Going Fast or Going Far

The college basketball season ended in historic fashion recently with two iconic coaches reaching new pinnacles in their profession. Coach K at Duke won his fifth national championship moving him past legendary Kentucky coach Adolph Rupp into second place all-time. Meanwhile, on the women’s side, Geno Auriemma led Connecticut to its 3rd consecutive title, and 10th overall under his reign.

The obvious comparisons of Coach K to Coach Wooden, who directed UCLA to 10 titles in 11 years, and Coach Auriemma to Coach Summit, who led Tennessee to 9 championships during her storied career, were frequently debated during the respective tournaments.

The accomplishments of any coach, or any leader, are naturally compared to the records previously set. Whether it is on the court or in the boardroom, the achievements of those who came before, set the standard by which the current leaders are measured. This dynamic always creates interesting debate… Could Wooden coach today’s players with the same level of success. Could Coach Auriemma have equal success coaching men? The most frequent discussion, and perhaps the most interesting of all, revolves around what all these legendary coaches have in common.

Similar comparisons exist in corporate America as well.

An excellent example of this is GE.

Jeff Immelt at GE was hand-picked by his iconic predecessor Jack Welch. Immelt took command of GE in 2000, precisely at the start of the most challenging economic environment ever faced by the company. During the depths of the financial crisis in 2008, there was considerable doubt whether GE would even survive. Over the succeeding years, Immelt stubbornly clung to the game plan of balancing the industrial side of GE with the huge financial services component, despite repeated calls by analysts to jettison the financial businesses. Eventually, Immelt changed course, culminating in the most recent announcement that it was largely exiting its financial services operations. Whether this move will create significant shareholder value over time, remains to be seen. Now for the interesting questions… Should Immelt have made this decision earlier? Would GE’s stock price be higher today if he had?

Meanwhile, fairly or unfairly, Immelt’s legacy will undoubtedly be measured by how well the stock does, particularly against the stock’s performance under Jack Welch. Under Welch’s leadership, from 1981 to 2000, GE’s stock price advanced over 2,000%, outpacing the S&P 500 which advanced about 1,800% during this powerful bull market. In contrast, during Immelt’s tenure as CEO, GE stock has actually fallen about 60% since 2000, trailing by a wide margin the 40% gain in the S&P. How would Jack Welch have handled the financial crisis? Would he have been more aggressive making changes at GE than Immelt has been? Again, lots of interesting questions...

GE and a lot of corporate titans are struggling to determine the optimal size to compete successfully in today’s era of slow economic growth and ever-increasing government regulation. Companies like GE, IBM, and Bank of America may actually be smaller companies in 5 years than they are today. Can they actually shrink and still grow the stock price? Seems counter intuitive, doesn’t it?

The longer these companies struggle, and all three have underperformed the market by a wide margin in recent years, the more intense the debate will be whether they are too big to manage successfully. The down-sizing, or arguably right-sizing process, may very well emerge as the critical determinant of success across multiple industries and sectors.

Not surprisingly, interesting questions come to mind as these bellwethers reinvent themselves in this challenging economic environment. What attributes do the leaders of these large, complex, but very different companies, need to have in common that will help them succeed?

Back to a basketball story…

There is a great story about Bill Walton, one of UCLA’s all-time best players telling his coach that he wanted to grow a beard, fully realizing it was against team policy. Coach Wooden explained that he respected Walton’s right to express himself in that matter, and that he would miss him, as breaking this team rule would prohibit him from remaining part of the team. Walton promptly shaved. Even the free-spirited Walton knew what the team was all about, what the vision, values and expectations were as a UCLA Bruin basketball player.

Isn’t a corporation governed by the same forces? Don’t all the key team members need to understand and embrace the vision, values, and expectations?

I can’t help but wonder whether the leaders of these various, struggling corporate behemoths have articulated the vision and values in a such a way that leads to wide spread buy-in across their respective organizations. I admit I’m highly skeptical.

Corporate earnings have been surprisingly positive thus far for the first quarter of 2015. While revenue growth may be lacklustre in most cases, companies across most sectors are finding ways to deliver reasonable earnings growth. Relentless cost cutting, acquisitions and divestitures, and share repurchases are all key drivers of earnings growth despite the overall sluggish economic environment. With this positive tone to earnings and the continued zero interest rate environment, stocks have rebounded nicely. What’s not to like?

I suspect that beneath this seemingly good news all is not well in the executive offices of many industry-leading companies. The companies that will ultimately succeed in these challenging times will all be driven by a charismatic leader who can articulate the right vision and then drive coordinated, relentless pursuit of that vision at every level of the organization.

There is an African proverb – “If you want to go fast, go alone. If you want to go far, go together.” But just where are we going?

It’s Only A Movie

This is a line from the “Exorcist”, the horror movie from the 1970s. A young girl becomes possessed by the devil and the rest of the movie is the fight of good versus evil. The Exorcist was a movie that gave me nightmares for months. Interest rates have been at or near zero % for the last 6 years and that is bad enough. But lately, there have been numerous stories out that can cause other nightmares. The latest horror? Negative interest rates!!! Cue the scary, sinister music!

How in the world can we have negative rates? And who would EVER buy a bond with negative rates? Where are rates negative?

Throughout much of Europe, interest rates are negative out to 5 years maturity. That means you actually pay someone to hold your money. Are they Crazy?

Now there can be many reasons for the phenomenon, from regulation, to fear, to deflation, or even speculation. Regulation? Yes, the regulators have forced banks to charge for large deposits. This may backfire down the road, but it is the case here now. Fear? Yes, when investors see only risk and the alternatives are bad, they may think that paying a little is better than losing A LOT. Deflation? When prices are falling, there is an incentive to hold cash or cash substitutes. If prices are falling quickly, the negative cost of holding cash may be preferential to owning an asset that is losing value quickly. Speculation? If prices are falling, someone may be willing to buy negative interest rates if he believes that someone else will buy it even more dear.

Let’s focus on the Fear and Deflation. For those of us raised in an economy where inflation has always been around, this seems silly. But, the last few years there have been periods of deflation or a lack of inflation for a myriad of reasons. Is it really so crazy to think about paying someone to hold our money? If I pay the bank for a safety deposit box, I pay them to keep my assets safe. In Europe (especially Germany and Switzerland) that is exactly what is happening. The fear of the Euro breaking up has investors scrambling to find something safe. As the Greece situation worsens and the fear increases of a possible break-up of the Euro, small losses are better than large ones. Now, the easy question here is, why not just hold cash instead? Why take the loss? If the amount is $500, the answer is, yes, keep it in cash. But, what if the amount is $500 million? Where do you keep that? Well in a bank of course, except now they have to charge for that privilege for regulatory reasons.

Deflation is the other major factor that could cause one to invest in negative rates. Bernanke was nicknamed “Helicopter Ben” because he said he would go up in a helicopter dumping cash dollars out if he thought he needed to fight deflation. We have negative rates here in the US if you were to buy some TIPS. (Treasury Inflation Protection Securities). TIPs are negative out to 5yr maturity, but the reason one invests is because they are afraid of inflation. But, in Europe they are facing real deflation similar to Japan for the last 20 years. And as I mentioned above, if the value of assets is declining, losing a small amount is preferable to losing a lot. You can see the effects of deflation by looking at how the value of the Euro has dropped. The Euro has fallen over 30% versus the U.S. dollar since 2008. As the $ has appreciated, the US imports deflation and Europe exports deflation…except they haven’t exported enough! Their economy is still in decline.

Strategists in the US have been predicting higher rates in the US for some time now, so this may be a passing phenomenon. But with Europe and the Japanese economies faring poorly, it will be difficult for the US economy to ignore the rest of the world economy forever. The world economy could use an exorcist to rid itself of the horrible policies that have plagued it for the last 20 years. Or maybe, we all just close our eyes and repeat…”It’s only a movie, it’s only a movie!”