Economy, Markets and Business:

Anticipating and Preparing for the New Normal

Industry

Business
Economy +
•Strategy
Geo-Politics •Operations

Economic Situation , Market Outlook and Business Performance Requirements

Llinlithgow Associates
contact@llinlithgow.com

January, 2010.
Business is facing a decade of severe performance pressures ….
…. And it’s not clear that many are prepared or preparing!
Employment vs GDP: 1960-2009
6.0%
y = 0.63x - 0.00
Real GDP growth of
4.0%
R2 = 0.62
4.0% is required for
breakeven employment
Employment(YoY%)

2.0%
growth of 2.5%.
0.0%
Expected growth of 2.5%
-2.0% leaves us short. We
-4.0%
need 46 million jobs in
the next decade but will
-6.0%
-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% probably get 20 million
Output(YoY%)
at best.
Many businesses were
surprised by the depth of
the downturn and not well-
prepared.
Now they are struggling to
recover.
Few are prepared or
preparing for a sustained
period of strains and
challenges.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
The “New Normal” will not return to the old “business-as-usual”
Companies whose growth depends on the inclination and ability of the American consumer to
spend are under pressure. Americans remain deeply pessimistic about the economy's current
state, … But consumers do not see themselves simply trimming on a temporary basis. One in
three (33 percent) strongly agree that changes to their lifestyles are most likely permanent. (GQR
Research. Fall, 2009).
How long will it take the unemployment rate to go back down to 5 percent? A rough estimate can
be obtained by looking at the rate of decline in the unemployment rate after recent recessions: … ,
or almost 7 years. (Mark Thoma, Economic professor. Dec.,2009)
We have not been on a sustainable economic track and that has to be changed. But those
changes don't come overnight, they don't come in a quarter, they don't come in a year. You can
begin them but that is a process that takes time. (Paul Volcker, Der Spiegel. Dec., 2009).
Seven years later, what are the lasting lessons of Enron? There were two or three. This was a very
young and inexperienced management team, and I think both management—and possibly the
board—thought the good times could never end. That's one lesson: the good times do end. We're
going through that right now. (William Powers, Enron CEO. Newsweek, October, 2009).
Plenty of lessons can be learned from the glut of businesses that have fallen under the swift
sword of a merciless recession. There are a number of mistakes being made, but the number one
cause of failure is misguided strategy—not sloppy execution, poor leadership, or bad luck. (Paul
Caroll, Business@Emory. August, 2009).
Volatility is here to stay. What this does is force managers to harmonize two critical capabilities:
on the one hand, strategic clarity and consistency; on the other, agility and resilience in
operations. This may seem counterintuitive, but organizations can handle extreme change only
when they can address it within a clear strategic framework. (C.K. Prahald, Businessweek.
September, 2009).
Although it is true that most companies do not explicitly articulate an operations strategy, the
decisions made by operations executives ultimately produce — or erode — competitive
advantage. Are you certain that your operations managers know the right choices to make — or
are they mindlessly pursuing “best practices”? (Tim Lasseter, BCG. December, 2009)

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
We’ve cycled thru a sequence of reactions, judgments and fears …
and there’s still a lot of confusion, uncertainty and doubts

Reading clockwise
from the upper left
1.An already weak and
slowing economy was
tipped over into near
collapse by the
breakdown of the
financial and credit
markets
2. Which resulted in
widespread panic – which
was not out of line with
possible realities. It was a
“near-run” thing
3. The collapse and
consequence was taken
as the “Death of
Capitalism” but that was
exaggerated
4. If anything we’ve
returned prematurely to
complacency with too
little attention on deep
risks
5. And are facing a great
deal of confusion and
puzzlement about what’s
next.

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Two major sources of confusion – assuming a calm economy is
the normal state and being surprised by storms.
- and not appreciating the underlying patterns!

The Economy follows the same recurrent patterns, driven by the same forces and
governed by the same relationships but the actual behavior varies considerably.
The challenge is to understand the structure and relationships and monitor the
changes in the forces to anticipate what’s coming.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 Economic Cycle
CREDIT
1. Any developed economy follows a
linked cycle where the core engine is the
Consumer
Consumer Consumer driving the rest of the
Confidence
Confidence Economy (65-70% in the US –
Consumer historically high).
Hiring 2. Businesses respond by producing what
Spending
they can sell now and, IF demand is
The Great growing hiring more workers and
Economic investing in equipment and structures.
Business Economy 3. Part of their decision-making process is
Investment Circle of Life a multi-part “Credit” evaluation of
outlooks, risks, financing and
Business expectations.
Expectations 4. Going round consumers perform a
similar evaluation based on jobs, wages,
expectations, uncertainties and
CREDIT asset/wealth & financing value
• The last two bubbles were NOT based on
Business Cycles: wage or job growth but were artificially
stimulated by leveraged asset-
Consumer-led Normal vs. Investment-driven Speculative appreciation
1. As the Economy moves around the
cycle the result over time is a wave
pattern with repeating structures,
relationships, timings, etc. that depend
on how hard the “wind” is blowing
Consumer-led • A Normal cycle is led by Consumer
Investment-driven spending
Policy-managed • A Boom is driven by speculative
Investment (Tech, Real Estate)
• When excesses correct the impact can be
years on the bottom without public
Strategy without execution is fantasy. Execution without Strategy is thrashing.spending
And without a Management System
both are improbable
The economy has bottomed and is starting to “recover”
but employment lags and will lag for many reasons

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
The current state results from the links between the US and
World economies, credit and equity markets and Housing
The LUV Outlook & Risks
1.The US Economy will have weak
growth (U) and poor job creation
2. while Europe is facing a slower
and weaker outlook (L) and
3. the developing countries are
likely to be more V-shaped with
4. some major structural challenges
– China in particular
• China needs 6% growth for labor
breakeven and is
• facing the structural change in an
export-led economy
5. US Housing remains weak
6. Credit markets are self-repairing
but credit isn’t flowing because of
bank balance sheet damage, lower
demand and economic risks
• Small businesses are vulnerable
• Consumer demand is constrained
7. We think equity markets are over-
valued on a $ carry trade and are
exposed
• PE Ratios are abnormally high
• Economic growth will NOT be as
good as priced
• Earnings outlooks optimistic
• Likely priced beyond perfection

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Real economic data looks startlingly like the patterns we
showed …. Telling us a lot about the future
GDP a nd Consum ption (yoy%) 1. GDP &
16.0%

14.0% Consumption have

GDP
12.0%
followed the cycle
10.0%
PCE
since 1950
GDPTre nd
8.0%
2. Both have turned
6.0%
up but are still very
4.0%
weak – a post WW2
record
2.0%

0.0%
3. Growth this
-2.0%
decade was WEAK
-4.0% 4. The long-term
-6.0%
trend slowed and
1950-I 1955-I 1960-I 1965-I 1970-I 1975-I 1980-I 1985-I 1990-I 1995-I 2000-I 2005-I cliff-dove in the
GDP vs. Consumption vs Employment (yoy%) Great Recession
12.0%
GDPx
10.0% PCE 1.GDP follows PCE
Em ploy but Employment
8.0%
follows GDP
6.0%
2. Employment has
4.0% NOT turned yet
2.0% 3. It also shows a
0.0% steady downtrend
since 1980.
-2.0%
4. Employment
-4.0%
growth was weaker
-6.0% each decade
1980-I 1985-I 1990-I 1995-I 2000-I 2005-I
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 In the short-run Retail Sales is a good high-frequency
indicator for the Consumer side of the economy
Retail Sales:(YoY%)
15.0% 1. Both real and
nominal sales
10.0% abruptly fell off a cliff
in late 08, been
5.0% marching long the
bottom but now show
0.0%
significant
improvement.
R2 = 87.3%
-5.0%
2. They both remain
Real
Nominal negative on a YoY
xAuto
Trend basis – badly so.
-10.0%

-15.0%
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09
LT Economic Outlook:
1. Consumption tracks
GDP, Consumption, Real
15.0% 12.0% real Sales thruout the
Re al Sale s
GDP entire business cycle.
10.0%
Cons um p
10.0% 2. The drop in this
8.0%
downturn was the worst
5.0% 6.0% since 1960.
4.0% 3. Despite the upturn the
0.0% level remains very poor.
2.0%
4. Growth in Sales (&
-5.0% 0.0%
Consumption) will
-2.0% demand on Consumer
-10.0%
-4.0%
demand – which
depends on jobs and
-15.0% -6.0% wages.
1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 Capital goods orders are encouraging though a directional
change shouldn’t disguise remaining weakness
Ca pita l Goods O rde rs vs Ec onom y
20% 9%
1.Durable goods orders
15%
7% and orders x-Aircraft
10% sharply improved
5% 5% tough still negative
0%
and indicate better
3% potential for
-5%
investment spending
1%
-10%
DG O rd 2. DG Orders and xAC
-15% exA C -1% are still near –10%
-20%
G DP YoY. Things are much
-3% less bad, not growing.
-25%

-30% -5%
1993Q1 1995Q1 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1

20.0% 10.0%
O rde rs(x AC),Ca p e x , In d P ro d 1.Economic activity
15.0% (GDP) drives
10.0% 5.0% Industrial Production
drives orders drives
5.0%
capital spending in a
0.0% 0.0% typical cycle.
-5.0% 2. The order pickup is a
-10.0% -5.0%
sign of improving
capex potential.
-15.0%
xA C Or d s 3. BUT …. Capex lags
-20.0% C ap e x -10.0% as much or more as
In d Pr o d
-25.0%
Employment so
equipment and tech
-30.0% -15.0%
demands are limited.
1993Q1 1995Q1 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 Residential Investment (new homes) are a critical driver of
growth …. And remains in abysmal condition
GDP vs. Residential Investment (yoy%)
8.0% 15.0% 1.YoY Changes in RI
10.0% mirror and drive GDP
6.0%
growth – on a long
5.0%
enough timeseries we
4.0%
0.0% find that RI is a
2.0% leading indicator.
-5.0%
2. RI is also turning up
-10.0%
0.0% slightly on a YoY
-15.0% basis, after reaching a
-2.0%
GDPx terrible depth.
-20.0%

-4.0%
RI 3. At –23% it remains
-25.0%
abysmal however.
-6.0% -30.0%
1995-I 2000-I 2005-I

Re side ntia l Inve stm e nt (RI) vs. GDP, Gross Inve stm e nt
6.5% 40.0% 1. RI has a steady-state
38.0%
relationship around
6.0%
5% of total GDP for
36.0% years but was turned
5.5%
34.0% into a serious bubble
5.0%
by financial
32.0%
4.5% engineering.
30.0%
4.0%
2. Relative to total
RIGDP% 28.0% Investment it is
RIInve s t%
3.5%
26.0%
turning up – more a
3.0%
measure of reduced
24.0%
Investment than
2.5% 22.0% health.
2.0% 20.0%
1995-I 2000-I 2005-I
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Housing has arrested its freefall but is a long way from healthy
… or even beginning to repair the sustained damage.

1. New Home Sales

appear to be flattening
at a level at or below
the worst historical
one.
2. There is a worrisome
gap between New &
Existing Sales (existing
sales don’t contribute
to growth)

1. The Inventory of New

Homes has improved
significantly but
remains at very high
levels (comparable to
previous peaks).
2. Housing prices are at
more reasonable
(affordable) levels but
DO NOT appear to
have reset to prior
lows – leaving
exposure.
3. THE goto source of
Housing is
CalculatedRisk.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
The key to real growth, a healthy economy and
future prosperity is JOBS, period.
P riva te Job Cre a tion:1980-Now
150000 1.The US economy
Pu blic
140000 has created ZERO
Pr ivate
130000
private jobs in over
a decade, since
120000
1999Q2.
110000
2. It is the worst
100000
post-war jobs
90000 performance on
Ne t P riva te Job cre a tion is ZERO since 1999!
80000 record
70000 1. Labor force growth
means we need about
60000
1980Q1 1984Q1 1988Q1 1992Q1 1996Q1 2000Q1 2004Q1 2008Q1
150K/month +/- to stay
even.
8000 1500
LT Em ploym e nt Tre nds 2. Net New jobs is the
6000 1000 difference between
4000
500
new jobs and 150K.
2000 3. A rolling total since
0
0 1980 shows extremely
-2000 -500 poor performance
-4000 -1000
4. We entered the
-6000
Recession in the hole.
-1500
-8000
5. We are now –12.2
AggNw Jobs -2000 million in the hole.
-10000
Ne tNe w Jobs
-2500
6. We estimate 46
-12000
Ne w Jobs million jobs would be
-14000 -3000 prosperity but
1980Q1 1984Q1 1988Q1 1992Q1 1996Q1 2000Q1 2004Q1 2008Q1
anticipate getting 20
(BLS says 15!)
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
To understand the performance outlook follow clockwise
around the economic life cycle and read off the line…
Consumption vs GDP:1960-2009 Employment vs GDP: 1960-2009
10.0% 6.0%
y = 1.04x - 0.00 y = 0.63x - 0.00
8.0% R2 = 0.74 R2 = 0.62
4.0%

Output (yoy)
6.0%
2.0%
4.0%

2.0% 0.0%

0.0% -2.0%

-2.0%
-4.0%
-4.0%
Consumption (yoy)
-6.0%
-6.0%
-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%
-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Output vs Capex:1995-2009 Output vs Investment:1995-2009

20.0% 15.0%
y = 3.63x - 0.05 y = 3.67x - 0.07
15.0% 10.0%
R2 = 0.79 R2 = 0.91
10.0%
5.0%

Capex (yoy)

Investment (yoy)
5.0%
0.0%
0.0%
-5.0%
-5.0%
-10.0%
-10.0%
-15.0%
-15.0%
-20.0%
-20.0%
GDP (yoy) GDP (yoy)
-25.0%
-25.0%
-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%

Consumption growth of 2.5-3.0% implies GDP growth of 2.0-2.5%, the outlook for next year. 2.5% GDP growth
means Employment growth of <2.0%; really need 4% GDP growth. This is a weak and atypical recovery (typical
post-war recovers are 6% real growth) but means that Employment growth will be poor and Unemployment
stubbornly high. Especially given that long-term forecasts (OMB/CBO) call for growth in the 2.2-2.5% for the
decade. Investment (real estate and business) won’t pick up without strong growth, though residential tends to
lead a recovery it’s weakened and in repair mode for a long time. To see a surge in Investment spending would
require GDP growth north of 4%, or better. So not only Employment will be weak so will Investment and Capex
spending (implying weakness in the Tech and Equipment industries).
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
The single best indicator of demand is the change in real wages + employment
– and the critical question is whether the economy achieves takeoff velocity
where growth becomes self-sustaining…
7 .0 % 7 .0 % LT Cycle Drive rs: Consum ption, W a ge s, Em ploym e nt
C o n su m p tio n v s D e m a n d Consum p 12.0% 10.0%
W +E 6 .0 % GDP Co n W +E
6 .0 % 10.0% 8.0%
5 .0 %

4 .0 % 8.0% 6.0%
5 .0 %
3 .0 % 6.0% 4.0%
4 .0 %
2 .0 % 4.0% 2.0%
1 .0 %
3 .0 % 2.0% 0.0%
0 .0 %
2 .0 % 0.0% -2.0%
- 1 .0 %

- 2 .0 % -2.0% -4.0%
1 .0 %
- 3 .0 % -4.0% -6.0%

0 .0 % - 4 .0 % -6.0% -8.0%
Jan -95 Jan -97 Jan -99 J a n -0 1 Ja n -03 Jan -05 J a n -0 7 Jan -09 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1

7 .0 % 4 .0 % 8.0% 10.0%
Fu tur e De m a nd C om p on e nts :9 5 -0 9 Future De m a nd: W a ge s+ Em ploym e nt
6 .0 % 3 .0 % 6.0% 8.0%

5 .0 %
2 .0 % 6.0%
4.0%
4 .0 %
1 .0 % 4.0%
3 .0 % 2.0%

2 .0 % 0 .0 % 2.0%
0.0%
1 .0 % - 1 .0 % 0.0%

0 .0 % -2.0%
- 2 .0 % -2.0%
- 1 .0 %
-4.0%
- 3 .0 % -4.0%
- 2 .0 % Wag e s Em ploy W+E(R)
W +E W ag e s Em p lo y
- 3 .0 % - 4 .0 % -6.0% -6.0%

- 4 .0 % - 5 .0 % -8.0% -8.0%
Jan -95Jan -96Jan -97 Jan -98Jan -99Jan -00Jan -01 Jan -02Jan -03Jan -04Jan -05 Jan -06Jan -07Jan -08Jan -09 1965Q1 1969Q1 1973Q1 1977Q1 1981Q1 1985Q1 1989Q1 1993Q1 1997Q1 2001Q1 2005Q1 2009Q1

1. Demand (= YoY change in wages + employment) drives Consumption. Employment dropped but real
wages went up as inflation fell due to falling oil prices. Now employment is flattening but labor market
pressures are causing wages to fall.
2. Continued weak labor markets will keep pressures on wages for the foreseeable future. The drop in
Demand (on the monthly and quarterly) charts is worrisome and should be watched closely.
3. Economic growth becomes self-sustaining when organic demand leads to higher Employment and the
increase causes Investment to accelerate growth. The outlook is problematic for the decade. As it was
for the last but
Strategy no longer
without disguised
execution by Execution
is fantasy. asset bubbles.
without Strategy is thrashing. And without a Management System
both are improbable
Mythologies to the contrary economic performance ultimately
drives profits, earnings and markets 1. These charts show normalized
1600.0 rolling (cumulative) growth in
SPX: Nominal vs. Real
1400.0 the SP500, Profits and GDP
SPX from 1960 thru 2009Q3.
1200.0
SPXi
1000.0 2. That the markets went thru
800.0
two major aberrational bubbles
in one decade is clear. You
600.0
have to question whether
400.0
another is possible.
200.0
3. Adjusted for inflation SPX
0.0 performance has not recovered
1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1
900.0 900.0
(matching ~1998). More than a
Profits vs. SPX Lost Decade.
800.0 800.0
Profits
700.0 700.0 • Prior decades real performance
SPXi
600.0 600.0 was not very good (looked at in
500.0 500.0 this framework)
400.0 400.0
• 50-68:UP, 70-85:DOWN,85-
300.0 300.0
95:UP, 95-09: Bubbles, Swings
200.0 200.0
and Range, 10-20: Range-
100.0 100.0
0.0 0.0
bound?
1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1 1. It is clear though that the SPX
followed corporate profits-
16000 900.0
GDP vs. Profits
800.0
more closely in the 60s/70s,
14000
GDP Profits
700.0
diverging in the 80s, bubbling
12000
600.0 in the 90s and re-aligning in
10000
500.0 the 00s.
8000
400.0 2. It is even clearer that Profits
6000
300.0 grew with GDP, on the whole.
4000 200.0 Again very closely earlier.
2000 100.0
3. ECONOMY  PROFITS 
0 0.0
1950Q1 1955Q1 1960Q1 1965Q1 1970Q1 1975Q1 1980Q1 1985Q1 1990Q1 1995Q1 2000Q1 2005Q1
MARKETS Economy
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 At any moment markets are being driven by multiple factors across multiple
timeframes and have differential impacts on different asset classes.
K
Tim ey F Structural Fundamental Technical Sentiment
1. A decision to invest in a particular asset is
efr act
am or a bet on the four factors at the time you
e
execute – explicit and deliberate or NOT.
Immediate
2. The Four Factors are Structural,
Fundamental, Technical & Psychological
Short-term
• Structural = long-term changes in basic
relationships (globalization, emerging
markets) Current: C/C-, better but jittery
Intermediate • Fundamental = business cycle phase and
asset performance (for equities business
performance) Current: C/C-, improving
Long-term • Technical = are existing trends in the market
and (oddly) actually capture investor
psychology. Current: B/B-, deteriorating
As Key Structural Fundamental Technical Sentiment • Sentiment = investor perceptions, myths and
se Fa
tC c beliefs. Current: B/B-,dropping
las tor
s 1. The allocation among asset classes should
Cash & reflect the state of the factors, the outlook,
Equivalents
personal situation and shifts in
Income Assets understanding.
(Bonds)
• Too many US investors aren’t exposed long-
- Domestic
- Foreign
term to the right balance of foreign
- Emerging
investments
- ETFs • Allocations should be based on strategy.
Active management should see those adjusted
Equity Assets relatively frequently rather than held
Special Assets constant.
- Real Estate • Traditional weightings are 60/40
- Commodities Income/Equity but a better strategy is risk
- Hedge/ PE weighted
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Markets have gone thru a lot of turbulence this year as last year’s
disruptions began to be stabilized, though we’re still not at “normal”
1. Markets went thru several
phases this year
• Another near collapse as fears
of bank failure mounted
• A relief rally as the Stress
Test and earnings rescinded
the argument
• A flat market as the long-
term outlook was questioned
• The beginnings of another,
milder rally based on a long
list of myths and a Dollar
carry trade funded by low Fed
rates
• Another Flat market at the
end of the year
1. The question is what drove
things after August?
• From August on the number
of arguments from
Hyperinflation to China saves
us to Dollar collapse, to Gold,
and so on and so on were a
long list.
• The Fed is maintaining
historically low rates which
means liquidity for
speculation is widely
available.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Dollar, Gold and Exchange rate comparisons in two
timeframes …. 1. Gold (& Equity/Asset)
Markets spent the entire year
largely going up as the Dollar
went down and visa versa
• The behavior was similar
across all markets – that is
they are highly correlated.
Telling us fundamentals
aren’t driving.
• There was a return flight to
the $ as sovereign debt fears
under-mined complacencies
1. The $ has had a long
downtrend this decade as the
result of trade imbalances and
$ outflows.
• This was interrupted by the
flight to quality fears last Fall
• It was based on US consumers
borrowing abroad to continue
spending
• As the world economy re-
balances and US consumers
re-build their balance sheets
this will not continue
• The $ will remain the
dominant reserve currency
for years or decades
• It’s probably reached the
bottom for now

Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Despite all that the markets remain in a downtrend 1. Markets were in a normal bear
when the crisis hit, creating
chaos that almost collapsed
them last Fall.
2. And again this last Spring.
Chaos is when things are
completely unpredictable while
Turbulence can be analyzed but
remains uncertain.
3. We are still in turbulent
markets with serious risk
factors and an uncertain
economic outlook
4. The recent rally has just
touched the upper bound on the
downtrend channel and has
also retraced the 50% limit of
the Fibonacci indicator from the
Oct07 highs to the Mar09 lows.
5. We’re looking for a range-
bound market with volatile
swings for the rest of the
decade as misinterpretations
trump data & analysis.
6. Significant improvement from
here will be based on
• Upside surprises in the
Economy, especially
Employment
• Continued trading and
speculative activity
• Which depends on worldwide
Central Bank policy in general
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable and the Fed in particular
The notion of a lost decade is widespread (now) but in fact we’ve been in a range-bound
market since 1997/1998 (which coincided with the topping out and relative flattening of GDP
growth). Our outlook thru the decade is range-bound, wide-swing volatilities driven by more
mythologies but reduced bubbles.

1. A Fibonacci indicator test

from the start of the 90s
bubble to the 2007 peak
shows us back at roughly the
62% resistance level –
matching the intermediate
term analysis.
2. A horizontal resistance that
trims the 98/99/00 bubble also
trims much of this last several
years and also defines
another source of resistance
being approached. That
coincides with the Fib levels.
3. Taken all together we’re
going to be in a range-bound
Trading Market, are in one
now, and, if you believe the
Economic analysis, will be in
one for a long-time.
4. Which puts a premium on
analyzing the factors driving
markets, assets, valuations
and performance.
5. And active investing
strategies and asset
allocation management
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
There are two keys to understanding likely investment performance in this
market: valuations and returns. Which define a 3rd – the Margin of Safety, or
the difference between what you pay and what you’re CERTAIN it’s worth.
50.0
LT Value Trends:PE Avg vs Difference 1. From S&P’s long-run
40.0 historical PE data (1936-2008)
PEAvg Av36-90
Diff
PEDiff Trend
PETrend the avg. for 36-08 is 15.5 but
30.0 36-90 (pre-bubble) is 14.3 an
8.4% difference.
20.0
2. From 36-99 the difference
10.0 between the avg. and the
actual tended to net out to
0.0 zero, over the course of the
business cycle. As of 2008 it
-10.0
Diff is the difference between the 3MoMA of trailing PEand the 1936-1990 average. is as high as it’s ever been by
-20.0
Note that until this decade it was self-correcting but now has overshot significantly.
a phenomenally large
Dec-36 Dec-46 Dec-56 Dec-66 Dec-76 Dec-86 Dec-96 Dec-06 proportion (2009 data NA).
3. Over almost any period of
time market returns are
highest when initial PE’s are
in the bottom decile. Implying
that the likely returns at these
levels are poor, at best.
4. In a range-bound market
income investments (bonds)
often out-perform equities.
But there are market-cycle
ebbs and flows
5. An an active asset allocation
and selection strategy is
called for. Which requires
understanding the
performance outlook of the
asset.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Equity performance is driven by profits (and the economy) – and
needs to be broken down into Finance and non-Finance industries.
16 0 00 60 0 .0 1. GDP (lhs) vs. sector profits
G D P vs. P ro fits ($B )
14 0 00 show Non-Fin & Finance (rhs)
GDP 50 0 .0 in $B from 1950 to 2009Q3.
12 0 00 Fin 2. Relative performance using a
No n Fin 40 0 .0 rolling (cumulative)
10 0 00
normalized scale shows Non-
8 0 00 30 0 .0 Fin tracking GDP until the late
6 0 00 60s then lagging badly. It then
20 0 .0 surged during the Tech boom
4 0 00 and bubble this decade.
10 0 .0 • The NonFin bubble resulted from
2 0 00 restrained hiring, under-
investment and financial
0 0.0 engineering (buybacks) to maintain
1 9 50 Q11 9 55 Q11 96 0 Q11 96 5 Q11 97 0 Q11 97 5 Q119 8 0Q 119 8 5Q 119 9 0Q 119 9 5Q 120 00 Q 12 0 05 Q 1 short-term stock prices (bonus
consciousness?)
7 00 1 80 0 .0 1. Finance growth was steady
G D P vs. P ro fits (n o rm a liz e d ) 1 60 0 .0 but lagging until the late 70s
6 00 but, after a major drop,
G DP 1 40 0 .0 accelerated dramatically from
5 00 No n Fin
1 20 0 .0 83-00, largely as the result of
Fin
4 00 1 00 0 .0 de-regulation. Beginning in 00
Finance profits bubbled
3 00 8 00 .0
spectacularly.
2 00 6 00 .0 • From 07 thru 08 the Finance
4 00 .0 Industry destroyed the cumlative
1 00 profits back to approx. 1990.
2 00 .0
• Over half of those losses have been
0 0 .0 recovered in the last three
quarters, largely on proprietary
- 1 00 - 20 0 .0
trading.
1 9 50 Q 11 95 5 Q 11 9 60 Q 11 96 5 Q 11 9 70 Q 11 9 7 5 Q 11 9 80 Q 11 9 8 5 Q 11 9 9 0 Q 11 9 9 5 Q 12 0 0 0 Q 120 0 5 Q 1 • Regulatory reform is not likely to
tolerate a continuation of excess
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
Finance profits.
both are improbable
BCG Research found a large majority of major worldwide enterprises were caught flat-
footed by the downturn and protected profits by arbitrary cost-cutting. Recent research
indicates companies are still focused short-term.
1. Agile and resilient
enterprises would anticipate
the downturn, act early and
prepare to take advantage of
the upturn.
• Non-agile enterprises were slow to
react after being caught un-
prepared.
• They also appear to be counting on
a vigorous upturn to avoid more
serious re-thinking of strategies and
operations.
• Deeper restructurings require
improved controls and management
systems as well as new initiatives.
1. The focus of cost-cutting has
largely been on short-term
trimming of existing
operations
• Cost-cutting should NOT be evenly
spread across all operating
functions. Instead it should analyze
and weigh each function separately
and as part of the total enterprise.
• Performance goals and cost and
investment decisions should be
based on the short- and long-term
performance potential of each
function.
1. In the business environment
we will be facing there will be
major profit and performance
differences between
enterprises.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 1. Enterprise Performance
Total Returns = Earnings(Profits) X Valuation. Valuation should starts with understanding the
be driven by Economic outlook. Profit IS driven by business gaps between customer
performance in a difficult environment, which will persist! needs and solution
• Defines products and service
• Business strategies and models
• Operating strategies
Problem and VA
N
LU • Fundamental Value Proposition
IO Value Focus E
UT
1. It must be able to sell what it
EC

makes as it Goes-to-Market
EX

(G2M).
• Marketing is the process of
understanding the market and
Management System
•Budgeting
Enterprise Marketing, Sales,
making the market understand you
• Sales is the process of direct contact
•Operating Plan Performance Service
• Service is the management and
• Same Value message
• Compensation
And • x-linked
delivery of an order
•Infrastructure 1. It must be able to Deliver
• Efficient (operations)
Value Delivery • Effective (business) what it promises – whether
it’s making (Mfg), moving
(Distributor) or Selling (Retail)
• Operational effectiveness has
Op

deteriorated more than any other

e

capability
ra

Key Operating Functions

ce
• Operations are NOT best practices
t io

an
• Mfg, Logistics,
na

they are choosing the right ones,

m
Procurement, etc.

or
lD

running them efficiently (cost) and

rf
• Efficient locally effectively (enterprise value)
e li

Pe
ve

1. Management Systems are

2M

•Effective
ry

generally weak to extremely

G

• Linked x-function
weak
• Enterprise aligned • Establishing real goals with real
resources and measuring delivery
against plan is the heart of
A Business Enterprise exists to create and deliver value in the Market … it must have the performance.
right focus, strategy, ability to sell, deliver and execute to create value. And it must do so for
today and tomorrow simultaneously.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
Business performance improvement results from understand and assessing each
function by itself, in the context of the enterprise and balancing decisions across
functions based on overall performance contribution and potential
contribution. Assessment Actions Status
Resources
Initiatives & Focal Areas 1 3 5 7 9 $ Staff Capital

Strategy Magic is not in the shopping

Markets & Products list but in the blueprint
Problem & Value
Profit/Business Model 1. Knowing the functional
Management System specifics
Metrics & Controls
Change Management 2. Knowing how to integrate
Environment & Culture
Communications + Incentives them for leverage
Operations 3. Orchestrating all the
Marketing & Sales
Customer Service moving parts into a whole
Procurement
Logistics 4. And in setting the right
Core Operations goals realistically
Product Management
Planning & Scheduling 5. And putting real
Support Areas operating plans in place
Technology
Finance
HR

Each enterprise needs to 1) assess the current performance situation then 2) development a short-
term improvement plan based on that stress test. Next it needs to 3) develop a longer-term
strategic plan which 4) incorporates investments in new strategies and innovation initiatives. The
number of firms actually doing this would appear to be limited – promising rather poor short-
term and long-term performance outlooks.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
The key questions to ask of executive leadership are what is your
strategy and business plan and how are you going to deliver against
it? What should we look for in 10 months? 10 quarters? 10 years?
Resources
Initiatives & Focal Areas Phase 1: Strategies & Objectives Actions Status
$ Staff Capital

Strategy
Markets & Products

Strategic & Business Plan

Management System
Problem & Value

Activity Controls
Profit/Business Model
Management System

Operating Plan
Metrics & Controls
Change Management
Environment & Culture
Communications + Incentives
Operations
Marketing & Sales
Customer Service
Procurement
Logistics
Core Operations
Product Management
Planning & Scheduling
Support Areas
Technology
Finance
HR

Each stakeholder (employee, customer, supplier, business partner, investor) in any enterprise owes
it to themselves to understand what the current performance outlook is for every enterprise in
which they have an interest. They also need to understand how well that aligns with the
requirements of the “New Normal”, what the company is doing to meet those challenges, how it
plans to get from here to there and (most especially) how it plans to manage execution of those
plans.
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable
 Every enterprise will face an extremely challenging environment and
needs to prepare for it. Such preparation appears to be lagging
requirements.
- Stakeholders should be asking key questions to test the performance outlook.

SUMMARY
1.We are facing a weak recovery
Poor job creation
Weak demand growth
Rapidly developing economies dependent
on export-growth will be especially
challenged
1.Markets appear to be anticipating an
immaculate V-shaped recovery
Valuations are extremely high
Top PE decile returns are poor and
bottom decile returns are the best
performers
K ey A reas of F ocus
S tra teg y
P ro b lem & V a lu e
M a rke ts & P ro du cts
P ro fit/B u sin ess M o de l
G o-to-M a rke t
M a rke ting
S a le s
C u stom er S ervice
C ritical Q uestions
W h a t are w e a ll abo u t ?
W h at value do we crea te ?
Is it su staina ble or tem porary ?
W h o are we going to sell what ?
W h at’s it w orth ?
H ow w ill w e m ake m oney ?
P rod uct, services, finance ?
S ubscription, P a ckage , P er R ide ?
R ig h t S to ry to R ig h t P e o p le R ig h t W ay ?
W h at targets ? M essages ? M etho ds ?
F ind ? P rospe ct ? D e velop ? C lose ?
O rder ? P rocess ? D eliver ? S ettle ?
S up port, S ustain a nd G ro w ?

Investors need to adopt a more active

O p e ra tio n s H o w d o w e m ak e, d eliver a n d s u p p o rt ?
investment management and asset P ro cure m e n t S up pliers ? H o w m an y ? M ana ge ? C on nect ?
allocation strategy. L og istics W h at m o ves ? B est wa y/m ix ? S ervice Le vels ?
We are in a range-bound market and are C O R E O P E R AT IO N S B est layout ? W orkflow ? S kills ?vsLeBan
ulk ?
P ro d uct M a na g e m e n t
likely to be for the decade P la n nin g & S ch e d u ling
W h at fea tures/functions for what m arkets ?
H ow do w e synchronize the m oving parts ?
1.Businesses are struggling to prepare
2.Investors need to focus on the
performance outlook
Strategy without execution is fantasy. Execution without Strategy is thrashing. And without a Management System
both are improbable