Full steam ahead? Although fear of recession stalks America, business is undeterred

Full steam ahead? Although fear of recession stalks America, business is undeterred

By Francesco Guerrera, James Politi and John Willman

Published: February 12 2008 19:15 | Last updated: February 12 2008 19:15

From where Paul Double stands, on the placid banks of the Mississippi, the gloomy predictions of an impending US recession emanating from New York and Washington are no more than a faint hum from places far away.

Mr Double, whose Canamar International makes huge plastic sheets to cover coal and grain from a plant nestled on the Minnesotan stretch of the big river, sees no signs of a slowdown.

“Our business is in excellent health,” he says, adding that booming demand for commodities is prompting clients including Conagra and Cargill, the agricultural products groups, to place record orders. “By November we were already ahead of the past 12 months; by the end of our fiscal year in March we will have had our best year since 2005.”

Mr Double’s jubilation points to a stark difference in opinion between two important constituencies in the US financial and economic landscape: when it comes to the health of the world’s largest economy, it appears that economists are from Mars and businesspeople are from Venus.

Tugboat

In recent months, as a litany of poor data, tales of woe from the financial sector and reports of belt-tightening consumers prompted expert after expert to predict the first US recession in almost a decade, businesses have begged to differ. From entrepreneurs such as Mr Double to huge multinationals including General Electric and Kraft, corporate America has been decidedly more upbeat than the Federal Reserve and private sector economists. As one senior executive puts it, the US economy at the moment is like a stormy sea: tempestuous for those looking at it from the top but a lot calmer for those inhabiting its deeper reaches.

To be sure, most corporate executives express concern at the prospect of a darkening economic picture – and companies directly affected by the subprime meltdown and the decline in consumer confidence, notably banks and housebuilders, are already ensnared in their own mini-recessions. But the attitude of most of the rest of US business is well summarised by David Cote, chief executive of the conglomerate Honeywell. Asked by an analyst last month about the recession, he replied: “We don’t really see it yet.”

That sentiment is mirrored by business leaders across the Atlantic, alert to whether the US malaise is spreading to their home shores. Ian McCafferty of the CBI, the UK’s largest business organisation, says that as he travels around the country, its members’ views become more optimistic the further they are from the City of London. “I have been asking members whether they are facing significant constraints from tougher credit conditions. The answer across the board is: ‘not much’,” he says.

From Germany’s industrial heartland, meanwhile, Jürgen Hambrecht, chief executive of BASF, this week accused the financial industry of “panicking” – and predicted that the US would not suffer a recession this year.

Video: Why US companies remain confident
Francesco Guerrera

In the first of a seven-part video series, Francesco Guerrera explains why corporate executives see themselves as insulated from the US recession that they think is about to begin

Such protestations of optimism by American and European captains of industry raise the issue of whether companies’ desire to capitalise on the last leg of the business cycle will leave them blindsided if a slowdown does arrive. As US economic health deteriorates, the question for chief executives and investors is: can corporate leaders ensure their companies do not lose revenues and customers by retrenching too soon, while at the same time preparing contingency plans for the possibly leaner years ahead?

To many experts, the confident statements coming from American boardrooms ring increasingly hollow. The prospects of a US recession have grown significantly over the past fortnight, as key indicators on employment and business sentiment disappointed economists and Wall Street investors. On February 1, the Labor Department released figures showing that the US had lost 17,000 jobs in January – the first decline since March 2003.

The second bombshell came on February 5, as many Americans headed to the polls for the presidential primary elections, in the form of the Institute for Supply Management’s monthly report on the health of the services industry. That gauge of the largest sector in the US emerged below 50, which separates an expansion from a contraction, also for the first time since March 2003.

The news confounded hopes that, despite a marked deceleration in growth in gross domestic product to an annual rate of just 0.6 per cent in the fourth quarter, sectors not directly tied to the mortgage crisis would be able to escape the worst. Since the double whammy of bad data, forecasters have been lining up to declare the onset of a US recession.

In a note headlined “Free Fallin’”, Goldman Sachs economists last week gave voice to the concerns of the bears, which include their colleagues at Merrill Lynch, Morgan Stanley and a dozen other financial groups. Even less pessimistic pundits such as Bruce Kasman, chief economist at JPMorgan Chase, admit that the economy is close to breaking point. “Recessions are all about shifts in business behaviour. This is the key call,” he says.

But many of the executives in charge of making that call do not appear ready to switch into recession mode just yet. In their view, battening down the hatches at a time when their markets are still growing would be, quite simply, bad business.

They point for example to Procter & Gamble, the world’s largest household goods group and one of the savviest predictors of consumer behaviour, which detects little or no impact on its domestic operations. Clayt Daley, P&G’s chief financial officer, told Wall Street analysts this month it had gained market share in three-quarters of its US business because consumers had not switched to private label versions of its products such as Tide detergent and Pampers nappies.

Other corporate leaders argue that their businesses are, to varying degrees, recession-proof. Food companies such as Kraft and PepsiCo maintain they would benefit from a downturn as people eat at home more frequently or plump for affordable “treats” including sodas and snacks to beat the recession blues. Logistics groups such as UPS, whose brown vans help keep the economy ticking over, still predict that their domestic business will grow this year as people and businesses keep sending letters and packages. As a senior executive at one of UPS’s rivals says: “We are a need, not a want.”

Small businesses, which have fewer financial and operational resources to withstand economic convulsions, are also unwilling to throw in the towel. When SurePayroll, a group that prepares payrolls for some 18,000 small US companies, analysed January staff data, it was surprised to find that small businesses were still hiring and increasing employees’ salaries.

“Recession, schmecession. That’s what most small business owners appear to be saying about the economic storm clouds,” says Michael Alter, SurePayroll’s president. “Our data indicate that the news of the demise of the economy has been greatly exaggerated.”

Students of past downturns argue that the gap between economists’ pessimism and business confidence is due to a combination of timing and psychology. First, different companies perceive recessions differently, because economic downturns and individual industries’ business cycles are not synchronised. In addition, experience suggests that as the threat of a downturn increases, corporate leaders tend to understate it, in an attempt to maintain morale among staff, customers and investors. When Bain, the management consultancy, looked at the behaviour of 377 of the largest US companies in 1981-2001, it found the same overconfident demeanour displayed by many chief executives today.

“As evidence gathers that a downturn is likely, executives often continue to radiate confidence – and even clairvoyance – about the future. They don’t want to frighten the troops, which will only make matters worse,” say the Bain authors in the Harvard Business Review. “Our research shows that most executives are likely to be overly optimistic in the face of an approaching downturn. Some will contend that their industries are safe, period. Others believe that their own company’s ability to weather a downturn is superior to that of competitors.”

Yet executives’ fighting talk cannot be dismissed as a clever psychological ruse, hubris or even plain old wishful thinking. In today’s globalised economy, a number say their company really can cushion the impact of a domestic downturn, by relying on overseas operations. Jeffrey Immelt, chairman of General Electric, has made it clear that his promise of 10 per cent-plus growth in the conglomerate’s earnings in 2008 is driven by the fact that over half of its revenues come from outside the US.

US economy

With a lower dollar boosting exports and demand for infrastructure such as energy and aerospace equipment soaring in emerging markets, Mr Immelt remains confident that a US slowdown will not derail GE. “A lot of the senior leadership team, including myself, travelled around the world and the emerging markets,” he told investors recently. “Every place we went there’s a need for power, there is a need for planes, there is lots of capital being invested in infrastructure and there are just no signs that this global infrastructure boom is slowing at all.”

It is no coincidence that some of the more optimistic statements have come from industrial companies that have placed bets on fast-growing overseas markets. Yet even airlines – a frequent victim of slowdowns, especially when, like now, they are accompanied by high oil prices – are relatively upbeat because of solid demand for international travel. “Looking ahead to the first quarter, demand in all our regions remains strong,” Jeff Smisek, Continental’s president, said last month.

Critics charge that the positive talk coming out of America’s boardrooms is in danger of obscuring the worsening reality, thus preventing companies from planning for a downturn. Indeed, evidence from the last recession six years ago suggests that far too many executives insist on seeing the world through rose-tinted glasses.

“Decision-making is very tough in downturns. Psychologists say there are at least three ways executives botch decision in times of economic stress,” says Bain’s Darrell Rigby, who has studied downturns since 1987. “Their perceptions become distorted, they obsess on insignificant details and they try and prove that their mistaken hypotheses were right all along.”

Mr Rigby estimates that fewer than one in five US companies enters a downturn with adequate survival plans, even though implementing timely contingency arrangements has been proved to be a key competitive advantage during economic contractions. In 2000-01, for example, the electronics group Emerson fared better than most because its sophisticated planning system, which required every unit to file a quarterly forecast each month, enabled management to predict the downturn.

But most companies prefer merely to slash capital expenditure, fire employees and squeeze suppliers. Some of those classic recession tactics have already been on display this time around. Investment banks have shed thousands of people, while Detroit’s struggling carmakers are reportedly putting pressure on suppliers in an attempt to rein in costs.

Management experts say such moves are rarely useful and often counter-productive, as they deprive companies of the resources needed to take advantage of the next upturn. “The specific question executives need to answer is, what is the benefit of hunkering down versus the opportunity costs of not continuing to invest?” says Patrick Viguerie, head of McKinsey’s corporate practice in the Americas.

Indeed, recessions, which in the US last less than a year on average, have proved to be good times for nimble companies to steal a march on their competitors. Starbucks, for one, harnessed the 2000-01 slowdown to consolidate its position as the world’s largest coffee shop group. Building on prudent financial management in the years preceding the downturn, the Seattle chain expanded internationally and increased the proportion of licensed, rather than owned, outlets – a strategy that boosted its profit growth.

Others were less proactive – and were punished for their inaction. McKinsey estimates that 40 per cent of US industrial companies and one in three US banks lost their position as their sector’s best performer during the last recession. “When economic uncertainty increases, you have this temporary freeze,” says Nick Bloom, economics professor at Stanford University. “Companies don’t hire, don’t spend, they just wait. The irony is: if every company in the economy waits, that in itself exacerbates the recession.”

In the current uncertain times, this fear is starting to dent the aura of confidence displayed by corporate leaders. As John Chambers, Cisco chief executive and one of the information technology industry’s longest-serving and most thoughtful leaders, said recently: “When I talk to many CEOs, most of them would say, ‘I feel pretty good about my business but I don’t like what I’m hearing and seeing’.”

Additional reporting by Justin Baer, Jonathan Birchall, Hal Weitzman and Chris Giles

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Changing habits put defensive plays in doubt

In 1991 and 2001, the last two US recessions, those without jobs spent their days waiting for the phone to ring, the old-fashioned kind that was plugged into a wall, writes Aline van Duyn.

During the wait, and in evenings spent at home – going out had become too expensive – people watched television, their most important source of entertainment.

Chances are that people who lose their jobs in the current economic downturn will behave slightly differently. For a start, most people with traditional telephone connections now have mobile phones. There are also more alternatives to television, such as playing video games or watching films via high-speed internet connections.

This may have implications for investors. “The lowest earnings risk rankings are mostly in traditional defensive areas, specifically consumer staples, pharmaceuticals and telecoms,” analysts at Morgan Stanley said recently. But what if changing habits also alter the performance of traditional “recession-proof” sectors such as telecommunications?

“Historically, the telcos and cable operators were both ideal defensives,” says Craig Moffett, an analyst at Sanford Bernstein. “After all, nobody in their right mind would disconnect their phone line, or their cable service, in a recession. What if someone miraculously called with a job offer? And what else is there to do but watch TV while you waited for the call?”

Mr Moffett, however, believes that changes in the types of business done by telecoms companies could turn this on its head. “What if everything we think we know about this sector behaves in a recession is wrong?” he asks.

For example, people may be more inclined to disconnect landlines and hang on to their mobile phones. Growth in mobiles could well slow – in the US, 80 per cent of the population has one already. The race between cable companies and telecoms groups to offer customers bundled phone, internet and television services could make it more likely that people will switch regularly to lock in the latest cheap offers.

Exposure to emerging markets could have a bearing on what stocks prove to be defensive. Many equity investors have based their strategies around an expectation that growth in countries such as China, India and Brazil would remain solid even if the US slows down.

Others are unconvinced. “This decoupling theory is starting to be very severely tested,” says Tobias Levkovich, an analyst at Citigroup. “This makes it hard to hide out, because some sectors [such as energy and materials] which can perform well in a downturn may not do so if commodity prices fall on the back of lower global demand. It is very uncomfortable.”

In the 2001 downturn, the bursting of the technology bubble was particularly painful for internet start-ups that had developed plans around expectations of a huge boom in online business. This time around, online companies are widely expected to benefit, with traditional media bearing the brunt of any downturns in advertising. The large audiences for web-based content, and the increased ability to target customers through detailed information about their web-surfing habits, are widely expected to accelerate the shift from traditional to online media.

One sector that should live up to its traditional defensive role, however, is healthcare. Extending healthcare services to the millions of Americans who currently have no insurance or coverage is expected to be an important issue in this year’s US election. Regardless of the direction of US economic growth, there is little chance that spending on healthcare will diminish, certainly not in this economic cycle.