Risk Predictions for the New Year and Interesting Business Cases in 2016
With 2016 just about a week old, I would like to share some risk issues that are interesting to consider in 2016.
Federal Reserve Interest Rate Increase
Although delayed many times, the Federal Reserve did finally increase the benchmark interest rate. However, inflation does not seem to exist in a significant manner and some sectors, like energy and commodities are seeing deflation. There has already been discussion of the Federal Reserve slowing its rate of interest rate increases. The recent move to increase interest rates is a real test and vote of confidence that job expansion and growth are happening and will continue to happen.
I think the underemployment situation is a major risk to the economy that hinders growth prospects. The U6 measure of underemployment, which accounts for those unemployed and underemployed, as tracked by the US Bureau of Labor Statistics, ticked up in November 2015 to 9.9% and remained there for December of 2015. Although it is on a long-term downward trend from the peak in 2010, the level of 9.9% is still at levels seen in 2008 and 2002, when we had major recessionary pressures, suggesting the job market is still delicate. With many baby boomers existing the job market, the hope is that even a sluggish job growth in the economy can suffice to bring job growth.
Even with the seemingly strong job growth numbers in the recent December labor report, there is a strong concern of wage stagnation. “Wages simply did not grow, and with Wall Street expecting a 0.2% increase in average hourly wages, in December not only was there no wage growth, but in fact, average hourly earnings posted a tiny decline from $25.25 to $25.24.”
Outlook and Prediction: Look for the Federal Reserve to reverse course by the third quarter of 2016, either by reducing rates or increasing liquidity through more quantitative easing. The first week of 2016 had already shown that there are many forces working against wage growth.
Most of the world remains in shock that the seemingly disorganized militants and extremists can pull off the attacks seen recently. The reality is that they are more organized and funded than we admit in the media. With the recent San Bernardino attack, it is clear that ISIS is a growing and formidable risk for the US and all western countries.
Outlook and Prediction: ISIS will continue to dominate the US presidential election as a major concern. The ability to respond to this risk will command attention of the US voting populous. Nationalistic feelings are on the upswing in Europe and even in the US, as demonstrated with the swelling support for Trump. Actions by ISIS and the role of the US in the region will be important to voters. Continued terrorist actions by ISIS lift Trump, too. It will make for an interesting and risky election, especially for candidates that look soft on or inexperienced with terrorism.
Deflation (In Various Forms and Places)
The danger that economist all try to avoid is that of deflation. Deflation is great if you hold cash, as assets become cheaper in the future, but for economies built on consumerism and borrowing, it is really bad news and leads to default and lack of investment (See Irving Fisher for his great work on this topic). Deflation is alive in Japan. Consumer prices fell in Europe in late 2015, showing signs of the deflation beast, even with the massive quantitative easing at work in Europe to ward it off. Here in the US, we have seen deflationary trends, largely driven by the drop in energy prices. China has shown signs of a slowing economy, and demographic realities of an aging US, Europe, Japan (and even China) are deflationary forces that might be kicking into high gear. (See my recent posts on China’s changing Demographics and the The World in 2050). A real danger is that as deflation takes hold, firms can and will pay less for labor and with underemployment already high, the risks of salary stagnation or even salary deflation is growing in the US and globally. (Ask the people working in the energy sector or even on Wall Street. Ask what bonuses get paid out this year, too.)
Outlook and Prediction: Hopefully, low energy prices will stimulate growth in various sectors, but it has not seemingly happened yet. Low energy prices are typically seen as an opportunity to expand, but much of the economy is driven by services that are not directly related to energy. There is some additional benefit to lower energy prices, still. Paying less for energy may allow consumers to spend more elsewhere or save more, which is generally seen as good. Currently, holding cash does not offer a large penalty now for investors, which already sounds like deflation, so stimulating saving over spending is not too helpful now. Look for firms to hold hiring increases in 2016 and for deflationary issues to weigh on salary growth.
Some interesting firms were in the news in 2016, offering lessons on the handling of risk and how they will recover from the risks seen will prove very interesting. Here are a few to consider:
Cars: Volkswagen, GM, Tesla, (Plus Gas Prices)
The cheating and deceit at VW is only surpassed by the ignition scandal at GM (See post on The Value of Trust and Leadership Failures at VW). In the case of GM, knowingly installing faulty ignition switches harmed and killed people. GM will try to get its cases resolved quickly, but a divided Congress and an election year can make it a bigger mess. Which politician will stand with GM’s position this year? Few if any, I predict. With the concurrent VW case unraveling and everyone vilifying VW, supporting the GM case just got harder for GM (or anyone else like politicians or unions). Expect expensive settlements soon. As for VW, it has cheated customers and the environment. Its position as a progressive, labor-forward, and environmentally oriented firm is damaged for a long time. There will be fines, maybe some prison times for executives, and a period of apology. People will remember this for a long time.
Outlook and Prediction: VW will survive, but its image as the progressively minded car manufacturer is tarnished and it will take a big hit in credibility. VW has lost the halo of being the environmentally minded and labor-forward firm that can teach others how to operate. VW sold a lie. BTW, who needs diesel cars now? Gas is at early 2000 levels (See graphic below from the EIA). In the absence of an environmental promise on clean diesel, what is the benefit of a diesel car? While you are trading in that diesel VW, get an electric car, like a Tesla – that is what all the uber progressives want anyhow. Tesla can’t make cars fast enough!
This darling of the fresh, humane, fair, and sustainable food movement has hit more than a few bumps in 2015. The shortage of carnitas (due to a lack of pork raised by humane practices) was handled very well by management. Some might even say it helped Chipotle strengthen its sense of ethos and trust with consumers. However, the recent and multiple E. coli outbreaks at Chipotles across the US have raised concerns about the firm’s handle on its supply and operations. Can these guys keep the food safe? The stock analysts thought the burritos were a bit too hot and beat the stock down. Chipotle’s stock is down big time, losing the heat a rate of nearly 30%!
Outlook and Prediction: The food industry is driven by fickle tastes. Is Chipotle a movement, like Starbucks and Panera Bread, or is it a fad that will be beaten back by changing tastes? The safety issues will test consumer demand for Chipotle, and lots of options exist for consumers to get their burrito fix elsewhere. I think Chipotle will bounce back. But it will require that management really gets a handle on its sourcing and operations. It will further require a strong demonstration that things are different going forward and that the risks are under control. It will be a great example to exercise the benefits of risk and supply chain management to return to its pepper hot place in the market.
There seems to be no sport that has ever enjoyed the dominance currently enjoyed by the NFL. Fans are engrossed each weak, gambling (no, um, playing games of skill) for weekly payouts. But the NFL has major issues facing its image. Last year, the high profile cases of players assaulting women made the news. This year, the release of Concussion, a movie that highlights the concussion risks in the NFL, will, in my opinion, cement in the minds of millions that football is a real health risk (and avoidable). Added to this, we have seen various health warnings on playing youth football and challenges by doctors in recommending not to play the youth sport.  A recent survey of views of parents by NPR shows that 51% believe high school football is too risky or needs to be made safer (See graphic below). It is not a good sign for the creation of the next generation of NFL players.
With the NFL owners and teams desiring more luxurious stadiums in various markets and with local municipalities all suffering economically from the downturn in tax revenues since the Great Recession, the appetite for municipally financed stadiums is on the decline. In a major twist, the stadium proposed for relocating the St. Louis Rams to LA would be financed by the owner. This is a change in course for teams and will give some cities increased leverage when teams demand municipally financed stadiums in the future.
Outlook and Prediction: The NFL has a major liability with concussions. Indeed, it has (and likely will) pay for the health damages experienced by past players. But its impact to the image of the sport and the cultivation of younger fans is a growing risk. How many kids go into boxing? The NFL can be experiencing a similar downturn.
The role of cities in funding stadiums is a potentially alienating risk, too. Although not sanctioned by the NFL, the gambling sites for the sport offer long-term risks. Will football be about the sport or the payouts in fantasy football? The answer will change the make-up of fans and what they want out of the sport. Gamblers are less likely to follow one team, I think, making the franchise model less valuable to owners. And, the growing public image of a game destroying people with concussions and municipalities supporting this with stadium subsidies will become a challenge to NFL advances on the stadium front. I think the recent movie, Concussion, will galvanize people to believe more strongly that football is dangerous and that other people should play it and other people should pay for it, but they will continue to watch the product on TV.
Happy New Year!
About Russell Walker, Ph.D.
Professor Russell Walker helps companies develop strategies to manage risk and harness value through analytics and Big Data. He is Clinical Associate Professor of Managerial Economics and Decision Sciences at the Kellogg School of Management of Northwestern University.
His most recent book, From Big Data to Big Profits: Success with Data and Analytics is published by Oxford University Press (2015), which explores how firms can best monetize Big Data. He is the author of the text Winning with Risk Management (World Scientific Publishing, 2013), which examines the principles and practice of risk management through business case studies.
You can find him at @RussWalker1492 and russellwalkerphd.com
 Fed Raises Rates after Seven Years Near Zero, WSJ, Dec. 16, 2015.
 Fed Raised Rates Even as Inflation Debate Continued, Reuters, Jan. 6, 2016.
 U6 Unemployment Rates (2000-2015)
 The True Unemployment Rate, U6 vs U3.
 December Jobs Soar by 292k, Smash Expectations, but Average Wages Post First Drop Since 2014.
 Japan Falls Back into Deflation for First Time Since 2013. Financial Times, Fall, 2015.
 Eurozone Faces Renewed Deflation Threat as Consumer Prices Fall. WSJ, Sept. 30, 2015.
 US Historical Gasoline Prices from EIA.
 Chipotle Stock price for 2015, CNN Money
 Noted Surgeon, Dr. James Andrews wants your young athlete to stay healthy by playing less.
 America’s Most Dangerous Football is in the Pee-Wee Leagues, Not the NFL. The Atlantic. Aug. 2013.
 NPR Poll on High School Football Safety, Feb, 2014.