Real estate, alternative real assets and other diversions

Coronavirus, business confidence and what comes next

The Analyst

The Covid-19 crisis is approaching its economic peak. Most Western economies are largely closed. Stock markets have been in freefall for several weeks, and may yet test deeper lows. Companies are in shell-shocked reaction mode, scrambling to protect what remains by cutting commitments across the board. Yet that instinctive reaction – to conserve by reducing risk and locking away cash – might well be the worst possible thing they could do.

Consider the asymmetry of the private and public worlds. Governments across the developed world have taken one look at the Covid-19 challenge and reached for the money taps. A rough calculation of the stimulus already agreed puts it around $4 trillion right now, but expect that figure to rise. It is already the biggest government spending spree since the Second World War.

This would not have happened if the private economy had not moved in the opposite direction. There are exceptions, like Amazon’s reported plan to hire 100,000 new staff, but most companies are retrenching: shutting up factories and offices, closing retail chains, and standing down distribution networks. Governments are turning on the taps because businesses are wrenching them in the opposite direction.

Imagine the setting of a large corporate crisis management team today. Most big companies will have a team structure and protocols already in place as part of their routine disaster recovery planning. They will have been through simulations of pandemics, along with other disasters like terrorist attacks including dirty bombs, nuclear accidents, bacterial releases, and severe weather. They may have psychological profiles of how employees are likely to react, and resilience maps to show how strong or vulnerable their business partners are. They will have designated crisis leaders (usually not the chief executive, who is more likely to be tasked with running what is left of business-as-usual), and frontline teams designed to feed back data to the crisis management office.

Yet for most of the last few weeks the most important thing these crisis teams need will have been missing, and that missing thing is information. The list of known unknowns has been very long. What is the true case fatality rate of Covid-19? What is the transmission rate? How long will the pandemic last, and where will it emerge next? What are government guidelines and policies today? What will they be tomorrow? In a vortex of uncertainty like this the temptation to act fast and act defensively becomes very strong.

Hard data show that businesses have already begun to do that. The Purchasing Manager’s Index which measures spending intentions in the corporate economy and is a good guide to near-future business activity has collapsed to record lows across Europe and the US – and those readings are based on data gathered just before the Covid-19 virus fully took hold.

Effectively, business has become ultra-short term. Long-term confidence has evaporated. Cash is king, and meanwhile budgets not yet allocated are being suspended. Projects, hiring and capital expenditure are all on hold because amid extreme uncertainty anything beyond the end of the month spells risk.

Companies will say that is how it has to be, because they have no idea what their future revenues will be. But is that really how it ought to be? There is evidence that businesses that meet a downturn by cutting back hard and fast on investment, talent and new projects may not do particularly well when the economy recovers. They may not even survive at all.

A few years ago Harvard Business School looked at how businesses had reacted to several downturns including the recessions of the 1980s and 1990s, the dotcom bust of 2000 and the global financial crisis. The research gauged how companies changed their investment strategies, their hiring and their financing. In all, over 4,000 company histories were profiled according to their reactions to recession (bear in mind the UK along with the rest of Europe and the US is almost certainly in recessionary conditions right now, although technical recession will only be called after two consecutive quarters of data).

In the Harvard study companies were grouped according to how defensive they were during and after a recession. The most defensive cut their costs faster and deeper during the downturn, and held that strategy for longer. They were also the least likely to succeed during the recovery period. Some did, but around 75% of companies with purely defensive strategies did not do well in terms of financial performance, or sales and revenue growth, compared to the average.






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