Recession watch: flexibility during hard times can create advantages

As part of an occasional series on dealing with a possible recession, we’re asking CFOs and other finance pros who have been through a prior recession how they’re gearing up in case the economy does contract in the coming months. Want to share your wisdom? Drop us a line, and let us know your thoughts.

Campbell Harvey, a professor of finance at Duke’s Fuqua School of Business and founding director of the Duke CFO Global Business Outlook, has been thinking deeply about recessions for a long time.

In his 1986 dissertation, Harvey developed the Inverted Yield Curve, one of the most accurate models available for predicting a recession.

But this looming recession might be different—harder to get a read on because of the complex and uncertain economic conditions, Harvey said.

CFO Brew spoke to Harvey about what finance professionals should be thinking about in the near-term, how to find a competitive edge during a recession, and why the Fed might be making things worse.

This interview has been edited for length and clarity.

Will you describe the current economic moment that we’re in and the potential for recession?

This is the time of heightened uncertainty, and there’s many driving forces for that uncertainty. One is that we’ve got an inflation rate that is at a 40-year high…My research suggests that often these inflation episodes are followed by recessions.

One of the main things that I worry about is that the Fed really believes that this tool of increasing interest rates is sufficient to fine-tune inflation. If they really believe that, that’s dangerous…Traditionally, hiking interest rates has been kind of the go-to tool in a tightening, and we’ve seen some success. But this time might be different indeed. Every time is different.

For example, what are the root causes of the inflation that we’ve got right now? Some of them are kind of intuitive, like supply-chain disruptions. So is it going to make a difference to those supply-chain disruptions if the Fed increases the rates by 50 basis points? No.

Effectively overreacting or taking a step that’s more drastic because you didn’t take a less drastic step early on increases the uncertainty. It increases the probability of a hard landing, which means we go into a serious recession. Nobody wants that. There are huge economic costs and huge human costs to doing that.

The soft-landing scenario is much more desirable. That could be slower economic growth or it might be a mild recession…and then we move on to recovery.

For our audience of CFOs and finance professionals, what should be top of mind for the next six to 18 months?

It’s fairly simple, and most CFOs have already done this exercise. That is, scenario A is a hard-landing recession that begins in the winter of 2023. And a hard landing could be year-over-year real growth of negative 3%. What happens to our firm? You could do the simulation and figure it out.

Then scenario B is a soft landing where maybe you have zero growth or 1% real growth. What happens to our company? You’ve got to plan, so as soon as there’s a strong indication that growth substantially decreases, you can start pressing the buttons.

You need to have these scenarios and you need to know what to do. The worst way to manage is to have to improvise…You need to have a plan.What are you going to do, and what are the triggers where you take some action?

The key here is to be able to weather the storm and come out of the storm, potentially, in a position that’s stronger than your competitors.

Where do you see organizations finding advantages in this kind of environment? The organizations that do come out stronger, where do they succeed?

Often when a company goes into a slowdown or a recession, they effectively have to spend the cash that they’ve got. Then there might be a great opportunity, once the economy turns, but they can’t finance it. A company that has been really wise in terms of its debt management and cash management, they can seize that opportunity.

Financial flexibility is really important, and that’s often where you get the competitive advantage.

A very bad strategy is to make cuts that are relatively easy to do but damage your long-term position…You don’t want to cut into the bone because that’s going to make you weaker.

If you do that, then you might come out of this on paper saying, “We’ve got some cash,” but you’ve sacrificed the long term. You might emerge in seemingly good shape, but your competitive positions can be damaged because you’ve done things to sacrifice long-term value creation.

There’s been so much for firms to deal with in the last five years. For organizations that haven’t had the time or wherewithal to start planning for the recession, is it too late?

It’s never too late, and it totally depends on the company…You need to do whatever you can to buy time. If you need to organize an extra credit line, do it now. If you need to refinance your debt, do it now…This is not the time for luxury…We can’t wait until the hard landing, so we need to take some steps now. You need to be proactive on this.—DA