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The Downturn: Is the Worst Over?

It hasn't shown up in the government statistics yet, but we may be seeing the first signs of an economic rebound in the U.S.

Over the past few weeks, I've met with more than a half-dozen U.S. CEOs whose companies represent a wide range of industries. They all told me that while their January and February performance was predictably horrible, they had significantly exceeded their internal forecasts in March. Their first-quarter 2009 revenue projections already had been adjusted downward from first-quarter 2008 numbers, so they were all surprised—and almost afraid to believe—that they were beating both their internal projections and their previous six months' performance.

One company that makes luxury products, which had experienced an extraordinary 98% decline (yes, almost total) in sales, has now seen a rebound to about 30% of its early 2008 peak. Others are seeing unexpected sales increases of 10% to 20%.

None of them are ready to celebrate, but they are seeing what may be the first signs of hope.

When I met with the last few CEOs, they were surprised to hear that other companies are also witnessing a rebound. It was unexpected—and is happening faster than anyone had anticipated.

The rebound, if that indeed is what we're seeing, hasn't shown up in the government statistics yet. But the government's economic performance and job numbers, compiled by the Commerce and Treasury Depts. and the Bureau of Labor Statistics, always lag performance. Remember: We were well into the current deep recession before the National Bureau of Economic Research, the official arbiter of such matters, declared that the expansion that started in November 2001 had peaked in December 2007. It took a year, in fact. The official finding by NBER's Business Cycle Dating Committee did not get published until Dec. 11, 2008.

With the majority of the government stimulus funds still in the pipeline, a rebound now must be for other reasons. Why might a rebound be happening? Of course, we can't even be sure that it is happening. But if the experts tell us six months or a year from now that we did in fact reach the bottom in early 2009, there are a number of reasons a new virtuous cycle might now be beginning.

1. The Forrester Effect. Named for computer engineer Jay Wright Forrester, a professor at MIT's Sloan School of Management and the founder of an analytical process known as System Dynamics, the Forrester Effect uses feedback to analyze supply-chain disturbances. The resulting Forrester Effect Map can be used by management to adjust actions. Thus, when a manager sees a 10% drop in orders and growing inventory levels, he or she can cut production by 20% to shake the excess from the supply chain. This causes the next company in the chain to see a 20% decrease in orders and growing inventory levels and the next manager cuts production by 30%. As this continues to spiral downward, the downturn is exaggerated before it reaches a new equilibrium.

This is exactly what appears to have happened. Economist Polina Vlasenko of the American Institute for Economic Research reported on Apr. 10 that during the current recession, companies have been cutting their inventories faster than in past recessions. "And they started doing so sooner after the peak of the business cycle," Vlasenko noted. Quite possibly, Vlasenko suggests, the rapid inventory reductions were made possible by "the just-in-time economy," with improved supply management enabling firms to carry lower inventories; when there are lower inventories during expansionary times, reducing inventories rapidly during slowdowns becomes easier.

What we now may be seeing is the reverse. When the same managers see demand increase by 10% while inventory levels are falling rapidly, they increase production by 20% to make up for the decline.

2. Confidence from the Stimulus. While some like to argue that the stimulus has made a difference, these funds are just now starting to filter into the economy, so the stimulus money couldn't be the answer. However, faith in the stimulus package's potential could be. Congress and the White House have given the American people confidence that they will do whatever needs to be done—and then some—to prevent a replay of the Great Depression.

3. The Bottom Didn't Drop Out. When consumers and business executives realized that we were not heading for the end of capitalism and not everyone would lose their job, they stopped hunkering down. Companies began spending again. Likewise, many consumers had deferred purchases for six to nine months. But everything can't be deferred forever. So some consumers, by necessity or choice, also started spending again—spurred in many cases by falling prices.

4. Banks Are Lending Again. It turns out that everyone is not a deadbeat. There are lots of viable businesses, especially after they cut 20% out of their cost structure. As bankers get used to this new environment, they may be more confident in their ability to separate good risks from bad. They also may be realizing that the spread between the rate they pay for funds (which is now very low) and the rate they charge borrowers is larger than it has been. There is a lot of money to be made on good risks.

5. Preparing to Win. Many companies have been getting into fighting shape during the recession—cutting excess costs, restructuring manufacturing facilities, etc.—and are now starting to make their moves: buying "wounded" assets on the cheap, capturing customers from hurting or bankrupt competitors, and attracting world-class talent from those who can no longer afford to pay the market rate.

Unfortunately, the reports I hear from Europe are not the same. Just further declines, with no signs of an upswing. Europe, which entered the recession after the U.S., may still be working on the downside. Hopefully, this will change soon.

Many things can still go wrong. We are not out of the woods. But perhaps we have reached bottom and are heading up again. Perhaps the U.S., with our economy on the rebound, will lift the rest of the world from recession. And perhaps we will see confirmation of this before 2009 ends.

Perhaps, too, if your company has not yet taken the steps necessary to win on the upswing—cutting fat and turning it into muscle—now is the time to do so. Take advantage of the fact that some companies are struggling, thus creating the opportunity for you to hire their best people, claim their customers, and buy their assets on the cheap.

I think I see a light at the end of the tunnel and I don't think it's an oncoming train. Best to be prepared, however, whether it's a train or the light of a growing economy.

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