Just because the economy is treading water, doesn’t mean your business has to.

History suggests that the stock market performs best under a Democratic President and a Republican Congress. Investors like predictability. If this scenario becomes a reality it will yield little in the way of new legislation.

The market has generally been a leading indicator, and many have been waiting for our economy to switch gears. But our economy appears stuck in a vicious cycle.  Lackluster GNP growth translates into little job creation.  The combination of unemployment and underemployment (thought to be close to 20%) is creating downward pressure on any potential housing recovery.

Kiplinger’s (October 8^th) predicts a housing double dip, with prices declining as much as 3% next year.  With housing starts at soft 600,000-700,000 units, massive shadow industries such as construction, and building materials, will remain depressed.

The wild card in world economics is currency fluctuations as governments continue to manipulate their currencies and provide subsidies on various products and raw materials. China, who now possesses about $1 Trillion in U.S. debt, is only raising their influence within the U.S. economy.  If the dollar were to crash and raw materials or energy prices rise (most are imports), hyper-inflation could become a reality quickly.

So we are likely in for much of the same.  I maintain what I have been saying for 2 years, there is more downside risk than upside risk, but the greatest probability is that growth remains positive but sluggish.  Stronger companies who planned for a downturn and have sufficient cash, and/or those with strong value propositions will continue to be profitable.  Those stuck in a wave of commoditization that has marginalized their business will tread water. The weak will go away.  Those industries that have not yet consolidated are ripe for M&A activity.

Some executives got fat and lazy in the extraordinary run of the last two decades, knowing they could pass on a 4% price increase ever year and generate 10% on the bottom line. The economics of the day require us to view the world differently. The problems are not cyclical, they are permanent.

It all comes down to the same formula that works in times of boom or bust. Companies need to find a sweet spot, a narrow range in which they can provide value to the marketplace.  Customers are fickle and professional buying organizations more frugal; often requiring a Request for Proposal (RFP) process, for even the most mundane (one bid we heard of included toilet paper).

The downturn has only reinforced that to maintain a sweet spot the marketer may have to be narrower than in the past. The world has become hyper-competitive, and if anything competitors from emerging markets are becoming stronger. Most businesses do not have a cost problem, they have a revenue problem. Don’t rest on your laurels, become completely consumed with improving your offer; every day.

There is nothing like spending your summer vacation pondering the prospect of financial doom, which is what I did recently with a read of The Big Short by Michael Lewis. While I don’t offer a book review here, I do have a fresh perspective on the liquidity crisis, from which we have still not fully recovered.

The Big Short is a recap of “greed is good” Part II.  The book portrays Wall Street analysts, bankers and traders as arrogant, lazy and in many cases remarkably stupid.  And while that may not be a surprise, the details that have emerged that portray the recklessness of venerable firms (such as Lehman Brothers and Bear Sterns) are truly shocking. It appears as if the sharpest people on Wall Street had no idea what assets they owned or what risks they were taking in credit default swaps and collateralized debt obligations (CDO’s).  It is one thing to make a bet and lose but another thing not to know what bet you are making.  Most of us have accepted the burden of the past; but how will we approach the opportunities in the  future?   Lessons learned include:

1. One should never ignore something just because they don’t understand it. In this case, it turned out that the insurance (credit default swaps) that companies like AIG were selling had no limits. When the hen came home to roost, it nearly bankrupted the company and threatened the solvency of the U.S. government itself.
2. Ego can get the best of you. The CEO of AIG AF, Joe Cassano was a former Drexel Burnham  Lambert execute and ruled as a benevolent dictator. He simply did not listen to the reason of the people who tried to warn him of the magnitude of AIG’s exposure.  As reported by Lewis, his response to such warnings was, “it is my expletive money”.
3. Don’t become blinded by competition. According to Lewis, Moody’s and Standard and Poor maintained Tripe A ratings of sub-prime debt out of fear of losing business to other rating agencies.
4. Don’t take the easy way out. Mr. Lewis’ most pointed criticism was reserved for the people within the financial system who were responsible for assessing risk, but did not assess risk at all. Even the big Wall Street firms got sucked into a wave of commoditization, as internet stock trades bit into their fat profit margins. CDO’s were a shortcut to an easy profit.  When things are too good to be true, they almost always are (too good to be true).

If there are numbers on your financial statements that are vague, it is incumbent upon the executive to “seek to understand” (as Covey put it).  We all need to think for ourselves, and question the prevailing wisdom of economists, experts and politicians.  Let us be weary, be smart, and take the time to weigh the risks and rewards.