Coal Mine Canaries

Down here at burningpants we spend a lot of time examining the signals of the economy – looking for the signs that the choppy economic cycle we are in is ending and that we might return to what we think of as normal economic cycles.

To be honest we’ve been keeping a very close eye on two things; savings, particularly as a percentage of GDP (which has been very high since 2008) and borrowing – particularly for businesses.

The news is, as you would expect in these times, mixed – savings is down slightly, but so is spending and so is borrowing – particularly at the smaller end of the business market which means that at least the traditional signs of economic growth are still muted at best.

But here’s the thing and this is enough to give any business owner pause; there are still signs in the market of a great calamity to come, that the great flood may not yet be over.

One of the bellwethers of the economy is what is called the future orders book – that is how much demand is banked up in businesses, in particular manufacturing businesses. It gives analysts a view of two things: what demand looks like in an industry and how much other businesses are spending.

Of the industries that you want to keep an eye on there are a few which are well known future demand indicators – things like factory machinery, forklifts, paper, steel and internet infrastructure.

Here’s the thing; the internet as we know it runs pretty much on one set of machinery, manufactured by one company – Cisco Systems. They dominate the space so fundamentally that they are a proxy for the future of the internet.

And here’s the news, in case you missed it; on Thursday, Cisco stunned both the tech world and the stock market when it cut its sales forecast for the second time in a row.  Worse than that, the report stated that the company’s current situation is the result of outside forces beyond the company’s control – in particular, declining orders from cable companies and government agencies.

That means that Cisco’s two biggest clients – Telcos and governments – have stopped buying, which in most western markets is about 30% of the entire economy.

But there is more to the message than this, particularly for those of us old enough to have been in the business since 2001, the last time that Cisco announced that their orders had dried up.

In 2001, when the Chairman of Cisco appeared on TV after coming back from his holidays to find that his forward order book had evaporated he was intelligent and measured and spoke with confidence, but that moment was widely regarded as the precursor to the dot com crash.

So if investors aren’t spooked by Cisco’s announcement they ought to be. If this was the world of agriculture, it would be like getting information that no one was planting crops this year.

What’s even more curious is that two of Cisco’s competitors, IBM and Motorola, have announced that they are optimistic about their government and Telco business. The question is: are they deluding themselves and their shareholders or are is there something wrong at Cisco?

It’s at this point in the discussion we like to apply a little known philosophical tool called Inwood’s Razor, which we cheerily admit is an idea we burgled from William of Occam and his famous Occam’s Razor.

William of Occam developed, or at least made famous, his idea called Occam’s Razor (or in latin, the law of parsimony), which basically states that the simplest explanation (usually in mathematics) is the correct one.

Inwood’s Razor is slightly different. After years of observing company announcements and proclamations we look at what companies are saying and say what is actually most likely to be true – which of these statements is most likely to be managing shareholders for keeping the share price up.

So applying Inwood’s Razor, let’s look at what is most likely to be true.

1. The Economy is growing – it’s just Cisco that is missing out. Given that they fundamentally dominate so many areas of internet infrastructure and have survived everything so far – that seems really, really unlikely.
2. IBM and Motorola have got it wrong. Their markets are tanking too and they just won’t be honest about it.
3. Cisco has it right, this part of the economy is tanking quickly and they are being prudent in talking things down ahead of a nasty crash

In real terms is likely that both two and three are correct, and if that’s the case, there may be a bumpy flight ahead for investors and cash may after all be king again.

One Comment on “Coal Mine Canaries”

• November 18, 2010 at 9:12 am
  John says:

  Or more likely GOLD will be King……..

  Reply