Northwestern Mutual CEO: 3 lessons I’ve learned from managing economic crises before the coronavirus

There is no one-size-fits-all approach.

Northwestern Mutual CEO: 3 lessons I’ve learned from managing economic crises before the coronavirus

Companies today are making significant changes to maintain business operations while protecting their workforce, customers, and the community from the spread of the coronavirus. Although markets are volatile, and there are many unknowns, I have deep confidence in the long-term resilience of our country and economy.

Why do I feel this way? Because I’m fortunate to lead a company where we’ve seen it before. 

In our 160 years, Northwestern Mutual has overcome recessions, the Great Depression, natural disasters, wars, and even a pandemic flu—and each time, society, the economy, and markets bounce back. In more than three decades at Northwestern Mutual, I’ve seen five major market downturns—and the resilience that follows. 

There is no one-size-fits-all approach to overcome these challenges, which place significant pressures on businesses and people’s day-to-day lives, but there are lessons to be learned from a longer-term view. When I was named CEO in 2010, the country was still in the early stages of emerging from the 2008 financial crisis. I’m leaning on three major lessons from that period as we navigate the COVID-19 crisis.

First, financial strength—which means money in reserve, cash on hand, and a strong capital position—takes foresight and preparation, and is necessary to weather economic storms. Prior to 2008, I saw many other companies focus on how quickly they could grow, rather than the importance of a solid balance sheet. We at Northwestern Mutual knew that the challenges coming out of the market meltdown in 2008–09 could be managed, mainly because we took long-term financial strength very seriously throughout that time.

Early on as CEO, I traveled to Japan and formed relationships with leaders in the life insurance industry there. They had experienced decades of low interest rates and shed light on the consequences that had on their companies. I learned from them the importance of wisely managing expenses and maintaining financial strength in a low-interest-rate environment. Even during recent years of record-high stock markets, we have followed this advice.

While we could not predict the coronavirus and its rapid spread across the globe late last year, we knew we were deep into a bull market and needed to be prepared for any potential correction. As a result, we built up our capital reserve to ensure our financial stability. We also regularly stress-test how various catastrophic events could affect our business—including crises in a low-interest-rate environment—which has given us the confidence to face the current situation from a position of strength.

Second, businesses should plan for the long term, but maintain flexibility. In a society of immediate gratification, many businesses are tempted to make decisions based on short-term opportunities for gains. But lasting success takes discipline over time—in good times and through challenges. 

It is not always easy and requires patience and practice, but those that plan for the long term are not only able to withstand challenges and market turbulence, they can also seek out opportunities in this period. (Northwestern Mutual offers financial planning services to businesses, and therefore could profit from this advice.) For organizations and individuals that have the means, now is an excellent time to seize long-term investing opportunities in the markets. Long-term investors should take advantage of buying opportunities in a down market, knowing that the economy and markets will bounce back.

Third, leaders need to communicate with authenticity and empathy. Employees and consumers will remember how companies acted and communicated in a crisis long after it’s over. The safety and well-being of employees, clients, and the community comes first, and leaders need to look at how they can provide resources and support during difficult times.

Transparent communication in a crisis is essential, and employers have a critical responsibility to relay pertinent information to their employees quickly and thoroughly. A recent Edelman survey found that employers were people’s most trusted source of information on the coronavirus, trumping government and health company websites and traditional and social media. Nearly two-thirds of respondents wanted updates from their employer at least once a day. 

At my company, we have made a commitment to talking with our workforce often—even if the updates are small—so that we keep the conversation going. Our regular communications range from providing the latest guidance from the CDC, to reassurance that we’re prepared for this, to tips on working remotely and the technology that’s available. We’re ensuring that our employees feel supported and know where to go if they have questions or concerns.

At this difficult moment, America needs to remember that we have overcome significant setbacks many times in the past. We’ll get through this one too. If business leaders focus on what’s under our control and lead with confidence, we’ll come away from this even stronger than before.

John Schlifske is chairman, president, and CEO of Northwestern Mutual and a member of the company’s board of trustees.

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—WATCH: The CEO of Canada’s biggest bank on the keys to Listen to our audio briefing,

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Stocks are now overpriced by 22%, according to this rule

The recent rally means that investors believe EPS will surge past the 2019 peak and increase from there. But that's fantasy.

Stocks are now overpriced by 22%, according to this rule

Investors are brimming with fresh optimism that’s brought one of the greatest rallies ever. But if they’re right, then future earnings will need to be to be terrific. Don’t fall for the wishful thinking. The coronavirus crisis will hammer profits that were already in a bubble, and due for a fall.

Since hitting a low of 2237 on March 23, the S&P 500 surged 638 points or 28.5% by the close on Friday, April 17, regaining well over half of its drop from the record high of mid-February. That extraordinary jump means Wall Street believes that future earnings are looking a lot better now than they did three weeks ago.

But current prices point to a level of profits that defies reality. Stock prices reflect the stream of profits companies are expected to generate for many years come. Depressed results in 2020 and 2021 caused by the COVID-19 outbreak are far less important than where earnings settle when they’ve recovered to what we’ll call “normal” levels, meaning a benchmark where they start expanding again with the newly-growing economy.

So based on the S&P’s close at 2875 on April 17, where do investors put the normal earnings for America’s big cap stocks? Over the past 60 years, the market’s median price-to-earnings multiple stands at 17.4. But the PE has been a lot higher over the past three decades, averaging 21.3, a legacy of record-low interest rates that may or may not continue, and perhaps, excessive enthusiasm. We’ll start with the average of the two, 19.4, and round it up to 20-times, estimating that a magic wallet sprouting $100 a year in earnings should sell for $2000.

Deploying the 20 PE is Part 1 of what we’ll call the “Tully-20 Test.” If the “normal” profits you get by dividing the S&P by 20 look unreasonably high, then stock prices are inflated.

At our 20 PE, the S&P’s sturdy earnings-per-share, when the U.S. gets chugging again, should be $143.75 (2875 divided by our PE of 20). But wait, that’s higher than the $139.47, based on four quarters of trailing GAAP earnings, where the S&P finished 2019! That mark was an all-time record, a gain of 48% from the close of 2016. It also capped something of a golden interlude for profits. Operating margins averaged 11.1% in 2019, 1.9 points higher than the margin in 2016, and sales over the last three years jumped by almost a quarter, at an annual pace of 7.3%.

Those trade winds have since turned into a tornado. It’s impossible to predict how hard the pandemic will hit profits. But we know that projections are a moving target that’s rapidly getting worse. On April 9, analyst polled by Refinitiv posited a drop of 8.5% for the year. A week later, their estimate had almost doubled to 15.5%. Look for forecasts to keep dropping.

Once again, what matters most is where earnings land when the turmoil ends. The bull run means that investors believe that EPS will surge past the 2019 peak to $144, and increase from there. But earnings were in something of a bubble at the end of 2019 due to the unusual confluence of margins and sales growth that far exceeded their historic levels. We don’t know for sure if big caps earnings will quickly rebound to $144, but we do know where they need to go in the three years after the good times return to reward investors. Assuming companies continue paying 40% of their profits in dividends, and 60% in buybacks and cash reinvested in plants and products, earnings should wax at 5% a year––a pretty good number in an economy projected to grow at a long term “real” rate of 2%-2.5%, or 4%-4.5% including inflation.

Investors’ view that profits will replant the flag at greater heights than the 2019, golden age record, is probably a fantasy. So the S&P flunks Part 1 of the Tully-20 Test. Let’s move on to Part 2. If $144 is an inflated starting point for a comeback, what’s a reasonable base? And where does that put a reasonable value for the S&P?

An excellent guide is the Cyclically Adusted Price Earnings ratio developed by economist Robert Shiller. The CAPE uses a 10-year average of inflation-adjusted profits to smooth their erratic course, including spikes like the one before the virus struck. The CAPE’s most recent reading for “adjusted” profits is $107.

Of course, that figure will decline somewhat with the blow from the pandemic. But since Shiller’s methodology spreads earnings over a long period, the downward adjustment is most likely to be just a few dollars. I’ll also add 10% to the Shiller number because using a price level ten years old to adjust earnings over the next decade makes the current number look artificially low. After fiddling with the CAPE’s figure, I calculate a base for earnings per share, the footing where they’re most likely to settle when the U.S. emerges from the trough, at around $118.

The Tully-20 Rule reaches its judgment by applying the PE of 20 to that benchmark. That formula yields a fair value for the S&P of 2360 (20 times $118). The S&P actually dipped 5% below that number on March 23. But as of April 17, the index floats 22% above where the Tully-20 rule put fair value.

Conclusion: The latest party was a bash. Get ready for the hangover.

More must-read finance coverage from Fortune:

—5 veteran investors on —These countries’ stock markets have been —China’s next coronavirus crisis: —This time, the banks were ready: —How the American economy can recover from the coronavirus pandemic
—Listen to , a Fortune podcast examining the evolving role of CEO
—VIDEO: 401(k) withdrawal penalties waived for anyone hurt by COVID-19

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