Everyone knows the current stock market roller-coaster is more digital hallucination than real economy rebound. Wall Street seems confused about the severity of COVID-19 even as thousands of Main Street businesses fail. The Federal Reserve has supplied markets trillions of dollars of liquidity, while the Treasury has mailed millions of Americans checks to tide them over. Amateur investors, bored at home, are pouring their savings into the latest chimera.
The world is full of risk, but we refuse to act like it. Coronavirus cases are rising again. More than 20 million Americans are unemployed. Government relief programs will begin petering out by August. If America Inc. wants to make it through winter, it needs to take a hard look at business fundamentals.
Human beings, and Americans in particular, tend to ignore systemic risk. Imagine it’s the year 1925 and you are negotiating to buy a company. You are presented with the firm’s five-year historical performance including revenue growth, margins, and cash flow, as well as a tidy estimate of the present value of future cash flows—all a solid basis for generating a credible valuation. Would you have responded to the data by saying, “This is all well and good, but what if an unpredicted catastrophic event occurs such as a second world war? Won’t that knock your company off-kilter?”
For a time, the convulsions of the midcentury led to a more conservative stock market. Between the two World Wars and the subsequent Cold War (and its perpetual nuclear shadow), exogenous risk became a feature of business life around the world (e.g., Soviet honey traps or importing Cuban cigars to the US in 1960). For Western multinationals, political risks such as expropriation also rose to the forefront in evaluating portfolios and investments.
But in the 1990s, valuation got lazy. Amnesia and naïveté set in as the more risk-conscious Greatest Generation retired while the post-Cold War “peace dividend” presented rosy scenarios for globalization, especially with China and then India joining the global economy. Investors were numbed into over-confidence by the rapid recovery from the late ’90s dot-com bubble and 9/11 terrorist attacks, followed by injections of massive liquidity that side-stepped the worst of the Great Recession. A narrow approach to valuation took hold that focused on market demand and competition to the exclusion of other variables. Wars, pandemics, climate change, and other macro shocks were ironed away by the chronocentrism of living in the moment and the assumption that vulnerabilities—such as Greek debt or Libya’s civil war—could be ring-fenced.
Softbank’s $100 billion Vision Fund embodies these cornucopian ventures in its ambition to reshape civilization through technology and “capital dominance” but without a commensurate appreciation of complexity and risk. But gargantuan investments in Uber, WeWork, and other companies that required enormous cash flows only to lose billions every quarter shouldn’t have been justified even in the most Panglossian world, let alone amid a global recession. Bottom line: “Shit happens” can no longer be reconciled to a footnote in a prospectus.
If and when the Fed begins to taper, plenty of firms will once again resemble the junk the coronavirus exposed them for.”
Already, however, we can behold the shit flying towards the fan. The Fed’s “whatever it takes” corporate bond purchases are injecting epic volumes of liquidity into markets, lending artificial buoyancy to equities as investors flock to risk rather than away from it. If and when the Fed begins to taper its expansive credit facilities and unwind what could be a $10 trillion balance sheet, plenty of firms will once again resemble the junk the coronavirus exposed them for.
Uncertainty is everywhere, and forces are colliding in unpredictable ways. Consider how just as the coronavirus lockdown was ending and the retail and hospitality sectors were meant to thrive again, curfews began in dozens of cities due to mass protests stemming from the death of George Floyd. We cannot escape these complex chain reactions—especially with looming volatility related to climate change, the US-China confrontation, and the upcoming presidential election.
If today’s entrepreneurs genuinely want to build anti-fragile companies, they should have airtight answers to questions such as these.
Are you an essential service such as healthcare, food, or education that can deliver to customers physically or digitally across a range of disruptive scenarios? E-commerce and logistics firms such as Amazon, equipment manufacturer 3M, online education companies like Coursera, remote healthcare providers such as Teledoc, and plant-based nutrition companies such as Impossible Foods have been clear winners out of the COVID-19 chaos. They and others such as Google, Facebook, Netflix, and TikTok have also reinforced their credentials by hiring rather than firing workers, serving as platforms for knowledge exchange, or offering “freemium” products and services.
Even if your firm fell to zero revenue and required government support, did you manage your cost basis and service in a way that you maintained loyal customers and kept up relations with suppliers? Some hospitality companies, for example, have opened their doors to frontline healthcare workers for free, and Hyatt Hotels has even offered complimentary rooms for healthcare personnel on their off days or to be used for post-pandemic holidays.
Have you pivoted your business model to take advantage of present circumstances and take off as the market recovers? Much like Ford Motor Co. retrofitted its assembly lines to produce bombers during World War II, fashion brands ranging from niche Ministry of Supply to luxury giant Hermes have added high-grade and stylish face masks to their offerings. Looking ahead, think sanitized mobility, especially for the elderly, vertical farming to diminish exposure to food supply chains, and so forth.
In times of great upheaval, forward-thinking management with diversified access to capital is the foundation of successful corporations. Too many firms, however, still fall in the opposite category. They are waiting passively for the light at the end of the tunnel and hoping things return to how they were before. They are turning away “expensive” capital even if it could help them retain their positioning in the industry. American companies, in particular, haven’t anticipated that post-COVID regulations may revive a post-war model of regulated capitalism in which stakeholders matter as much as shareholders.
Some investors have woken up. Pension funds are pushing for ESG metrics to be included in valuations so that exposure to climate change and clean supply chain regulations are factored into equity analysis. We need to do the same for catastrophic risks, such as a prolonged pandemic, cascading environmental crises, or another world war. This will lead to firm valuations being generated with a healthy degree of caution, exerting pressure on management to make genuine efforts at resilience—a virtuous circle. Post-coronavirus, valuations do not have to settle at structurally lower levels. Rather, a robust stock market should be predicated on a rational economy: one that anticipates and reflects the values of a post-pandemic society.
Dr. Parag Khanna is founder and managing partner of FutureMap and author of numerous books including Connectography and The Future Is Asian. Karan Khemka is an investor and director in education companies globally. He previously founded the Asian operations of the strategic consultancy The Parthenon Group (now EY-Parthenon).