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.

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 :-).

NextWealth–Distributed Incubation and a new outsourcing model with profound implications

On a recent trip to Bangalore to visit with Duron Energy, an Idealab company, I was fortunate enough to meet with Dr. Sridhar Mitta, the original Chief Technology Officer of Wipro, one of its earliest employees, and, as President of Wipro Global R&D, the key missionary of outsourced product development. He is the Founder and Managing Director of NextWealth, www.nextwealth.in.  After receiving his M. Tech. from IIT he went on to get a second Masters and his Doctorate at Oklahoma State University. (He did say it was nice to meet another “Okie.”) He returned to India and spent several years in the public sector before joining Wipro in its startup days. He retired in 2001 and subsequently has been involved in a number of technology companies. His career truly traces the development of the IT industry in India. But his primary focus now is NextWealth, which may represent another step along the IT path in India and possibly elsewhere.

NextWealth is a for-profit social enterprise that is taking advantage of a significant cost arbitrage between urban and rural India, but also, profoundly, makes use of and reinforces certain cultural and social aspects of the Indian society.

In addition to the famous network of IIT schools in most of the major urban locales, India has located many very good technical schools in rural areas in an effort to increase the number of college educated members of the workforce.  Many of these campuses have quite complete infrastructures including, importantly, sufficient primary and back-up power. The schools provide a college education to students in rural India who would not be able to move to urban areas because of the costs and the prospect of separation from their families at a young age. This particularly applies to the young women from the rural areas. The problem is that once they receive their degrees, the job opportunities are most likely elsewhere, not in the local community.  In India, culturally, family takes precedence, but the economic realities brought about by the demand for technically trained individuals in the large engineering complexes in the cities require difficult decisions for these graduates. NextWealth finds an entrepreneur or entrepreneurs either living in the rural areas, or more often working in urban areas, who would prefer to be nearer to home and family. NextWealth provides the start-up funds and other support to create a business that can scale locally. Dr. Mitta pointed out that in many ways it is a distributed Idealab concept. While Idealab incubates the companies at its facility on West Union in Pasadena and then moves them out, typically to a nearby location (Duron is an exception!), NextWealth starts the incubation where it knows the workforce will exist to sustain and grow the company. The willingness and ability of the US college-graduate workforce to locate almost anywhere allows for the Idealab model. NextWealth is to some extent capitalizing on the current state of the Indian infrastructure, but more so, the cultural phenomenon of the importance of geography and family.

The NextWealth model, itself, has some profound implications. We have all seen the articles and dissertations on the urbanization of populations globally. The pundits are predicting that, ultimately, 90% of the population will end up living in cities. It is hard to imagine what life will be like if that occurs. In many societies as the migration takes place the disruption to the concept of family is significant and is being resisted. That is certainly the case in India and is happening in China as well. Dr. Mitta is pragmatically taking advantage of the ties to family and geography in India. But in so doing, he is creating an alternative model to this inexorable march toward the mega-cities. In addition, Dr. Mitta told me that NextWealth’s companies are primarily employing educated women, where the pull from family is the strongest and the prospect of moving away to a single life in the city is remote. NextWealth is bringing many more women into the workforce in roles that provide higher incomes than they historically were able to receive and where they are actually making use of their education. The incomes are lower than they might earn if they moved to the city, but the cost of living is more than proportionately lower, while the quality of life and family interaction is higher. The empowerment of these women feeds on itself in the local area providing a model for other younger women to pursue an education without the prospect of it disrupting the pull of place and parents.

For this to work does require Tom Friedman’s Flat World. It requires global connectivity as well as the local infrastructure resulting from the creation of these rural educational facilities. It relates primarily to service businesses as opposed to manufacturing. It also requires acceptance by the customer that a reliable network and an educated workforce does exist in rural India.  Dr. Mitta says the selling process to the customer reminds him of the early days of Wipro, when the first response to the idea of outsourcing to India was “Where’s India? And how can they possibly speak and read English?”  He says the questions today are “Where’s Karnataka? And how can they possibly have that skill set?” Sounds like we still have a bit of work to do in the US educational system on Geography and Global History in addition to Math and Science.

This model won’t apply everywhere, but with some tinkering it might even work in the developed world. Dr. Mitta is exploring that possibility, starting with regional educational institutions in the US. One of the Indian businesses that has been funded is providing math tutoring for K-12 students in the US, www.tutorvista.com . Yes, that’s right. Educated individuals sitting in the town of Mallasamudram, in the state of Tamil Nadu, India, are helping US students improve their math skills. Dr. Mitta thinks there is an economic model that doesn’t require outsourcing the service all the way to India. He may be right, but in the meantime, the model is changing lives and bringing more of the world’s population into the global economy.

I must admit that this post has very little to do with Climate Change, and probably belongs in a blog with a different URL. I guess the closest I could come is that the purpose of my trip to Bangalore was to visit Duron, www.duronenergy.com , which is providing solar home lighting to rural India. The original point of contact with Dr. Mitta was his interest in learning more about the company. When one has the opportunity to meet such a unique individual doing some unique and possibly profound work, sharing the story may stimulate others to think outside the box and come up with unique ideas of their own, whether it relates to climate change or other big issues confronting us over this century.