accountability, transparency, and incentives.

4. Why now? This invites a consideration of the specific situation of the proposed reorganization. The sudden shift in demand for your products, the entrant of a new competitor into your market, or a change in technology or regulations could trigger a revision of your strategy and thus, a change in the organization structure.

Conclusions for Leaders

Bill Utt reorganized the leadership of KBR three times in seven years because the strategic landscape changed sharply and he felt an enormous obligation to the stakeholders of the firm to get it right. The Global Financial Crisis and Great Recession triggered a slump in construction spending and then a slow recovery. To some extent, the ongoing reorganization of a firm is a discovery process. Bill Utt is candid in admitting that “the hard part is in the implementation and having the focus, determination and stamina to see these successfully through.”

Charles Darwin got it right: the ability to adapt is the key to survival in a world of relentless change. While he was writing about evolutionary biology, his notion is nonetheless relevant to businesses and other kinds of organizations. History is replete with examples of firms that failed to adapt to change. Perhaps they tried to reorganize but didn’t do it effectively, or didn’t reorganize at all. Think of Eastman Kodak and Polaroid confronting the advent of digital photography; integrated steel mills versus the advent of mini mill technology; and more recently, newspaper publishers facing the Internet. Many organizations in society today suffer from ills owing to an inability to change with the times: these include some religious institutions, governments, unions, and yes, universities. As Darwin vividly showed, adaptation is never easy. But for many organizations there is no alternative. Standing still is not an option.

[i] Donaldson, G., 1990. Voluntary Restructuring. Journal of Financial Economics 27, 117-141.

[ii] See: Kaiser, K., and Stouraitis, A., 2001. Reversing corporate diversification and the use of the proceeds from asset sales: The case of Thorn EMI. Financial Management 4, 63-102.

[iii] Schumpeter, J. A., Capitalism, Socialism and Democracy, New York: Harper & Bros., 1950 3rd. Ed., pages 82-84.

[iv] Sorkin, A., 2002. Market place; Investors react negatively to Tyco’s new, and abrupt, breakup strategy. New York Times , January 24. Downloaded from http://query.nytimes.com/search/restricted/article?res=F70810FE355F0C778EDDA80894DA4044.

[v] A quotation of Ron Taylor, Schaeffer Investments in Cincinnati, in Fakler (2002).

[vi] For a summary of such research, see Chapter 6 of my book Applied Mergers and Acquisitions.

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The Advice We Need

Dear Abby: I have always wanted to have my family history traced, but I can’t afford to spend a lot of money to do it. Have you any suggestions? — M. J. B. in Oakland, Calif.

Dear M. J. B.: Yes. Run for a public office.

Dear Abby: My wife sleeps in the raw. Then she showers, brushes her teeth and fixes our breakfast — still in the buff. We’re newlyweds and there are just the two of us, so I suppose there’s really nothing wrong with it. What do you think? — Ed

Dear Ed: It’s O.K. with me. But tell her to put on an apron when she’s frying bacon.

The author of these replies was Abigail Van Buren, who wrote the popular “Dear Abby” advice column. Her recent passing prompted reflections on her craft, wisdom, and wit. You will find no science or grounded analytics in Abigail Van Buren’s advice. We read her work mostly for pleasure. But her cheeky, abrupt, and even snarky replies offered kernels of insight or advancement. Like Mark Twain, Finley Peter Dunne, and Will Rogers, she presumed to lift the reader through aphorisms and one-liners that were humorous and memorable. She showed an excellent instinct for who had what at stake. And she rarely gave advice without suggesting some kind of action—in her case, it was often impractical and hilarious; but she was trying to entertain readers, not fix a company. She was less an adviser Yet her writings serve as a foil for thinking about an important question: What kind of advice does a decision-maker need?

The world has no shortage of advice about giving advice—if you Google “the advice we need” you get some 17 million results. Deans get a lot of advice—much of it unsolicited. An awful lot of it. After eight years of deaning, I consider myself something of an expert in listening to advice. Through experience and years of engagement with decision-makers, I have concluded that good advising is a rare talent—and that it is learned, not inherited. This bestows a grave responsibility on all professional schools: it is not sufficient to train rising generations of professionals to diagnose problems; schools must also instill the grace and skill to convey advisory wisdom.

Advisory skill is based on tacit knowledge: “tacit” is drawn from a Latin word, meaning “touch.” Good advising is learned by touch, by human engagement, typically in close association with a mentor. For this reason, many professions required apprenticeships before granting full license to practice. There is a role for higher education in this. The measure of an excellent professional degree program should include the student’s growth in advisory skills.

There are few models on which to base such training. Perhaps we could look to iconic advisers in history; but rarely did they leave any expression of philosophy or tradecraft on which to base training. Marvin Bower was an important exception. He built McKinsey & Company into a leading consulting firm on the basis of principles about advising and left a legacy of writings on which to draw. In a eulogy of Bower, John Byrne wrote, “He [insisted] that values mattered more than money. He preached the notion that consulting was not a business but a profession, arguing that, like the best doctors and lawyers, consultants should put the interests of their clients first, conduct themselves ethically, and insist on telling clients the truth, not what they wanted to hear.” A colleague of Bower’s said, “He was plenty smart and plenty stylistic. But what I admired most was his absolutely compelling, unemotional logic, absolute disarming candor, a directness that was completely untainted by self-interest, and his unwillingness to mince words….The last thing you came away with was that Marvin was absolutely relentless in constantly thinking about how to make us better.” [1] Bower expressed key principles of management advisory work in a 1937 memo, which Fortune Magazine summarized this way: “A McKinsey consultant is supposed to put the interests of his client ahead of increasing The Firm’s revenues; he should keep his mouth shut about his client’s affairs; he should tell the truth and not be afraid to challenge a client’s opinion; and he should only agree to perform work that he feels is both necessary and something McKinsey can do well. Along with the professional code, Bower insisted on professional, as opposed to business, language, which is why McKinsey is always The Firm, never the company; jobs are engagements; and The Firm has a practice, not a business.” [2]

Bower’s example brings us closer to the elements of good advising. Quite possibly, such elements would comprise a very long list. Here are some points to spark the reflection of business practitioners.

  1. Are you “telling” or advising? Genuine advisory work begins with an attitude of wanting to help and an intention of contributing to substantive advancement. [3] Thus, as you approach the opportunity to give advice, ask yourself: what are you trying to accomplish? There is a difference between talking at someone and talking with someone. Three decades of teaching by the case method impresses me that significant and lasting change is better achieved by questions and conversation that bring the other person through a reflective process to a reasoned conclusion. What outcome are you trying to achieve? If it is to gratify yourself or vent some emotion, “telling” works fine. But if it is to achieve lasting change, then the advising exchange will truly be more conversational. A friend, a world-class defense attorney, says that the first and most important quality of an adviser is listening.
  2. Does your role warrant giving advice? Every customer and parent probably feels entitled to give advice. But in many situations giving advise might conflict with the important goals and relationship you have with the advisee. Consider, for instance, the role of psychotherapists for whom telling the patient what to do might undercut the patient’s ability to learn to work things out independently. One therapist wrote, “In my opinion, we should give out life advice very sparingly and typically help our patients figure out for themselves what’s best for their given situation. If we’re hesitant about saying something that sounds like advice, then we probably shouldn’t say it. Otherwise I fear that we risk convincing our patients (and ourselves) that we have the answers when we really don’t. The bottom line: no advice is better than bad advice.” Another therapist wrote, “we distinguished between two types of advice: process advice and substantive advice. Substantive advice is when therapists impose or give specific suggestions for specific solutions to problems. It’s essentially telling people the solutions to problems. We believe this type of advice is often counterproductive. The second type, process advice, is when therapists teach their clients strategies for how to solve problems. To say, “You might want to think about your commitments in terms of your own values and well-being,” for example, is different than saying, “I think you should dump the jerk!” First advice—process. Second advice—substantive (although a little extreme).”
  3. Is your assessment of the situation truly grounded in facts? A hallmark of useless advice is a foundation on opinion, not reality. I have learned to probe upon receiving advice: “how do you know that’s true?” I’ve learned not to put up with the “I say” kinds of justifications, bald opinions based on some narrow perspective. The largest and most frequent errors of assessment have to do with defining the problem for the decision-maker. As we see repeatedly in case discussions at Darden, the problem in any given situation may not be what the protagonist thinks it is. [4]
  4. Consider tradeoffs and values. A classic error is to cast advice in terms of a yes/no or go/no-go decision. Few problems come in this form. The biggest lesson of economics is the concept of opportunity cost, the notion that by taking one course of action, you forego an alternative that might be better. In this vein, most practical problems are not of the yes/no variety, but rather of the either/or variety. And once you get into thinking about either/or, you are likely to find that the alternative path could be structured in a host of ways that reveal tradeoffs among things you care about. And once you start talking about “care,” you are talking about values. The fastest way for a decision-maker to tune out is to suggest something contrary to his or her values.
  5. Recommend a solution. Academics are experts at problem-finding and analysis. MBA students are pretty good at this too. Very often, the unsolicited advice I receive simply amounts to, “You have a problem.” And just as often, my reply produces an awkward pause: “What do you think I should do?” Volunteer advisers generally don’t carry their assessments into recommending action, the very point at which the practicality of their thinking would be exposed.
  6. Be brief. Abigail Van Buren’s signature reply to a request for advice was a one-liner. Realistically, professional advice entails a much longer narrative. One adviser I had simply couldn’t reach a conclusion in the hour allotted, so we scheduled a second, then a third meeting to get closure. After three hours, I quit and bade her goodbye, wishing I had done so at the end of the first hour. Franklin D. Roosevelt’s advice to public speakers also applies to advisers: “Be sincere. Be brief. Be seated.” Long PowerPoint pitches in a darkened room are deadly. I’d really rather get to the point quickly and then have time for conversation and questions. When you come to the end, stop. Leave it to the listener to continue the conversation or consulting engagement.
  7. If you have a self-interest in the matter, say so. Some of the worst advice is thinly-veiled lobbying for a particular outcome. If you have a personal interest in the decision, it’s best to explain so at the outset. It’s deadly for an advisee to hear a pitch and then find out later that the supposedly objective adviser stood to gain from the recommendation. This breeds a sense of betrayal rather than enlightenment.
  8. Don’t assume indifference or deafness. It helps to motivate advice, but if you’re advising me on a worthy problem, I’m probably more motivated than you suspect. Advisers can make the classic mistake of rookie teachers: they start from the adviser’s point of view rather than from a reading of the listener. Judging an audience, adjusting to the context, sizing up group dynamics—all of these are attributes of social intelligence of which we teach a lot at Darden, both directly and indirectly.
  9. A touch of empathy, please. Are you wound-up? Angry? Overwrought? Arrogant? The odds are that you’ll project onto the decision-maker a set of attitudes that don’t exist—this is a classic lack of emotional intelligence. Scolding the listener is probably not the best way to reach a positive outcome. A sense of humor and affiliation with the advisee helps.
  10. If you get confused, see point #1.

Effective advising is one of the most challenging facets of professional work. A number of courses at Darden help to build such skills. Generally, I doubt that business schools do enough—for good reason: such learning grows only with serious investment. It takes time, low student/faculty ratios, special training for faculty, graduated experiential exercises, and field work. MOOCs and technology are unlikely to be of much help; there are few economies of scale when it comes to tacit learning. In an era of deepening austerity for higher education, schools can find it easier just to teach students technical analytics and leave them to develop advisory skills in the school of hard knocks—but in a world gasping for good advice, this seems like a dereliction of duty. What would Abigail Van Buren say? Here’s how I imagine it would go:

Dear Abby: Professional schools are criticized for irrelevance. It is said that they graduate good analysts who can’t deliver actionable recommendations to important problems in a way that has impact on the world. What should the schools do? – Higher Ed.

Dear Higher Ed: Mother never said it would be easy. And Mother always expected better: pull up your socks; straighten up and fly right. Don’t let her down.

  1. I commend the biography by Elizabeth Haas Edersheim, McKinsey’s Marvin Bower: Vision, Leadership, and the Creation of Management Consulting. []
  2. Huey, John (November 1, 1993). “How McKinsey Does It”. Fortune. []
  3. The book by Peter Block, Flawless Consulting, defines consulting as ““You are consulting any time you are trying to change or improve a situation, but have no direct control over the implementation”—that entails a range of activities such as giving advice, coaching, training, facilitating, asking generative questions, etc. []
  4. Gerald Weinberg’s book, The Secrets of Consulting, posits “The First Law of Consulting: In spite of what your client may tell you, there’s always a problem. The Second Law of Consulting: No matter how it looks at first, it’s always a people problem.” []
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Sequestration is a Symptom, Not the Cause: Its Implications for Managers and Investors

Sequestration is much in the news this week. It seems increasingly likely that the government will succumb to a forced reduction in spending on Friday (March 1). Despite much hand-wringing and recrimination by both political parties an alternative seems not in store. And after that comes a debate over lifting the debt limit of the Federal government, which runs out of cash of March 27th. March blows in like a lion and out like a…bear.

If sequestration is implemented, politicians and experts point to all manner of ills, affecting air travel, crime prevention, health care delivery, and so on. Virginia’s Governor fears that the sequester will push the Commonwealth into a recession. One estimate suggests a loss of 5% of the Virginia’s jobs over two years. [1]

Curiously, financial markets and executives haven’t seemed to notice. The stock market has returned to its all-time peak, up 6.3% since the start of the year. The index of uncertainty (VIX) has fallen dramatically. There is a bull market for condos in Miami. And the announcement of two huge LBOs (Dell and Heinz) presage a new wave in mergers and acquisitions. A survey of executives shows a large turn toward optimism in early 2013. [2] Perhaps they don’t think the sequester and its ill-effects will come calling.

I think the sequester and debt-limit controversy are interesting mainly as harbingers of bigger challenges. Congress might well mitigate the ill effects of the sequestration. And on the other hand, the buoyant economic indicators most likely reflect the impact of financial repression by the Fed and the lowest interest rates in a lifetime, rather than deep-seated economic recovery. Perhaps the best advice is to keep your eyes on the big issues and not get too distracted by the forthcoming events of March.

The Big Issues

Since the Global Financial Crisis, I’ve been arguing that the only way for the U.S. and world economies to truly recover is to grow their way out of the crisis: no amount of taxes or wealth transfers will accomplish genuine, lasting recovery.

A wave of recent writing and research has sketched the drivers of this slump: adverse demographic trends, environmental degradation, deleveraging, the lack of blockbuster innovations, declining social mobility, growing income disparities, globalization, populism, geopolitics, and so on. I commend the reader to a sampling of such analysis:

  • At our UVA Investing Conference last November, keynoter Jeremy Grantham summarized the argument of a subsequently much-circulated research report, “On the Road to Zero Growth.” Grantham, one of the true gurus of equity investing, attained cult status for calling several prescient turns in the financial markets over the past 50+ years. His recent report declares, “The U.S. GDP growth rate that we have become accustomed to for over a hundred years – in excess of 3% a year – is not just hiding behind temporary setbacks. It is gone forever. Yet most business people (and the Fed) assume that economic growth will recover to its old rates. Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%.” He attributes a future of zero growth to low population growth, the decline of manufacturing, the diminishment of cheap natural resources, climate damage, food shortages, and perverse incentives (what he calls the “bonus culture.”)
  • Last August, Northwestern University economist, Robert J. Gordon, published a working paper that has garnered extraordinary attention owing to the sobering argument and the eminence of the writer. The paper is titled, “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds.” Gordon’s answer: yes, it’s over. He says that it is hard to foresee any breakthrough innovations like steam power, electricity, or indoor plumbing that might overcome the enormous drag of deteriorating K-12 education in the U.S., income inequality, globalization, resource and environmental constraints, and adverse demographic trends. In fact, he says that the growth rate in Real GDP/Capita has been slowing down since the middle of the 20th Century.
  • Professor Tyler Cowen of our neighbor, George Mason University, published his own analysis of the trend of long-term stagnation. The book is titled, The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will(Eventually) Feel Better. Cowen writes, “We have been living off low-hanging fruit for at least three hundred years. We have built social and economic institutions on the expectation of a lot of low-hanging fruit, but that fruit is mostly gone.” The three major forms of low-hanging fruit that he cites are free land, major technological breakthroughs, and an abundance of smart-but-uneducated kids. By exploiting land, technology, and education, the U.S. sustained an extraordinary trajectory of economic growth. He summarizes some research by Charles I. Jones at Stanford finding that from 1950 to 1993, 80% of the economic growth of that period came from exploiting previously discovered ideas along with added investment—Cowen writes, “In other words, we’ve been riding off the past…Meaningful innovation has become harder, and so we must spend more money to accomplish real innovations, which means a lower and declining rate of return on technology.” As if to confirm Cowen’s bleak outlook, The Economist reports stagnation in Silicon Valley: “Peter Thiel, a founder of PayPal…an the first outside investor in Facebook…says that innovation in America is “somewhere between dire straits and dead.” [3]
  • The book by Carmen Reinhart and Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly, adds a final consideration to this sobering perspective. They find that rising debt levels precede financial crises and are excellent predictors of low economic growth and long recovery cycles after the crises. Much-quoted is their assertion that Debt-to-GDP levels of greater than 90% are associated with low economic growth. Today, the Debt-to-GDP ratio for the U.S. government is over 100% and by some economic forecasts is headed beyond 200% in a few decades. Combining U.S. governments, households and businesses, the Debt-to-GDP ratio exceeded 380% as seen in the following figure—and it will take years to bring debt down to manageable levels. Until then, consumers must save more, pay more taxes, work more, and probably retire later.


Source: www.ecominoes.com

Low growth hypothesized by Grantham, Gordon, Cowen, Reinhart-Rogoff, and others means slow job creation. It will take longer to restore the economy to full employment (and fuller rates of consumption) until jobs get created. The following graph shows that the Global Financial Crisis and Great Recession are associated with stunningly slow recovery of employment.


What could be wrong with this negative picture?

History shows that periods of economic stagnation can be extraordinarily fruitful in terms of innovation. Perhaps adversity is the mother of invention—actually, I think that invention has many parents, including civil rights, geographic clusters of talent, abundant resources, a culture of risk-taking and reward, education, and luck (I’ve discussed these in other blog posts.) In a recent book, A Great Leap Forward: 1930s Depression and Economic Growth, Alexander Field argues that the Great Depression years of the 1930s featured very high rates of innovation. And in his latest paper, Robert J. Gordon associates a second industrial revolution with the years 1870-1900, roughly the years of the “long depression”—the leading innovations then included the commercialization of electricity, the internal combustion engine, and indoor plumbing with running water.

Perhaps some major new technology will come along that creates significant value for the US economy. Wishful thinking won’t feed hungry mouths. But it is also true that innovation has been declared dead before. Henry Leavitt Ellsworth, U.S. Commissioner of Patents, declared in 1843, “The advancement of the arts, from year to year, taxes our credulity, and seems to presage the arrival of that period when human improvement must end.” As Yogi Berra apparently said, “It´s tough to make predictions, especially about the future.”

A Path Forward: Some Implications for Business Leaders

The odds seem greater than ever, and rising, that America and the world will experience a longish stretch of disappointingly low growth. I earnestly hope that I’m wrong and that today’s buoyant stock market is right. But even if I’m wrong in the particulars, I doubt very strongly that any return to greater rates of growth will restore the post World War II environment where a rising tide lifted all the boats—a return to the growth rates of that era won’t even restore the U.S. back to potential GDP even if the government worked well. Recovery from credit-related slumps is slow. Therefore, I believe that the best strategies for the long term will include considerations such as these:

  1. Expect disruption and intensified competition. A future of low growth and austerity means that more companies will face a dogged share of market fight in order to sustain growth. Your firm can grow, but only by taking someone else’s lunch. In technical terms, this is a zero-sum future, rather than a positive-sum game where all firms could enjoy the benefits of a growing economy. Gentlemanly agreements not to poach a competitor’s clients, or intellectual property, or employees may fall by the way. Also, in times of financial austerity customers become more receptive to the lure of disruptive innovations. Low growth may make some managers sleepy. Instead, you must stay very alert to changing rules of competition.
  2. Relentlessly restructure, reinvent, and renew—because you can be sure that your best competitors will do so. In particular, identify the true “core” of your business and focus on improving it. Defer, delay, or discontinue the “nice to haves.” In a time of austerity, it is easy to be lured into other businesses than your core. A recent article in HBR by Evan Hirsh and Kasturi Rangan, “The Grass Isn’t Greener,” argues that high performance is less a matter of jumping into other industries than it is of gaining a strong competitive position within your core industry.
  3. Stay flexible. Austerity breeds uncertainty about the field of competition; therefore flexibility becomes extremely valuable. Flexibility is another name for real options and is evident in leasing (with cancellation clauses) rather than buying; in modular, rather than fixed, manufacturing operations; in dual-fuel rather than single fuel boilers; and in redundant sources of supply. Generally, flexibility entails the avoidance of large fixed costs. Therefore, stay lean and asset-lite. Now is not the time to relax your discipline on headcount, working capital, or capital spending.
  4. Innovate through small bets. Experiment before jumping into a new business or project with both feet. In the hysteria of a rapidly-growing market, project managers may recommend a major investment to grab market share before the competition piles in. But in an environment of austerity, the opportunity may be a mirage. I commend Peter Sims’ book, Little Bets, as a primer for how to proceed—it highlights path-breaking research by my Darden colleague, Saras Sarasvathy.

Some Implications for Investors

Many of the themes of this post were highlighted in the 2012 University of Virginia Investing Conference. The vision of low economic growth over the longer term sobers all investors. It has driven some investors to chase higher yields, as in non-investment grade debt, alternative assets, and exotic stock markets, such as Mongolia—if higher returns are associated with higher risk, then such strategies may face an unhappy reckoning.

An alternative approach would be to follow the thread of the Cowen-Gordon-Grantham-Reinhart-Rogoff argument and hypothesize a world of low macroeconomic growth and higher uncertainty. This raises interesting questions as the foundation for possible investing strategies:

Asset allocation. How will central banks unwind quantitative easing? How should investors hedge against the increased tail risk arising from shifts in monetary policy? Can financial systems withstand shocks from unexpected corners, such as Cyprus? Anyway, austerity is not evenly spread globally: which regions and countries will be relative winners and losers in the competition for growth? What does the maturation of emerging economies imply for demand for natural resources, food, consumer goods, and a sustainable environment?

Stock picking. As Robert J. Gordon noted, intensive innovations yield high growth over long periods; extensive innovations yield lower returns over shorter periods—where can investors look to find intensive innovations? How can investors find and take positions in disruptive innovations that will become mainstream in a decade or more? Since innovations occur at the levels of firms and their business units, information about these is likely to be distributed asymmetrically—how can investors engage in the search for plays in growth-driving innovations? In an environment of low growth and high competition, quality of management is more important than ever. Andy Grove, the former CEO of Intel, famously wrote, “Only the paranoid survive.” What kind of managerial attributes should investors seek?

Risk management. Low growth economic environments are vulnerable conditions for firms and their investors. Under such conditions, relatively small macro or micro surprises could yield outsized results. Changes in government policy are a major uncertainty, as last week’s anxiety over the release of the January Federal Reserve meeting minutes and the possibility of ending the Fed’s asset purchase program before the previously set unemployment targets are met. And then there are “black swans,” very low probability but very high adversity events.


The excitement over sequestration and the Federal Government debt ceiling should be put in perspective. These events—even if they should be resolved to anyone’s satisfaction—are not the conclusion of anything. Rather, they are symptoms of much deeper challenges. Such challenges seem to entail a “new normal” that could last for many years. And they present dangers and opportunities to managers and investors.

  1. “The Enemy Within,” The Economist February 23, 2013, page 27. []
  2. “A Bit Brighter,” ibid. p. 64. []
  3. “Has the ideas machine broken down?” The Economist January 12, 2013 page 21. []
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