I just recently wrote in this space about the housing market’s affect on our broader economy. It appears as if real estate is the Pareto principle at work. Five states (Arizona, California, Florida, Michigan and Nevada) have generated a shocking 46% of the nation’s foreclosures[i].

While there are a number of forces as work, there is one explicit predictor of foreclosure activity. States where judges must approve foreclosures in writing have 260% more activity than in other states.  As homeowners and banks wait for the government to take action, markets spiral downward, only diminishing the value of properties that have positive equity.

In the states where foreclosures are dealt with quickly, the market has already begun to turn.  Each of us can reach our own conclusions about the role of government (this is not the appropriate venue for such a debate).

The broader point is that the U.S. real estate market, like many other markets has vast regional differences and elements within it moving in different directions.  The concept of the “business cycle” is a bit of a misnomer. Traditional cycles have been disrupted and replaced with a series of variables that drive markets very quickly, sometimes without pretense or warning.

The events that created the recent housing bubble created the perfect storm.  The recovery will be another type of storm, with regions and even areas within regions recovering more quickly than others. We see similar phenomena in employment and growth in various industries.

It used to be that selecting the right industry was enough to ensure some level or prosperity. Today, entrepreneurs and investors need to find very specific opportunities and niches where growth and profit are plausible.

Like everything else, choose your real estate carefully.

A federal judge’s recent ruling that elements of the health care bill are unconstitutional has heightened the health care debate.  Republicans, feeling their oats and perceiving a mandate are threatening to repeal the Patient Protection and Affordable Care Act.

It was only after my friend and colleague Dr. Bala Chandrasekhar explained most of the information in this post to me that I first came to understand the fundamental problem.  Our medical community suffers from perverse incentives. The system does not reward results; it rewards the extension of care.

In the world’s best hospitals, such as the Mayo Clinic, physicians collaborate, in a finite space, where information is shared and decisions are made. In the overwhelming majority of cases, patients are shuttled around, from general practitioners, to specialist, and from one laboratory to the next.  Information about the patient’s medical history is rarely shared, an approach that does not support the best medical outcome for patients.

The advent of electronic medical records and new rules governing payments is the impetus to consolidation in a business so unsophisticated, that many medical files and prescriptions are managed with a piece of paper, pen and fax machine.  The institution of medicine needs to undergo radical change, and the prospects of larger organizations managing our care means that the stakes are getting higher.

Unlike professionally managed businesses, there are massive variations in best practices in medical groups.  Physicians hate oversight, and we pay the price in an estimated 100,000 people a year dying in U.S. hospitals from pure negligence (errors).

It is intuitive to all of us that raising medical care costs are unsustainable, yet the numbers are daunting.  The convergence of an aging populace and exponential health care inflation will double Medicare costs within a decade.  By 2020, Medicare and Medicaid are projected to increase from 21% to over 30% of federal spending (non-interest payments), and that doesn’t include massive spending by state and local governments. Proponents argue that we have the best medical care in the world; but at what cost? A knee replacement that costs upward of $40,000 in the U.S., costs $5,000 in Germany. We all want the best health care, but at some point common sense must prevail.

According to the bipartisan congressional report -Restoring America’s Future, “slowing the growth of health spending is realistic. Other advanced countries have substantially lower health spending as a share of GDP, while still achieving measures of access and quality that often exceed those in the United States. Although a uniquely American approach is required, these comparisons show what is achievable.” Health care reform focuses on capping costs for doctors and reforming various forms of insurance coverage (including universal coverage). It does little to reform the underlying behavioral issues that are driving up health care costs.  The fee for service model is dated and irrelevant.

If these costs are not constrained, our fiscal mess will get much worse, and our businesses and personal wealth will be drained by massive tax increases.  Small business owners, who bear the brunt of a bloated health care bureaucracy in the form of inflated health insurance premiums must advocate for more meaningful reforms.  Our economic future depends on it.

Many business owners are asking, just what should I expect in 2011 and beyond in terms of growth and demand?  Recent 2011 forecasts from Kiplinger’s include:

*        GDP Growth 2.8%
*        Unemployment Ending 2010 at 9.5% and slightly lower in 2011
*        Prime Rate 3.25%
*        10 Year T-notes 3% by late 2011
*        Inflation of 1.5%
*        Crude Oil $75-%80 barrel in early 2011

Demand and pricing is scattered.  The deflation debate seems to have softened as prices are stable and flat (projected to rise 1-2% next year). Upward pressure on raw materials and commodities such as cotton and copper are higher.  Providers of some consumables such as gasoline, coffee and cereals are raising prices, while prices for electronics, computers and automobiles are eroding. [i] A battle could be brewing over “rare earth” elements 95% of which are controlled by China. Materials such as Lithium, used in micro-electronics and products such as iPhone batteries could skyrocket.

The jobless recovery continues.  While the addition of 151,000 jobs in October was encouraging, it would take 20 years of growth at that rate to return back to the level of employment before the recession. Over 2% of Americans have been out of work for a year or more, and with the eventual waning of unemployment benefits, the future is bleak for the unskilled.  As a whole, soft employment and tepid housing prices will offer little in the way of a significant recovery; and the economy will be split between growing and sluggish industries.

The most creative and opportunistic will flourish.  Forms of social media and online marketing are practically free, providing impetus for those with a great idea to get the message out quickly and cheaply. Those with cash will buy up competitors and commercial real estate.

Venture Capital investment has exploded from the depths of a cataclysmic drop to less than $4 Billion in Q1 of 2009 to a projected $11 Billion by Q4, 2011.[ii] With multiples exceeding 6x, this is still a great time to sell a business.

The Federal government is about to enter a phase of complete stagnation. Splintered ideology will not provoke much in the way of bipartisanism and compromise.  Consider health care. A complete repeal of the health care is unlikely, and Republicans will push for less costly reforms. But Parma, and the medical community are gearing up for the addition of  nearly 30% of Americans who are uninsured and offer the industry new volume. In the absence of legislative movement, the administration will be forced to rely on regulatory actions led by political appointees and their cronies.  Early signs are that the Fed’s attempt at “quantitative easing” is not moving the needle very much on lending.

Emerging markets continue explosive growth in Singapore, China, India and Brazil (representing 75% of global GNP growth in 2011).[iii] Infrastructure stocks continue to boom. Cloud computing enables continued strength in the technology sector.

There is momentum behind the return of low level call center jobs to the U.S. as “rural outsourcing” is hot in information technology and other sectors. Small town America offer substitutes for outsourcing,  including Indian Tribes offering U.S. based alternatives, at only 10-20% premium from their Asian counterparts[iv] .

There is plenty of room for optimism. Competitors are weakened, and companies with strong balance sheets and cash flow should prosper.  Well run companies will invest based on relatively stable macro-economic assumptions. The strong will get stronger. Focus on being one of them.

[i] The Kiplinger Letter November 19th 2010

[ii] Money Tree Reports

[iii] The Kiplinger Letter November 19th, 2010

[iv] Rural Outsourcers” Vs. Bangalore

Here we go again. Suddenly, people are fleeing the stock market for the safety of muni’s and other low risk investments. The U.S. dollar is strong only because of the weakness of the Euro and other foreign currencies supported by extraordinary deficits.  Emerging markets such as China, India and Singapore are the only ones growing and even China’s forecasts are cooling. Some economists are calling all of this a dreaded double dip.  Is this spasm an overreaction?

I am not here to offer a prediction as much as some perspective. Historically, there have been two elements that have preceded U.S. recessions.  Typically, there has been a scandal such as the Savings and Loan Crisis, Michael Milken, Enron/Worldcom, and most recently the liquidity crises triggered by the likes of Goldman Sachs, AIG, Lehman Bros, and Bear Stearns, where someone has manipulated a market (most recently derivatives and credit default swaps).  Secondly, the recession usually follows a bubble (dot.com, real estate, etc).  In other words, our economy gets fat and happy, investors take advantage, and then the bubble bursts.

We certainly have not seen our economy swell over the last 12 months.  People have been so desperate for good news that we accepted what little there was as signs of a recovery.  The reality is that our economy grows at about 5% in times of prosperity, and 2% in times of stagnation.  Three percent swings us from optimism to pessimism, which reinforces the magnitude of emotions in our decision making. Fear is always the most powerful emotion and motivator, greater than love and all the others.

So how will the next few months play out? I don’t have a concrete answer for that but what I do know is that our reaction to the sound bites from economists and experts is quite personal. Our practice is thriving at the moment (in part due to the acceptance of the book) which is proof positive that the performance of an organization can be driven in part by one’s confidence and sheer will. Certainly, market forces are in play and in some businesses (like construction) you can still hear the giant sucking sound.  In others the business can best be described as mediocre and the entrepreneur must decide how much investment (in sales and marketing for example) is appropriate.  What I have seen from manufacturing clients is that are petrified of expanding their factories out of fear that they will not be able to dial back capacity.

In a universe where most are passive, there is more opportunity for the aggressors.  I read of one recent investor who bought BP and shorted Apple, a counter strategy that clearly made him a lot of money. While I am not dispensing any investment advice, I am suggesting that we all must make individual choices on the level of risk we are willing to accept. In an age when things are uncertain, there is as much evidence that we will continue along a modest recovery path as there is that the bottom will fall out, and I have made the choice to stay on course. If you are not comfortable with the status quo, it may be time to find new product, services, channels or sectors because there does not appear to be a hockey stick coming any time soon.