.jpg "hero")
Global Perspectives
Heads its Recession – Tails its Recovery
Over the last two decades, coordinated action by central banks and G20 governments led many to believe that the 'goldilocks' economy was here to stay.
Neither too hot nor too cold, a little stimulus here, an interest cut there, and all could be kept on track. It worked for a long time.
In these columns, we have previously commented on the sheer scale of quantitative easing and other unconventional measures leading to the risk of over-stimulating asset prices. Too much money chasing finite investment opportunities we feared would re-ignite inflation and lead to a tech and start-up boom and bust.
Notwithstanding, the benefits of coordinated action to address the fallout of the Global Financial Crisis in 2008 and the 2019/2020 pandemic were considerable, with financial stability restored. However, an unfortunate difference with today is that a world without inflation provided generous headroom for unconventional policy measures.
Today, a combination of factors, including US economic stimulus packages, the War in Ukraine, food and energy shortages, the remaking of supply chains, mounting wage pressures, slowing economies, technology disruption and geopolitical tensions, have all combined to stoke inflationary pressures. Central banks, late to recognise the mounting price pressures, responded with the fastest interest rate hike in living memory.
With present-day inflation stubbornly high, remedies are sparse. Stimulus and interest rate cuts would worsen matters, whilst fiscal measures designed to reduce spending power look complicated, with some countries already experiencing taxation at 70-year highs.
As we predicted in 2021/2022, central banks and governments are boxed in, with limited policy options. Withdrawing quantitative stimulus to take the steam out of the credit market too quickly could destabilise the banking system, with soaring interest rates already seeing the restructuring of SVB, Credit Suisse and others.
The IMF has forecast global inflation to fall slowly from its peak but to remain well above the 2% target in most developed economies. Given the current cost-of-living crisis, there is still ample opportunity for core inflation to rise and debt distress to manifest, especially in emerging and frontier markets.
Despite waning energy prices, food and wage inflation remain a problem. Fold-in labour shortages and developed markets may see creeping stagflation with high-interest rates and low growth. Odds are on bank rates passing 5% on both sides of the Atlantic, although in Europe, the ECB may be able to top out at lower levels, with Germany already in recession and inflation in France and Spain falling quite rapidly.
Economists' views on a trans-Atlantic recession are mixed. Still, with relatively low unemployment, central banks seem inclined to redeem themselves in a relentless drive to crush inflationary pressures, the only moderating factor being the fear of a full-scale banking crisis.
Further out market expectations of average inflation over the next five years in the US and the leading EU economies are stuck in the 2% - 4% range, with some commentators predicting a recession will be needed to achieve even these numbers.
So, should investors be on 'Recession Watch' and what are the implications for private capital?
Uncertainty certainly cools investment, and large deals with significant leverage have slowed. Still, they have continued. Portfolio investments concluded in downturns have historically delivered super-sized returns, and with $3.7trn dry powder at the end of 2022, many GPs can afford to be both patient and contrarian.
Higher borrowing costs are impactful for private capital but not an exclusionary barrier to acquiring high-quality assets at reasonable prices. Targets can always be won by deploying more equity and then refinancing when rates are cheaper.
According to Bain & Company, multiples in the US (average EBITDA price multiple for leveraged buyout) reached 11.9 x by the end of 2022 and, in Europe, fell to 10.7 x. The eye-watering prospect of single-digit multiples for good assets will undoubtedly draw well-funded players with solid LP backing onto the field.
Whilst overall trade may reduce in the event of a recessionary environment, the re-mapping of supply chains will continue as economic activity becomes more regionalised, with increased restructuring and new regional investment compensating as countries respond to the new geopolitical and economic realities of a US-China gradual decoupling.
Recession may be looming, but innovation and productivity will receive a boost as firms fight inflationary forces through the more rapid adoption of AI, the promotion of energy efficiency measures, and the introduction of more flexible labour practices.
At a macro level, whilst central banks may not achieve the perfect landing (lower inflation and no recession), any reduction in uncertainty, as inflation and interest rates decline, will be welcomed and no doubt accompanied by a boost to deal flow.
The prudent, agile, and selectively adventurous will likely be rewarded.
About our Blog
Global Perspectives provides regular, on-point commentary on relevant topics in a pithy and accessible way. Our observations and points of view are based on listening hard to clients global needs, priorities and concerns. We draw on insights from every area of our business and collaborate to deliver this global thinking; something that clients tell us is distinctive and sets us apart. If you'd like to find out more, please get in touch.
View our previous posts here.
Contact
About Mourant
Mourant is a law firm-led, professional services business with over 60 years' experience in the financial services sector. We advise on the laws of the British Virgin Islands, the Cayman Islands, Guernsey, Jersey and Luxembourg and provide specialist entity management, governance, regulatory and consulting services.
