In a fascinating recent development, John Kerry, Democrat of Massachusetts, and Richard Lugar, Republican of Indiana, introduced the Start-up Visa Act to the US Senate, as reported in Inc. magazine.

The legislation is a forward-looking bid to turbo-charge entrepreneurial venturing in the U.S. by attracting foreign entrepreneurs and connecting them to U.S. capital, therein driving new economic growth and local jobs. What’s really interesting is it goes against past common wisdom that recessions are ‘bad for immigration’ (as citizens demand job protection.)

If passed, the bill gives U.S. visas to foreigners who can raise $100,000 from an angel investor or $250,000 from a qualified VC firm. After two years, if the immigrant entrepreneur can create five or more jobs (excluding family), attract an additional $1 million in investment, or produce $1 million in revenue, he or she gets a green card (permanent residency.)

The only current option, the EB-5 business investment visa, requires immigrants to invest at least $1 million in the U.S. and employ 10 people.

Job creation

The  National Venture Capital Association says 25 percent of America’s venture-backed, publicly-traded businesses, incl. Google, Yahoo!, eBay and Intel have been founded or co-founded by immigrants. According to Richard Herman, author of Immigrant, Inc.: Why Immigrant Entrepreneurs Are Driving the New Economy, nearly all U.S. job creation in the past 20 years has come from companies less than five years old.

The history of US immigration policy has been schizophrenic to say the least, with periods of great social openness followed by about-face door slamming. The slamming has always corresponded to economic downturns or anxiety thereto. But here we have the opposite effect. And we have legislators taking a forward view! Both proof that the future is sure to surprise us.

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Predictions of the dollar’s demise are as old as the greenback itself of course, but over recent weeks the specter of the dollar heading way way below its trading range — a dollar crunch — has entered the zone of the credible, or, in scenario terms, the ‘cone of plausible uncertainty.’ That means decision-makers with lots at stake are taking it seriously.

Like the British pound, the dollar has been under a cloud due to perceptions of economic fallout from the credit crunch and global recession, but particular questions about the US currency have recently surfaced, driven by reports [Robert Fisk's 'The Demise of the Dollar' story in The Independent (Oct 6)]  that “Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council” (Saudi Arabia, Abu Dhabi, Kuwait and Qatar).

The subtext is far from merely financial. Practically, it would mean that on any day, the real cost of oil to US consumers and businesses would go up or down depending on the strength of the currency. This is something America is not used to. But, more deeeply, dropping dollar-denomination of oil is a direct shot across the bows of Washington’s say over oil affairs, and the hegemony of the dollar as the dominant global reserve currency.

De-dollarizing oil would not in itself push the US currency below its 25-year range. But it is portentous of the clear trend to a genuinely multi-power world, for better or worse, in which the dollar will get no favors. That will push the dollar down, at least while the news and fallout make their way through the financial and real economic systems.

Rumors of de-dollarization have been hotly denied, as further reported here, but as the Independent points out, denials are to be expected, and are always issued in these situations. They mean nothing. Even cub reporters know that.

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Scenario thinking

What’s particularly interesting to me is that a ‘scenario’ of dollar demise has become not only plausible in the mainstream view of the future, but scenario thinking is being used as a way to consider the nature of this outcome, and how best to respond without predicting the outcome either way. As recently as directly pre-credit crunch, the media question would have been: ‘what is the best prediction for the dollar (or the housing market, or credit default swaps?) and that, rather then scoping out the implications of the lesser-likelihood, would have dominated the discussion.

So, what struck me forcefully in the Business Week video interview above, where BW Chief Economist Mike Mandel interviews the news magazine’s Economics Editor Peter Coy (see Coy’s underlying story here), is how the less-likely, non-predicted, but very significant outcome is actively addressed:

Says Coy: “It’s so hard to know what the dollar is going to do. We don’t argue that we know… what we do is we say, ‘it could happen’ and let’s take that possibility seriously, in the same way we should have taken the possibility of falling housing prices seriously…”

This is not formal scenario-building of course. But it is, fundamentally an adoption of the framework, saying in the classic ‘scenarios’ way: “we can’t predict if it will happen or it won’t, but if it does it will have significant impact. So let’s just ask: ‘what if ‘ it does and explore the outcomes and our responses. What will the word look like? What would be the implications, the knock-ons and spinoffs? If it comes to pass, what would be wish we had done today?”

Perhaps failing to predict the credit crunch has dented predictors’ halos enough to cause a mini-zeitgeist-shift towards the only real way to cope with important uncertainty: exploring all outcomes that pass the plausibility and significance test, whether or not we actually believe they will happen.

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DJIA since Sept '08

The answer is, broadly, yes. Stocks are shares in the future earnings of a company. They are therefore a “bet” on (er, an “investment” in) the future performance of a company, or many companies. The trading price on any day is the price at which there are as many buyers as sellers for these future returns. Rising prices mean there are more buyers than sellers, that means general expectation of future profits is going up. Investors are putting a higher price on the future.

The market is therefore considered a leading indicator of economic conditions. (By contrast, employment figures are lagging indicators — due frictional forces, not to mention morality, it takes companies a while to downsize in recessions or upscale in booms, so employment levels track economic conditions but with a delay.)

But how valid and dependable is the market as a leading indicator? It is also apparent that markets move up slowly and steadily, but fall in a hurry. So the downward move can hardly be held to be predictive. But the upward move appears to hold some weight as harbinger of better times. How much weight?

What’s particularly important is that the aggregate insight into future returns from shareholding investments — across many investors and many stocks — cancels out individual errors. Any one person may have a dumb idea of the ‘future cash flows’ from one or many companies, and the price of any one company may be unreliable for innumerable reasons, including fraud, but the knowledge and intelligence of hundreds of thousands of people, when aggregated and spread over many thousands of stocks, corrects for all these errors. It becomes robust.

Prediction Markets

This reliability of shared, aggregated insight — the wisdom of crowds — is precisely what makes ‘prediction markets’ such a powerful forecasting tool, as I have mentioned in previous posts. (Prediction markets apply market-like wisdom to create foresight in areas that are not normally ‘tradeable.’) Any one person will, as likely as not, get it wrong, but everyone together, rather astoundingly, get it right.

Ironically, crowd wisdom is much more reliable than the technical forecasting models that investment institutions use to try to determine how business, macroeconomic, interest rate, or other conditions will affect future stock prices. These predictions, based on the assumptions of a handful of model programmers and/or model users, are deeply vulnerable because there is no crowd-wisdom balance. It’s no better than reading tea leaves, only apparently (and unaccountably) more respectable.

Having said all this, it is well known that the ‘crowd,’ aka the ‘herd’ can and do all get it wrong together. This is what happens in price bubbles, or panic market exits, with everyone buying or selling because they are making the same wrong assumptions, or just doing what everyone else appears to be doing. (Most players making the same mistake together is the basic problem when prediction markets fail too.)

However, what is clear is this case is there was a very hard sell-off in the months prior to March 09, following revelations of the gravity of the Credit Crunch, but that this has slide has been arrested and mostly reversed. This says that innumerable smart people with, collectively, billions of dollars at stake, are expecting future profits higher than they did in March. That’s a prediction one can rely on.

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Christian Blanckaert, Executive Vice President at Hermès International was quoted as saying: “We have absolutely no visibility into 2009!”

On the one hand, fair enough. This economic downturn is steeper than previous down cycles, and the basic viability of the financial sector has been tested. Access to credit is normally easier in a recession, but in this one it is not. All of which makes luxury spending harder to predict.

No doubt the most unlikely prediction of all would have been that Hermès, Burberry, LVMH, Moët Hennessy, Louis Vuitton, and PPR (Gucci , Yves Saint Laurent) have all recently reported better-than-expected results.

Nevertheless luxury industry leaders have declined to provide investors and analysts with any official outlook. What’s curious, from an industry foresight point of view, is how executives such as Blanckaert thought they really had more “visibility” into any previous year, or that they will somehow gain it again when the financial crisis is over. They will not. The world will continue to surprise them and us. What they will gain, certainly, is a greater likelihood that the standard business-as-usual future assumptions they make will not be upset by reality.

Meanwhile, judging by the conference, the luxury goods industry has a very decent grip on current social and moral trends, and clear insight into the bigger picture of change in its industry over the next five to ten years. As they know from before, what happens in a recession is that luxury goes out of fashion. Conspicuous consumption wanes, or retreats further behind secluded walls. This is a basic pendulum swing that tracks the economy (witness how the early 1990s recession stimulated a return to “values” era after the “me, me, me” 1980s.)

Sustainable luxury

So we are again in a swing to modesty. But we also know that each swing of the pendulum also carries with it the specific issues of its time. Current key issues for consumers in this segment are sustainability, global warming, business ethics, and globalization (or fear thereof).

Therefore the luxury brands will be looking for ways of making, transporting, and displaying goods in an energy-efficient and socially conscious way, including a renewed emphasis on local artisans and traditional craftsmanship that speaks sustainability in both natural and human resources. This will be the basis of the “sustainable luxury,” positioning that the famous houses will define and compete in. Fabulous and renewable  – now there’s something you can charge top dollar for.

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My question, as the Dow Jones Industrial Average (DJIA), and the FTSE100, the DAX, the Hang Seng and so on have hit a decade lows is, what is this predicting, if anything? What is the long-term value of this prediction, and could it be used to make better decisions in the real world?
We know that the value of a common stock – a share in a company – is based ultimately on the returns (dividends) it will bring. Buyers and sellers therefore derive a daily market price based on their views of the share’s expected, that is, predicted future payback. The greater the expectation, the greater the price. A high price vis a vis earnings (P/E ratio) suggests confidence in future earnings, and vice versa.
Therefore the current steep fall in share prices is an expectation of (crowd prediction of) lower future payouts. Of course the complexity in human-prediction situations is that this basic level is also overlayed with a meta-level: people are not only trying to figure out what will happen, they are trying to figure out what others think will happen. So falling PE ratios are an expectation of what others will do (predicting they will continue to sell.)

Madness or not?
One of the perplexing things about the markets is they very often seem to react opposite to what is expected; to what would be common sense. They often fall on good news, rise on bad news, close unchanged on big news, and so on. Although there is – famously much irrational behavior and herd instinct in the market – you don’t get hundreds of thousands of decision-makers wagering significant money not using common sense.
What is going on, of course, is that the market has often already risen or fallen in prediction of the news. When a new condition – an interest rate move, for example – is imminent, the market will move to “price in” the expectation. If market participants as a whole have called the future correctly the market will not move much on announcement.

Pricing-in the future
Because of this predictive component to group decision-making in market situations, the stock market as a whole is a classic leading indicator of the real economy. When prices move they may be taken as the crowd “pricing-in” a future prediction. So markets will fall ahead of real economic problems (they may continue to fall, as now, during steep economic declines.) But they will also turn up well before any real, measurable upturn.

By the way, there is little doubt it will overshoot in this time, as it always does. This is because, as in prediction markets, the wisdom of crowds can predict the trend but not the turn. Trend extrapolation will never show you the key shifts, and this is why predicting the bottom or top of a market is so hard.

The point, for market speculators, is that long before the real gloom is over the markets will be zooming upwards. The point for the rest of us is that recession times will be with us even after the markets move up. In the long term the market will go up. Like death and taxes, it’s the surest thing there is.

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