Pull Your Head Out of the Sand – Something’s Gotta Give

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, …” so goes the famous opening line by Charles Dickens in March 1869. That line from A Tale of Two Cities perfectly captures where we find ourselves today. Its time to start thinking about reducing your risk exposure in both your business and investments and prepare to take advantage of various opportunities as they arise. My logic is as follows:

The best of times:

• We are 11 years into a bull run on the stock market. The multiples on the S&P500 have soared almost fivefold (on earnings, sales and book value – whatever you want to look at). Equity investors have made a lot of money!
• Debt is cheap with interest rates at record lows.
• Unemployment in North America is almost non-existent – if you want a job, you can find a job.
• Technology is enhancing lives. Technology has contributed to improvements in communications, home entertainment, housing, health, wellness, and education. There appears to be no slow down in the development of new technologies, which is increasing productivity and leading to an explosion in new opportunities.
• We are living longer and healthier today compared to even a couple of decades ago. Life expectancy in North America is 76 for men and 81 for women.  In Canada, the numbers are even higher at 80 for men and 84 for women.
• Education is on the rise in the 3rd world.
• Poverty is declining worldwide.

The worst of times:

• Economist Hyman Minsky notes that, at some point, reversion to the mean must happen. Lance Roberts summarizes a Minksy Moment as a time “… when investor psychology collides with leverage and the problems associated with market liquidity. It will be the equivalent of striking a match, lighting a stick of dynamite, and throwing it into a tanker full of gasoline.” Again, we are 11 years into a bull run on the stock market.
• The statistical relationship between the equity markets and the economy has never been as low as it is today. The bull market is not being driven by corporate earnings; they have been in decline since midway through 2019. The market is being fueled by access to cheap debt.  Corporations have been using cheap debt to do large share buybacks, driving share prices up. Business capital investment has been negative over the last few quarters.  If you’re running a business, you’re probably feeling the squeeze – limited ability to increase your selling prices and declining margins with increasing wages.
• There is a growing earnings and wealth disparity not only between individuals but also between corporations. The top 5 companies on the S&P500, representing 1% of the 500, make up 18% of the market value of the S&P500 today. The top 10% earn 80% of the profits. How likely are we going to see a repeat of the spectacular returns experienced by these same top companies over the next decade?
• As of February 13^th there have been over 60,000 cases of the coronavirus identified worldwide and the WHO is unable to tell us whether the virus is continuing to spread aggressively or whether we are at the point of containment. Since the beginning of 2020, the market has ignored the virus risk, with the S&P500 up 5%. The virus has shut down businesses, cities, and provinces in parts of China. With China representing 16% of global GDP and even more of global GDP growth, we can be sure that there will be a significant impact on global growth and global supply chains. The only question is the timing of the impact and how fast businesses will be able to recover. There will be a hit on businesses in either the 2^nd or 3^rd quarter this year.
• Climate change continues to be at the forefront of every conversation with global scientists urging the world to take immediate action. The Intergovernmental Panel on Climate Change (IPCC) says the world is headed for painful problems sooner than expected, as emissions keep rising. The impact on both businesses and the markets will be significant. Industries and companies on the wrong side of this will suffer and many will disappear.
• Debt levels in North America are at the highest they’ve ever been and will continue to climb as North American politicians push tax cuts and pressure monetary policymakers to reduce interest rates and increase quantitative easing. At some point, there is going to be a reckoning under the weight of all this debt.

So, as a business operator, investor and someone who cares for your family what actions can you take?

It’s time to hunker down and reduce your exposure to risk both personally and within your business.

• Cash is king in any downturn – ensure both your organization and your family have an adequate source of liquid assets available to manage through a downturn and have the liquidity to take advantage of opportunities coming out the other side.
• Revaluate the timing of your capital expenditures within your business. Stretch investments out for another 6 to 12 months to gain a better understanding of where the economy is heading.
• Consider the timing of your next hire and watch the utilization and productivity of your workforce.
• Manage your inventory closely with a lean mentality.
• If you’ve been thinking about selling your business, the timing right now may be opportune.
• Find yourself a wealth advisor who has a deep knowledge of wealth management and who you can trust to preserve your capital and identify opportunities in a potentially rapidly changing market. Make sure they understand the impact and possibilities of climate change.  Even in declining markets, there are opportunities to preserve and grow capital.