Steps Your Company Can Take To Be Recession-Ready
The following article first appeared in the Insights section of JPMorgan Chase’s website. It is reposted here with permission.
With second-quarter U.S. gross domestic product down from the prior quarter, there’s heightened debate around whether the U.S. economy is already in or heading toward a recession.
We walk through the key aspects shaping that debate and offer strategies for business leaders to consider during periods of heightened volatility and slower economic growth—including a recession.
Is a Recession Coming?
First, we have to answer a different question: What counts as a recession?
A recession is informally defined as two successive quarters of negative GDP growth. The last two quarters fit that bill, with GDP contractions of 1.6% in the first quarter and 0.6% in the second three months of the year, as calculated by the U.S. Commerce Department.
An official declaration of recession in the U.S. would come from the National Bureau of Economic Research, which incorporates a broader range of indicators, including employment markets. But it could take months before NBER issues an announcement.
JPMorgan Chase looks at a combination of economic factors and market signals to inform the thinking around the potential onset of a recession.
At the end of July, the firm’s models pointed to slightly less than a 50% chance of recession within the next year. Meanwhile, volatility and significant corrections in the stock and bond markets were pricing in a much higher recession risk of between 75% and 80%.
Some industries tend to be more or less recession-proof. Consumer staples, healthcare and food are examples of relatively inelastic products and services that consumers buy even when household budgets tighten.
What Can Your Business Do About It?
Terminology aside, two consecutive quarters of real GDP contraction illustrate the risk of slower economic growth and the need for boards and management teams to prepare for continued uncertainty.
We offer three key ways business leaders can prepare for a potential recession.
1. Watch data for warning signals—and stay nimble
Manage the risks within your control and retain a flexible cost structure and business model. Be proactive and devise an action plan for any potential slowing of sales and profits:
- Explore risk-reduction strategies, including forward buying of inputs or locking in interest rates.
- Identify discretionary expenses and overhead you can reduce or defer to maintain margins without sacrificing long-term growth plans.
- Think about near-term adjustments to your strategy, pricing or product mix that might help you weather the storm.
- Consider negotiating agreements with strategic suppliers or explore outsourcing functions to a vendor that may be more efficient.
Whether or not a recession materializes, business leaders should be prepared for multiple scenarios.
“Companies have been forced to be nimble the last few years, and we expect that mentality to be a requirement for operating sustainably in the near- to mid-term,” says John Simmons, head of middle market banking and specialized industries with JPMorgan Chase Commercial Banking.
2. Maintain a fortress balance sheet
Maintaining a financial bill of health that can withstand shocks is paramount in a recessionary environment.
- Focus on maintaining adequate liquidity to sustain your business through a downturn.
- Consider proactively refinancing debts that are coming due within the next one to two years.
- Balance deploying excess COVID-era liquidity with maintaining a buffer for downturns.
- Maintain a dialogue with lenders to provide updates on business performance and cash management.
3. Be bold and take advantage of volatility
A downturn is more of a buyer’s market, creating unique opportunities for some companies.
- Consider merger and acquisition opportunities where you can take advantage of the equity market valuation premium for scale, growth and strong margins.
- Lower equity prices may provide an opportunity to acquire undervalued assets.
- Cash consideration can be used to deploy excess liquidity.
- Equity consideration can be used to take advantage of near-record equity multiple dispersion and minimize downside risk.
Note that at the end of July, S&P 500 valuation multiples had contracted significantly in 2022.
- The price-to-earnings ratio has contracted year to date and from the 2022 peak to trough.
- Technical changes in the past three decades—such as S&P 500 sector composition changes, strengthening profit margins, and robust balance sheets—may help support multiples at current valuations or higher.
“There will always be pockets of opportunity and growth in any economic cycle,” notes Rama Variankaval, managing director and global head of the J.P. Morgan Center for Carbon Transition and Corporate Finance Advisory.
“Many companies focus inward during a recession, but that may mean missing a unique chance to scale with a strategic merger or acquisition.”
About the author: Ginger Chambless is head of research for commercial banking with JPMorgan Chase, focused on on economic and market insights, industry trends, and the capital markets.
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