Your company in the next recession

Followers of our monthly newsletter have already been alarmed that 2019 could be an infliction point for the global economy. Just to name a few, we have since the beginning of the year seen decelerating growth in the manufacturing sector (see the graph below), downward revisions of global economic growth (e.g. the IMF), central banks holding back on interest rate hikes, and yield curves approaching their inversion points. While keeping abreast with developments in the global economy makes for a good conversation, the essential question for companies is of course the impact on their tactical reality.

How to assess this issue? Firstly, let us consider the context. Whereas most economists see dark clouds on the horizon, there is also an acknowledgement that the world economy overall is doing well. There has not been a substantiated forecast that suggests a recession like the 2008 financial crisis (albeit such events are nearly impossible to predict), and the world economy is expected to continue its expansion – at least in the short-term.

Given its past track-record, a potential inversion of the yield curve is the most troubling signal (in this case, it is the difference between 2- and 10-year government bonds, as illustrated in the graph below). A yield spread below zero may indicate an upcoming recession - but with a considerable time lag. In the case of the United States, there has on average been a 21-month gap between the spread turning negative and the start of a recession, with the longest time gap being around three years.

In the case of Germany, although the yield-spread remains above zero, interest rates are negative on both 2- and 10-year government bonds, which may indicate a weakness in the economy. This leaves limited headroom for the European Central Bank to implement monetary stimulus in case of a crisis. Whereas interest rates in the United States look healthier, the yield spread remains close to zero and thereby close to an inversion of the yield curve.

In sum, there is plenty of evidence to suggest that the world economy is undergoing a deceleration that could end in a recession within the next two years. What actions should companies consider?

While “be prepared” is the key objective, this does not imply an initiation of “DEFCON 1”, abandoning all expansion projects and hoarding cash to cover expenses for the next 2 to 3 years. Rather, “prepared” means understanding a variety of potential scenarios and developing responses such that your company can take adequate action. Specific measures include ensuring appropriate leverage and access to funds, i.e. credit, equity or internal cash flows, and allowing flexibility to change the company’s purchasing and marketing strategies.

In short: Optionality is key! Allowing your company the flexibility to be on the offensive can provide a unique opportunity to prosper while others are struggling to survive– and many companies have struggled exactly because they did not have the flexibility to change course as the economic tide turned. Therefore, now more so than ever, every company needs to assess its ability to prosper in a harsher economic reality where there might not be room for everyone.