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As the Cycle Turns

It may be time to start paying more attention to the business cycle.

A Feel for the Economy

Peter Navarro’s latest book, The Well-Timed Strategy: Managing the Business Cycle for Competitive Advantage (Wharton School Publishing, 2006), is mostly about managing, not forecasting. A professor at the University of California, Irvine’s Paul Merage School of Business, Navarro contends that every function of the corporation — from finance to marketing and human resources — should be conducted with respect to the business cycle.

Accordingly, his book is replete with examples of companies that “manage” the business cycle (“master cyclists”) and companies that run afoul of it (“reactive cyclists”). Master cyclists pull back on capital expenditures before recession strikes, as Johnson & Johnson did in 1999, or invest countercyclically in advance of a recovery, as Intel did a couple of years later. They cherry-pick other companies’ cast-off talent during hard times. They time acquisitions and divestitures to the cycle, buying cheap and selling dear, and tactically hedge interest-rate and commodity-price risks according to the cycle’s phases.

The most sophisticated master cyclists hedge risk through business-unit and geographical diversification. Running a company with the business cycle in mind, Navarro told CFO, is akin to playing poker, where players “can manage their bets and shift the odds in their favor.”

As for forecasting, Navarro recommends conventional tools — leading indicators, the yield curve, oil prices, and so on. He also advises CFOs to use a stock simulator to maintain a mock portfolio. “It’s a great way to keep in tune with financial and business-cycle conditions,” he says. “The more you practice, the more you develop a feel — it is a feel — for which way the economy and markets are going.”

Moore’s Disciples

Two more of Navarro’s favorite forecasting tools are the weekly leading index and future inflation gauge published by the Economic Cycle Research Institute (ECRI). The forecasting firm was founded by the late Geoffrey H. Moore, a pioneer in the study of business-cycle indicators.

Today ECRI monitors some 20 indexes of leading indicators, says Lakshman Achuthan, its managing director and managing editor. Globally, the firm also maintains indexes for 19 other economies. Achuthan and Anirvan Banerji, ECRI’s director of research, describe the firm’s approach to forecasting in Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy (Currency Doubleday, 2004).

ECRI has an enviable forecasting record. It called the 1990 and 2001 recessions five and six months in advance, respectively. Between those downturns, the firm didn’t forecast recessions in 1995 or 1998, when others did. “Not making a recession forecast is as important as making it,” comments Achuthan. ECRI also divined the growth without inflation of the 1990s and the so-called jobless recovery of this decade.

Most managers’ “eyes glaze over” when it comes to economic forecasting, concedes Achuthan, but they ought to take it seriously, he adds. “Whether they’re doing it explicitly or implicitly, I think CFOs have different scenarios about what might happen,” he says. “Recognizing that all of these economic scenarios don’t have the same probability can save them money or investments or time.”

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