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A Red Letter Day for Global Trade


Brexit

July 24, 2016 is a day when two events impacting world trade became real – and create
a puzzle of after-effects. The implications of Brexit and the opening of a higher-capacity Panama Canal are going to ripple through a wide range of industries over the coming months and years.

At this writing markets are roiling around the world over Brexit. What’s puzzling is that there seemed to be almost no market adjusting in advance of the vote. What? Didn’t the polls continue to estimate the vote was too close to call? In those instances I always advise clients to be ready for either outcome and to take actions in advance to hedge, protect, and be ready to trigger pre-thought moves.

The EU is a key piece of the global economy. There’s no doubt it is weakened by this action. In economic forecasts recently I’ve been warning of the difficulty that arises when two major economic players are simultaneously at risk of recession. Britain and the EU may simultaneously dip after this action and the difficulties in Brazil, Argentina, Canada, and China could trigger a serious downturn.

The Canal? A longer-term but perhaps even more precarious situation. Panama took the low bid on the reconstruction of their overwhelmingly prime asset. The limitations to “Panamax” sized vessels limited shipping for at least the last 40 years of the century-old infrastructure. The rebuilding of the lock system enables very large container vessels through the “new” Canal.

Problems? Count em. Substandard concrete based on fracture-prone Panamanian rock. Poor design. Reliance on Spanish-built tugs that can only reliably operate in reverse, not forward. Not enough room in the locks for giant ships and the tugs at front and rear of the ships. Insufficient steel reinforcing in several areas of the new locks. And all that along in an El Nino-induced record drought that means that super-vessels don’t have enough water to float between the oceans.

One mistake. One super-ship into a lock wall and it all comes tumbling down. Planned volumes through the Canal like US grain into Asian markets are disrupted. China’s shipments to US East Coast ports. Months if not years of delays. Funding shortfalls that could topple the Panamanian economy.

Fiduciaries, leaders, directors, management? Sharpen up your implication thinking and start the discussions and actions now.

Image - Copyright: nerthuz / 123RF Stock Photo

Quick Look at the Economy

2016 isn’t off to the greatest economic start if you’re anywhere but the United States. China’s stock market has flirted with free fall, the Middle East has Shia-Sunni outright war in the tea leaves, and commodity prices have all but collapsed. The EU and Japan still pass the mirror test to see if they’re breathing – but barely.

With clients in agriculture, financial services, and construction on the agenda for the first half of the year I’m asked to weigh in. Generally, I’m optimistic.

There are problem areas. Commodity prices in the low range means crop farmers see the end of their 6-7 year run of record returns. Not a lot of new pickups in the shed these days. It’s a return to eking out profit from slim margins. Livestock producers benefit from lower feed prices. A lot of eyes are on the presidential election where a Republican win could affect biofuel policy that’s been buoying up grain prices – with corn as the leader. Plus the El Nino introduces even more weather and moisture uncertainty than usual. The dollar is expected to remain strong, working against exports. Huge amounts of US grains are sold overseas and the competition is stiff.

Financial service companies – banks, insurance, credit unions – depend on a stable to rising economy to produce loan demand. A GDP performance for the US economy usually points to a reasonably good year but it’s not quite that simple. The Fed is raising interest rates, albeit tentatively. The rest of the world is not. It makes for difficult decision-making. I’ll be in the room for about a dozen strategic planning meetings in this sector this year and the discussions will be “interesting.”

No sector deserves a better environment than construction and the outlook is fairly good this year after nearly a decade of abysmal to bad news. Commercial construction for 2016 should be up. One of the key indicators, billings at architectural firms, were up significantly for all of 2015 which should translate to buildings coming out of the ground in ’16. The home building sector is also looking positive. The National Association of Home Builders is projecting about a 25% increase in 2016 year on year despite some nagging worries about labor availability and costs. Job creation is a big driver in this sector.

But the question about whether the US economy can stand up to a world slowdown still stands. There are several factors that work in the country’s favor:

  • The US is so much better an investment destination than other global regions that it stands to attract more capital.
  • US consumers, as long as the job outlook remains strong and fuel prices remain low, will spend.
  • China is a totalitarian state. Don’t overlook the possibility that it can do almost anything it wants to get growth back up to a 5% GDP range. Plus it still possesses huge cash reserves.
  • The EU and Japan don’t have a great recent track record for growth but neither do they stand to take a deep dive into recession.

Lessons from the Iran Negotiations

Most of my work is with groups making decisions. Typically those are strategy decisions being made in uncertainty.

This week I was struck by the reporting of what resulted in a tentative nuclear deal between the rest of the world. It was painful, wrenching, intense, and eventually somewhat successful. In the months ahead more of the same will be necessary to put something in writing.

256px-Iran_negotiations_about_Iran's_nuclear
By U.S. Department of State from United States [Public domain], via Wikimedia Commons

Here’s the story I read from the New York Times:

http://www.nytimes.com/2015/04/04/world/middleeast/an-iran-nuclear-deal-built-on-coffee-all-nighters-and-compromise.html

There were several areas where pragmatists who deal with or participate in group dynamics and the best practices of decision-making could take lessons:

The resolution of the two sides to stay engaged was key. Both sides need a deal. Iran wants to relieve the oppressive burden of sanctions. The implications of an ability to produce nuclear weapons by a Shiite nation has driven fear to the top of the scale for Mideast nations, especially Israel and Saudi Arabia.

Wendy Sherman, the lead American negotiator, used a white board to track agreements and record problems and hurdles to overcome. Seems old school but an ability to put big print in front of groups is where I live. It’s essential. It also points up the need for somebody to be organized, to hold feet to fires, and to not let go until solutions emerge. One uses what works. In Sherman’s case it was brilliant. A failure to keep the group accountable would have led to failure.

The negotiation group also realized that artificial deadlines are a detriment to good decisions. The end of March deadline came from the Obama administration. The French pushed back. The wrangling will go on the months ahead but the spirit of the deal is there and came a bit after the imposed deadline.

It’s much the same when I work with strategy teams. In a couple of weeks one of my clients has an issue involving systemic risk that will involve painful and contentious discussions that have a long history in their region and organization. While I think we’ve set aside enough time, my goal is to have the big pieces of an agreement in place and let the word-smithing discussions to take place after contemplation. Important decisions can always benefit from a bit more time for consideration.

Learn what you can from Lausanne. Keep engaged. Keep organized. Have a driver in place that won’t lift eyes from the road to the goal. Work steadily and painfully, if necessary, toward agreement. Get creative. Don’t hesitate to extend deadlines when the goal is in sight.

The Oil Forecast

For the last three years, ever since it became obvious that the world was slipping into a recession and commodity prices would come down, I’ve forecasted an inevitable return to rising oil prices.

My logic: the recession reduces demand but only temporarily. Recovery from recessions is uneven globally. Some regions recover months, perhaps even years before others. A robust economy in Asia and to a lesser extent in Latin America will create demand that will drive prices up despite a slight fall in use in the U.S. and the EU.

Speculation or unexpected geopolitical events – “triggers” – will create volatility. Speculators will enter the market on supply shortages. No regulating body can keep them away from the opportunity to make money.

My forecast from mid-2008 forward: 75 to 85% confidence that an oil price spike and permanent plateau above $100/barrel will come sometime in the 2011-2014 time frame.

It’s been of interest to clients in, well, almost every field. Because as one CEO said to me on being asked what energy prices affect, “Everything!”

As the economic recovery has forged ahead strongly almost everywhere except the North Atlantic the price of a barrel of oil has risen back through the $50, $70, then $90 levels. Now the unprecedented events in the Middle East have taken Brent futures over $111. West Texas will follow.

Will it stay there? Of course it depends on a complex array of factors. Economic effects, how high the price spikes, volatility, whether the Saudi’s can really make up most of the shortfalls, refining bottlenecks, and more. In the weeks ahead I’ll place more information here on the implications of this important trend.

In the meantime I’m getting a lot of queries from clients who quickly remember my forecasts and are running through their Plan B strategies to react to the development or are confident because they planned for the high probability of this years ago.

The Buffett Letter

I read Warren Buffett’s letter to me as a shareholder this morning. Direct, analytical, balanced as usual. I like this passage a lot:
“Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy.”
The chairman’s contention that obvious upside growth is no guarantee of success is one that many leaders miss. I see it in industries challenged by bright but unclear futures.
Agriculture is an example. It’s obvious that increasing world population is going to demand food and a growing middle class will increase demand for animal protein in diets.
OK. Barring a major disease outbreak or a comet hit, this is an obvious outcome.
Many in agriculture assume that North America will be the big winner. That the world will beat a path to their production. That other nations, other producers will not be able to keep pace or match their products. Here the Buffett interpretation is missed.
Predictions from Malthus to Paul Ehrlich to recent forecasts of peak oil after-effects have breathlessly proclaimed danger. I watched Lester Brown of the Worldwatch Institute in 1995 do a predictive presentation on
Who Will Feed China. He’d written a book with that title.
The answer to Brown’s question? China itself. While importing substantial quantities of soybeans and vegetable oil it is quite adept at meeting its own food needs and exporting very large quantities of foodstuffs and value-added products to the world.
Where is Buffet’s “host of competitors” battling for supremacy? Everywhere.
I can cite examples of basic crop rotation and sound agronomy’s ability to triple and quadruple the productivity of land in Asia and Africa.
Then there’s wonderful technology
not involving genetic modification but making use of plant genomes to bolster Mendel’s techniques in developing even better crops and nutritious food. Mega-competitors like Brazil, Argentina, and huge multi-national corporations that have bought land in the poorest nations will crank out food, feed, and fiber in the next 3 decades.
Errors in judgment like looking at autos in 1910 or TV sets in 1950 or hand-held converged devices today with rose-colored myopia abound. There’s no argument that strong demand is ahead but there are no clear, dominant, easy winners.
Heck, one of my clients, Motorola, is spinning off its well-known handset business and retrenching to the predictable, profitable platform that has been there for decades: two-way radios and similar technology. Personally I think it’s a solid, overdue strategic move.
Question the too-easy and too-optimistic assumptions. Widen your view. Look ahead. Identify the potential competition before it surprises you. And then adjust your strategy to compete in the good, but challenging times ahead.