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Man Is But A Reed

Earlier this week, my attention was drawn to a passage of Blaise Pascal’s ‘Pensées’ (1670): ‘Man is but a reed, the most feeble thing in nature; but he is a thinking reed. The entire universe need not arm itself to crush him. A vapor, a drop of water suffices to kill him. But, if the universe were to crush him, man would still be more noble than that which killed him, because he knows that he dies; and the advantage which the universe has over him, the universe knows nothing of this. All our dignity consists, then, in thought. By it we must elevate ourselves […]. Let us endeavor, then, to think well; this is the principle of morality.’

With this noble objective in mind, let us take a look at what happened during the Great Financial Crisis and the ensuing Great Recession. Since macroeconomic forecasts currently have a shelf life of 24 hours, scenario planning is taking over. In that context, the events from a decade ago when the earth stood still for a few long weeks represent a relevant reference point for the months to come. As a matter of fact, the Flash Purchasing Managers’ Indices (PMIs) released on Friday bring us back to the steep declines observed in 2009.

  • Based on IMF data, Global GDP went down by -0.1% in 2009 (North America -2.8%/Europe -4.8%/Emerging Economies +2.8%) to rebound to 5.4% in 2010 (NA 2.8%/EU 2.5%/EE 7.4%), and to stay at around 3.5% per annum over the following years (vs. higher than 4% pre-crisis)

  • The ‘Average Joe’ in the Industrial Technologies space saw its revenues decline by c.15% and its operating profit go down by 30-35% in 2009

  • The decline in earnings mechanically boosted the net debt/EBITDA by 50%, though unlike in 2002, the sector went into the downturn generally conservatively capitalized (like today)

  • Restructuring plans announced in 2009-10 sought to save costs to the tune of approximately 2% of revenues

  • Revenues and operating profit recovered fast and reached pre-crisis level in 2011, i.e. within three years

  • Working capital measures associated with a decline in revenues freed up a significant amount of cash in 2009

  • Late cycle companies had a delayed reaction which ended up being more acute from a cash flow perspective (lower revenues often associated with lower order intake driving lower advanced payments)

  • Equity values for the sector troughed in March 2009, 10 months after the May 2008 peak, by which time they had halved; it took a year and a half (October 2010) for them to get back to the historical peak

  • Valuation multiples for the broad sector went from 9x forward EBITDA to about 6x in 2009 to fully recover by 2010 (see Back To The Futurefor a more detailed analysis)

  • M&A collapsed in 2009 (I do vividly remember working on the $6+ billion sale of Areva T&D that year) with consideration in stock gaining in importance, and started to recover meaningfully in 2010 already, alongside market sentiment and valuation multiples

  • Brazil, Russia, India and China or the ‘BRIC’ (and with them, commodities) as well as renewable energy (we will harness [the energy] from wind and the waves and the sun’) and more generally infrastructure spending helped drive the recovery as fiscal policy was used to boost demand in the smartest possible way (with some overshooting in China); digital strategies started to emerge in the sector

  • The post crisis world saw the rise of cash-rich Sovereign Wealth Funds, private equity, fiscally conservative countries such as Germany and China, central banks and U.S. finance (see A European Failure Of Epic Proportions); and the collapse of Dubai and Greece (with the European Union on the verge of implosion due to the sovereign debt crisis) and the first ever downgrade of the U.S. federal government credit

Scenarios tend to come in threes, with a central case surrounded by a good and bad one. Whether or not the Great Recession scenario becomes the central scenario as opposed to the bad one will only become clearer over the next few months. For now, the stock market oscillates from one scenario to another like a headless chicken. With Q2 anticipated to be a quarter to forget, the trends will realistically not get clearer before the Q3 results are published in Q4. For now, it is critical not to let the volatile market sentiment affect the ability to think well.

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