Does your company’s forward plan require adjustment for 2023’s second half? After all, the U.S. economy surprised both investors and economists in the first six months of 2023, and the recession braced for has yet to materialize. Unemployment is not budging from historic lows, and credit defaults appear contained. The term “soft landing” has even re-entered analysts’ vocabularies.
But all that is already in the rearview mirror. Whether it is time for companies to take a more aggressive approach to growth and investment or stay defensive depends on what’s ahead.
Here are the risks and opportunities CFOs and their C-suite peers need to consider to have their organizations well-positioned for the rest of the year and early 2024.
Risk: Misjudging the direction of the U.S. economy
The Federal Reserve’s preferred inflation benchmark (12-month core PCE) may still clock in at above 4% this Friday. Will it fall back to near 2% this year or early next? There is a possibility it will “get stuck above the goal range, forcing the Fed to keep rates high,” wrote Brandywine Global’s Francis A. Scotland, director of macro research, in late June. Steady higher inflation would not be kind to businesses’ margins or to consumers looking for cost-of-living stability.
“Despite the evidence which would support an end to the tightening, the Fed has been very aggressive and may indeed hold out for one more hike in September."
Dan North
Senior Economist, Allianz Trade North America
But continued bumps in the Fed funds rate could also have adverse effects. “We probably need to see some slowdown in spending to get inflation” under control, Treasury Secretary Janet Yellen said on June 23. It’s a near certainty the Fed will hike the Federal funds rate by 25 basis points this week, putting the benchmark range at 5.25% to 5.5%, the highest level since 2006.
“Despite the evidence which would support an end to the tightening, the Fed has been very aggressive and may indeed hold out for one more hike in September,” said Dan North, senior economist at Allianz Trade North America. At that point, the prime rate banks charge consumers (the engine of the U.S. economy) would be a stomach-churning 8.75%.
With personal savings rates below pre-pandemic levels and real personal consumption expenditures contracting in the latest report, consumers may look to add debt. But that will be costly, and some providers may balk. The overall rejection rate for consumer credit applicants increased to 21.8%, the highest level since June 2018, according to the New York Federal Reserve Bank’s June survey of consumer expectations.
So a recession may come, but arrive later than initially expected. The Conference Board projects a recession beginning this quarter. Bank of America’s Global Fund Manager Survey released on July 18 found that most fund managers expect a mild downturn beginning in the last quarter of 2023 or the first quarter of 2024. But we’ve heard plenty of dire economic predictions that haven’t panned out this year — a rising 19% of those fund managers see no recession before 2025.
Risk: Burdensome credit costs or no credit available
Commercial Chapter 11 bankruptcies rose 68% in the first half of 2023, according to Epiq Bankruptcy, but a quickening of headline borrower defaults hasn’t happened yet.
A lack of maturing debt is one reason; the other is “high-yield issuers are servicing fixed-rate debt obligations with highly inflated assets and cash flows, which makes it much more difficult to default,” according to Bill Zox and John McClain, portfolio managers at Brandywine. However, “there are many high-yield bonds that are likely to be called in the next year or two, or that mature in the next two to three years,” Zox and McClain said. A more severe credit crunch may not occur, then, until 2024.
But other credit segments are displaying hints of weakness.
“Middle market borrowers are facing increasing pressure that could result in a higher number of downgrades and defaults, according to a June 29 Fitch Ratings report. Some borrowers are diverting “cash-to-pay interest,” said Fitch, which could … cause “covenant violations, pressure on liquidity, and inability to invest in growth initiatives.”
The spark that starts a fire, though, could come from the wall of maturity in commercial real estate in the next 12 to 18 months. “Global regulators have made it clear they are paying close attention to the sector,” said Som-lok Leung, executive director of the International Association of Credit Portfolio Managers. Office loan delinquencies in Fitch-rated U.S. commercial mortgage-backed securities transactions are set to double to between 3.5% and 4.0% at yearend 2023, from 1.8% in May, said the rating firm, as more maturity defaults occur.
CFOs in any industry wishing to prevent a default when a more arduous refinancing lies ahead should already have a capital plan in place that addresses capital returns, leverage ratios, [and] funding options, said Steve Rosvold, the founder of CFO.University.
Opportunity: Allocating more capital to growth investments?
Is it time to think about growth again?
The answer is highly company-dependent; some broader trends stand out. Capital spending grew 21% among the S&P 1500 in 2022, according to Scott Chronert, a managing director at Citi, but this year the cost of capital is making C-suites “incrementally less enthusiastic about capex plans.” Capex growth, estimated Chronert, will be a “more muted” 7% in 2023. His early estimate for 2024 is a “flattish” 2% increase.
But individually, CFOs may be relatively optimistic about pursuing business opportunities in the second half. The June Duke Unversity/Richmond Fed CFO Survey found finance chiefs were as optimistic as last year about their company’s expected performance. The Deloitte first quarter CFO Signals survey found that 40% of participating CFOs said now would be an opportune time to take more significant risks, up from 29% at the end of 2022. The increased risk appetite probably reflects “higher net optimism for [CFOs’] own companies’ financial prospects,” Deloitte said.
Indeed, CFO.University’s Rosvold said, “Individual companies may find opportunities in their industry, product development, or geography that far surpass their cost of capital.” With M&A activity down nearly 50% over the past seven quarters, Rosvold added, the last half of 2023 could be “an excellent time to review acquisition candidates.”
Opportunity and Risk: Reassessing tech portfolio investments
Many eyes will be on Alphabet’s earnings report on Tuesday, looking for a glint of business tech spending behavior, especially in the cloud. High inflation and lower margins pushed businesses to be more efficient in the past year, with the S&P 500 cutting operating expenses by 5% in the first quarter. Cost-cutting and projects aimed at operational efficiency will continue in the third and fourth quarters.
But tech investments can boost efficiency, so unless a company is in financial distress, it’s not likely to cut core IT spending. Automation, technology integration, and new technologies like generative AI (artificial intelligence) are potential areas of a renewed focus on ROI-based spending for enterprises and midsize businesses in the second half.
But where to start with new AI tools like ChatGPT? In recent conversations with Prashanth Southekal and Tobias Zwingmann, Rosvold said the consensus was that the first investment in AI needs to be “in understanding how and where to deploy it [in] the CFO suite with a near-immediate investment in a use case.”
In finance specifically, generative AI and traditional AI can “dramatically” increase productivity, said Prophix Software CEO Alok Ajmera. An example would be applying AI to anomaly detection, he said. Financial professionals could “spot inaccuracies impossible to detect with the human eye, allowing them to close their books faster and without error,” he explained.
“CFOs should use their unique risk-focused perspective to push for, and help shape, a policy ... that mitigates the risks posed by unrestricted use of ChatGPT.”
Mark D. McDonald
Senior director analyst, Gartner
Some finance executives may hesitate to take a hands-on approach. Still, they must try to understand how they can augment their jobs for “better and faster outcomes,” according to Ajmera. Of course, ChatGPT may prove just as applicable on the plant floor. Mercedes-Benz recently announced a ChatGPT voice-based interface for factories that “will allow employees without programming backgrounds to leverage data analysis tools and evaluate process production data.”
Wherever tools like ChatGPT might be used, Gartner’s senior director analyst in the finance practice, Mark D. McDonald, reminded CFOs that they have a risk management role. “CFOs should use their unique risk-focused perspective to push for and help shape a policy ... that mitigates the risks posed by unrestricted use of ChatGPT,” he said. Those risks include output quality, data security, and regulatory, “as well as their downstream implications,” McDonald said.
Opportunity: Self-evaluating your current job and skill set.
If the United States is entering another turbulent or negative-to-low-growth economy, more CFOs might decide they would rather not deal with it and retire or move to a different kind of finance job. Companies in poor financial health will switch strategic imperatives and may look for a new CFO with suitable expertise. A high turnover means opportunities for other finance chiefs or upcoming finance executives.
“The historical reporting and cost-cop role continues to exist, but the growth part of the job is in the future."
Steve Rosvold
Founder, CFO.University
CFOs and CFOs-to-be should be prepared. As sophisticated professionals, most know to ask themselves regularly whether they’re satisfied or fulfilled in their current role. But judging the probability of reaching goals and driving successful outcomes in a CFO job given the company’s culture and short- and long-term objectives is also important. Evaluating a job offer from that second angle can avoid a wasted professional year or two.
On a personal level, finance leaders should make evaluating investments in their professional development a regular exercise, said Rosvold. Career mentors and 360-degree feedback can be invaluable for supplying an objective perspective.
“The historical reporting and cost-cop role continues to exist, but the growth part of the job is in the future,” Rosvold said. “CFOs are tasked with influencing areas requiring more general business acumen and collaborative skills.”