History imparts many lessons, and among them are that all good things come to an end. In the early stages of 2019, all signs are pointing toward slowing economic growth both domestically and internationally.
Global economic growth appears to have peaked in 2018 at 3 percent, and analysts at the trade credit insurance firm Atradius estimate global growth to ease to 2.8 percent this year. The slowdown will be felt in both developed and emerging markets and will be driven by monetary policy decisions, a fading U.S. fiscal stimulus, increased volatility in financial markets and rising uncertainties about future trade relations.
Theme of the Moment: Uncertainty
While global trade growth remains relatively strong, it is decelerating, reaching 4.7 percent in 2017, 3.7 percent in 2018 and predicted to further slow to 3 percent in 2019. The overarching threat to global economic growth in 2019? Uncertainty.
No matter what form uncertainty takes, it tends to have the same effect: lower business investment. A large source of uncertainty at the moment is the unfolding trade war between the U.S. and China. While conversations have begun and will be focused on intellectual property and technology transfer, should these countries significantly ramp up their trade conflict, the forecasts for 2019 economic growth would likely be revised downward.
Another big area of uncertainty is another looming U.S. government shutdown. Although a short-term agreement was reached at the end of January, it remains to be seen what will happen next. Will the government remain functional for some time? Or will it come to another impasse? At this point, it’s nearly impossible to say, and the 35-day shutdown has already made its mark on consumer confidence.
A Snapshot of the U.S.
The U.S. is not immune to the slowdown trend, but several economic tailwinds continue. According to Oxford Economics, real GDP growth is predicted to slow from 2.9 percent in 2018 to a still robust 2.5 percent in 2019, with increased downside risks related to trade and monetary policy decisions.
By the middle of this year, if the current pattern holds, the economic expansion in the U.S. will have lasted 13 years, the longest on record. So far, private consumption has been the engine behind the economy’s growth, aided by record low unemployment and wage growth in line with inflation.
All that said, various factors are making the U.S. economy increasingly fragile. Business investment and overall growth face challenges from trade protectionism and monetary policy, which are simultaneously increasing input costs and borrowing costs. In addition, U.S. housing data is beginning to look weaker, which is not much of a surprise given rising uncertainty, a lack of material wage inflation and a rising rate environment.
The Federal Reserve increased interest rates again in December 2018 to 2.5 percent, reflecting the Fed’s perception of ongoing strength within the domestic economy but quickly shifted to a more dovish tone by January. Although analysts expect the pace of tightening to slow, with no further hikes forecasted in 2019, the future is currently difficult to predict with monetary policy expected to be data dependent moving forward. Based on historical data, the flattening yield curve and tight treasury yield spreads could suggest a looming recession though the Fed balance sheet looks significantly different from past economic cycles.
The Corporate Sector
U.S. corporate insolvencies decreased a respectable 8 percent last year, but as business risks mount due to the recent rise in interest rates, significant levels of corporate debt and overall trade policy uncertainty, business failures are expected to decline by only 2 percent in 2019, according to the Economic Update published by Atradius in January.
A similar slowdown is expected elsewhere. Although 2018 brought a 3.6 percent decline in insolvencies in advanced markets in North America, Asia-Pacific and Europe, analysts at Atradius predict 2019 will likely see a more modest 1.7 percent decrease. In emerging markets, the picture is slightly worse, as global financial conditions become more volatile and some countries face unfavorable domestic policy situations.
One current area of concern the business sector faces is credit risk. Corporate balance sheets show significantly more leverage than they’ve had in previous economic cycles, with a large proportion of BBB-rated debt. As a result of the fiscal stimulus following the 2008 financial crisis, many companies took advantage of the easy (and cheap) access to financing in order to fund growth. However, heavily leveraged corporate balance sheets could now face meaningful refinancing risk in light of the significant interest burden coupled with expectations for earnings growth pressure.
Event risk also remains inescapable within the corporate sector. In worst case scenarios, event risk can drive insolvency situations as seen recently with both PG&E and Toys R Us. Event risk refers to a business facing material financial risk after a specific external event, such as when PG&E filed for bankruptcy after facing significant potential liabilities related to the California wildfires. In the case of Toys R Us, media coverage suggesting the toy retailer had hired well known restructuring advisors resulted in supplier fear leading to global supply chain issues and ultimately, insolvency. The lesson here is that anything can happen—whether it’s natural disasters, a fast-paced media controlling a company’s narrative, or sudden unexpected changes in trade relations that translate to disruptions in supply chains.
Areas of Opportunity
As early indications suggest slowing global economic growth in 2019 and the continued uncertainty surrounding trade policy are cause for concern, the need to know your customer increases in importance. Whether trading domestically or internationally, areas of opportunity exist and businesses across industry sectors reflect varying degrees of financial health and stability. No matter the economic cycle, businesses should take steps to mitigate risks. Trade credit insurance, for instance, protects company’s accounts receivables, providing peace of mind for continued growth and sustainable cash flow. It is always a smart idea to monitor corporate debt levels and the payment practices of trading partners in an effort to understand whether they have a balance sheet that can weather a slowdown.
David Culotta, CFA, is the senior manager of U.S. Buyer Underwriting for Atradius Trade Credit Insurance Inc. located in Hunt Valley, MD. In his role, David is responsible for providing strategic direction for the U.S. underwriting platform and for monitoring the development of the U.S. portfolio and adapting the risk management approach as necessary. David earned his MBA at Loyola University Maryland and is a CFA charterholder.