4 minute read 14 Oct 2019
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Why an economic slowdown does not imply a recession

By

Steve Krouskos

EY Global Vice Chair – Transaction Advisory Services

Driving growth and investment priorities for global EY TAS. University of Florida alumnus. Son, husband and father of four.

4 minute read 14 Oct 2019

Despite prevailing fears of an economic slowdown, the C-suite expects growth and a continuing M&A upward trend.

T
he global economy is softening and desynchronizing, but according to the EY Global Capital Confidence Barometer, respondents still expect growth. Global economic activity has slowed in some of the major economies in 2019. But most major economies are still growing.

Macroeconomic and external environment: global economy is showing resilience in the face of elevated geopolitical, trade and tariff concerns

Challenges arise from tariff and trade concerns and uncertainties over geopolitics and national politics. These risks are putting downside pressures on export-oriented countries and those with divided domestic agendas. However, economies that rely predominantly on services and consumer spending are being supported by elevated levels of employment, strong wage growth and a benign inflation environment.

M&A survey growth perspectives economic slowdown does not imply recession

The likelihood of a recession in the near term is not considered a significant threat by respondents. While there has been more speculation about the potential of a global correction, executives do not see this on the immediate horizon. A majority does not expect a severe downturn, and of the minority that do, say it is not likely until 2021 or 2022.

Companies should be taking advantage of today’s conditions to reassess their portfolio vulnerabilities and divest assets that are not part of their future growth strategy.

M&A survey results reveal half not expecting economic slowdown other half possibly years away

Capital markets steady in the face of headwinds

All asset classes have had a roller coaster ride in 2019, but equity and credit markets are benefiting from renewed central bank support. The past 12 months have been volatile for markets, but a reversal of policy direction, by both the US Federal Reserve (the Fed) and the European Central Bank (ECB) have calmed investors, for now.

Uncertainty about market direction and the difficulty of exiting an easing cycle has softened the levels of positivity seen in the 2018 Barometer. But most respondents are positive in their outlook for the next 12 months.

However, market shocks and reversals can be unpredictable and happen at any moment — for example, recent tensions in the US repo market and the spike in oil prices following the drone attacks in Saudi Arabia.

Companies could utilize the current environment of ultra low, even negative, interest rates to optimize their capital structure to safeguard against potential threats.

Corporate financial performance metrics to remain positive in the near term

The mildly positive outlook for the next 12 months is supported by respondents’ confidence in a modest improvement across a range of financial metrics. Revenue is forecast to be more positive than earnings. This is a clear indication that the margin pressures seen in reporting through 2019 will likely continue. But the overall picture is one of positivity. Respondents predict an uptick in free cash flow generation and investment in R&D and capex.

Responding to growth challenges: external threats to growth exist across a range of time horizons

It is impossible to avoid the headlines about geopolitical and trade disputes as well as regulatory changes. As equally immediate and pressing is increasing competition from innovative startups built on new technologies. Executives are acutely aware that a new business model or route to market can quickly undermine their competitive strengths and positioning. Proactively scanning an evolving industry landscape is a prerequisite for today’s companies. Acquiring or co-opting these emerging challengers is often a necessary response.

Broader societal issues are also increasingly impacting boardroom strategies. For example, the demand for action on climate change is not new and is growing stronger. Companies need to be proactive in addressing these issues or they will find customers shifting to competitors who are perceived to be more in tune to their concerns.

M&A survey external threats include economic slowdown

Building optionality and resilience into supply chains and operations is the response to trade and tariff uncertainties

The challenges of changing trade and tariff rules are being proactively addressed by nearly two-thirds of respondents. Reconfiguring supply chains and other business operations is becoming business as usual. But as we have seen over the past year, new disputes and uncertainties can arise at any time, and often with severe impacts on supplier relationships and access to markets.

Companies should be examining all aspects of their operations through a lens of scenario and threat analysis. They should identify potential vulnerabilities and build the optionality that will enable them to pivot as required.

M&A survey geopolitical, trade, tariff uncertainty economic slowdown

Margin compression is the biggest factor constraining growth intentions; low inflation environment does not extend to input costs, squeezing profitability

When looking at their own immediate growth plans, executives are trapped in a confluence of interrelated challenges. Increasing input costs are hard to pass onto customers in a low inflation environment, especially with technology companies and startups waiting in the wings to capture market share.

In response, companies have to constantly reassess their operating models as well as drive continuous improvement around indirect costs.

But traditional barriers inside an enterprise are also a threat. Internal inertia, combined with a shortage of the talent and skills required, may leave some companies vulnerable and unable to respond proactively to these threats.

M&A survey challenges company’s growth plans economic slowdown

Summary

The EY Global Capital Confidence Barometer (pdf) gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their Capital Agendas.

About this article

By

Steve Krouskos

EY Global Vice Chair – Transaction Advisory Services

Driving growth and investment priorities for global EY TAS. University of Florida alumnus. Son, husband and father of four.