The Zone of Expectation

At the encouragement of a key client with whom I have been actively working for the last two years, I am starting the New Year with a fresh blog. Count me among those who fear there are too many blogs out there. We are information over-rich and over-run, and short on time. Could we please have one simple insight once in a while that actually helps?

Don't count on one here. But I am emboldened by a recent exercise undertaken just before Christmas with a crowd of Morgan Stanley-Asia executives who are variously still with the institution, or not, since they last worked together there in 2004. A scenario look into the near-term future produced what for me was - is - a real insight.

The topic that drew us together - and an interesting framework of uncertainty that we employed - was the dynamic between China and the US. These have been the two fierce pedalers (not to be confused with peddlers) of the global macroeconomic bicycle. 

That the bicycle nearly fell over in 07-08 was a function of the faltering dynamic - the US economy, fueled by consumer credit, buys low-cost-labor Chinese manufactured goods, and the Chinese accept dollar-denominated assets in return. And the global financial world turns.

With the value of financial assets suddenly plunging, and the dollar weaker, and credit shut off to US small businesses (the growth engine of the US economy), everything had to pause, and the bicycle began to tremble. That it did not fall over (yet, some would say) was credit to government liquefaction - governments print money and pump it into the economy fast.

Morgan Stanley Asia Chairman Steve Roach was on Bloomberg television moments ago to warn that the worst may be far from over - that the governments that pumped money in should begin to suck it out - now - to avert another dreaded bubble, and the bursting that necessarily follows. (Roach had been invited to our convocation at the Asia Society, but he had been unable to attend. Still he sent stern warnings about an over-stimulated Chinese economy and troubles to come.)

The insight that came to me during the session was an echo of history. In a Japan 1997 Morgan Stanley scenario exercise, a roomful of similar Japanese and Asia market experts proclaimed two key uncertainties: whether the Japanese economy would recover or decline, and whether Japan's governmental institutions would instigate meaningful reforms (or remain mired in bad practices.)

The scenario technique produced its own "zone of expectation" from the collective insight. This zone suggested that, as one participant put it, "there is no plausible upside for 3-5 years." Based on that view, Morgan Stanley ducked a proposed acquisition of Yamaichi Securities (the one that cost Merrill Lynch $1.2 billion in losses) and stayed highly profitable in the next three years in largely merchant banking activities. It paid off richly not only to see how things might not get much better but to commit to that view and behave accordingly, which Morgan Stanley Japan did under the leadership of Thierry Porte at the time.

At the Asia Society, the group discovered a similar "zone of expectation" for the global economy. Given the issues facing China and the US, the zone that emerged was implicitly negative, suggesting that for the next 1-3 years both economies might struggle and their relations might be corrosive if not combative.

Ignore this zone at your own risk.

This is just one scenario, of course. But I found myself thinking that I (and others) should take seriously the collective intelligence and intuition gathered in the room - representing about 1.5 centuries of recent financial market/Asia experience. Consider that the group might have seen clearly, if through a glass darkly, that the negatives for now outweigh the positives.

So what? Be cautious about the "Asia rescue" story that is being told, and "recovery is here" proclamations. The scenario treatment can bring to bear enormous collective insight in ways that top-down organizations, individual "experts" and off-the-shelf consulting approaches do not. So my opening salvo in 2010 is - "recovery buyer" beware.