by Adam Hartung | Jan 15, 2014 | Current Affairs, Leadership
The S&P 500 had a great 2013. Up 29.7% – its best performance since 1997. The Dow Jones Industrial Average (DJIA) ended the year up 26.5% – its best performance since 1995. And this happened as economic growth lowered the unemployment rate to 6.7% in December – the lowest rate in 5 years. And overall real estate had double-digit price gains, lowering significantly the number of underwater mortgages.
But if we go back to the beginning of 2013, most Wall Street forecasters were predicting a very different outcome. Long suffering bear Harry Dent predicted a stock crash in 2013 that would last through 2014, and ongoing cratering in real estate values. And bear Gina Martin Adams of Wells Fargo Securities predicted a market decline in 2013, a forecast she clung to and fully supported, despite a rising market, when predicting an imminent crash in September. Morgan Stanley’s Adam Parker also predicted a flat market, as did UBS analyst Jonathan Golub.
How could professionals who are paid so much money, have so many resources and the backing of such outstanding large and qualified institutions be so wrong?
An over-reliance on quantitative analysis, combined with using the wrong assumptions.
The conventional approach to Wall Street forecasting is to use computers to amass enormously complex spreadsheets combining reams of numbers. Computer models are built with thousands of inputs, and tens of millions of data points. Eventually the analysts start to believe that the sheer size of the models gives them validity. In the analytical equivalent of “mine is bigger than yours” the forecasters rely on their model’s complexity and sheer size to self-validate their output and forecasts.
In the end these analysts come up with specific forecast numbers for interest rates, earnings, momentum indicators and multiples (price/earnings being key.) Their faith that the economy and market can be reduced to numbers on spreadsheets leads them to similar faith in their forecasts.
But, numbers are often the route to failure. In the late 1990s a team of Wall Street traders and Nobel economists became convinced their ability to model the economy and markets gave them a distinct investing advantage. They raised $1billion and formed Long Term Capital (LTC) to invest using their complex models. Things worked well for 3 years, and faith in their models grew as they kept investing greater amounts.
But then in 1998 downdrafts in Asian and Russian markets led to a domino impact which cost Long Term Capital $4.6B in losses in just 4 months. LTC lost every dime it ever raised, or made. But worse, the losses were so staggering that LTC’s failure threatened the viability of America’s financial system. The banks, and economy, were saved only after the Federal Reserve led a bailout financed by 14 of the leading financial institutions of the time.
Incorrect assumptions played a major part in how Wall Street missed the market prediction for 2013. All models are based on assumptions. And, as Peter Drucker famously said, “if you get the assumptions wrong everything you do thereafter will be wrong as well” — regardless how complex and vast the models.
Conventional wisdom held that conservative economic policies underpin market growth, and the more liberal Democratic fiscal policies combined with a liberal federal reserve monetary program would bode poorly for investors and the economy in 2013. These deeply held assumptions were, of course, reinforced by a slew of conservative commentators that supported the notion that America was on the brink of runaway inflation and economic collapse. The BIAS (Beliefs, Interpretations, Assumptions and Strategies) of the forecasters found reinforcement almost daily from the rhetoric on CNBC, Bloomberg, Fox News and other programs widely watched by business people from Wall Street to Main Street.
Interestingly, when Obama was re-elected in 2012 a not-so-well-known investment firm in Columbus, OH – far from Wall Street – took an alternative look at the data when forecasting 2013. Polaris Financial Partners took a deep dive into the history of how markets perform when led by traditional conservative vs. liberal policies and reached the startling conclusion that Obama’s programs, including the Affordable Care Act, would actually spur investment, market growth, jobs and real estate! They had forecast a double digit increase in all major averages for 2012 and extended that same double digit forecast into 2013 – far more optimistic than anyone on Wall Street.
CEO Bob Deitrick and partner Steven Morgan concluded that the millenium’s first decade had been lost. Despite Republican leadership, the eqity markets were, at best, sideways. There were fewer people actually working in 2008 than in 2000; a net decrease in jobs. After a near-collapse in the banking system, due to deregulated computer-model based trading in complex derivatives, real estate and equity prices had collapsed.
“Fourteen years of stock market gains were wiped out in 17 months from October, 2007 to March, 2009” lamented Deitrick.
Polaris Partners concluded the situation was eerily similar to the 1920s at the end of Hoover’s administration. A situation which was eventually resolved via Keynesian policies of increased fiscal spending while interest rates were low, and federal reserve intervention to both expand the money supply and increase the velocity of money under Republican Fed chief Marriner Eccles and Democratic President Franklin Roosevelt.
While most people conventionally think that tax cuts led to economic growth during the Reagan administration, Polaris Financial turned that assumption upside down and put the biggest positive economic impact on the roll-back of tax cuts a year after being pushed by Reagan and passing Congress. Their analysis of the 1980 recovery focused on higher defense and infrastructure spending (fiscal policy,) a massive increase in debt (the largest peacetime debt increase ever) coupled with a more balanced tax code post-TEFRA.
Thus, eschewing complex econometric models, elaborately detailed spreadsheets of earnings and rolling momentum indicators, Polaris Financial focused instead on identifying the assumptions they believeed would most likely drive the economy and markets in 2013. They focused on the continuation of Chairman Bernanke’s easy monetary policy, and long-term fiscal policies designed to funnel money into investments which would incent job creation and GDP growth leading to an improvement in house values, and consumer spending, while keeping interest rates at historically low levels. All of which would bode extremely well for thriving equity markets.
The vitriol has been high amongst those who support, and those who oppose, the economic policies of Obama’s administration since 2008. But vitriol does not support, nor replace, good forecasting. Too often forecasters predict what they want to happen, what they hope will happen, based upon their view of history, their traing and background, and their embedded assumptions. They believe in the certainty of long-held assumptions, and forecast from that base.
But as Polaris Financial pointed out, in beating every major Wall Street firm over the last 2 years, good forecasting relies on looking carefully at historical outcomes, and understanding the context in which those results happened. Rather than relying on an interpretation of the outcome,they looked instead at the facts and the situation; the actions and the outcomes in its context. In an economy, everything is relative to the context. There are no absolute programs that are universally the right thing to do. Every policy action, and every monetary action, is dependent upon initial conditions as well as the action itself.
Too few forecasters take into account both the context as well as the action. And far too few do enough analysis of assumptions, preferring instead to rely on reams of numerical analysis which may, or may not, relate to the current situation. And are often linked to assumptions underlying the model’s construction – assumptions which could be out of date or simply wrong.
The folks at Polaris Financial Partners remain optimistic about the economy and markets for the next two years. They point out that unemployment has dropped faster under Obama, and from a much higher level, than during the Reagan administration. They see the Affordable Care Act opening more flexibility for health care, creating a rise in entrepreneurship and innovation (especially biotechnology) that will spur economic growth. Deitrick and Morgan see tax programs, and rising minimum wage trends, working toward better income balancing, and greater monetary velocity aiding GDP growth. Their projection is for improving real estate values, jobs growth, and minimal inflation leading to higher indexes – such as 20,000 on the DJIA and 2150 on the S&P.
Bob Deitrick co-authored, with Lew Goldfarb, “Bulls, Bears and the Ballot Box” in 2012 analyzing Presidential economic policies, Federal Reserve policies and stock market performance.
by Adam Hartung | Mar 29, 2012 | Current Affairs, Disruptions, Innovation, Leadership, Lock-in, Openness, Transparency
No businessperson thinks the way to solve a business problem is via the courts. And no issue is larger for American business than health care. Despite all the hoopla over the Supreme Court reviews this week, this is a lousy way for America to address an extremely critical area.
The growth of America's economy, and its global competitiveness, has a lot riding on health care costs. Looking at the table, below, it is clear that the U.S. is doing a lousy job at managing what is the fastest growing cost in business (data summarized from 24/7 Wall Street.)
While America is spending about $8,000 per person, the next 9 countries (in per person cost) all are grouped in roughly the $4,000-$5,000 cost — so America is 67-100% more costly than competitors. This affects everything America sells – from tractors to software services – forcing higher prices, or lower margins. And lower margins means less resources for investing in growth!
American health care is limiting the countries overall economic growth capability by consuming dramatically more resources than our competitors. Where American spends 17.4% of GDP (gross domestic product) on health care, our competitors are generally spending only 11-12% of their resources. This means America is "taxing" itself an extra 50% for the same services as our competitive countries. And without demonstrably superior results. That is money which Americans would gain more benefit if spent on infrastructure, R&D, new product development or even global selling!
Americans seem to be fixated on the past. How they used to obtain health care services 50 years ago, and the role of insurance 50 years ago. Looking forward, health care is nothing like it was in 1960. The days of "Dr. Welby, MD" serving a patient's needs are long gone. Now it takes teams of physicians, technicians, nurses, diagnosticians, laboratory analysts and buildings full of equipment to care for patients. And that means America needs a medical delivery system that allows the best use of these resources efficiently and effectively if its citizens are going to be healthier, and move into the life expectancies of competitive countries.
Unfortunately, America seems unwilling to look at its competitors to learn from what they do in order to be more effective. It would seem obvious that policy makers and those delivering health care could all look at the processes in these other 9 countries and ask "what are they doing, how do they do it, and across all 9 what can we see are the best practices?"
By studying the competition we could easily learn not only what is being done better, but how we could improve on those practices to be a world leader (which, clearly, we now are not.) Yet, for the most part those involved in the debate seem adamant to ignore the competition – as if they don't matter. Even though the cost of such blindness is enormous.
Instead, way too much time is spent asking customers what they want. But customers have no idea what health care costs. Either they have insurance, and don't care what specific delivery costs, or they faint dead away when they see the bill for almost any procedure. People just know that health care can be really good, and they want it. To them, the cost is somebody else's problem. That offers no insight for creating an effective yet simultaneously efficient system.
America needs to quit thinking it can gradually evolve toward something better. As Clayton Christensen points out in his book "The Innovator's Prescription: A Disruptive Solution for Health Care" America could implement health care very differently. And, as each year passes America's competitiveness falls further behind – pushing the country closer and closer to no choice but being disruptive in health care implementation. That, or losing its vaunted position as market leader!
Is the "individual mandate" legal? That seems to be arguable. But, it is disruptive. It seems the debate centers more on whether Americans are willing to be disruptive, to do something different, than whether they want to solve the problem. Across a range of possibilities, anything that disrupts the ways of the past seems to be argued to death. That isn't going to solve this big, and growing, problem. Americans must become willing to accept some radical change.
The simple approach would be to look at programs in Oregon, Massachusetts and all the states to see what has worked, and what hasn't worked as well. Instead of judging them in advance, they could be studied to learn. Then America could take on a series of experiments. In isolated locations. Early adopter types could "opt in" on new alternative approaches to payment, and delivery, and see if it makes them happy. And more stories could be promulgated about how alternatives have worked, and why, helping everyone in the country remove their fear of change by seeing the benefits achieved by early leaders.
Health care delivery, and its cost, in America is a big deal. Just like the oil price shocks in the 1970s roiled cost structures and threatened the economy, unmanagable health care delivery and cost threatens the country's economic future. American's surely don't expect a handful of lawyers in black robes to solve the problem.
America needs to learn from its competition, be willing to disrupt past processes and try new approaches that forge a solution which not only delivers better than anyone else (a place where America does seem to still lead) but costs less. If America could be the first on the moon, first to create the PC and first to connect everyone on smartphones this is a problem which can be solved – but not by attorneys or courts!
by Adam Hartung | Mar 25, 2011 | Current Affairs, Defend & Extend, In the Swamp, Innovation, Leadership, Lock-in
It is unlikely anyone in business or government thinks productivity is a bad thing. Productive students get their homework done faster, and learn more in the available time. Productive musicians make more recordings, and tend to learn more over their careers. And productive companies produce more goods and services with less inputs – like labor – thus offering more to customers at lower cost while making more money for investors. At a national level, the more productive we are at everything from growing wheat to making cabinets to writing smartphone apps improves the quantity of goods available to our population – growing the gross domestic product (GDP.) Improving productivity is one of the most critical activities to creating and maintaining a healthy economy, improving incomes and generating wealth.
Then why is American policy so anti-productivity?
American manufacturers today are about the most productive in the world. In the Wall Street Journal's "The Truth About U.S. Manufacturing" we learn that American factory workers are producing triple the output of 1972. The use of ever more sophisticated equipment, often with digital controls, and a higher trained workforce has made it possible to make more and more stuff with less and less labor. While considerable manufacturing has gone offshore, it is not because our workers are competitively unproductive. To the contrary, productivity is amongst the highest in the world!
Unfortunately, most of America's business/economic policy at the government level has been trying to preserve jobs that are, well, not that productive. Take for example agriculture subsidies. They pay farmers to produce less and otherwise make less productive use of land, feedstocks, grains, etc. By giving farmers (most of which are now huge corporations, not the "family farm" circa 1970 and before) subsidies it actually lowers agricultural productivity.
Similarly, bank and auto bailouts (and all subsidies to any manufacturer) in effect lowers productivity. It gives money to a bank, which makes nothing. Or to an unproductive manufacturer to keep its plant operating when the value of the output is insufficient to cover costs. These spending programs serve only to defend and extend the least productive jobs in society – jobs that are economically unviable. By spending money in these areas the government attempts to preserve the old (companies such as GM and Chrysler) at the expense of productivity.
America can create highly productive jobs
"Amazon.com On Hiring Spree" is the Seattle Times headline. Amazon has revolutionized book retailing, publishing and is changing a number of other markets as well. The result is a far more productive workforce in these industries than previous competitors. Borders, to cite a recent example, could not be nearly as efficient selling or publishing books with its out of date model, so it recently followed 90% of other book sellers into bankruptcy. The more productive company, Amazon, is hiring people as fast as it can to grow its business. Its productivity allows Amazon to sell more and create jobs.
Had the government chosen to bail out Borders there would have been a public outcry. Why should we protect the jobs of those store shelf stockers? Likewise, as the number of printed books drops, replaced by digital books, should it be government policy to subsidize book (or magazine, or newspaper) publishers/printers? Whenever a business is no longer competitively productive – whether it be agricultural, manufacturing or anything else – bailouts serve only to keep the unproductive competitor alive. Which actually harms the more competitive company that subsequently must fight the subsidized competitor.
The right policy would be to subsidize Amazon. Amazon is growing. Theoretically, the more money Amazon has the faster it could grow and the more jobs it could create. But, of course, nobody feels good about subsidizing a growing, profitable concern. And Amazon isn't asking for subsidies, anyway.
Our public investments are shifting in the wrong direction.
The right public policy is to invest in creating new Amazons. New businesses that create products and services which are desirable to customers, productively using resources and creating jobs. By helping these new businesses get going the government spending creates new markets. Government money "primes the pump" for investors. Early stage funding allows the business to get started, create a product or service, generate initial revenues, demonstrate a P&L and entice others to invest. The payback to society is a growing enterprise that creates jobs, both of which creates future tax revenues which repay the early investment funding.
The current administration touts investing in the tools for creating growth. In early February the MercuryNews.com reported on a Presidential speech in Michigan, "Obama Promotes Plan for Near Universal High-Speed Wireless." But, like previous Presidential administrations, this is just a lot of talk. While Mr. Obama may think national wireless technology to promote economic growth is good, there is no money for it. In the same article it is noted that Michigan congressional representatives, who resoundingly backed putting billions into the auto bailouts, question the efficacy of investing in emerging infrastructure tools. Protecting the past, while questioning (or opposing) investments in the future.
Unfortunately, for the last 50 years American policy has been headed in the wrong direction! Innovation investment projects peaked around the Kennedy administration (early 1960s) with several American efforts to dominate new technologies through programs such as the famous "space race." Since then, less and less has gone into America's future, and more and more has been spent preserving the past – through entitlements, military spending and tax cuts which provide less and less incentive to invest in unproven projects.
Source: Silicon Alley Insider Chart of the Day from BusinessInsider.com
Since 1953 government "pump priming" by spending on R&D for innovations has declined by 50%!!! No longer is even 1% of Gross Domestic Product spent on R&D. Businesses, which require an immediate return on investment and are generally loath to spend money on things which are uncertain, have been left to fill the vacuum. As a result, total spending has been stagnant. Worse, most spending by business is on sustaining innovations – improvements which defend and extend an existing business – rather than on breakthroughs which create new markets, and a lot more jobs (for more on sustaining innovation investments by business read Clayton Christenson's books including "The Innovator's Dilemma.") Investment in innovation has been woefully underfunded, allowing America's economic leadership position to shrink.
America is driving innovation offshore
The Wall Street Journal has reported "More Companies Plan to Put R&D Offshore." When things are equal, business will invest where the costs are lowest. With little incentive to undertake innovation in America, increasingly U.S. companies are moving their R&D — along with manufacturing, customer service, telesales, etc. — to emerging markets. And their plans are to increase this movement offshore by 50-100% by 2015!
![[EMERGING]](http://si.wsj.net/public/resources/images/MK-BK032A_EMERG_NS_20110221173344.jpg)
What will happen if innovation investments move from America into emerging markets? Will intellectual property remain an American advantage? Will new product development be done in America, or elsewhere? If the manufacturing is already in these markets, is it hard to predict that new products will increasingly be made offshore as well? Asked another way, if we outsource the innovation jobs – what jobs will America have left?
A dramatic change in American policy is needed
Last week America started bombing Libya. Part of protecting the national interest. But, this is not free – reportedly costing Americans $100M/day. Two weeks is $1.4B (probably a lot more, to be honest.). Let's not debate whether this is necessary, but rather recognize (as Roseanne Rosannadanna used to say on Saturday Night Live) "it's always something." There are programs, policies, military bases, agricultural lands, national parks and jobs to protect in every district of America – and its interests around the globe. And that's increasingly where America's money goes. Not into innovation.
So why are Americans surprised that job growth struggles? When the head of GE, a company that has moved manufacturing, information technology, engineering and R&D to offshore centers across the last decade, is made head of the U.S. jobs initiative is there much doubt? When the spending and incentives, as well as the selected leaders, have as their #1 interest preserving the past – largely in areas where American productivity lags – why would anyone expect new job creation?
America's protectionist mentality is causing its lead in innovation to slip away. The President, administration officials, Senators and Congresspeople needs to quit thinking that talking about innovation is going to make any difference in investments, or job creation. If America wants to remain globally economically vibrant it requires a change in investments – starting with more money for R&D via grants, subsidies and tax breaks.
If America wants jobs, and healthy economic growth, it needs innovation. Innovation that will create new, highly productive jobs And that requires investing in the future, rather than spending all the money protecting the past.
