Category: Demographic Risk

Risk Predictions for the New Year and Interesting Business Cases in 2016

Risk Predictions for the New Year and Interesting Business Cases in 2016

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.[1] 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.[2] 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.[3][4] 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.”[5]

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.

ISIS

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.[6] 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.[7] 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).[8] 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!

Chipotle

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%![9]

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.

NFL

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.[10] [11] 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).[12] 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

[1] Fed Raises Rates after Seven Years Near Zero, WSJ, Dec. 16, 2015.

[2] Fed Raised Rates Even as Inflation Debate Continued, Reuters, Jan. 6, 2016.

[3] U6 Unemployment Rates (2000-2015)

[4] The True Unemployment Rate, U6 vs U3.

[5] December Jobs Soar by 292k, Smash Expectations, but Average Wages Post First Drop Since 2014.

[6] Japan Falls Back into Deflation for First Time Since 2013. Financial Times, Fall, 2015.

[7] Eurozone Faces Renewed Deflation Threat as Consumer Prices Fall. WSJ, Sept. 30, 2015.

[8] US Historical Gasoline Prices from EIA.

[9] Chipotle Stock price for 2015, CNN Money

[10] Noted Surgeon, Dr. James Andrews wants your young athlete to stay healthy by playing less.

[11] America’s Most Dangerous Football is in the Pee-Wee Leagues, Not the NFL. The Atlantic. Aug. 2013.

[12] NPR Poll on High School Football Safety, Feb, 2014.

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Understanding China’s One-Child Policy Shift: Big Demographic and Economic Changes Ahead

Understanding China’s One-Child Policy Shift: Big Demographic and Economic Changes Ahead

Understanding China’s One-Child Policy Shift: Big Demographic and Economic Changes Ahead

Today, China announced that it is abandoning its 35-year policy of limiting families to only one child. This policy has become a demographic experiment unmatched in the history of the world. Owing to this policy on reproduction, China is experiencing many challenges and risks that were not foreseen when the one-child policy was adopted. At its core, is a challenge to the social composition of China and its economic trajectory within the global economy.

Gender Imbalance will Pose Social Risks

The one-child policy and cultural preferences for boys over girls, has created a horrific gender imbalance. Enabled by ultrasound and gender specific infanticide, China now has more men than women. Some estimates have 116 boys being born for each 100 girls. Over many years, this imbalanced is estimated to result in some 80 million men in Asia without wives by 2040. It is an imbalance that the world has simply not seen before. Will these men demand wives from poorer countries? Probably. Will they succumb to deviant and dangerous behavior? Probably, but hopefully not. 80 million is about the population of Germany. It is about a quarter of the US. The void will be felt for years. Owing to wars, society has overcome lower numbers of men, but lower numbers of women is mostly unseen in our recent human history. It will pose social risks unseen before.

The Rise of Little Emperors

Younger people in China live a different life compared to their parents and grandparents. The one-child policy, exercised over 35 years, means that 4 grandparents, produce 2 parents, and one grandchild. It means a child grows up with 6 adults doting on him or her. It also means that child gets more of what he or she wants. This new psyche is called, “the little emperor.” And understandably, the six adults want the best and most for their only heir. In a country where eldercare has historically been handled at home, it also challenges how the Chinese will age and where they will live. We think of cultural challenges with millenials in the US, but China is dealing with the same issue, too.

Rapid Aging is in the Future for China

Below is a population pyramid of China now and in 2050. The gender imbalance is most obvious in the youngest people. The aging of China is soon upon us. It will have major economic implications to the world.

Impact of China on Global Economics

We often lose sight of the impact that China had on global prosperity. In the 1990s, trade and business with China really opened-up and expanded. It allowed US and European firms to move manufacturing to China in a big way. It provided a reduction in the cost of manufacturing to much of the world. That controlled the cost of making many things. Indirectly, it meant that inflation could be more easily controlled in developed markets. As long as some (and a growing part) of the manufacturing base could be shifted to low-paid Chinese workers, the developed markets could see expansion in product offerings and firms could expand without as much of a concern for inflation. In many ways, the success of Walmart has been tied to its ability to source from China. Walmart brought an increase in lifestyle offerings to the US middle class, built on low-cost labor in China. China has also been a boom for some US firms. Even Starbucks sees its future as tied to growth in China. The ability to add millions of new customers to a business is invaluable. China has offered that to the world market since the 1990s. Expansion in nearly every commodity over the past 40 years has been tied to the growth and increase in prosperity in China. That growth is now under examination.

Questions about China’s Growth Going Forward

Questions about the future growth in China are increasing. With economic growth recently coming in below expectations, these concerns are becoming more poignant. Trade is flat with China. Even internal consumption, like electricity use is more or less flat. The concern is that China is not growing as projected. Few people trust the economic numbers published by the Chinese government. Maybe China has reached a plateau in economic growth. The future does have some challenges for China. The one-child policy has left an aging China. Before 2050, China will be a smaller country than it is today. It is hard to believe. It will be an older country, too. Smaller and older counties have less productivity and consume less (unless then make large investments in technology to boost productivity and keep older workers working). The imminent aging of China is bad news for businesses that have grown to rely on China as a labor source or demand source.

It is interesting to think that we have spent the last 40 years in the US and developed markets defeating inflation. In many ways, China helped us control inflation, by providing a low cost labor source. China and our economic partnerships with China now pose new risks to the global market going forward. As China ages, its labor offerings will become less valuable. Might global labor costs increase – stimulating inflation? Might demand from China tail off – driving deflation? It really depends on what happens in other parts of the world For international firms, it will require pivots away from China. Here are some things to consider with the demographic shift at work in China.

China and the World will Age

The one-child policy and demographic experiment is over. China has seen the problem that is looming and is hoping to correct it, but the next 20-35 years are in the books already. China will be an older country. How does your business work with the elderly? There will be great expansion in products and services that help the elderly. Healthcare and housing will require major investments. Technology that serves the elderly will be a prerequisite.

Leverage Automation

If your business is built on low-cost labor in China, look for opportunities to further remove the labor through automation. Any expansion from more young workers in China is decades away, at best. The next few decades suggest that China will not be the workhorse that it was over the last few decades.

Look for Labor and Growth In India and Africa

The population boom is alive and well in India and Africa, however. The state of the economies in these parts of the world still involves pulling people out of abject poverty. In spite of that, fundamental investments in infrastructure, people, and products will occur. Map a path to capture this growth.

Some Thoughts and Observations on Growth

For companies and investors looking for growth in the world, I offer a few major trends. The world will have massive expansion in the warmest climates. Warm climates demand air conditioning, refrigeration, and such comforts go a long way in changing the satisfaction of the population. With rare exception do people ever give up such comfort. Also, the growth of these populations (especially in India) will correspond to higher per capita GDP. As people move out of the depths of poverty and into the so-called “global middle class” they adopt a richer diet that is based more on animal protein. This will require more soybean production for the raising of animals and put new pressures on sustainable animal husbandry as meat consumes not just soy beans, but large amounts of water and energy. These people will need transportation and communications. The development of low cost automobiles and the expansion of mopeds will bring these growing populations access to combustible engines and the continued environmental challenges posed by them. On the flip side, the U.S., Europe, Japan and China will need solutions for an aging population. Obviously healthcare is a focus. But these aging populations will consume services. Some of this can be met by immigration, but automation and even robots will, and already are answering the call.

Build your plan for the future. Take note; China has and does not like what it sees.

About Russell Walker, Ph.D.

Dr. Walker is Clinical Associate Professor of Managerial Economics and Decision Sciences at the Kellogg School of Management of Northwestern University.

Professor Walker has developed and taught executive programs on Enterprise Risk, Operational Risk, Corporate Governance, Analytics and Big Data, and Global Leadership. He founded and teaches the Analytical Consulting Lab, Risk Lab, Global Lab, and Digital Lab – all very popular experiential learning classes at the Kellogg School of Management, which bring Kellogg MBA students together with corporate opportunities focused on data and strategy. He also teaches courses in risk management, analytics, and on strategies in globalization.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 book Winning with Risk Management (World Scientific Publishing, 2013), which examines the principles and practice of risk management through business case studies. He has also authored many business cases and published multiple Kellogg case studies through Harvard Business School Publishing. His cases have been highlighted by the Harvard Business School Publishing, the Aspen Institute, PRMIA, and the Bank of England for excellence in teaching risk management.

He serves on the Scientific and Technical Council for the Menus of Change, an initiative led by the Harvard School of Public Health and the Culinary Institute of America, to develop healthier and more environmentally friendly food choices. He was formerly on the board of the Education and Technology Committee to the Morton Arboretum. He was a board member of the Virginia Hispanic Chamber of Commerce, where he developed support programs for Hispanic entrepreneurs and worked with US senators on US Latino matters.

He is at @RussWalker1492 and russellwalkerphd.com.