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Lead or Be Led by Fear - Roger Brinner, Parthenon Group from Mass Technology Leadership Council 2012 Annual Meeting
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Lead or Be Led by Fear - Roger Brinner, Parthenon Group from Mass Technology Leadership Council 2012 Annual Meeting Presentation Transcript

  • 1. Lead or Be Led by Fear T HE PARTHENON G ROUP Boston • London • Mumbai • San Francisco Roger Brinner Partner & Chief Economist The Parthenon Group March 2011
  • 2. Conventional Wisdom Ignorance T HE P ARTHENON G ROUP 2
  • 3. Yields on Bonds and Stocks Remain Exceptionally Low, Leaving Shares Undervalued T HE P ARTHENON G ROUP 12 12 10.6 Treasury Bond Yield 10 10 E/P Ratio 8.3 Earnings-Price Ratio 8 7.5 7.7 8 Bond Yield 7.1 6.7 6 5.6 5.6 6 4.7 4.5 4.5 4 4 3.0 2.8 2.1 2 2 0 0 60s 70s 80s 90s 00s 2010 2011 q4Source: Global Insight; Parthenon Analysis 3
  • 4. Stocks Have a Huge Long-Run AdvantageOver All Other Asset Classes T HE P ARTHENON G ROUP 4
  • 5. Profits are Strong Due to Rising Labor Productivity and Improved Capacity Utilization T HE P ARTHENON G ROUP 16% Pre-Tax Profit Share of GDP 125% Labor Productivity (Real 15 Output per Hour) 120 14 Manuf. Capac. Utilization (%) 115 Profit Drivers (2005=100) 13 Profit Share of GDP 110 12 105 11 100 10 95 9 8 90 7 85 history forecast 6 80 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1Source: Global Insight; Parthenon Analysis 5
  • 6. Share Prices Are Far Below the Fair ValueMeasured as the Discounted Present Valueof Likely Future Earnings T HE P ARTHENON G ROUP Underlying and Realized Value of the S&P 500 Price Difference vs. Fair Value Markets are pricing in unprecedented risk and slow growth 6
  • 7. The Impact of Risk on Current Share Prices T HE P ARTHENON G ROUP Fair Market Valuation 45% Key Action Steps Under- Valuation • Cut your deal … large investment(s) or acquisitions(s) … NOW – Low interest rates Current Valuation – Low P/E ratios • Absent the above, raise dividend or repurchase your shares – Dividend increases impact share price more positively than share repurchases – Cost of Debt < Cost of Equity 7
  • 8. Economic Outlook T HE P ARTHENON G ROUP Core Assumptions Productivity growth keeps employment growth weak given real GDP growth near 2% Greek Crisis ends without collapse of Euro but with mild Euro-area recession; $US improves Congress “kicks can down the road”: Super Committee dismally fails, and Congress extends payroll tax cut and unemployment benefits. But significant US fiscal restraint begins in 2013 or 2014 Fed keeps both short- and long-term interest rates at record lows, as inflation remains under control Oil firms up as Iranian tensions rise; otherwise, oil prices recede with global growth deceleration, weak natural gas prices, and stronger $US Consumers’ dismay/disgust with Washington antics fades but remains weak and bleeds strength from 2012 Housing recovery begins, driven by cheap mortgages, demographics, and modest job growth 8
  • 9. The “Great Recession” and a Weak Recovery Imply Meager Employment Growth in the US T HE P ARTHENON G ROUP Real GDP, Employment, and Productivity (Real GDP per Employee) Relative to Peak Performance Relative to Beginning of Recession 112 1980-84 Cycle 106% Real GDP Current Cycle 111 Real GDP 105 Payroll Employment 110 Payroll Employment Real GDP per Employee 109 104 Real GDP per Employee Trend Productivity Performance Relative to Beginning of Recession 108 103 Trend Productivity 107 102 GDP 106 Recession 101 105 104 GDP 100 Recession 103 99 102 98 101 100 97 99 96 98 95 97 94 96 95 93 94 92 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 1980Q1 1980Q3 1981Q1 1981Q3 1982Q1 1982Q3 1983Q1 1983Q3 1984Q1 1984Q3 As in the last major business cycle, productivity first surged above trend and then fell back, creating job growth even with decelerating GDP growthSource: Parthenon Analysis; Bureau of Economic Analysis; Bureau of Labor Statistics 9
  • 10. Economic Headwinds from Fiscal Contraction T HE P ARTHENON G ROUP Fiscal Stimulus Will be Cut by 3-4% of GDP in 2013 Compared to 2010 “Total Deficits” reflect both policy changes and “Cyclically Adjusted Deficits” the business cycle adjust for revenues lost and higher unemployment benefits due to the recession history forecast history forecast Adjusted Deficit (-) as Percent of GDP 0 0 Italy World ChinaDeficit (-) as Percent of GDP Advanced Euro Area -2 -2 economies -2 Canada Euro Area -3 Canada -3 United Kingdom -4 -4 -4 Spain -4 -4 United States -5 UK -5 -6 -6 US -6 -6 -6 -7 India Japan -8 -8 Japan -10 -10 -12 -12 -14 -14 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 Source: International Monetary Fund (IMF) 10
  • 11. National Government Debt Burdens T HE P ARTHENON G ROUP Don’t Bet Against the US (and the US Dollar): The US Has Less Government Debt Than Either Europe or Japan 150 150 131 United States (Net) Government Debt as % of GDP Euro Area Japan (Net) 98 100 93 Italy 88 85 France 75 70 United Kingdom Germany 53 50 Spain India Brazil 0 2008 2011 2013 Source: International Monetary Fund (IMF) 11
  • 12. Due to Weak, Slow, Misguided Policy Actions, the European Recessions Were Deeper and Will Be Longer T HE P ARTHENON G ROUP Real GDP Growth, 2007 Q1–2012 Q1 est. 5% U.S. 4 3 Percent Change Versus a Year Ago Euro Big 4 2 1 Eurozone 0 UK -1 -2 -3 -4 -5 -6 -7 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4Source: Oxford Economics; Bureau of Economic Analysis 12
  • 13. “BRICK” Growth Cycles in Parallel, But from Higher Path T HE P ARTHENON G ROUP Real GDP Growth, 2007 Q1–2012Q1 14% BRIC 12 Brazil 10 8 India 6Percent Change Versus a Year Ago 4 China 2 South Korea 0 -2 U.S. -4 -6 -8 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 Source: Oxford Economics; Bureau of Economic Analysis; Global Insight 13
  • 14. Demographics: The primary driver of new house sales over the long-run. T HE P ARTHENON G ROUP Easy credit drove sales far above historic norms during the mid-00s…. New home sales (adjusted to include estimated owner- constructed units) Adult population growth Adjusted to reflect 1.8 adults 18-85 per householdSource: Census Bureau, Parthenon analysis. 14
  • 15. House Prices & Affordability T HE P ARTHENON G ROUP Prices stabilizing, with affordability at record levels. 50% 260 240 Carrying cost assumes 80% loan-to-value mortgage, at 230 45 prevailing income levels and Share of Typical Household Income 250 mortgage rates. Median Existing Home Sales Price Median New Home Sale Price 220 40 240 (thousands) 210 35 new house 230 200 30 190 220 25 180 210 existing 20 house 170 200 160 15 2005 2006 2007 2008 2009 2010 2011 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011Source: Census Bureau, Nat’l Ass’n of Realtors, Bureau of Economic Analysis, Federal Reserve, Parthenon analysis. 15
  • 16. The Plural of “Anecdote” Is Not Data! T HE P ARTHENON G ROUP The Deficit! • Class Warfare • Federal Deficit 16
  • 17. Class Warfare:The Facts About Pay and Inflation-Adjusted Pay T HE P ARTHENON G ROUP • Claims that “real pay” has fallen are simply false. • Even if benefits are ignored, base pay has outstripped the headline consumer price index (CPI) • Benefits should be included because health costs are in the CPI • Moreover, the CPI is biased by assuming consumers cannot adjust to changing prices; a preferred mathematical formulation (the “perfect” or chain-weighted CPI) shows less price inflation hence higher real compensation 1.35 Wages+Benefits 4.0 Benefits /Correct CPI 3.8 1.30 3.6 3.4 Wages and benefits 1.25 3.2 3.0 1.20 Wages only 2.8 2.6 CPI 1.15 2.4 Correct ("Perfect" ) CPI 1.10 Wage/CPI 2.2 2.0 1.05 1.8 1.6 1.00 1.4 1.2 0.95 1.0 0.90 0.8 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 17
  • 18. Household Incomes, Post-Federal Income Tax(Adjusted for Consumer Price Inflation) T HE P ARTHENON G ROUP Lowest Second Middle Fourth Highest All Quintile Quintile Quintile Quintile Quintile Quintiles Top 10% Top 5% Top 1% peak-to-peak annual growth 79-89 0.1% 0.2% 0.7% 1.3% 2.7% 1.7% 3.3% 3.7% 5.2% 89-99 2.5% 2.3% 1.7% 1.9% 3.0% 2.5% 3.4% 4.0% 5.2% 99-07 0.5% 1.2% 1.4% 1.4% 2.7% 1.8% 3.2% 3.8% 4.8%2.25 “Middle Class” Top Quintile (1st) • The “Middle Class” is doing fine: real income Top Quintile (1st) rising much as in prior2.00 Second Quintile decades Third Quintile1.75 Fourth Quintile • The lowest quintile also Bottom Quintile (5th) sees rising All Households Second Quintile income, although at a1.50 Third Quintile Fourth Quintile low pace, but this Bottom Quintile (5th) “income” doesn’t1.25 include some welfare and other benefits1.00 • The growth margin of the top 10% is the same as in the past:0.75 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 education, skill, effort, h eritage matter 18
  • 19. Reagan & Bush Income Tax Changes Were Highly Progressive, Not Regressive as Accused T HE P ARTHENON G ROUP Effective Federal Income Tax Burdens Income Percentile 24 ($ average 2005 income pre-tax) 21 Top 0.01 %-tile ($35.5 mill.) 18 %-tiles 99.9 - 99.98 ($4.7 mill.) %-tiles 99.5 - 99.8 ($1.2 mill.) 15 %-tiles 99.0 - 99.4 ($588k) 12 %-tiles 96-98 ($270k) 9 %-tiles 91-95 ($162k) 6 %-tiles 81-90 ($121k) 3 Fourth Quintile ($85k) 0 Middle Quintile ($59k) -3 Second Quintile ($37k) -6 Lowest Quintile ($16k) -9 Average 75-86 Current Law According to • Moved the Bottom 2 Quintiles (40% of All Households) from Tax Payers to Credit Recipients the Nonpartisan • Cut Middle Quintile Burden by 60% Congressional • Slightly Reduced Effective Tax Rates on Top 2 Quintiles Budget Office and IRS, • Reduced Tax Rates on Very Highest 1/1000 of Households by Far Less than the Tax Savings Republican Tax Reforms: for Any of the Bottom 3 QuintilesSource: Parthenon Analysis; Bureau of Economic Analysis; Congressional Budget Office 19
  • 20. Reagan & Bush Income Tax Changes Removed 23% of Households From Income taxation T HE P ARTHENON G ROUP IRS Returns with Zero or Negative Taxes (%) 50% 40 30 20 10 0 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Reagan’s Tax Reagan’s Tax Clinton’s Bush’s Jobs & Reform Act of Reform Act of Budget Act of Growth Act of 1982 1986 1993 2003Source Internal Revenue Service 20
  • 21. Understanding the Facts, Developing anInformed Point of View, and Making Decisionsin an Uncertain Economic Environment T HE P ARTHENON G ROUP THE FACTS 1) Equity markets are priced for high risk and a zero-growth future 2) The cost of debt is at record low levels for high-quality borrowers IMPLIED VIEW OF WALL STREET: PARTHENON’S “PROPER PESSIMISM”: MARKETS ARE PROPERLY VALUED MARKETS ARE UNDERVALUED BY 40-50% POINT OF VIEW A major recession devours Europe, “Proper Pessimism” is most and spills heavily over to US and the realistic: low but positive global rest-of-world, implying flat revenues revenue growth and flat profits and sharply falling profits for years without a new global recession PLANNING AND • Businesses that have a strong balance sheet and good margins can: - Borrow cheaply to buy market share and exposure to BRIC countries DECISIONS - Reset hurdle rates lower to evaluate (internal or external) investment opportunities - Explore relevant adjacencies (adjacent markets, participating in other areas of a value chain, etc.) - Consider a stock buyback • Businesses that are vulnerable should: - “Hunker down” and address fundamentals - Prepare for the macroeconomic recovery, positioning for growth 21
  • 22. Parthenon Background and Contact Information T HE P ARTHENON G ROUP About The Parthenon Group The Parthenon Group is a leading advisory firm focused on strategy consulting with offices in Boston, London, Mumbai, and San Francisco. Since its inception in 1991, the firm has embraced a unique approach to strategic advisory services built on long-term client relationships, a willingness to share risk, an entrepreneurial spirit, and customized insights. This unique approach has established the firm as the strategic advisor of choice for CEOs and business leaders of Global 1000 corporations, high-potential growth companies, private equity firms, educational institutions, and healthcare organizations. Roger Brinner, PhD Partner and Chief Economist rogerb@parthenon.com 617.478.4690 Executive Assistant: Elise Tjernagel etjernagel@parthenon.com 617.478.4626 22
  • 23. Appendix T HE P ARTHENON G ROUP 23
  • 24. U.S. Housing Remains Crippled, but a Massive Eventual Recovery Is Inevitable T HE P ARTHENON G ROUP • Almost 350,000 units are demolished per year (0.3% of our 116 million stock of dwellings) and our household growth is 1.6+ million, implying annual demand for 2 million new units constructed Net New Dwellings Added 3.0 Household Growth Excess construction Adult Population Growth/1.8 versus household formation 2.4 Annual Change (Millions) 2.2 Housing Starts+Manuf. Homes Inadequate 2.2 construction versus 2.1 2.1 2.1 2.0 2.1 2.0 2.0 household formation 2.0 1.9 1.9 1.9 1.8 1.7 1.7 1.7 1.7 1.7 1.6 1.6 1.5 1.5 1.5 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.3 1.3 1.3 1.3 1.3 1.2 1.2 1.1 1.1 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.9 0.8 0.8 0.6 0.6 0.5 0.5 0.5 0.0 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015Source: Parthenon Analysis; Global Insight 24
  • 25. Economic Outlook T HE P ARTHENON G ROUP February 2012 Outlook Novem Growth rates (unless noted) 2011 2012 2013 Real GDP and Productivity Growth Real GDP 1.7 2.2 1.6 Payroll Employment 1.2 0.4 0.1 GDP per Employee 0.5 1.8 1.5 Unemployment Rate (%) 9.0 8.5 8.7 Greek Crisis Real GDP - Major Trd. Partners 1.7 1.0 1.6 Total Exports, $2005 6.8 4.6 3.8 Fiscal Restraint Federal Deficit (-, $billion)) -1187 -1039 -753 change -148 -286 Federal Reserve Policy, Inflation and Oil Prices Federal Funds Rate (%) 0.1 0.1 0.5 10-Yr. T-Note Yield (%) 2.8 2.1 2.2 CPI 3.1 1.2 1.1 Core CPI (excludes food and energy) 1.7 1.8 1.2 Avg. Price-Imported Crude 102.8 95.5 96.4 (year % ch.) 35.4 -7.1 1 Consumers Real Consumer Spending 2.2 2.1 2.1 Real Disposable Income, 2005$ 0.9 1.2 0.1 Consumer Sentiment Index 67 72 75 Housing Recovery Single-Family Starts (million) 0.43 0.56 0.68 (year % ch.) -9 30 22 Profits and Real Equipment Spending After-Tax Profits (US Official Statistics) 5.7 7.0 14.3 S&P 500 Operating Earnings 15.7 4.8 4.6 Equip. Investment, 2005$ 10.3 6.7 4.0 25
  • 26. 2016 2016 136 136Share Prices Are Far Below the Fair Value17 PE Multiple 2016 xx 17 PE Multiple 2016 2,305 2,305 1,738 1,738Measured as the Discounted Present Value sum sum 2,222 2,222of Likely Future Earnings S&PT 500on 11/29 S&P500 P ARTHENON1,197 HE on 11/29 1,197 G ROUP implied discount versus fair value implied discount versus fair value 46% 46% ** 5.8% discount rate== 1.55% 5 Year Treasury + 4.25% Equity Risk Premium 5.8% discount rate 1.55% 5 Year Treasury + 4.25% Equity Risk Premium Apprent Market Calculation Today: No EPS Apprent Market Calculation Today: No EPS Fair Value Today Growth and 5% Higher Risk Premium Growth and 5% Higher Risk Premium Discounted Discounted Discounted Present Present Present Value @ Value @ Value @ EPS (S&P 500) 5.8%* EPS (S&P 500) EPS (S&P 500) 10.8%** 10.8%** 2011 91 2011 2011 91 91 2012 92 2012 2012 91 91 sum 2012-2016 577 483 sum 2012-2016 sum 2012-2016 455 455 326 326 2016 136 2016 2016 91 91 2016 x 17 PE Multiple 2,305 1,738 2016 xx17 PE Multiple 2016 17 PE Multiple 1,547 1,547 867 867 sum 2,222 sum sum 1,194 1,194 S&P 500 on 11/29 1,197 S&P 500 on 11/29 S&P 500 on 11/29 1,197 1,197 implied discount versus fair value 46% implied discount versus "fair" value implied discount versus "fair" value 0% 0% * 5.8% discount rate = 1.55% 5 Year Treasury + 4.25% Equity Risk Premium ** 10.8% discount rate== 1.55% 5 Year Treasury + 9.25% Equity Risk Premium 10.8% discount rate 1.55% 5 Year Treasury + 9.25% Equity Risk Premium Apprent Market Calculation Today: No EPS Growth and 5% Higher Risk Premium Discounted Present Value @ 26
  • 27. European Productivity is Abysmal, Well Below 2007 Peaks 9 Quarters Into Recovery T HE P ARTHENON G ROUPEU “Big 4” Real GDP, Employment, and Productivity Relative to Peak in Current Cycle Germany UK 106% 106% 105 Real GDP per Employee 105 Real GDP per Employee 104 Real GDP 104 Real GDP 103 103 Payroll Employment Payroll Employment 102 102 101 101 100 100 99 99 98 98 97 97 96 96 95 95 94 94 93 93 92 92 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 France Italy 106% 106% 105 Real GDP per Employee 105 Real GDP per Employee 104 Real GDP 104 Real GDP 103 103 Payroll Employment Payroll Employment 102 102 101 101 100 100 99 99 98 98 97 97 96 96 95 95 94 94 93 93 92 92 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1Source: Parthenon Analysis; Bureau of Economic Analysis; Bureau of Labor Statistics 27
  • 28. Income, Consumer Finances, and Psychology Drive Spending in Systematic Patterns That Are Still Valid T HE P ARTHENON G ROUP Income Net Worth Psychology Consumer Spending Elasticity Estimate Growth in Real Consumer Spending and Key Drivers, 2000-2015 1978- 2005 Real Consumer Spending Income 0.8 Disposable Income 7% Household Net Worth (right scale: 5x) 35% Net Worth 0.2 6 Consumer Sentiment (right scale: 5x) 30 Sentiment 0.1 5 25 4 20 Elasticity Estimate 3 15 1978- 2011 2 10 Income 0.8 1 5 0 0 Net Worth 0.2 -1 -5 Sentiment 0.1 -2 -10 -3 -15 -4 -20 Impacts for key drivers are nearly identical, whether estimated through -5 -25 1978-2005 or 1978-2011 -6 -30 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Source: Parthenon analysis; Bureau of Economic Analysis 28
  • 29. Housing Supply: The Glut Has Been Greatly Diminished. T HE P ARTHENON G ROUP Inventories have fallen sharply over the past 4 years. 0.8 3.5 20% 50% 0.7 3.3 New Home Share of All Homes for Sale Inventory of Existing Homes for Sale Price Premium for New Homes Sold Inventory of New Homes for Sale 40 0.6 3.0 15 0.5 2.8 30 0.4 2.5 10 0.3 2.3 20 0.2 2.0 5 10 0.1 1.8 0.0 1.5 0 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011Source: Census Bureau, Nat’l Ass’n of Realtors, Parthenon analysis. 29
  • 30. Only When Employment Expands Will the Fed Push Short-Term and Long-Term Rates Higher T HE P ARTHENON G ROUP Interest Rates vs. Inflation and Unemployment, 1999–2013F History Forecast 8% 8% 6 6 4 4 2 2 0 0 -2 10-Year Treasury Note Rate -2 Fed. Funds Rate -4 Job Growth -4 CPI Inflation -6 -6 1999Q1 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1Source: Global Insight; Parthenon Analysis 30
  • 31. Economic Recovery and Legislation Can Combine to Fix the Deficit in 7 Years T HE P ARTHENON G ROUP Curing the US Deficit 26% 24 Spending $100 thsd. 100% 22 20 Tax Revenue Federal Debt / GDP Average 72-07 18 Federal Debt Average 72-07 16 80 (Inflation-Adjusted) / 80 14 HouseholdPercent of GDP 12 Debt per Household 10 8 60 60 6 Debt / GDP 4 2 history forecast 0 Deficit (-) 40 40 -2 -4 Average 72-07 -6 -8 20 20 -10 -12 history forecast 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 0 0 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 31
  • 32. Who Holds Government Debts? T HE P ARTHENON G ROUP 32