Contrarian Insights Into PriceWaterhouseCoopers Global CEO Survey

Introduction

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This is a long post so it will be the only post for a period of time. I had originally planned to post this many months ago but one thing led to another and I decided to hold it until an opportune moment. That moment is surely upon us given the fevered hysteria that the U.S. is now on the verge of ruin while the rest of the world escapes any media or Wall Street attention. Tonight are the opening ceremonies of the Olympics as well and I anticipate China's communist government is planning a major propaganda show. I would encourage everyone to watch. The meeting of these two inflection points gives me maximum opportunity to take advantage of sentiment with this post - the oft believed new power rising in the east and the seemingly near universal belief of the old power falling in the west. Saving the post has also allowed me to incorporate additional worthwhile analysis and to actually allow witness to many of the consequences of the data in real time.

From a contrarian perspective, I believe this fevered hysteria confirms how little the mainstream prognosticators really do understand about what is going on in the global economy and what has driven us to this point. Not that the U.S. doesn't face very substantial economic problems. Of course, the prognosticators have been generally wrong about everything that has unfolded so far and they will surely continue to be wrong. And, while I am bearish, I do not consider myself in the camp of most bears. Most bears are wrong on many macro factors driving this crisis and, therefore, the most significant risks and probable outcomes are not being factored into their positions. But, then many bears are on a dogmatic war against what they believe are 'end of days' types of problems in the U.S. including the fact that we have a central bank that is supposedly printing money like there is no tomorrow. The problem with these 'end of days' analyses is that many of the problems cited have existed since the beginning of time. They are irrelevant to the long term. In other words, many bears are bearish because they've always been. And, that position is just as invalid as always being bullish.

Personally, I believe this is one of the most interesting posts you will read on here or anywhere else for that matter. Why? We are living through a moment in history where the data presented below will provide a look into a very substantial reality as it unfolds. It provides measurable analysis that invalidates many commonly held beliefs - that is, if you recognize the importance of the analysis. It also supports much of my proprietary work and what I have been stating since I started this blog - emerging markets are a ticking time bomb. That includes the oil producing economies of the Middle East as well. And, while I have not written in detail on this topic for what seems like a few years, that I expect China and many other emerging markets are at great risk of experiencing economic calamities or volatility on a scale that will involve dire and enormous unknowns including the potential for economic depression and social unrest. And, while everyone points to the U.S., the very serious long term economic problems reside outside of the U.S. as I have written extensively. And, although I am not a conspiracy theorist, as I wrote before, I can't help but wonder if the U.S. has pinpointed China with economic warfare in an attempt to destabilize the country. There is a compelling argument the American form of capitalism needs more and more outlets for its capital to continue to grow. And, all of the data fits. The U.S. would gain substantially by an overthrow of the communist system in China and in many ways that aren't well understood. But, that is simply verbalizing a wild notion.

As you read this, remember all of the media reports, best selling books, television shows and intelligentsia who have been telling us of the China miracle for the last decade. There is nary a single financial mind on Wall Street that wasn't consumed by the China or emerging markets story. Not one. Even the bears are bearish on the U.S. but remain generally bullish on anything related to global growth or China. One reason I started this blog was to refute the best-selling book written by author Thomas Friedman that The World is Flat. Something I never explicitly posted but the world wasn't flat, isn't flat and never will be flat. Fairy tales are better left to children and, of course, to writers of fiction. And, as I wrote some time ago in my post about the 41 Untruths Perpetrated by Wall Street, globalization is not a foregone conclusion. Friedman and Wall Street are very likely top-ticking globalization. This cycle will likely end with a substantially muted globalization for a period that could include many decades. Not for any reasons of sentiment or other silly proof points so often perpetuated by Wall Street but because of fundamentals. You remember those? Archaic concepts from ages gone by. Something to think about as it pertains to investments, risks, politics, volatility and just about everything that affects each of us on a daily basis.

The U.S. economy has been deflating on some level for at least thirteen years. What we are witnessing is more and more of the economy joining that deflation. So, when we hear the experts say they don't think this or that will spill into the overall economy, they are completely inaccurate in their assessment. The economy is spilling into housing and banking and will continue to spill into more and more areas as it has been doing. That very fact is missed by every quotable expert. Housing is a symptom. The banking crisis is a symptom. Yet, this deflation has allowed the U.S. to gain a significant head start on rationalizing its economy in varying degrees while the emerging markets continue to ramp up to shove more and more output down our gullet. But, then I wrote this very fact on here three years ago. At the worst time in modern history emerging markets are partying at what they believe is the new golden age. They are partying on the head of a pin and there is little room for them to maneuver. For these reasons and more Wall Street and emerging markets will be caught off guard at what will likely be the end state of this cycle. Part of that end state will include an eventuality that the U.S. will very likely emerge in a more dominant economic position than at any time in my life. Not before significant distress and not because of some perspective of patriotism or hope but because fundamentals support it.

Of course none of this, including what is written below, has come to pass yet. When it does, and unless some miraculous intervention by God occurs, it will, just remember that for all of the trillions of dollars, thousands of people in research and the enormous amount of people working in the machine, they missed the mark entirely before, during and after events unfold(ed). (Tipping points are always excellent opportunities to express contrary opinion.) Use this to your advantage. Use it to develop the confidence in yourself and not in the intelligentsia for the reality is they know less of what is best for you than you do. They know no more about the future than you do. And, as we have talked about repeatedly, they obviously know little about what is best for the economy. If it doesn't feel right to you, it probably isn't good for society and at some point will have a lasting and negative impact on the economy or you. How often are we told that something is economically beneficial to us yet the message seemed completely at odds with your intuition? This very fact and society's general acceptance that self-proclaimed elitists do know what is best for society is the primary contributor to this mess.

Enjoy the post!

Post

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"We believe we've become a earnings growth company for the first time in our history. We are breaking the economic cycle associated with our industry. We are very committed to not turning down with the cycle and our strategy speaks to that. We're going to take the word trough out of the lexicon of the company." -- Andrew Liveris, CEO Dow Chemical, January 29, 2008

Dow Chemical starts to shutter plant capacity -- June 24, 2008

Dow Chemical pays $15 billion for Rohm & Haas at a 74% premium. Very possibly near the peak for deep cyclicals. A potentially major gaffe. -- July 10, 2008

Impressive commentary back in January by Mr. Liveris. But extremely improbable statements. As odd as it might sound, I consider this a disappointing statement if I'm a Dow shareholder. Why? You shall read why in this post. Liveris was extremely confident in this interview. In the past year or so Liveris has become a regular on financial television. In fact, he's probably become the most publicly available CEO on the financial media circuit. That to me is an anecdotal sign of trouble. So, Liveris is going to be a proof point for this post. Liveris has been so bold to say Dow is investing $60 billion over the coming years and none of it is in the U.S. Some of the markets Dow is investing in are historically the most economically and socially unstable on earth. We shall see how much of that $60 billion gets deployed, how much gets written off as bad investments and how much has a subpar return on investment.

Here's the point. CEO confidence is good. CEO hubris leading to corporate overinvestment, demand miscalculations and overexpansion obviously isn't good. In other words, it's mismanagement. This dynamic, seldom talked about, contributes to significant economic busts. That is one reason why corporate governance and independent boards acting as a check on behalf of shareholders are so important. Yet, independence and shareholder interests have become nearly nonexistent in many corporations. The term 'I' and 'me' seems to be part of Liveris's speaking style as if he were personally responsible for the success at Dow. "I am investing $60 billion....." By 'I' and 'me' I am assuming he means the company owners are investing. I've spent a career learning to read people and picked up on the potential use of Liveris' hubris as a proof point back in January. So, I jotted down his remarks. Liveris's boldness about future economic success and his overly public presence on the media tour seems to me as potentially significant overconfidence and if that is true then it likely involves significant economic miscalculations on his part.

We heard the same exuberance from CEOs in every one of the bubbles we've seen over the last decade. In fact, John Chambers of Cisco was extremely exuberant as recently as the middle of last year when his stock was at the cycle high. Still down 70% or so from its peak but at a cycle high. Since then Cisco's stock has been chopped by over forty percent and Chambers turned cautious. In one quarter his outlook changed significantly. In other words, he seemingly had no insight his business was peaking at the very time he was telling us he had never seen such strong global growth. By the way, John Chambers is a very good CEO. He could be a great CEO if he learned the importance of economic forecasting. That said, few companies have access to strong forecasting mechanisms beyond their own business pipeline. Chamber's mistakes cost Cisco shareholders greatly as the technology bubble was popping as well. Or what about BHP's $150 billion offer to take over a competitor when commodities are at highs never seen in the last one hundred and thirty years? Right before the U.S. economy started seizing. Can one pick a worse time to announce the most expensive acquisition in history? I remember an interview with the BHP CEO where he was so confident of the future of global growth for coming decades that he talked as if it were foregone fact. If he was so able to predict such growth, why didn't he make a bid for Rio in 1999 when he could have paid 90% less for the company and used the anticipated profits to pay for the deal many times over? Why? Because he didn't know. And, today he doesn't know anything more about the future than he knew in 1999. The reality is he is basing his view of future economic activity on what is happening right now. That is a very dangerous practice. My point is the list of CEO gaffes regarding future business prospects are endless. Often they are predictable on some level as you will see below.

So, what is the primary measurement of a CEO's failed strategies and/or overconfidence? Well, overinvestment in capital expenditures, overhiring, mega-mergers, taking on too much debt, layoffs and often bankruptcy. We are going to see alot of that last one around the globe. In my estimation layoffs are an ultimate indicator of failed leadership. Yet they are cheered by Wall Street. The consequences and costs to the corporation associated with layoffs are just now being understood. But that's another topic. Here's something to think about. Is stock price, which can be manipulated for executive gain by weakening shareholder value or distorted by other factors, a good CEO compensation point? Maybe in tandem with other sustainable objectives. CEO compensation should reinforce expected behavior not what a compensation committee, most often with very serious conflicts of interest, believes is appropriate. What might that be? It would be different for each company but what about creating jobs outside of the normal losses associated with productivity enhancements? Or deepening capital investment? Or other measurable investment factors leading to the higher probability of long term shareholder value. I'm not espousing any particular position. I'm just trying to stimulate a thought process. One that has worked in times gone by or even in other cultures. And to remark that the current process is not transparent and often not in the best interest of shareholders. You remember shareholders? The company owners have been thrown under the bus as executives raid the company of wealth.

I don't know Andrew Liveris but I have no reason to believe he isn't a capable CEO. He might be a very good CEO. He's made himself available by being in the press a lot recently so I'm simply using him as an example to make a point. CEO's typically have a certain set of skills. That doesn't usually include self-moderation or self-regulation of the human psyche. In fact, I seriously doubt most CEOs have even thought through the concept of self-awareness. So the quotes above are very likely based more on overconfidence in the PwC survey below. (I'm sure PwC would rather I highlight the report as evidence of future growth or CEO foresight instead of contrary analysis.)

This next statement is a profoundly simple fact that escapes most for whatever reason. In the end much of CEO genius is transient. In other words, their genius is only as good as the fundamentals supporting their company's business. When the climate turns negative for their business so often does their brilliance. The media is unknowingly complicit in this false belief system by assigning values that have no basis in fact. Mostly because the media isn't focused on discovery or journalism but instead is focused on kowtowing to executives in order to maintain access. Each time CNBC has rolled out executives of homebuilders, then mortgage companies, then hedge funds, then private equity, then emerging market executives and then sovereign wealth funds, I have taken an opportunity to write contrarian posts on these areas of the global economy. Each one and more were, or are in bubbles. Their genius is a function of exogenous and unsustainable factors that has little to do with their ability or validation of their strategy. All may be very good executives but we have been in a lengthy period of mania and we now are just starting to see many were far from brilliant. Many more will appear far from brilliant as this cycle winds down. Personally, I believe a focus on the operational aspects of business resiliency and a healthy paranoia are very overlooked CEO competencies. As former Intel CEO Andy Grove taught us, 'Only The Paranoid Survive'. It might also be noted that Intel's executives have generally exhibited positive qualities I talked about in the above paragraph as theirs is a culture built on long term investment and long term capital deepening. In the end, regardless of the fact that investors ran the company stock to bubble levels, Intel is a force in business markets because of its culture of investment. It also doesn't hurt to be a near monopoly.

Now that we've set a backdrop, let's continue to the recent PwC CEO survey. It is a unique insight into behavioral economics and CEO psychology. We are using this as an educational tool in a manner not anticipated by PwC. But, it is a perfect opportunity to witness CEO sentiment data based on very extreme readings. You can view it here. I am providing access for educational purposes only. If you would like a personal copy, I would ask you to respect PwC's intellectual property and download it from PwC.com.

The survey is quite lengthy. You may peruse the entire document for insight but for purposes of this discussion let's focus on the page seven global graphic. (Not page seven of the PDF file but the page number of the document.) This graphic shows CEO confidence on a global map. The survey shows a very bifurcated world. While CEOs in Japan, Canada, the U.S. and Europe are cautious to extremely cautious in their economic outlook, CEOs in Brazil, Russia, India, China and Mexico are near unheard of levels of exuberance. Most specifically Mexico, India, China and Russia. CEO confidence at 90% in India? As I have written repeatedly, emerging markets are at major risk and the hubris of these survey results are most assuredly a sign of doom to come.

There is published behavioral research that concludes quite effectively that CEO confidence is significantly affected by stock price. And, that CEOs are no different than anyone else participating in a bubble. In other words, they start to believe their own invincibility or in irrational expectations. That means there is an argument to be made that CEOs could possibly use stock appreciation and unsustainable fundamentals as a confirmation their strategy is working. And, therefore, continue with overinvestment, taking on too much debt, hiring too many employees or other strategies that creates severe imbalances and risks within a company. A CEO seeing a stock appreciate at 30-50% or more on an annual basis could misinterpret a bubble for confirmation that they should continue to make more and more of what will be seen as imprudent investments in hindsight until finally when the bubble pops the company's future is jeopardized by poor business decisions, poor risk management and overinvestment. Compare this to a culture where calculated prudence is used to achieve a growth rate agreed to in a company's strategic plan or business plan - aka Honda as an example. And, not to overextend corporate resources to achieve greater growth rates in times of significant economic hubris. Or not to take on significant debt for share buybacks as has happened in many U.S. and European companies over this last cycle. That includes many nonfinancial companies that have jeopardized their future business prospects by loading up on debt as we have touched on in past posts.

There is also published research that shows CEO earnings and business forecasts have no better accuracy rate than coin flipping over an extended period of time. In other words, they use the same trend-following projections as economists typically do. That means they likely conclude next quarter's results will be better than last quarter's....until they aren't. I'm well aware of this fact because I've been part of it for the majority of my career. Better supply chain management and CRM forecasting has alleviated that problem over a single business cycle but not over the longer term. And, these technologies have not changed human behavior. May we therefore conclude that many participating in the PwC survey incorrectly believe their own genius and infallibility? We saw the same thing in the 1990s technology bubble and we are now reliving it in the current emerging markets and finance industry bubbles. We also saw the same situation in early 2007 when professional Wall Street confidence surveys were at the highest levels since 2000 - something we wrote about at that time. And, by the way, those Wall Street confidence levels were substantially less optimistic than the PwC CEO confidence in the countries I have cited above. The extreme measure of CEO confidence in emerging markets is a very ominous development. Is it simply amazing that we have access to these very facts yet executives are generally unable to learn from them? Or come to grips with their own instinctive fallibility that is part of being human?

This brings up an interesting point. On a scale of human self-awareness and development, what stage do you think we are in today? Infant, teenager, early-middle-late adulthood? Most likely we are at the infant or teenager level of awareness and development. Both infants and teenagers may have tremendous abilities to consume knowledge and may be inherently intelligent but how often do we find nuggets of wisdom from children? The goal is to make it out of these stages of development without destroying ourselves in the process. This cycle is going to test that very notion.

Hey Harvard, I have a new class for your executive education program. I'll even teach it. It'll have the largest return on investment of any class you have ever offered. The title of the class is "Don't Believe You Are That Smart. It Can Destroy Your Company.". Of course, I could rename the class to be more socially acceptable. Maybe "Behavioral Psychology and Sustainable Economics". You could offer it every year as part of a CEO's continuing education.

Comparatively, look at the PwC survey results of conservative Japanese CEOs who, similar to emerging markets, are also reliant on the American and European economy for sustainability. I can assure you Japanese CEOs are better prepared for an uncertain future. Why? Because they've lived through an eighteen year economic malaise post the Japanese bubble economy. They have learned the effects of hubris. And, because Japanese culture is much more conservative, corporate decision making is often made by creating consensus through intellectual discourse. Therefore Japanese CEOs may often be more reliant on calculated risk and prudence that has more effectively survived debate. This style isn't limited to one particular country. It's governance that involves checks and balances that are key to effective corporate leadership. Today that system is not working properly in many instances. A key difference to point out here is that effective corporate governance is less of a CEO kingdom and more of a process where leadership hashes out decisions through intellectual debate. Isn't that the decision making process in a democratic society? Is the CEO really any different than the Congress or legislative branch and the board should act as the executive branch or the President as a balance in effective corporate governance? The roles are not exactly the same but the spirit of how effective governance should work is similar.

If CEOs and boards were more aware of their fallibilities or there were more checks in the board rooms, is there a possibility bubbles would be lessened? If housing CEOs would have taken a more conservative growth approach or if boards would have challenged CEO thought processes, would we have this oversupply of homes that is now deflating? If mortgage CEOs were challenged by boards would have taken a more realistic strategy based on sound practices, would we have deflating homes? If commercial real estate developers had been more aware of their own fallibility, would we be seeing their industry teetering on the precipice? If Wall Street executives would have had more checks against their foolishness, would we have all of this toxic trash coursing through the global economy? And watching their own industry literally crumble before their eyes?

As much as everyone wants to blame Greenspan for all of this, he didn't hold a gun to any one's head and make anyone do anything. If Greenspan or anyone had personally offered to loan you one billion dollars, would you have to take it? Would you have to spend it? Would you have to do so by employing risky schemes? Would you have used that loan to buy back your own stock? Wall Street created their own mess. But Wall Street has the media microphone. They always have. Is any one person able to defend themselves from such a frontal assault by the Wall Street media machine? How many times have you read or heard the banking mess is Greenspan's fault? Thousands? More? Greenspan is the lackey Wall Street first used to get an unregulated environment they sought at all cost and is now the lackey they are publicly burying for their mistakes. The system he defended is now burying him. Ironic? Not really. You can't expect Wall Street to take responsibility can you? It's so easy to manipulate the press and throw Greenspan under the bus. It diverts attention from the real problems. That this is a Wall Street created crisis and the system needs overhauled. But, then doing so would involve substantial change and reduced wealth. Does anyone on Wall Street want change? Or do they hope this all goes away so we can continue with more of the same? Divert attention in an effort to buy time hoping the status quo will mend itself? If Bernanke doesn't appease Wall Street, they'll attempt to throw him under the bus as well. We already see this unfolding.

Does anyone find additional irony in these survey results? India, China, Russia and Mexico are four of the biggest economic laggards over the last century. At least three of the four countries have problems with chronic corruption, chronic underemployment, chronic debt, chronic underinvestment and opaque financial markets that have repeatedly shattered. But now they are held up as the inheritors of the future economy. These economies are chronically chronic. The U.S. has had a hand in bailing out financial crises and debt crises in emerging markets over the years. How many emerging markets ever make it out of the "emerging" stage? There is a reason they are emerging.

As I wrote before, we might be bailing out our own messes this time. Should these economies fracture again, they will be left with their own ineffective policies and governance to finally deal with their own problems rather than relying on the U.S. for further bailouts. In other words, what will happen to these economies when the global liquidity pool no longer supports their development? The consequences are potentially dire as these countries show limited or no ability of being able to rebound from self-inflicted crises. On the other hand, the U.S. is always dealing with self-inflicted crises. Dozens of times in the last one hundred years. We are a crisis engine. And, what has always been the long term outcome? We have a proven record of solving our problems. The pertinent question is why? If you understand the answer, you never believed the emerging markets hype.

If global markets are experiencing hubris on a scale never before seen, what are the primary outcomes we will see should a major downturn develop? What are measurable outcomes of CEO miscalculations? What are one of the key messages we have repeatedly talked about? Volatility. How will that manifest itself? Unemployment? Social unrest? Revolts? Famine? Wall Street has convinced everyone to invest in emerging markets as they have. Not just in stocks but in major economic investments across the board. Many that are illiquid. In other words, there is no way to hedge times of volatility or risk. These economies are disproportionately exposed to severe volatility and risk. So are international companies that have made relatively recent large investments in many of these economies. Many of these investments were fueled by debt. Much of that debt will likely become toxic as well.

What can you take away from this? Well, first of all, I have great respect for anyone who starts their own company and creates jobs and wealth, or anyone who dedicates themselves to excellence or achievement including CEOs. I have the utmost respect for those who aspire to excel by accomplishment in any endeavor. But we assign values to people because of association and they are invariably invalid. It is no different than assigning values or skills with people on Wall Street because they work with money as I have often used John Galbraith's quote to point out. So, every time you see a CEO in an interview on television, you should realize their appearance is likely fulfilling their ego or career motives more than it is telling you something about the future of their stock, their company, their industry or the economy. That's not a bad thing. Nor is ego a bad thing. But, it shouldn't be taken as investment advice or legitimate prospects of future economic activity. There are many things CEOs can teach us about leadership, operational ability, managing change and other talents but in times of hubris leave the skills requiring introspection and self-awareness off of the list. This is one such time.

The PwC survey came out some time ago. So, let's do a follow up and look at how dynamics have changed since then to highlight many of the points I've made above. We aren't going to look at China because the majority of their statistics are infused with propaganda. Inflation in China has likely outstripped growth for some time. The average Chinese citizen is therefore very likely swimming against the tide and seeing wealth deteriorate. China is likely sporting negative real growth and starting the process of wealth destruction contrary to what they media is telling us. Any nation that dresses up government officials as monks and parades the international press past them to cover up the murders of 140 of its own citizens is surely not trusted with providing transparency and truth. So, let's focus on India. India is a better example anyway because CEO hubris is the greatest. Here are figures from India's industrial output the quarter after the survey was released. Remember, at this time was when trash talkers such as Jim Rogers were at their maximum bullishness on emerging markets comparative to the U.S.

Indian Industrial Production Growth Rates
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Textiles down 62%
Textile Products down 58%
Paper & Paper Products down 76%
Rubber, Plastics, Petroleum & Coal Products down 26%
Non-Metallic Minerals down 51%
Basic Metals & Alloys down 39%
Metal Products & Parts growth turned negative
Machinery & Equipment down 30%
Transport Equipment & Parts down 81%

If this trend continues across Asia, may I ask what effect this will have on energy and commodity demand? Isn't the enthusiasm for commodities really nothing more than another way to look at the PwC CEO survey and the hubris in emerging markets? Emerging market economies are major bubbles. But then we've talked about that for years. The bubbles just keep getting larger and larger. That means the misappropriation of capital continues to grow larger and larger. And, that means the end of this cycle and the ultimate mess just keeps getting larger and larger.

Where are those again positing this is the Asian century? That the U.S. is kaput? Where do the greatest risks lie? Who is unprepared for a significant and potentially extended global economic slowdown? Who likely has the most excesses and imbalances built into their economies? Being a creditor nation aka China or others does not mean anything. The U.S. was a creditor nation in 1929 while many European nations were debtor nations. European nations generally came through the Great Depression much faster than the U.S.

As I have said, the world economy is more reliant on the U.S. than at any time in my life. Those saying the U.S. is a less significant player in the global economy have no idea what is going on in the global economy. Most likely the U.S. will come out of this cycle with an even greater comparative economic advantage than it had before it went into it. There may be hell to pay in the interim but there is no Asian century. There could be but there won't be. For the same reasons the last one hundred years weren't the Asian century. Another of the myths perpetrated by book sellers, prognosticators, Wall Street and media.

What did actually happen is that emerging markets have received the equivalent of an economic Marshall Plan by American and European economies. Except it has been substantially larger. The Middle East, China, India and other emerging markets haven't created wealth. What we've seen is simply shifting of wealth from the U.S. and Europe. The current world economy that is written of as being the biggest boom in history is really nothing more than a reshuffling of the economic deck. That cannot and will not continue for many reasons. Now we shall see how these miracle economies respond when it is left to their own accord. The real miracle is how many people believe it.