The Problems of Recovery

Comparisons abound between the Great Depression of the 1930s and the Great Recession of the 2000s. So far, we seem to have avoided the depths that were reached in the earlier experience, but we still have to consider whether or not the breadth of the two might be similar. That is, almost everyone one forecasting the recovery of the United States economy in the 2010s seems to be expecting that it will be a long, slow process.

The comparison I would like to consider in this post is the possibility that both of these periods represent a time in which the United States economy was going through a substantial structural change. Many people that have studied the 1930s period argue that the economy that existed in the United States in the 1950s was substantially different from the one that existed in the 1920s. Huge shifts took place in both manufacturing and agriculture throughout the 1930s and these shifts were just accelerated in the 1940s, a period of world war. The underlying cause of this change: technology had changed and the American economy had to adjust to become a modern nation. However, the mismanagement of the financial crisis in the 1930s just exacerbated the depth of the decline.

The argument can be made that major structural changes had to take place in the United States economy as it entered the 21st century. Changes of the magnitude of the present adjustment did not take place during the shorter, less severe recessions of the post-World War II period because the buildup of technological change takes time in order to build up a sufficient backlog of the new technology to really be disruptive. By the end of the 1990s, the structural change connected with the move from a society based upon manufacturing to an information society was ready to occur.

This buildup was not really a sudden one. It has been occurring throughout the last fifty years or so. I believe that the decline in the figures on capacity utilization for the United States captures this change very well.

Note in the accompanying chart that capacity utilization continues to decline throughout the whole period since the late 1960s. Obviously, cycles in this measure took place that were related to the various recessions occurring during the time span, but each new peak in capacity utilization never exceeds the peak it had reached in the previous cycle.

This, I believe, captures the changing nature of the United States economy and the movement from the foundational base of the Manufacturing Age to the growing impact of information technology and the Information Age. The conclusion that can be drawn from this is that the United States economy is not going back to where it was. But, this will take time.

Let me just point out three important factors that are playing a huge role in this change: evolving technologies, changing structure of the labor market, and the rise of the emerging nations.

First, the core of American commerce is not going to be manufacturing as we have known it. The future belongs to information technology, biotechnology, and knowledge. For the government to attempt to “force” workers back into jobs they held in the manufacturing world is just going to postpone the changes that WILL take place and threatens the stability of the society by re-establishing the inflationary environment of the last fifty years.

Second, the age of the labor union is past: non-public sector labor unions are legacy. There was a time when labor unions were needed to temper the pressures and demands of the industrial age of the large corporation who needed large numbers of physical laborers. These unions now compose less than half the union population in America yet have an over-sized impact on the politics of the country. In the next fifty years, the importance of the labor union is going to decline, economically and politically, as the United States moves from the manufacturing base that has dominated the last fifty years into the Information Age described in the previous paragraph.

Third, the United States, although it will remain the number one economic and military power in the world, is going to see its relative position in the world decline. The reason is that major emerging nations are beginning to feel their power and exert it. The immediate group of nations that come to mind are the BRICs. But, there are others. China, as we well know, is starting to exert its influence throughout the world. We see Brazil directly challenge America in the World Trade Organization concerning tariffs and subsidies. (See “Tax Move by Brazil Risks US Trade War”: http://www.ft.com/cms/s/0/dbf4284c-2afa-11df-886b-00144feabdc0.html.) And, more of this is to come! This is going to provide its own pressure for the economic structure of the United States to change.

These adjustments are going to take time. There will be substantial pain for those of working age who are not trained or educated for the new era. I believe that even the number of underemployed, 16%-17% of the work force, under-estimates the structural problem that exists. Thus, the estimate of 11 million new jobs that are now needed in the economy to get us back to where we were before the Great Recession began also under-states the problem.

Investment-wise, just as in the 1950s, the whole structure of opportunities available is changing from the earlier age. But, one needs to consider the new format of the economy that is evolving out of the manufacturing age in developing ones portfolio strategy. Similar to the 1930s, the 2000s are producing a modernization of the United States that will alter the world as it has been known and will produce a world that we can’t even hardly imagine yet.

Uncertainty: The King of the Market and what to do about it

This is a time that is particularly conducive to impulsive or instinctive behavior. It is a time that behavioral economists love because it proves their case about irrational human behavior. People react and they react on the basis of a gut feeling or a snap judgment.

These researchers tell us that this type of behavior is what has helped the human species survive. However, it is not necessarily the kind of behavior that leads to decisions or actions that are in our best interest when investing. “Relying only on intuition in finance can lead to very bad outcomes, not only for individuals but also for markets.” (This quote comes from David Adler’s new book “Snap Judgment”: see my post that reviews this book, http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) Yet we humans, individually and collectively continue to perform in this way.

Right now, the concern is whether or not the economy is bottoming out and starting to recover. We get “green shoots” here, but then some other indicator of economic activity comes in worse than expected. Alcoa puts up better than expected loss numbers but retail sales come in lower than expected. Sales of existing homes improve yet we get wind of another wave of subprime mortgage problems. (See “Subprime Returns as Housing Woe,” http://online.wsj.com/article/SB124709571378614945.html#mod=todays_us_money_and_investing.) And, what about the problems in commercial real estate, credit cards, and Alt A mortgages?

Then there is the question about whether or not there should be a second round stimulus bill. Paul Krugman has argued for a long time that the first stimulus bill was not enough. Yesterday Laura Tyson indicated that she thought that there needed to be a second round. Now the debate is all over the place. But, wouldn’t another stimulus bill add more to the government budget deficit going forward? And, there are questions about the possibility that the government has already committed to too much debt.

So the Dow Jones average goes up from 6500 and looks very strong approaching 9000 and then goes into a swoon. The price of crude oil was approaching $40 a barrel in February and then shot up to above $70 but now has returned to the $60 range. The yield on the 10-year treasury issue was nearing 2.00% in December 2008, jumped up to around 3.90% in the middle of June and traded at 3.30% yesterday. An index relating the value of the dollar against major currencies was around 70 in July 2008, popped up to the mid-80s in March 2009 and has since declined to about 77.

When the economic indicators seem strong the price of oil goes up as does the stock market and the price of bonds and the value of the dollar decline. When the economy seems weaker we get just the opposite movements. And, my bet is that it is going to continue this way for a while. So, uncertainty, and hence volatility, rule the marketplace.

This is the short run. Recently, however, I have been writing more upon the long run, what deficits do to long term interest rates and to the value of the dollar. Over the longer run, historically, some patterns repeat themselves over and over again. This, of course, brings to mind the statement made by John Maynard Keynes, “In the long run we are all dead!” Still, we need to take the long run into account.

This is where we need to take heed of what the behavioral economists advise. We, as investors, must not rely on intuition or gut reactions. We must not over react to the environment we now find ourselves in. Research has shown that acting in this way is not necessarily in our best interest.

The research also indicates that investing based on fundamental economic reasoning does work. Therefore, it seems as if now is a time for discipline and hard work. And, it is a time for patience.

But, this does not mean that one needs to totally ignore the short run. It is perhaps impossible to expect that most people will just sit out this stage of the economic cycle and invest their funds in safe, low-yielding assets. So, what kind of strategy might work here? My suggestion is that one needs to segment one’s portfolio, allocating some money to playing in the current market volatility, but allocating a larger share of the funds to potential future fundamental investment choices.

The smaller part of the portfolio can be allocated to playing both sides of various markets. Obviously, getting into the market near a “bottom” would be very profitable, but selling short near a “top” would also work. But, by all means consider any investments here as short term in nature because it is highly likely that the “bottom” may not turn out to be a “bottom” at all. Likewise for a “top.” So, one must be very agile in investing this way. Don’t hang onto losses, but let gains ride. Behavioral finance tells us that people tend to operate in the opposite way hanging onto losses hoping for the best and quickly selling gains to have something to show for their efforts. This is where discipline and focus are crucial.

Furthermore, remember that, on average, the expected returns on trading are zero: and there are still fees that need to be paid. But, using part of your funds in this way keeps you “playing the game” while still keeping the major part of your portfolio available for “value” investing to take advantage of longer run opportunities.

As research has shown, the fundamentals do apply over longer periods of time. Perhaps, however, it is not quite time to commit to some of these “value” propositions. People are worried about the potential inflation that may come about due to the large government budget deficits and the possibility that the Federal Reserve will have to monetize a substantial amount of the debt created. But, there are many people who think that deflation is going to be more of an issue in the near term. Hence, it is perhaps a little premature to put funds into investments that will prosper from a future period of high inflation. This part of the portfolio should be kept safe, but also should be able to be accessed when the time is right to commit to the longer run fundamentals. Research, however, has shown that it is alright to be a little early on these types of investments because the possible returns on such a commitment to fundamentals are substantial enough that being a little early is not harmful.

It is also important that an investor should stay in the areas of the market that they know best. If your skills lend themselves to the technology sector of the stock market then stay there. If your skills are in the government bond market then stay there. If your skills are in the foreign exchange market then stay there. Again, discipline and focus are all important.

Uncertainty is going to remain with us for quite some time in financial markets and commodity markets. The behavioral economists have warned us that this is a dangerous time to act in just an impulsive or instinctive manner. So, if being methodical is not your “cup of tea” then beware for the statistics are not with you. Chasing every “green shoot” or market reaction is not going to produce happy results. Acting in a focused and disciplined way may be very difficult for us to achieve but we need to try. That is what humans have learned they must do in activities like investing in financial or commodity markets.

Uncertain Asset Values and the Stock Market

“Value investors prefer to estimate the intrinsic value of a company by looking first at the assets and then at the current earnings power of a company.” This comes from the book “Value Investing: From Graham to Buffett and Beyond” by Greenwald, Kahn, Sonkin, and van Biema.

In value investing, the value of the assets is the first thing you should look at. Value, however, is uncertain and decisions about value are risky…that is, placing a bet on the value of an asset is a risky decision…and this throws us into a probabilistic world.

But uncertainty comes in different flavors. For example, in some situations we have a relatively good idea about what the underlying outcome distribution looks like. Games of chance like roulette or blackjack have uncertain outcomes but the probability distribution of possible outcomes is well known. On the other hand, the possible outcomes of a war are uncertain and we generally have very little knowledge of the probability distribution of possible outcomes. So at one end of the spectrum of uncertain situations we can say that our estimated probability is objectively determined, while at the other end we have to admit that our estimated probability distribution is entirely subjective.

The United States is at war right now…at war against an economic and financial crises. And, investors, as well as everyone else, have no idea what the probability distribution of possible outcomes looks like. We can’t even approximate such a distribution from historical statistics because there is insufficient information to produce any kind of a result that would be relevant in the current situation. The information that we are getting seems to be getting worse and worse.

This, to me, is why financial markets are performing as they are at the present time. No one can state with any certainty the values relating to the vast majority of assets in the United States.

Until people can gain some confidence that they know…even approximately…what is the value of assets relevant to them…they will not be willing to place substantial “bets” with much confidence. And, this will mean that financial markets will continue to meander lower.

One effort to get a handle on asset values is the “stress test” exercise of the Federal Government on large commercial banks. The effort is, of course, to see whether or not the asset values of these banks will hold up in a relatively severe economic downturn. The outcome of these stress tests will determine, to a large degree, the amount of financial help these institutions will get from the Treasury Department.

The problem is that the whole economy needs to face a stress test. It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets. This is scary!

We have heard over and over again in the past year that one factor that has “caused” or at least “exacerbated” the current crisis is accounting rules such as the “mark to market” requirement faced by many institutions. I think that this is nonsense!

The problem, to me, is that there has been too little information forthcoming from the businesses and financial institutions in this country. I contend that the only reason the “mark to market” requirement might have caused organizations any trouble is that the managements of these companies believed that they would never be held to live up to this standard.

The “mark to market” requirement is meant to warn managements that their decisions with respect to asset choices will have consequences on their balance sheets and this will be revealed to the investment community in real time. Therefore, Mr. Management, if you want to invest in riskier assets or mis-match the maturities of your assets and liabilities in order to increase your return on equity, you will have to account for them “up front” if your decisions sour.

Knowing this to be the case, why would these managements go ahead and assume riskier positions unless they believed that the accounting rules would not be enforced?

Another bad argument to me is the one used by Long Term Capital Management in terms of the portfolio positions they took…”We can’t release information on our positions because of the fact that if we did our competitors would know what we are doing and copy us.”

Well, guess what? Their competitors knew what positions they were taking and copied them. And, the spreads Long Term Capital Management worked with got narrower and narrower…and so LTCM needed to use more and more leverage to get the returns they were shooting for…and trouble developed…and who knew about it? Not their banks…not their investors…not the regulators…no one but them. And, we ended up with another crisis.

And, this goes back even further. I am reading a book about Goldman Sachs. One situation stands out…the financial crisis created by the Penn Central bankruptcy in the early 1970s. The Penn Central hid information about its financial problems from Goldman Sachs, as well as others in the financial community, which resulted in a collapse of the commercial paper market leading to a Federal Reserve rescue and millions and millions of dollars in losses as well as an enormous amount of time in law suits and other regulatory assessments.

In doing bank turnarounds I found out very quickly in each bank I was involved in that the first thing an organization does when their decisions start going south is that they attempt to “cover up” results. One of the first things needed in any turnaround situation is to open up the books and let the fresh air in. It always seemed to me that greater openness and transparency of reporting results would have reduced the number of bank problems and bank failures that took place in this country.

Many argue that if people knew the trouble that banks had gotten themselves into there would be more “runs” on banks and the system would be less stable. This is an argument “after the fact” much as is the argument about “marking to market.” If the information were available earlier to the public and the investment community, there would be pressure on managements to respond quicker to bad decisions and resolve them before they got out-of-hand. Allowing the managements to delay action on these issues only exacerbates the problem, for it does not force the managements to solve them.

If there are to be any regulatory changes…and I am afraid that there will be way too many of them in our future…I would argue that the most important one would be related to the reporting requirements of all businesses in the United States. The records of American businesses…non-financial as well as financial…need to be more timely and more open and transparent to the world.

The investment community and the regulatory community should never be in a position where there is such uncertainty about asset values as there is at this time! We have the computer systems to accommodate a requirement to be more open and transparent…there is no reason why more information should not be forthcoming on a real time basis.

The stock market…as well as other financial markets…will continue to move lower as long as the uncertainty exists about asset values. A government “recovery program,” a plan to ease the burden of foreclosures, and even a bank bailout plan, will not stimulate bank lending and move the economy out of recession until we get a handle on asset values…throughout the whole economy. Valuing assets will take time…and even more time will be required to work out the associated solvency issues. But, even now, greater openness and transparency would help speed this process along. And, maybe give investors enough confidence to start buying again

Good Management Never Goes Out Of Style!

I recently asked a group I was speaking to what was the difference between responding to incentives and “greed”. “Greed” is, of course, one of those loaded words that can immediately draw a visceral reaction when mentioned. The basic answer of the group was that greed was like pornography…greed is what an individual sees it to be. Responding to incentives is how the world goes about its daily living and for the response to incentives to become greed is just a matter of degree…it is an “excessive” response to incentives.

A concept like greed, to me, is like the concept of ego. All successful people have an ego…and that ego can be quite large for people who are very, very successful. But, it is not the fact that successful people can have extremely large egos that gets to me…it is how those people with extremely large egos use their egos. Let me give you three people with extremely large egos whose egos do not both me: Tiger Woods, Michael Jordon, and Bill Russell. (Yes, these are all sports figures, but they serve my purpose in this post.) Yes, these individuals have very large egos but…these people tend to make other people around them at least as good, if not better, than they would be otherwise. That is, they raise other people to levels they would not be able to achieve individually and this produces teams that win and win and win!

The point I am trying to make is that responding to incentives, in and of itself, is not “bad” but how this response is applied that makes all the difference in the world. “Greed” in building a management team and creating an exceptional company is definitely good and a benefit to the society and culture in which it resides while “greed” aims at self glory tends to be destructive and short-lived.

The difference to me is focus, with an emphasis on the longer term, on sustainability. To me, this is what ultimately defines “good management” and it is something that one should look for because good management, even in the face of fads and frenzies, never goes out of style. “Good management” builds winners…sustainable winners. “Good management” is what one should look for to invest in at all times.

Good management must first create an organization that has some kind of competitive advantage, something that differentiates it from other organizations, within the marketplace. This competitive advantage is generally built upon something the firm has, some core competencies that others don’t possess. And, these core competencies are enhanced by the team that management builds to enhance and sustain these core competencies.

In judging a company, I have gotten away from just looking at the head of the organization, the top dog. What has become crucial in my appraisal of any organization is the people the head person brings in to support and enhance the firm. If a leader surrounds him- or her-self with very talented people, people that will challenge and question the leader, people that will push others, including the leader, to do their very best, then I believe that such a company will have a fair chance to build up a competitive advantage over other companies and sustain that competitive advantage over time. A “leader” that cannot stand to have other “stars” around his heavenly presence may be able to create a competitive advantage for his company to start with, but generally he will not be able to sustain that competitive advantage over time.

A company in which the leader facilitates the very capable people around them is better able to “keep focus” on what is important much better than the leader that must generate all the ideas himself. It is important in the modern environment to constantly be bringing new or better products to market on a regular basis, but someone must keep the focus of the company. “Good management” encourages, supports, and promotes the team to keep up this “time pacing” of new products and services while, at the same time, maintaining focus on what created the competitive advantage of the company and what factors will sustain this competitive advantage.

Alternatively, a leader that does not build a strong team to surround him finds that the competitive advantage that the company initially boasted slips away over time. This is because creating a competitive advantage produces exceptional returns. (In the book “Competition Demystified” by Bruce Greenwald and Judd Kahn, exceptional returns are defined as a 15% to 25 % return on capital after taxes.) However, here is where the longer run is important. Others see this exceptional return and capital is drawn into this space to attempt to get some of the action. This additional competition works to break down the competitive advantage and reduce the returns that are earned by those in this specific industry.

One should note that the competitive advantage may come about only because the firm happens to be in the right spot at the right time; it has nothing to do with talent. Being in the right place at the start of a “bubble”, for example, can make someone look like a genius when there is nothing to back up the performance. (See Taleb’s first book “Fooled by Randomness” for a discussion of this phenomenon.)

In either case, as returns are being threatened by greater competition, the “leader” that has little talented support staff and limited new ideas begins to lose focus on what got them the initial competitive advantage and starts to focus on other factors that can enhance returns and have nothing to do with core competencies. Financial engineering is one such diversion that can bring continued returns. Increased leverage and mismatching maturities, as we have seen, are two such types of financial engineering that bring positive results…at least in the short run.

Less than stellar management, therefore, tends to lose focus on what initially brought them attention and eventually puts greater and greater reliance on other factors, like financial engineering, to keep attention. As is often the case, however, one cannot always tell the wheat from the chaff as the economy experiences “good times.” Only with the bust do we really find out who the good managers/leaders are.

Or are their clues we can observe earlier on that can give us some insight into which companies have “good management”? I, of course, believe that you can identify good managements early on. I have emphasized the word “sustainable”…which of course has to do with long term performance. Greenwald and Kahn argue that good managements are able to sustain the 15% to 25% returns for an extended period of time while still focusing on core competencies. Sustainable competitive advantage is also connected with relatively stable market shares within the core industry of the company.

Sustainable competitive advantage is connected with “how” the firm is able to achieve the high returns and the stable market share. Where do the earnings come from? Have they come from the core competencies of the company? Does the company attract and build up the talent that continually enhances these core competencies? Or, does the company have to go outside these core competencies to keep up performance? Or, do these companies rely upon financial leverage or strategies connected with mismatching durations to maintain performance?

Good management does not go out of style! I don’t believe that one has to argue for “conservative” management practices across the board. I do believe, however, that one should insist that the management of a company keep its focus on what it is strong in and build from that foundation and not depend upon extraordinary means to “puff up” its performance. In this, I believe that good management will build a good team and act “conservatively” because it doesn’t need to rely solely on its “super star leader” or “gimmicks” to create a winner…a team that continues to win over time. Therefore, I would argue that the concept of “Greed” is connected with FORCED performance…not with true achievement!

Investment strategies in this time of transition (I)

In my post of July 29, 2008, “Understanding the Economy” I discussed two possible interpretations of the current economic situation. One interpretation concentrated upon demand side changes in the economy whereas the other interpretation concentrated upon supply side changes. I argued that it was important to get the correct interpretation because the policy prescriptions would be different in each case and would produce substantially different results.

I gave two reasons for focusing upon the latter explanation as the cause of the business cycle and stated that it was important to create policies that provided supply side stimulus rather than policies that just attempted to stimulate demand. If the United States focuses on demand side stimulation, the argument is that this will just exacerbate inflationary pressures with little or no response in terms of increased output. Any governmental efforts need to be aimed at stimulating supply so that output can increase without undue pressure on prices.

A similar proposal has been presented by Kenneth Rogoff of Harvard University on Wednesday July 30 in the Financial Times, “The world cannot grow its way out of this slowdown.” (See http://www.ft.com/cms/s/29a40a90-5d6f-11dd-8129-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F29a40a90-5d6f-11dd-8129-000077b07658.html&_i_referer=http%3A%2F%2Fsearch.ft.com%2Fsearch%3FqueryText%3Dthe%2Bworld%2Bcannot%2Bgrow%26aje%3Dtrue%26dse%3D%26dsz%3D.)

Rogoff argues that “if all regions attempt to maintain high growth through macroeconomic stimulus, the main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future.” He goes on to say, “In the light of the experience of the 1970s, it is surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up.”

Furthermore, Rogoff states, “Commodity constraints will limit the real output response globally, and most of the excess demand will spill over into higher inflation.”

In other words, pumping up aggregate demand at this time is not going to get a supply response and hence almost all of the increase in aggregate demand will go into prices increases. Not a very pretty view of the future.

My description of this scenario was presented in the earlier post. In this post I want to examine investment strategies for the two different scenarios. Since we started on the demand side responses and believe that policies aimed at spurring on aggregate demand have the highest probability of occurring, let’s begin here.

Demand side programs, according to the scenario presented by Rogoff (and myself), will have more impact on increasing inflation than they will on increasing output. As a consequence, investor focus should be on protecting oneself from rising prices. (Sounds like the seventies doesn’t it!)

What to look for? More tax rebates (already being discussed); support for housing (already being discussed); keeping interest rates low (already being discussed); and other programs and policies being presented by presidential candidates and Congress.

Investment strategy? Where are your inflation hedges? Gold…commodities…housing seems to be out this time (it was a great hedge in the 1970s)…inventories…paintings…rare coins…

Obviously, these types of investment do not do a great deal to contribute to increasing output or stimulating productivity. This is what happened in the 1970s as the focus changed and people pulled back from investing in innovations and capital that resulted in increases in productivity and which also created positive externalities that spurred on the economy.

Demand side strategies at a time like this divert attention away from productive investment and toward investments that hedge against inflation and contribute little to resolving the underlying economic problems that plague the United States (and the world). But, demand side strategies are very popular with politicians because they can allow the candidate to talk about help to the ‘disadvantaged’ and the ‘little guy’ and beating up the ‘bad guys’. And, they promise faster results. Furthermore, when investors hedge against the inflation that is created, these same politicians can blast the ‘wealthy speculators’ for driving up prices which additionally harm the less well off. And, this is what happened during the years of the Carter administration.

Rogoff concludes his analysis with this warning: “In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater ad more protracted downturn.”

What about supply side policies? Not as easy to do and certainly not as easy to sell! First off, the fiscal authorities must take pressure off the monetary authorities by exerting discipline over the government’s budget. The irresponsible behavior of the current administration must be overcome by bringing the deficit under control. Doing this will help strengthen the value of the dollar, something that will help the performance of the United States economy in the longer run.

The attention of the monetary authorities must be focused on keeping inflation at a low level. What finally got the United States out of the malaise of the 1970s? Some tough policy actions on the part of Paul Volcker and the Federal Reserve that broke the back of inflation (even though this is not what Jimmy Carter really wanted). Inflation is counter-productive to economic growth, productivity, and innovation. We cannot get a supply side response as long as businesses and investors focus on inflation. Keeping inflation at a low level will also contribute to the strength of the dollar. (See Fred Mishkin’s last lecture before leaving the Fed: http://online.wsj.com/article/SB121726587261090311.html?mod=todays_us_page_one; and http://www.federalreserve.gov/newsevents/speech/mishkin20080728a.htm.)

Other supply side policies are still needed to spur on a recovery, but these will not result in programs that generate a short term payoff, something, of course, that politicians do not like. But, it must be remembered…it took us a long time to get where we are now and it will take a long time for us to get back ‘on track’. People must remind the politicians that they turned their heads aside for a long time allowing this economic dilemma to arise…and they are not going to be able to get us out of this mess with a wave of a magic wand!

It seems to me that there are at least two aspects to creating the platform for the next period of expansion. First, we must go through the economic transition to get our financial legs back under us, both in our financial institutions, but also in non-financial areas as well. Second, we must go through the technological transition that will result from the advent of new sources of energy. And, this transition will impact almost every sector of the economy. The important thing here is that the government must introduce policies and programs that will support the PROCESS of transition and which will not impede that process by shooting for specific OUTCOMES.

What to invest in given a supply side response by the government? Well, this is a time of transition and that means we must look into areas in which the transition is going to take place. One possible source for investment is in companies that are getting back to basics and bringing their focus back into the areas that they have or can establish sustainable competitive advantage. Here we can look for turnarounds, restructuring firms, and acquisitions to gain scale, customer captivity, or create barriers to entry. Second, we look toward those innovators that are working in the energy field to construct technologies or market structures that might create sustainable competitive advantage. This means that the scope of potential investments may be quite large, but the focus will be on future market structure. I will write more on these in the next two posts.