What to Expect in 2014 (And Beyond)

This outlook is being written a good 45 days later than when “What to Expect in 2013…” was written over a year ago. It is amazing how much can happen in that short time frame and can influence one’s view of the next year. If I let another 45 days pass I am sure there would be some things that would change. I believe the risks are to the upside on more positive news on the economy but at some point that news could affect Fed action.  Much of what could happen this coming year is influenced by what is going on in the energy sector. Middle East economies, of course, but also inflation, GDP growth, and geopolitical events will affect markets and the US economy specifically. These points will become clear as I spell out some of my expectations. Understand that these expectations follow the Byron Wien formula where I believe there is greater than a 50% chance they happen when the rest of the world may not agree. The “Expectations” are designed to stimulate thought. Some of them can relate directly to the securities markets, but some do not, and this year, a little whimsy. Hopefully, you can figure out which one that is. Let’s begin:

  1. After printing two 4% GDP quarters in 2013 and seeing a 1 percentage point drop in the unemployment rate, there is finally some recognition that, maybe, the Fed’s actions really did produce some stimulus. This could lead to self-sustaining growth in the US economy in 2014 with at least one more 4% print this year. Less noise from the crazies in Washington adds to business confidence and, ultimately, capital expenditures.
  2. Economic growth and job creation become more apparent with forecasts for a decline in the unemployment rate possibly approaching 6% before the end of the year. The Federal Reserve begins making noise about speeding up tapering and hints at reducing the time the Funds rate would remain anchored at its current level. This is in spite of limited evidence, at least early in the year, that the inflation rate is approaching the targeted 2% level. This ultimately has a dampening effect on the markets.
  3. We begin seeing some academic work and, of course, the pundits talking about an acceleration of the technological revolution making the case that low inflation or maybe even some signs of deflation are actually a good thing in this technologically driven environment. The low inflation picture is reinforced at the headline level by energy supplies expanding within the US, in the Middle East from Iraq and, ultimately, Iran. As other countries embrace fracking the potential for even more supply keeps downside pressure on energy prices.
  4. The negative elements on inflation, which are not sufficient to cause major concerns, come via erratic supply in soft commodities from continuation of drought in certain areas combined with weather abnormalities which, more and more, are blamed on climate change. As we get into the latter part of the year, the improving developed market economies combined with growth in Asia put some upward pressure on hard commodities. Investors must make the decision to invest in the extraction companies that have suffered from low prices or directly into the commodities themselves.
  5. The positive change in US trade balances from lower imports of energy combined with rising energy exports adds more than a percentage point to US GDP and reinforces the case for a strong dollar relative to almost every other currency except possibly the Chinese yuan. Asia shows growing signs of a currency war fueled by the impact of further weakening of the Japanese yen beginning to very seriously affect the export trade of its Asian competitors.  While this has a tendency to push up inflation rates in many of the Asian countries, the developed markets benefit from lower prices on many imported goods further softening their inflation rates.
  6. The impact of the currency wars raises questions about the stability of some of the emerging markets, particularly in Asia. There are also concerns about the pace of wage increases in these heretofore attractive locations for outsourcing. Manufacturing and some service corporations begin making different strategic decisions on the best places to locate manufacturing and processing centers.  The decisions are reinforced by a growing belief that technological advances will continue to allow capital to substitute for labor, or at least keep pressure on wages. More business activities find their way back into the developed countries of the world. China moves cautiously in the same direction, taking advantage of its own technological progress. It begins marketing itself as a technological leader as opposed to a low-cost labor market. This is not easy as China, at the same time, continues to push toward a more consumer-oriented society. Incomes have to rise and, politically, the population needs to be kept content. It will not be a smooth year for China.
  7. Coming elections in India point to a possible loss of leadership for the Congress party. Combined with continued economic difficulties and some strife associated with the potential leadership change, the country moves further down the path of being even less attractive for foreign direct investment. It loses another year to the relative growth of its Asian neighbors and finds itself participating in the currency wars as a possible way to salvage elements of growth.
  8. With the exception of Chile, Colombia, Mexico and Panama, the rest of Central and South America flounders. The US begins to pay more attention to its southern neighbors. Out of desperation, Argentina reaches a settlement on its outstanding debt and begins a focus on building its energy sector with some help from outside sources. A Menem-like regime change becomes a more likely political outcome.
  9. The changing energy picture outside the Middle East, combined with likely increased production out of Iraq and, ultimately, Iran, result in a change in the relative importance of Saudi Arabia and, to some extent, Israel. This could produce some positive movement in the Palestinian situation, and some changes in the relationships of Saudi Arabia with the rest of the Middle East and possibly Asia as the US becomes an even smaller market for its oil and an export competitor. On the other hand it raises the risk of some turmoil in the region as the power picture changes and attempts are made to preserve the old order in  a possibly military fashion.
  10. The fading newspaper industry surprises the street with its earnings in the early part of the year and benefits from contentious congressional races in the third and fourth quarters as well. The advertising related to Academy Award nominations and ultimately selections reaches new heights in print and social media. Studios advertise some small (but not cheap) movies to extremes to compete with some very high quality films and performances. We actually walked out of a couple of the most highly advertised ones. Aren’t two-page spreads a little extreme? Unfortunately, the correlation between the advertising and the nominations and awards becomes very direct leaving it up to the audiences to hopefully, make their own decisions after the fact. The quality and audience continue to rise for television productions and the associated delivery mechanisms for these performances leaving 3-D sequels and prequels to the movie industry. Can’t wait for “Inside Llewyn Davis Today–in IMax.”

So what does this all mean for the markets? I wish I knew. History says that the kind of equity market we had in the US in 2013 is usually followed by a decent year.  I don’t think it is that simple. We could see some re-allocation by institutions whose US equity portfolios have been pushed above their target percentages. At the same time, if we are beginning to return to a more normal relationship between earnings yields and fixed income yields, traditional debt doesn’t look that attractive. It may mean that markets outside the US are more attractive–maybe Europe and maybe some of the emerging markets if the currency is hedged out. There are some risk elements in the geopolitical situation. I think we will have to look harder for returns this year and the risks are high enough to look for some less correlated investments. I wouldn’t reduce my equity exposure, but I might change the mix.

We’ll have to see if another 45 days sets us up for totally different surprises. If nothing else I hope this has provided some food for thought.

I have some longer term expectations including a carryover from past years which, one of these days, will actually come to pass. I include these as additional repast for the brain. As has been the case since the millennium, the year will likely be more interesting than we anticipated.

  1. Contrary to normally quiet years during a transition of leadership, to some extent in reaction to some elements of an “Asian Spring” in the region, China takes further steps in response to a more activist populace upset with corruption, the environment, and some areas of economic stress. Externally, this includes significant acquisitions in other countries as well as the opening of manufacturing and service facilities where there is a receptive government. At home, R&D is accelerated, particularly in alternative energy, space and IT processing. Subsidies for hydrocarbons are reduced and an explicit carbon tax is put in place.
  2. As the US economy grows, corporations find qualified hires difficult to come by.  Enlightened corporations become educational institutions to provide skills and basic knowledge to a work force that has been idle and undereducated by the public systems. Corporations become much more vocal about creating paths to bring more immigrants into the US system, expanding visa programs and finding other mechanisms to add talented labor to the domestic pool. The tide shifts significantly on immigration issues. The skill match is aggravated by decisions on the part of some US corporations to bring business operations back into the States. Labor costs are rising elsewhere and the elements of control, rule of law, productivity, available feedstock and relative safety lead to better economics for manufacturing and service operations.
  3. Moore’s Law, driven primarily by Intel driving down the nanometer scale and introducing other innovations,  continues to march on. The use of Big Data becomes ubiquitous. This produces technological advances that enhance the opportunities in health care, manufacturing, extractive industries, media and services beyond even the imagination of some of the best speculative fiction writers. These advances, on balance, are positive but continue to raise concerns about the environment and quality of life and opportunity for those at the lower end of the economic and educational spectrum.
  4. Breakthroughs in stem cell research particularly led by work coming out of the New York Stem Cell Foundation change the nature of disease management and eradication and move general therapeutic advances away from animal models to direct testing on human cells. Targeted therapeutics driven by DNA analyses tied to narrower classes of patient recipients change the nature of drug and health delivery. It becomes apparent that the US FDA model is slowing the pace of US therapeutics development by the cost and time required to bring solutions to market. Much as financial services regulation was geared to the benefit of larger entities, it becomes clear that therapeutics development has been on the the same path. Change occurs in response to other countries moving more rapidly in bringing solutions to market.
  5. Away from continual ups and downs in financial assets as the world works its way through the hangover from the 2008-2012 financial crises, the general march of human progress is positive. I hope to be around to observe it. Maybe the breakthroughs suggested in the previous expectation will help that.

Adding to the Knowledge Base–Distinguishing What You Know and Communicating It in Today’s World

An acquaintance of mine, Tom Brakke, has an interesting blog, ResearchPuzzle.com. He is pulling together an e-book  based on letters he has posted to a young analyst giving advice on what it takes to be a great analyst.  Tom asked for any contributions that some of his friends might wish to make on the topic. Tom’s letters cover most of what an aspiring analyst needs. I would urge those interested in the topic to visit his site and stay tuned for the book.  While the book will be about analysts involved in the investment business, I think many of Tom’s observations have significantly broader application to anyone who does research of almost any type with the desire or obligation to make that available to an interested audience.  These days almost everyone is an analyst to some degree, collecting information in 140-word bites or more or from some visual or verbal media and then adding his or her thoughts via various media in return.  Some of the opinions offered actually add value to the dialogue, but many don’t.  I think what Tom is pulling together, if incorporated,  will raise the  value-add to garbage ratio of almost any dialogue.
I sent Tom a few of my thoughts on the topic, which, for the most part simply reinforced what he has already written.  My comments relate directly to investment research, but I also think they have application to a broader analytical universe.  Here are my comments to Tom:
One of the first things you might want to have a budding analyst do is read the HBS Lehman A Case about the rebuilding of that department back in the days when Lehman was alive as a part of American Express. It is about management, but also focuses significantly on what an analyst has to do to succeed.
I would also suggest that any analyst read Decision Traps by Paul Shoemaker and Ed Russo. Lots of good case studies in there, and some fun exercises that really stimulate the thought processes and make us realize how our mind and what it sees in front of it, can lead us to some very wrong conclusions.
Further thoughts: Any analyst of companies needs to get to the point where the companies are asking him/her questions. One learns more from a question than an answer. This requires thinking strategically and understanding the history of the company and the industry, not just what’s happening at the moment.  I also agree wholeheartedly that a good analyst wants to be surrounded by other good analysts and share wisdom and questions. I also think a good analyst, once a conclusion is reached, should immediately begin looking for disconfirming information. In the course of that, one will find confirming information, but the search is for disconfirming info.
 In addition, the thought process has to be out-of-the-box. With the info flow these days everyone starts with the same data. It’s what one makes of it that is key. One also has to look at both sides of the picture–positive and negative.
Don’t become an advocate too soon. When I taught Security Analysis at the Columbia Exec MBA program, the “final exam” consisted of preparing two reports on the same company–one positive and one negative.  This was to get the budding analysts to understand that the differences many times are not significant. A stock is being priced at any moment reflecting that.
I also always suggested to the analysts (and did this myself) to communicate with their toughest/smartest clients first. Thus, the gaps and uncertainties of whatever analyses have been done come into stark relief,  making the next calls, and the next report, that much better.
Your points, Tom,  about communication skills, written and oral, are key. Becoming recognized as a very good analyst (content, communication, presentation, visibility) feeds on itself. Companies and clients want to communicate with you if you are perceived as knowing your stuff and, subsequently,  that enhances one’s knowledge. One cannot sit in a room and slip reports under the door.  An analyst has many audiences—the companies, the investing clients, the salespeople who help deliver the message, the investment bankers, the media–each requires different packaging.  Don’t be too stuck on the purity of the analytical aspect of what one does. Packaging and delivery become key and provide the best feedback loop for even better analysis.  We are living in a different world where the tools for analysis are ubiquitous and the means of delivering the conclusions are vast.  What happens inside the mind becomes the differentiator. Not as easy as it used to be, but equally, if not more rewarding. I am eager to see Tom’s more complete thoughts on this topic.

An Alternate “Truth” About Jobs–Not Steve, but the rest of us working stiffs

A good friend recently sent me an email asking if I agreed with some conclusions reached by Scott Winship in a well-written piece in the Wilson Quarterly titled “The Truth about Jobs.”  Winship basically concludes that that the decline in labor force participation among men has been voluntary, aided by some changes in payments for disability and other factors, and that pay reduction relative to productivity improvements is merely a catch-up with overpayments from earlier decades prior to the ’80’s, and that, ultimately, this will come back into balance. Thus, not to worry. He makes some references to outsourcing, but concludes it has been a net benefit in terms of lower prices of goods. He ends with an important view, with which I fully agree, that skill levels are a problem for a growing segment of the population,  and we need to address that issue, specifically. This is a very brief and incomplete summary of Winship’s article, and I would suggest it is worth reading in its entirety.  I disagree with some of the conclusions which are drawn from a different view, or at least emphasis, on what has happened in the last 40+ years. I hope Winship is correct in his thoughtful and well-researched observations and his conclusions, but I am skeptical.

I think we do have a systemic jobs problem tied to demographics and the relative rise of other economies that are more easily participating in the global economy in terms of markets, intellectual contribution and the use of existing and rapidly changing technology.

Over the decades of change referred to in Winship’s analysis we have shifted into a much more global interconnected world where the movement of goods and services has been significantly enhanced via technological developments. Thus, the benefit of labor arbitrage between countries is real and possible as is labor/capital(technology) arbitrage everywhere.

For many years in the US, “outsourcing” has occurred within our borders, moving more production to suppliers which creates economies of scale and lower labor costs because the skill levels required are different.  And labor cost arbitrage still exists between geographies within the US.

As an example, while I don’t have the precise numbers, I would posit that global employment in the auto industry is up. However, required skill levels are down and, for some time, global geographical arbitrage on labor costs has existed with there being little, if any,  technological arbitrage among countries today–similar technologies are available to almost all. The last time I was in China visiting auto plants the difference in labor content between a Toyota plant in Japan and China reflected the labor cost differential with more workers and less automation on the lines in China.  As relative wages rise, the lines in China have become more automated substituting capital(technology) for labor within a framework of a newer, more efficient production system than might be found in the developed world. This is real and cannot be glossed over as having an effect on the US and other developed economies.

Winship’s dataset of men only and their wage and labor force participation numbers is also a problem. The impact on wages (for men and the total work force) has been, in part, the gender wage arbitrage that has existed, and in some cases continues to exist, between men and women, even though the skill levels are not different–some would say higher among the women. Winship mentions the wage differentials but he doesn’t explicitly incorporate it as a cause for the slower rise in men’s wages.

He points out that more men over 55 are staying in the work force. I agree with much of his analysis here which emphasizes the education levels and the desire to work, not the need. Although, I do believe there is an element of need that comes into play–the need to think about sustaining oneself and a lifestyle for a much longer period than historically has been the case. My personal anecdote is noting that my father lived to 100 and was quite active for almost all of that period. I always said to him that I would take his bad genes as long as I got the good ones. It appears that I did get both…  I have to think about what kind of life I want to lead over the next few decades both financially and actively with my mind and body. It is hard to move away from the stimulus of work (and the reward) as long as I have that opportunity.  And the opportunities appear to be there for me and others.

I think this does have a lot to do with availability of skills in that age bracket, the adaptation of that group, in general, to the new world of communication and technology,  and the recognition that productivity levels remain high, particularly among the better educated, more of whom are maintaining their health. It isn’t as automatic that as an employee ages he or she becomes less productive or less adaptable to the demands of the workplace. It helps that labor laws make it more difficult to end employment for age reasons alone.

On a separate point, as one works one’s way down the age brackets I think we are finding fewer individuals wanting to work within a formal structured work place–they are less available–, thus only the over 55 are available for those jobs. This is a big overstatement, but on the margin it is certainly the case. The use of the internet, the infrastructure in city-states and even within smaller communities leads to the availability of a more entrepreneurial approach to work and provision of services than has been the case historically—and more of this is in the cash (or grey) economy.

There has been much research trying to estimate the dollars floating around the rest of the world in an undocumented economy. There has been some recent work (U of Wisconsin– http://www.ssc.wisc.edu/econ/archive/wp2011-1.pdf) which may indicate a growing amount of that cash, more than previously estimated, resides within the US.  And, by the way, taxing that income could add $500 Billion to US governments’ revenues. More people are working than the BLS statistics pick up. Do we really believe that all the number of  long term unemployed are actually not working? But, instead,  aren’t they producing some income–maybe sufficient to sustain or even thrive?  Here’s an anecdote for you: We have all heard about companies pushing more people to part-time employment to avoid ACA rules and, ultimately reduce their costs. One of my fellow directors at a company told me that one of her clients–a national retailer–is having employees in certain states with insurance exchanges ask to be moved to part-time because the cost of insurance on the exchange will be lower than or no worse than their current costs. It makes them untethered to a company for the benefits, more mobile and flexible, and with the possibility of making up for the income at another job either on or off the books. One could make the case that the younger generations don’t view the government as doing much for them so why should they pay taxes. That is happening at a time when the ability to work off the books has risen and continues to. Just think what 3-D printing could do to that ability once it is truly operable. I attended a meeting with one of the founders of MakerBot where this was made apparent. The real discussion with him was about the grey economy.

Winship’s final paragraph re the importance of education is particularly valid and critical: People, for the most part, figure out how to survive and thrive under any reasonably open system. Their ability to maximize the thriving part does depend on skill levels, educational attainment and overcoming the systemic inequalities that exist. That does need to be a focus. The developed world has a more severe problem than the developing world as it is more difficult for good things to happen in a replacement economy vs. a growth economy. But we must do significantly better.

There is much more to be written on this topic but I do have other tasks to perform–mostly on the books :-).

Chemical Warfare: Never good but there could be a different outcome

On many levels this is out of my purview. However, in the early ’60′s I was an officer in what was then called the Chemical Corps. I spent the first year of my service running a chemical combat support platoon primarily stationed in Fort Ord, California. Then, clearly, I saluted somebody wrong, and spent two summers in the desert and the winter in between in Alaska and some other places testing various Chemical, Nuclear and Biological weapons delivery systems.  All of these were bad weapons.  I am not sure there is such a thing as a good weapon.

The Chemical Weapons Convention banning the use of chemical weapons (not biological) and calling for destruction of existing weapons went into force in 1997 after the initial discussions on the ban began in 1968.  Syria is not a signatory to the Convention.

I am not sure what a limited strike does to deal with this problem other than having, for sure, unintended consequences.  Also, are we simply saying that if conventional weapons had been used to kill 1400+ would we not care?  As I said, Chemical weapons are bad, and with a very few exceptions, the world agrees.

As opposed to more death and destruction as a retaliatory punishment, wouldn’t it make sense to use this time while Congress debates to present the fully documented case to the world, garner universal support against the use, universally demand  an apology and recompense from Syria to the families affected, and a promise not to use such weapons ever again? What is really in the interest of all in this instance? It is hard to believe that this was at the direction of Assad because of the stupidity of the action. If so, there needs to be the full mea culpa. However, if this was an attack generated and ordered within the military ranks, blame can be directed and action taken.

One cannot bring back the lives lost, nor for that matter the 100,000 lives previously lost.  However, why not turn this action into a reason for reaching a political solution as opposed to a continuation of the bloodshed using whatever weapons are available or provided.  It is in some ways an opening for the Assad regime.  More military action involving more participants will not have a good outcome.  This approach will surely sound naíve and wimpy to some.  It is one person’s viewpoint.  The killing by whatever means needs to stop.

Jeff Bezos, the Washington Post and Content (which will get even better)

I have a different view from what’s out there thus far re where this acquisition will lead.  Much of the discussion to date about this very interesting acquisition is focused on the content and the risk it will change for the worse.  One would expect this from the media since that is what they focus on.   The discussion also seems to bring in the idea of Bezos wanting this property because of the leverage it will give him in Washington.  I don’t buy that.  Wired.com equated it to Bezos’ other “quixotic” ventures.  Everyone, naturally,  also keeps trying to tie this to Amazon.  I think that is only valid in looking at Bezos’ managerial approach, not what Amazon itself is.  Bezos has said the focus is on the reader–understanding what he/she is looking for and providing it.  That is consistent with understanding what the customers at Amazon are doing and providing them with more of what they most likely want. The Post is not going to look like Amazon, though.  The tie-in to Amazon represents a narrow focus on what he can do and, in my view, is likely to do.  I think Bezos is interested in learning who the readers are and their behaviors  and is prepared to do that with the high quality content of the Post.

I am not so sure he really wanted to buy the other paper properties, but I doubt that the Post Company wanted to be left with any.  I think his initial focus will be on reducing costs of the back office and not touching the content side.  He can do a better job than the current management was doing.   He certainly runs a lean shop at Amazon.  I think people are missing that the Post’s digital revenues must be running close to $100mm.  Graham does deserve some credit for that.   Bezos is buying a digital stream at 2 1/2 to 3 times revenues if you give no value to the $400mm of off-line revenues. That’s pretty cheap.  Henry Blodget pointed this out in his very well written piece on the acquisition.  I also think the Post is closer to breakeven than the last 12 months indicated, given the costs included on the pension side and termination costs.  The management didn’t have a solution  how to get the profits up,  was trapped by the experience of the last 7 years and the board didn’t have the patience.  The Post has been firing content creators without looking hard enough at other ways to reduce costs making use of technology that exists on that end.  As a public company the Post Company couldn’t risk more losses.  In an interview on the Post’s own digital website Graham said there were twelve bidders and Bezos was the highest bidder.  It will be interesting to see who the other bidders were, which is info that will likely make its way out over time.  Graham would likely have had to sell to the next highest bidder and who knows who that was. He got lucky with it being Bezos, who I think is prepared to preserve the content and figure out how to monetize it better.  I wonder if he would have been able to say that another buyer was as attuned to the “values” at the Post.  Interesting that the journalist employees were “sad.”   They should have been sad if there weren’t a sale.   If I were there I would be excited about what could happen.  I think their job security has just gone up.

Bezos wrote to the employees about inventing and experimenting.   This is the classic approach to trying to figure out what the right business model is.  As a private company the Post can do this without as much worry about the short term impact.  But, as I said, I don’t think the road to profitability is that long.  I believe the Post will likely be providing even higher quality content than it has been for a while.  I also think it will likely expand from the very specific approach to its local environs to something more global, which would move it toward a bigger audience. This will be interesting and fun to watch, and, of course, it will be well covered. The media industry is the most self referential of any I know. Anything related to media is always a big story. I am looking forward to following this one.

The Economy, The Markets, Obama’s Climate Change speech and Idealab: A Podcast

I recently did a broadcast on the Hays Advantage reviewing the turmoil in the marketplace, tying it back to our outlook of last November. We also spent some time on Obama’s speech and introduction of some new regs on Climate Change. I pointed out that we need to do something as we are falling behind technologically what is happening in Germany, Japan and, to some extent, in China. I wrote about what Germany is doing a couple of years ago.  I think we would all agree that regulations have a place, but it is not the best way to deal with this issue. At some point we need to have an explicit Carbon price which allows for economic decisions within a broad framework of rules.

Kathleen Hays had visited Idealab two weeks before and we had a chance to talk about innovation and the process there as well. You might find the 20 minute podcast interesting.

The Future of Capitalism (and Commission Sharing Arrangements)

Two weeks ago I attended an all day session, “The Future of Capitalism,” put together by the the World Economic Forum (WEF) and The Forum of Young Global Leaders, with a big attendance by and assist from the World Policy Institute. While this session was under Chatham House Rules so I can’t go into great detail, it is safe to say that the general thrust of a series of wide-ranging discussions was that, in its current form, Capitalism has yet to prove it can function in a sustainable manner on a planet approaching a population of 9 billion.  There was much discussion of what could or should happen–some naive, but most quite pragmatic with some actionable steps. My favorite actionable step  was to require that CEOs, in addition to preparing their annual report to shareholders, should prepare an annual report to their children and grandchildren, describing what they do and don’t do and why, in clear understandable language relevant to these inheritors of what one would hope to be a sustainable planet.

More recently I attended a meeting where some activities in the financial world were described that may have more immediate negative impact on the Future of Capitalism. This is where Commission Sharing Arrangements (CSAs) have relevance.  A CSA is an arrangement in the investment community whereby an institutional investor does a security transaction with a broker and directs that a portion of the commission on the trade be paid out to a third party.  The third party is typically a smaller specialized firm that has provided research services to the institution. The institution has chosen to do the trade with a particular broker, usually one of the ten largest  broad-based broker-dealers (BDs), because of the belief that the BD will provide better execution at a lower commission than if the trade were done with a smaller firm. The larger BD typically has broader reach and visibility to get a larger trade done, including use of electronic trading systems developed by the BD or more accessible to the BD. In addition, the larger BD is more likely to be willing and able to commit capital to complete a trade in the event that the market place doesn’t. CSAs, a variation on soft dollar payments, that now is used with smaller BDs,  have come into vogue over the last several years, with help from the larger BDs, and already account for upwards of 30% of all commission dollars generated by institutional investors.

The above is a long explanation of what may appear to be a minor thing happening to Capitalism, in contrast to the grand ideas that came out of a WEF meeting. In my view it is not minor and has significant unintended consequences. Historically, smaller BDs have been an important part of the capital allocation and capital raising functions of the financial markets. They have provided research on smaller companies, been a part of price discovery in the marketplace through their trading desks and provided investment banking services including IPOs and secondary offerings for these companies that typically could not command the attention of the larger BDs. As institutions have elected to pay for the research by check vs trades, the ability of the smaller BDs to service these small companies as investment bankers has become problematic.  As trading becomes more concentrated among the big guys the economics are forcing many of these companies out of the trading and capital raising function and lessening their ability to hire and retain high quality professionals. The larger BDs do not step into the breach to service smaller private and public companies because the economics just don’t justify it. Thus, the capital markets business becomes more concentrated among a smaller number of bigger players. In a way, it is Capitalism at work within the financial services industry where unfettered Capitalism leads to concentration into fewer entities and, ultimately, monopoly positions.

Unfortunately, it doesn’t stop there. Concentration in the capital markets affects the role of Capitalism in the broader non-financial world as well. The less apparent outcome of this concentration, is a stunting of the capital-raising function for private companies leading to more limited access to the public markets. It produces an approach by early-stage investors of less reliance on the public markets providing liquidity and more focus on the direct sale of a company. I see that working its way into the investment decision process by venture capitalists and others, and the subsequent strategic process around the growth of a small company. If the expected exit or liquidity event for the investor is a sale, that becomes a big part of the way capital is allocated to “grow” the company. It also appears to shorten expected time frames from start-up to potential liquidity. And, it leads to the creation of products as opposed to companies, with an eye on where the product would fit into the business of potential corporate buyers. It changes the nature of the skill sets at the investment banking firms from understanding and supporting functioning capital markets to advisory merger and acquisition talent. Finally, it has the insidious effect of leading to concentration and lack of innovation in the corporate world as well. A large company can survey the universe of start-ups and smaller companies and snap them up before they become a threat or to fill a gap in their skill sets or product offerings. It is no longer a “make or buy” decison. It is just a “buy” decision.  With lower odds of a smaller company ultimately getting liquidity and raising capital through the public markets, the focus internally becomes one of positioning the company for a sale to one of the behemoths in its industry. Once the acquisition takes place, I have seen, in many instances, the innovation pace slowing or in many cases just disappearing. In some instances it can actually add to the portfolio of products offered by the larger entity, but not always. Ultimately, concentration increases, stifling growth and innovation, and creating less-free markets. It then takes big government to “regulate” these entities to prevent the ultimate outcome of true capitalism–a monopoly position.

So we end up with big financial firms, big corporations and big government—most likely all too big to fail or change, but more dependent on each other for their raison d’etre and most likely less responsive to leaving a better world for their children and grandchildren.  It’s not a pretty picture. It’s not all because of Commission Sharing Arrangements, but the pace at which concentration is happening is accelerated by this small change in the way business is being done in the financial sector.

I was actually encouraged by the discussions at the WEF meeting and walked away with some hope that the upcoming generation of Young Global Leaders might actually find ways to get this right. But, the small changes which have big implications and are taking effect daily will make their job tougher.

Lean In Again: Some Observations on the Comments re Sheryl Sandberg’s Great Book

In Dealbook, Professor Steven Davidoff published an interesting article, “Why So Few Women Reach the Executive Rank,” which provided a pretty good summary of what many have drawn from Sheryl Sandberg’s observations in her book. I still say everyone really does need to read her book. I would add to my admonition in my earlier post–Read the book, carefully. I would also suggest reading Davidoff’s article carefully as well.

I think one quote in Davidoff’s article is very telling– “women have to behave like men to rise to the top.” This seems to be a universal conclusion of what Sandberg is saying in her book. I think a more complete statement,  is “women have to behave like the men who are currently at the top to rise to the top themselves.”

I would posit that in many cases we have the wrong men at the top who are pretty much, across the board, producing sub-optimal performance relative to what it could be. Most corporations are operating below their potential because the culture does not allow the best talent, female or male, to rise within the organizations. Exclusion and prejudices about what constitutes a good worker or a good manager, in my view, often lead to less capable people managing parts of any organization. It is easy to identify women as a class being excluded. And there are a set of prejudices and difficult work environments that exist specifically related to women. There are also less explicit prejudices which end up excluding a set of men as well. Sandberg hints at this in her book. Organizations that minimize both these prejudices–female and male–end up with more successful women and a different set of successful men. And, I believe, a more successful business–certainly relative to their peers. We need to identify more clearly what it is about those organizations (too few in number) where this is happening.

Trying to understand what it is about the culture and the general environment in those few organizations where the presence of more women in the ranks may be an indication of that culture, might provide some clues about what it takes to create the right environment.  I am still trying to figure that out, in spite of having been part of an organization where that happened. I think we need a few professors to take on the challenge of identifying the organizations and truly figuring it out.

In Praise of Sheryl Sandberg (and all women)

While working out in a gym in Abu Dhabi, of all places, I watched Soledad O’Brien’s CNN interview with Sheryl Sandberg re “Lean In: Women, Work and the Will to Lead.” It was a reinforcing interview between two intelligent and focused women with a great supporting cast. It is worth watching as an adjunct to the book. Everyone should, of course, read the book–I mean EVERYONE.

My read of the primary focus of the book is an exhortation for professional women to look in the mirror with a new eye and seek leadership opportunities and not convince themselves (or allow others to do so) that they can’t or shouldn’t. There is an occasional recognition that there are many other women throughout the workforce who don’t get a fair shake. It is also an honest personal appraisal of Sandberg’s career to date, the mistakes she has made and the lessons she has learned. It is a management primer for women–and men–that specifically deals with the prejudices we all bring to our interactions with the other sex (notice I didn’t say “opposite”). It has application to interactions with anyone, since we are all different products of nature and nurture. The facts and data–read the appendix!–that document reasons for the gender gap, as well as the anecdotes throughout the book provide support for Sandberg’s conclusion that things won’t really have changed “until half our institutions are run by women and half our homes are run by men.” They certainly won’t change for the women further down the pyramid until that happens. She often says that men have to do their part to produce this change but she really puts the onus on the women. It is an important message.

In my mind, though, there is a bigger message in the book and an unstated opportunity for companies who get it now–and some have–to set themselves up to take advantage of “gender arbitrage.” This is not the classic definition of gender arbitrage, which is hiring smart women for less, but the “gender arbitrage” that was defined back in the late ’80’s when we took the Lehman Research effort from 15th to 1st in the rankings in three years. Boris Groysberg and Ashish Nanda, who did much of the work creating a series of Harvard Business School cases about what happened there, pointed out that we had more women and more successful women in the department–statistically off the charts–than any other firm in the business. Somehow, we created an environment where the best women on Wall Street were attracted to the firm and thrived and new female  analysts became successful quickly. It got defined as gender arbitrage after the cases were written. We also had many very successful men. It was a hard-working but supportive place to work. It was really IQ/Acumen/Attitude arbitrage. The women were not paid less than the men and in many cases made more, tied to their success as analysts and, ultimately, managers. There were many little and some big things we did that helped produce the success. I would suggest that you go to the HBS Publications website and spring for a copy of the Jack Rivkin Lehman A case if you really want to get into the nuances. Boris is now teaching a course at HBS, “How Star Women Succeed,” and the case is a part of it.  Why the environment initially existed is hard to explain. It started with just wanting to create something special that had nothing to do with gender–just capabilities and a big “no-jerk” policy.  There was one thing, though, that made a difference. From the very beginning there were many people involved in the interviewing processes, but our lead interviewers were two of our first outside hires–two very capable women. An interesting thing happened as a result. Here were two people who were clearly part of the decision-making process and were serious about talent and attitude. Other women they interviewed were attracted by their attitudes, their openness, their empathy and the clear understanding that they were decision-makers. Interestingly, the men they interviewed knew that they were a big part of deciding whether the men would be hired and that they (the men) might end up working for them (the women). Some men just opted out because of that, which was fine with us. The ones who didn’t, understood how the organization was going to work, recognized the talent and the opportunity and clearly didn’t have a problem with the working relationships. In fact they saw the working relationships as a big plus. It all fed on itself and created a supportive environment where the gender balance really worked for us. We didn’t just have a good gender balance. We got the absolute best where there were no impediments and much support in the work place and in their lives in general–for both the women and the men of like minds.

I don’t think organizational success has to wait until talented women lean in and work their way up the jungle gym to the top. If the organization truly creates the environment that doesn’t tolerate the jerks and provides continual support for both the women and men making decisions about their lives, they will end up with teams that really work. And the best managerial talent, which should be equally balanced among the sexes, will rise through the ranks. Who knows if the real organizational structure, if this truly happens, will have “ranks” as opposed to something more like the jungle gyms Sandberg refers to. Sandberg points out that “Research already suggests that companies with more women in leadership roles have better work life policies, smaller gender gaps in executive compensation, and more women in mid-level management.” I would submit that there are companies with all or some of the above because they started down this path many years ago. We need many more. What a waste of having impediments that prevent the best to rise. It is important to read Sandberg’s book, though. If male and female employees  and executives cannot empathize and learn from her story, the gender arbitrage, as I define it, won’t happen. There is more to say on this subject, but everyone please read the book, and then we’ll talk.

The Employment Situation is Quite Dynamic–2 Million quit their jobs in February

The February employment numbers are showing an encouraging trend that began last year. I expect this to continue with some ups and downs. It is supporting one of the surprises in “What Could Happen in 2012 (and beyond).”  Net, net, 227,000 jobs were added in February, and with a half million increase in new job seekers, the unemployment rate stayed at 8.3%. I am not sure everyone understands the components that go into that net number which reflect a very dynamic labor situation in the United States. The net number of new jobs is a result of about 4 million people being hired every month while roughly the same number leave their jobs. What is interesting is the make-up of those numbers. Using the latest available data (December 2011) here are some interesting facts that, if nothing else, will provide some cocktail conversation at your next party (don’t invite me, please):

In December 2011, 4.0+ million people were hired. 3.9 million were separated. Only 1.9- million were actually laid off. 1.9+ million quit, typically to take other jobs, and 330 thousand left for retirement or other personal reasons. At the end of the month there were 3.4 million job openings remaining to be filled.  This is up from 2.9 million in December 2010.

This kind of dynamic goes on every month in the US. If we look at some of the peak numbers prior to the recession, in 2006, average monthly hires were 5.4 million; layoffs were only 1.8 million; other separations were 0.4 million; Quits were a very large 3.0 million. The average number of unfilled jobs at the end of each month was 4.5+ million. Construction employment also peaked in that year averaging 7.7 million. In December 2011, it was 5.5 million.

December 2011 2006 monthly average
Hires 4.0 million 5.4 million
Total Separations 3.9 5.2
Layoffs 1.9 1.8
Other Separations 0.3 0.4
Quits 1.9 3.0
Net Jobs Added 0.227 0.155
Job Openings 3.4 4.5
Construction Employment 5.5 million 7.7 million
Unemployment Rate 8.5% 4.5%

There are many interesting statistics that tell a story of a fairly dynamic labor picture in the US. One of the most worrisome numbers, in my view, is Job Openings. In such a dynamic labor force there will always be substantial unfilled jobs. While geography, timing and Quits play a role, it is an indication that the skill sets don’t match up with the requirements.  Companies find much of their labor requirements from those who already have jobs and skills. It is great for those with the acquired skills who are improving themselves, but, on balance, it raises labor costs and does nothing about those who want jobs who don’t have the appropriate skills. I think corporations will have to fill the training role–and some are. Clearly, our educational system isn’t doing it, although the unemployment rate for those with a college degree is only 4.2%. The military can also fill this role as an important plus for those who do choose to serve. By the way, the unemployment rate for all veterans is 7% while non-veterans are at 8.6%.  Among male veterans/non-veterans it is 7.2% and 9.3% respectively.  I could go on with these little tidbits. For those who are interested just visit www.bls.gov. I find it much more interesting than browsing Facebook. It is tougher working it in to a cocktail conversation, though. Seems to have less impact than talking horoscopes or The Voice.

Accenture’s Downes, Altegris’s Rivkin Assess Disruptors (Podcast – April 11, 2014)

Apr 11, 2014

Larry Downes, co-author of “Big Bang Disruption: Strategy in the Age of Devestating Innovation,” and research fellow at the Accenture Institute for High Performance, weighs in on developing trends in the world of media, technology, the internet, and commerce broadly to identify which embody game-changing “big bang disruption” and which do not. Downes speaks with Bloomberg’s Kathleen Hays, and guest host Jack Rivkin, chief investment officer at Altegris Advisors LLC and a member of the board of directors of Idealabo, on April 10 on Bloomberg Radio’s “The Hays Advantage”.

Listen to podcast here: http://media.bloomberg.com/bb/avfile/Economics/On_Economy/ve9LOITvSObM.mp3

Altegris CIO Rivkin Discusses Stocks, HFT, Fed (Podcast April 10, 2014)

Apr 10, 2014

Jack Rivkin, chief investment officer at Altegris Advisors, discusses the direction of the stock market, Federal Reserve policy, and the complexities of high frequency trading. Rivkin speaks with Bloomberg’s Kathleen Hays on Bloomberg Radio’s “The Hays Advantage”.

Listen to podcast here: http://media.bloomberg.com/bb/avfile/Economics/On_Economy/v3fW4XPODeWA.mp3

Action Economics’s Englund: Fed Dug Itself in a Hole (Podcast – April 10, 2014)

Apr 10, 2014

Mike Englund, chief economist at Action Economics, says the Federal Reserve is trying so hard to be transparent, e.g., by providing a list of economic indicators it’s watching to decide when to move interest rates, that it may have dug itself into a hole where markets expect a move on policy when one may not be forthcoming. He also says the drop in jobless claims last week to the lowest level since 2007 is a legitimate sign of labor market improvement. Englund speaks with Bloomberg’s Kathleen Hays, and guest host Jack Rivkin, chief investment officer at Altegris Advisors LLC, on Bloomberg Radio’s “The Hays Advantage”.

Listen to podcast here: http://media.bloomberg.com/bb/avfile/Economics/On_Economy/v_l8eQ8bAtOI.mp3

Altegris’s Rivkin Discusses 2014 Fed, Investment Views (Podcast)

Summary: Dec. 18 (Bloomberg) — Jack Rivkin, chief investment officer at Altegris, says he’s concerned retail investors may be inclined to start buying stocks in 2014 just when stocks are set to plateau or post only very small gains. He says volatility may increase, especially as the Federal Reserve starts to taper its bond purchases, which is another obstacle investors will have to navigate. Rivkin speaks with Bloomberg’s Kathleen Hays and Vonnie Quinn on Bloomberg Radio’s “The Hays Advantage.” (Source: Bloomberg)

Listen to the podcast here - http://www.digitalpodcast.com/items/24717879

Altegris CIO Rivkin Discusses MSFT, GOOG, AMZN (Podcast)

Summary: Jan. 31 (Bloomberg) — Jack Rivkin, chief investment officer at Altegris Advisors, discusses reports that the board of Microsoft Corp. is getting ready to name Satya Nadella, executive vice president of Cloud and Enterprise, to replace Steve Ballmer as chief executive officer. He says it will help the software giant shift its focus from consumer to enterprise products and services. He also discusses recent earnings reports and new developments at Amazon and Google. Rivkin speaks with Bloomberg’s Kathleen Hays and Vonnie Quinn on Bloomberg Radio’s “The Hays Advantage.” (Source: Bloomberg) 

Listen to podcast here - http://www.digitalpodcast.com/items/26278078