RSS feedsA teacher was reading the story of Chicken Little to her class. “…And Chicken Little went up to the farmer and said, ‘The sky is falling! The sky is falling!’” she read. The teacher then asked her class, “And what do you think the farmer said?” Little Johnny stuck up his hand: “He said, ‘Holy shit! A talking chicken!’”
The point is, when the sun is shining, nobody is interested in what scaremongers are saying. No one wants to trade with merchants of doom. The least popular person is the party-pooper who tells you that not only have you had too much to drink, but that you’ve been mixing your drinks and that’s really bad. Or the forecasters whose prognostications of house price crashes trade headline space in the Daily Mail with the statisticians who prove we’ve never had it so good. A rising tide lifts all boats; it’s only when the tide goes out that you see the rocks or, as Warren Buffett puts it more graphically, when the tide goes out you see who has been swimming naked. (That’s enough analogies Ed.)
When things are going well, it’s no time to think about what might happen if things suddenly don’t go well. Except, of course, that that’s the perfect time to do so, but everyone is far too busy trying to make money to bother thinking about what happens later.
Twenty years ago a financial hurricane ripped through the stock market, blowing 20% off the FTSE-100 index in just 48 hours. And no, nobody saw it coming. The City tempest damaged portfolios but also got rid of a lot of froth-inducing practices. Ill-founded mergers and acquisitions were exposed as fragile artifices; suddenly companies rediscovered the importance of cash generation. Institutions that had hungrily agreed to take fees to underwrite BP’s share sale squealed so loudly when the price collapsed that the government pulled the issue but the City’s ‘My word is my bond’ reputation was severely battered. “People rely on booms but don’t know when to sell,” one FD told us ten years ago when we did a retrospective piece on the Crash of ’87.
A recent research report by Kroll goes a long way to highlighting the hidden dangers of long, bull business cycles. Economic stability is great, but can lead to excessive leverage; huge market liquidity meant that even companies that can’t repay their debts are able to secure new finance; business complexity creates opportunities as well as potentially great dangers. Underperformance doesn’t count as failure – not until things turn south, anyway.
As one FTSE-250 internal auditor put it in the report, “Understanding the totality of operational risk that a business is exposed to is quite difficult. Some businesses tend to put it in the ‘too hard to do’ box and hope it will go away. When it does emerge they find it very hard to respond to.” Nobody likes a killjoy, but he does have a point.
