Importance of Understanding the Economy’s Directions

Business Environment is Always Volatile and Shifting

Almost all employees, including HR Professionals carries the illusions that businesses are built to last and jobs are life-long.

These illusions feel so real because businesses create and perpetuate a vicious cycle called work-day. It provides a physical place to work; hires people into pre-defined roles; organize jobs into functions or departments; mapped and processes or routine tasks that job holders can follow through day in day out; pays money to employees who can use the money to buy what they need.

However that is not what reality is. Entrepreneurs who founded businesses are fortunate to be able to offer products or services that other people wanted and willing to pay for. That payment can come in different forms – banking systems and money are made inventions. To help entrepreneurs cope with the increasing business, one way is that they have to hire other people to help.

Implications for Human Resource Function

It will be good if the HR Professional can understand entrepreneurship, economics and the stock market as he or she manages one of the key resources for businesses. When the business is good, it hires more people. When business is poor, it lays off employees.

Lay-offs also meant losing people that the business took so much time to search, hire, orient, train and who had come to know the business needs and processes well. Losing these also meant that when the economic cycle is on the rise (that is business is getting better), the business will not be ready to accept increases in sales orders from customers.

The Human Resource professional will need to plan for both economic recession and recovery.

There are 3 other resources required for business – capital equipment (machineries) and materials (for production of products), location (lease). It is better to for the business to first seek reduce costs in these areas.

Four Business Truths

The first business truth is that even if a business may have abundant good products or services but if nobody wants it; nobody needs it; nobody will be willing to exchange what the business wants or needs in return for them.

The second business truth is with a bigger market size, a business have a higher probability of being able to sell to enough number of customers to keep it afloat.

The third business truth is that it is what the business is able to offer (Warren Buffett called this value creation) and the business model that is more important than processes and talents.

The fourth business truth is the business must think of a way to fend off other people from taking away the business’s customers (Warren Buffett called these moat strategies).

International Trade and Investments

Except for closed economy, even countries with protectionist policies (for example import tariffs, licenses, quotas), are open to direct foreign investments (capital) and international trade (exchange of goods and services).

Some countries, such as China has become increasingly integrated into global production networks for a broad range of goods, particularly labor-intensive manufactures.

Nations export when they produce more goods and services than they can be consumed in the home country (over production).

Interconnectivity through global trade can be problematic. For example, up until 2008, Japan had a booming export business with the United States. When American consumers became unable to buy Japanese products, Japanese companies lost a large portion of their consumer base.Read more at http://www.globalization101.org

Economic Recessions

When large market experienced economic recessions; because of global economic domino effect, may lead into global recession.

The causes of recession may include currency crisis, energy crisis, war, under consumption, over production, financial crisis, prices of fuel.

Effects of Recessions

The effects of recessions include bankruptcies, credit crunches, deflation, foreclosures, unemployment.

Business Borrowings, Equities and Bonds

Businesses borrow money for several reasons. A business requires money to get off the ground to fund, development or for sales and marketing.. A young business may borrow, when revenue is light or non-existent. Financially healthy businesses sometimes borrow when cash on-hand is insufficient to meet near-term expenses. A young business with a good product may not have the financial resources to ramp up production to meet a large order from a customer.

A mature business may need funds for various reasons such as to meet cash flow needs, set up new production plants or international operations, to purchase outstanding shares, to retire debt or to make acquisitions.

Business borrowing is also called a commercial loan. Businesses borrow from banks, private individuals or institutions, the government or by issuing debt through capital markets. Parents and family are often early lenders to aspiring entrepreneurs. Commercial loans are a large component of the world’s debt capital markets in which commercial bonds are bought and sold everyday.

Some Definitions

Recession – This is a decline in the country’s gross domestic product (GDP) for 2 or more consecutive quarters of a year. It is visible in industrial production, employment, real income and wholesale-retail trade. Unemployment is particularly high during a recession. Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation.

Depression – This is a sustained and severe recession. One definition is when (a) there is a decline in real GDP exceeding 10%, or a recession lasting 2 or more years. In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions.

Credit crunch (also known as a credit squeeze or credit crisis) – This is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks.

Business Cycles and GDP

In general, the business or economic cycle has 4 stages – (a) Recession (b) Depression (c) Recovery (d) Peak

During a recession, business people spend less than they once did. Because sales are failing, businesses do what they can to reduce their spending. They reduce production, lay off workers, buy less merchandise or materials, and postpone plans to expand. When this happens, business suppliers do what they can to protect themselves. They too lay off workers and reduce spending. Recessions feed on themselves. Unemployment starts to rise.

During a depression, there are large unemployment rates, a decline in annual income, and overproduction. This the lowest point in the business cycle time at which the real GDP stops its decline and starts expanding, this low point varies from a matter of weeks to many months.

During a recovery, the real GDP grows. The business begins to improve a bit, firms will hire a few more workers and increase their orders of materials from their suppliers. Increased orders lead other firms to increase production and rehire workers. More employment leads to more consumer spending, further business activity, and still more jobs.

During the peak of the business cycle, business expansion ends its upward climb. This is the point at which the real GDP stops increasing and begins its decline. Employment, consumer spending, and production are at their highest levels. It can varies from a matter of weeks to many months. When the peak lasts for a long time, we are in a period of prosperity.

Business Life Cycle and Product Life Cycle

Business cycles should not be confused with business life cycles.

Sector Rotation

The economy moves in cycles and specific sectors and industries within the economy will be likely to perform better in particular stages of the economic cycle. A sector refers to a group of stocks representing companies in a similar line of business or industry.

It began as a theory from National Bureau of Economic Research (NBER http://www.nber.org) data on economic cycles dating back to 1854.

Read more at https://www6.royalbank.com/educationcentre2/english/gp/strategies-advance-concepts/stock-selection-strategies-market-sectors.html

As both a human resource professional as well as an employee, you should identify which industry sector your company belongs to and try understand how that will affect your work and yourself personally.

The S&P 500 is divided into ten economic sectors, represented by Global Industry Classification Standard (GICS)

3 assumptions about the economic cycle are (a) The cycle last for 4 years (b) It moves through 3 stages of expansion and 2 stages of contraction (c) Assuming a strong US dollar scenario, the descending order of the cycle is

  • Transportation
  • Technology
  • Services
  • Capital Goods
  • Basic Materials
  • Energy
  • Consumer Staples
  • Utilities
  • Financials
  • Consumer Cyclical/Consumer Discretionary

THREE STAGES OF EXPANSION

TWO STAGES OF RECESSION
Stage 1(Early Expansion /Recovery) Stage 2 (Middle Expansion /Recovery) Stage 3 (Late Expansion /Recovery) Stage 4(Early Contraction /Recession) Stage 5 (Late Contraction /Recession)
TECHNOLOGY

  • Computer software
  • Measuring & control equipment
  • Computers
  • Electronics equipment

TRANSPORTATION

  • General transportation
  • Shipping containers
BASIC MATERIALS

  • Precious metals
  • Chemicals
  • Steel works etc
  • Non metallic & metal
  • Mining

 

CAPITAL GOODS

  • Fabricated products
  • Defense
  • Machinery
  • Ship & railway equipment
  • Aircraft
  • Electrical equipment

 

SERVICES

  • Business services
  • Personal services
CONSUMER STAPLES (NON-CYCLICALS)

  • Agriculture
  • Beer & liquor
  • Candy & soda
  • Food products
  • Healthcare
  • Medical equipment
  • Pharmaceutical products
  • Tobacco products

 

ENERGY

  • Coal
  • Petroleum & natural gas
UTILITIES

  • Gas & electrical utilities
  • Telecom
CONSUMER CYCLICAL

  • Apparel
    • Automobiles & trucks
    • Business supplies
    • Construction
    • Construction materials
    • Consumer goods
    • Entertainment
    • Printing & publishing
    • Recreation
    • Restaurants, hotels, motels
    • Retail
    • Rubber & plastic products
    • Textiles
    • Wholesales

 

FINANCIAL

  • Banking
  • Insurance
  • Real estate
  • Trading

 

 

To learn about the factors that affects sector rotation, you can refer to the book “Intermarket analysis – Profiting from Global Market Relationships” written by John J. Murphy (Published by John Wiley & Sons Inc., Hoboken, New Jersey 2004)

Stock Market Cycle

All markets are cyclical and it doesn’t matter which market you referring to.  They all go up, peak, and then go down and bottom.  The cycle then repeats.

The stock market is a well proven leading indicator on the business cycle. Some say that it leads by 3 to 6 months. Others say it leads by 6 to 9 months. The rise and fall of sectors within the equity markets provides ample clues of the correct phase of the business cycle.

To learn more about sector rotation, you can refer to the book “The S&P Guide to Sector Investing” written by Sam Stovall (Published by McGraw Hill, New York, 1995).

Economic Signposts

There are 4 economic signposts to watch for (a) Consumer expectations (b) Industrial production (3) Interest rates (4) Yield curve

Early Recovery This is when things start to pick up. Consumer expectations are rising, industrial production is growing, interest rates have bottomed and the yield curve is beginning to get steeper.
Late Recovery In this stage, interest rates can be rising rapidly, with a flattening yield curve. Consumer expectations are beginning to decline, and industrial production is flat.
Early Recession This is where things start to go bad for the overall economy. Consumer expectations are at their worst, industrial production is falling, interest rates are at their highest, and the yield curve is flat or even inverted.
Full Recession This is not a good time for businesses or the unemployed. GDP has been retracting, quarter-over-quarter, interest rates are falling, consumer expectations have bottomed and the yield curve is normal.

 

U.S. Economic Indicators

The Conference Board publishes a composite Leading Economic Index consisting of ten indicators designed to predict activity in the U. S. economy six to nine months in future.

You can read about leading and lagging indicators at http://www.moneycrashers.com/leading-lagging-economic-indicators/

Read more at http://www.investopedia.com/university/releases/.

Singapore Economic Indicators

Most industrial nations have adopted the use of Composite Leading Indices (CLIs) to anticipate the turning points of growth cycles, or fluctuations in the economy’s growth rate.

The CLI comprise of the following components:

  • Total New Companies Formed;
  • Money Supply (M2);
  • Stock Exchange of Singapore Indices;
  • Business Expectations for Stock of Finished Goods (Manufacturing
  • sector);
  • Business Expectations for Wholesale Trade;
  • US Purchasing Managers’ Index (Manufacturing);
  • Total Non-oil Seaborne Cargo Handled;
  • Domestic Liquidity Indicator (DLI); and
  • Total Non-oil Retained Imports (NORI)

The performance of a CLI is often judged against a reference series, which should preferably be an important economic indicator that measures broadly the level

of economic activity. Singapore has followed the approach of the US and UK by developing a Composite Coincident Index (CCI), which is an aggregate of macroeconomic indicators that move in tandem with business cycles, to track the state of the economy.

Read more at http://www.singstat.gov.sg/publications/economy.html

The CLI can be found at Singapore Department of Statistics website http://www.singstat.gov.sg/statistics/browse_by_theme/leading_indicators.html

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