Preparing for hard times
Businesses need to pay down debt and avoid long-term commitments

Businessmen are optimists by nature. They have to be. Otherwise they'd never take the financial risks nor put in the long hours that it takes to become successful. But although optimism is mostly justified, progress is not written in stone.

"Huge bull markets are inevitably followed by prolonged declines," said Robert Prechter, a stock market bear, and author of the recently released Conquer the Crash. "And market crashes inevitably lead to economic contractions so dramatic that they eventually become known as depressions."

Prechter, is president of Elliot Wave International, a 70-person Atlanta based forecasting firm that publishes a monthly newsletter called the Elliott Wave Theorist

He is a rare commodity. For the past decade he has been saying that stocks are vastly overvalued, and for much of that time he has been wrong. But as the old saying goes, even a broken clock is right twice a day, and with recent market weakness, his pronouncements are starting to make a heck of a lot more sense.

Prechter bases his forecasts on the work of wave theorists, such as Ralph Elliott, who believed that economies and markets function through cycles or "waves." With markets in their recent slumps, it pays for managers to a least consider Prechter's prognostications about what businesses should be doing, just in case things get real bad.

The problem with writing about a prolonged economic depression, is that just about none of us have ever been through one. Recent economic downturns have been relatively mild.

For example during the 2001 recession, despite slowness, the U.S. economy actually grew for the full year. Similarly, the recessions of the early 1980s and 1990s, were characterized by only slight, single-year contractions.

What Prechter is predicting is a multi-year deflationary 1930s style depression, characterized by huge drops in demand and output, which only the oldest among us remember. And that's precisely why it's so hard to identify the warning signs.

According to Prechter, stock markets and economies are largely a function of investor and consumer psychology. Unlike a piece of bread, or a movie ticket, few of us have even a clue how much a share in a company should be worth. So how much we are willing to pay is largely a function of whether or not we are feeling confident.

If people feel confident they will be buy, build and invest. But the fact that most of us have never lived through tough times before, means that our collective confidence is extraordinarily high by historical standards.

As a result we have borrowed to the hilt, and consumption, rather than saving is regarded as a virtue. According to Prechter that confidence is one of the key reasons that the US. savings rate in many years hovers close to zero, and that total U.S. debt now hovers at 300 per cent of GDP, compared to 250 per cent just before the 1929 market crash.

But that kind of secular cycle of confidence does not go on forever, and Prechter thinks that the air is finally being let out of the current bubble, with much more bad news to come.

"I think we are about half way through what will one day be regarded as a market crash," Prechter said. "We've still got a long way to go on the down side."

Even more significant says Prechter, is that every market crash that was pronounced enough to be noticeable on a long-term stock chart, such as the Tulip craze, South Seas bubble, and the 1920s run-up, has been followed by a pronounced depression.

So what should business owners who think there is chance long-term economic weakness do to prepare? It depends. According to Prechter there are so many different kinds of businesses that it's hard to generalize.

The first thing they should do, is to at least consider the possibility and maintain a flexible attitude. Other suggestions include paying down debt, avoiding long-term commitments such as onerous leases, and relocating to jurisdictions where you can fire employees inexpensively, it the need arises.

"If you own your building and your business equipment, you'll be far better able to manage a down downturn, than if you are heavily in debt," Prechter said.

The irony of Prechter's "worst case" scenario prescriptions, is that they make sense even if things don't go completely down the tube. In fact many managers would argue they have been engaging in these practices all along. But then again, most businessmen have never been through a depression, so they probably don't realize just how much cost cutting they are really capable of.

 

 

peter@peterdiekmeyer.com

-30-

Home | Gazette articles | Eye on Ottawa | Book reviews

peter@peterdiekmeyer.com
  © 2002 Peter Diekmeyer Communications Inc.