Autumn 2023 Economic Outlook

In 1996, world chess champion and all-around genius Gary Kasparov sat across Deep Blue, an IBM-powered machine. Kasparov would think in terms of popular moves. Deep Blue would use as much calculating power it possessed, to analyse all possible moves. But the challenge was not in having the information. It was in deciding. The more the information, the more difficult the decision. Kasparov won the first set. Mathematicians went back to the lab and remodelled the machine after the human brain. Instead of trying to eliminate the “bad choices” it ignored batches of choices altogether, focusing on clusters of “possible good decisions”. A year later, the “machine”, which started thinking more like a human, won.

“Too much analysis breeds paralysis”, investment analysts often say. To put it better, in Douglas Adams’s words, “[…] if life is going to exist in a universe of this size, then the one thing it cannot afford to have is a sense of proportion”.

The big thing about the C-suite is proportion. Someone standing on top can afford to have all or most of the information available. The suite is high enough and provides as much of a 360-degree view as possible. Modern AI tools can even help filter the information to the absolute minimum. But even then, realistically, there are unknowns, and information is still too much.

So, in this economy, plagued by one major war in Ukraine and the potential of a second one in the Middle East, where should C-suite executives focus?

First: it makes sense to focus on the global economic downturn. The key to remember is that a slowdown is happening, but the outlook is extremely uncertain. After the pandemic the economy rebounded, but the damages from the extended lockdowns were always going to hit home. The emergence of inflation forced an end to the 14-year period of ultra-low interest rates, compelling corporations that had previously incurred too much debt to refinance at higher rates. Already the UK is experiencing a record number of insolvencies, as business and financing models broke down due to high interest rates. High interest rates also reduce disposable income but, up to this summer, they had not affected consumer appetites. This is because, especially in the US, consumers had pent-up savings. However, our economist team suggests that consumers are now running out of savings. This means that growth, which temporarily rebounded after China joined the ranks of the no-lockdown countries, is set to slow down in the latter part of the year and the beginning of 2024. The question is how deep and how long will the slowdown be. Meanwhile, the outlook for inflation remains extremely uncertain. While consumers with depleted savings may help contain price rises, oil prices spiking could usher in a new cycle of inflation.

Second: geopolitically, the world is unstable and could remain so for some time. The war between Russia and Ukraine has already lasted for over a year and a half and forced actors all across the globe to take sides. One of the countries directly involved owns the world’s biggest nuclear arsenal, as well as the world’s largest gas reserves. The other is a key food producer. The war has divided legislatures in the West, and it would not be a surprise if support for Ukraine became a theme as we enter the 2024 US Presidential Electoral cycle. And it comes at the heels of seven years of prior geopolitical destabilisation, which started with China relinquishing its role as the global manufacturer, continued with trade wars, peaked with the pandemic and resumed with the further decoupling between the East and the West. As if this wasn’t enough, fresh disturbance in the Middle East could add exponentially to the destabilisation, especially if other countries are forced to get involved. Meanwhile, India is claiming China’s place at the heart of global supply chains and global capital is mobilised towards sustainable energy. The C-suite is finally realising that the era of geopolitical convergence is over, and in that respect, the world now resembles the 1970s. A world in turmoil.

Third: the cost of money will remain high, particularly of long-term money. In a world that is so inherently unstable, investors will require a higher yield, especially if they don’t know where inflation is going to land. Central banks are likely to keep short-term rates higher for longer too. Over the longer term the yield curve (the difference between short and long rates), which is now inverted, will normalise. This means that even when interest rates and shorter-term costs come down, longer-term ones could stay high. The C-suite should be especially attuned to this notion, as it might upend capital structure strategies that were for years based on the notion of cheap money. The only reason for rates to come down quickly would be a significant crisis. With rising risks, the probability that will force central banks to act and drive down borrowing rates is high. But even then, central banks, weary of the vagaries of flat interest rates, which breed mis-allocation of assets and endanger pension funds, will eventually try to return longer-term rates to a higher level. This means that if corporations find cheap financing, even if this is because of a crisis, it is perhaps wise to consider obtaining it, as the offer might not last for long.

Fourth: increased and erratic regulation. Presently, global companies are faced with the biggest tax overhaul in over 200 years, as some of the biggest global brands (think Google, Starbucks and Amazon), from more than 100 countries have agreed on a minimum tax rate for multinational companies. Meanwhile, new global sustainability standards are becoming the norm. The International Sustainability Standards Board (ISSB) recently published its first two global sustainability reporting standards – IFRS S1 and IFRS S2. What is important to comprehend is that an unstable world brings unstable regulation. Governments, often responding to political acrimony, would be compelled to make big changes and turnabouts when in office. Bigger problems, like climate change, breed bigger regulations. Higher deficits, in a world laden with debt, also bring higher taxation. Boards, who often find themselves on the back foot, having to deal with problems of today rather than focus on the future, should expect more, not less of those challenges.

What next?

While the issues facing the C-suite are certainly daunting, it would be good to be reminded of Chairman Mao’s quote: “Everything under heaven is in utter chaos; the situation is excellent.”

Fourteen years of quantitative easing bred complacency, and acted in favour of maintaining the status quo. The dominant players who survived the Global Financial Crisis became more dominant, using cheap money to buy out the competition early. A higher cost of money reveals weaknesses and allows challengers, increasing the probability that the better business models will finally be rewarded. Rapidly changing geopolitical conditions beget new and big infrastructure needs that need to be met equally rapidly. This only breeds more opportunity.

In this world, the C-suite should be ready for a fight, to be sure. They should start by reviewing their own business models and opine on their robustness. This market will probably give them ample time to adjust after a fatal mistake has been aired.

When everything is in disarray, it is the better prepared that will find themselves atop the next big economic cycle.

Published November 2023