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 :-).

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 Debt Ceiling, Long Term Deficit Reduction and Insanity

Having barely survived the Fiscal Cliff, we now face the prospect of the crazies using the debt ceiling as a second attempt to derail this recovering economy. Everyone acknowledges that we have a growing debt problem which must be solved. That is a long term issue and should be dealt with accordingly, as opposed to immediate austerity in the face of a fragile but growing US economy. Even the IMF has finally concluded that austerity at the wrong time and at the wrong level is not the answer.  Restoring the Payroll Tax is already a mistake. This is not the time to reduce any flows into this economy.  It is time to sit down and develop a long term plan to reduce the rate of debt accumulation via serious review of federal spending across the board, entitlement reform, tax policy and, at the same time, redirection of spending and policy toward areas that will produce long term economic growth and jobs in this country and the world. We know the levers that will produce growth–education, technology, infrastructure, energy independence, immigration.

We do run the risk of waking up one day and finding the global financial markets unwilling to finance the debt we continue to incur.  However, if we develop a serious long-term plan that begins to go into effect well before this administration is out of office, while still maintaining a growth path, the financial markets will likely be very supportive. Companies and individuals just need to know the rules and see an economy with opportunity. While it was a rather optimistic view, the forecast I made in December does provide at least a vision of what could begin to happen this year. Look at how global equity markets, including our own, have reacted to what was a modest resolution of the fiscal cliff. I would predict that if the debt ceiling increase is accompanied by the elements of austerity that the chief crazy, Mitch McConnell, wants to put in place immediately, financial markets will reverse in anticipation of a major slowdown in growth domestically with an impact on global economies as well.

Where are the folks that are prepared to have the discussions in meetings among disparate parties as opposed to fighting their battles in the media? This includes both sides of the aisle as well as the Executive Branch. We have a real opportunity to get this right. Let’s hope we don’t blow it.