February 2016, Vol. 243, No. 2
Features
Managing Risk Through Downturns
As a small business owner all too well of the struggles to manage overhead as we all struggle through sky rocketing health care costs and taxes and inability to raise prices due to economic conditions.
Whether one is managing a small business or managing wealth, the top priority should be preserving cash to ride out the current storm. Instead of becoming more levered to debt, businesses try to de-lever and manage operations on a free cash flow (FCF) basis.
One has to better scrutinize the risks to capital vs the rewards as we end an economic cycle vs begin it. For seven to eight years the U.S. government, mainly through Fed policy, has encouraged the opposite, while assuring that the economy is sound. Following the path of zero interest rates was too tempting for some, but many are now paying the price – businesses that did so now find themselves in deep financial distress.
The so-called anemic recovery has been fueled by debt, not the real growth that is typically found in most economic recoveries. Wages have declined (not increased); GDP growth never really exceeded 3%; underemployment never really improved despite government reports about the low unemployment rate; and all the while debt made up the difference.
Instead of looking at the rise of the NASDAQ to bubble territory and using that as a basis to assume the economy is strong, it is more useful to look at real assets like commodities. For real economic growth, commodities matter much more than a money printing drive to inflate stocks like biotech and technology.
The only way to manage through a debt-fueled economic cycle is to do the opposite: Preserve cash. In the commodity sector we are about to witness a lot of bankruptcies – so many companies followed central bank policies off a cliff. The ones that resisted the economic drugs pushed by the Fed will be in the position to prosper through prudent cash management as many competitors close their doors and will be forced to liquidate.
The businesses or individuals that will prosper after all the smoke clears will be the ones who are run conservatively. Central banks are literally out of bullets as they desperately use negative rates to force even more risk. Unlike other late stage recoveries/early stage recessions we are entering it with empty guns.
By Leonard Brecken, Oilprice.com
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