Five Systematic Risk Factors Facing Small Business in 2021
In 2020, a once-in-a-century pandemic mixed with material political instability created the most volatile economic conditions ever recorded in the United States – from an unprecedented 31.4% collapse in GDP in the second quarter to a 33.4% increase in the third quarter. This year, analysts are predicting substantial growth as the US economic recovery continues; however, there are plenty of reasons for entrepreneurs and managers to be nervous. In this note, we explore five systematic – or market – risk factors which we think are particularly noteworthy as we head into the second quarter:
(Ongoing) Pandemic risk
Looming Concerns: Five Systematic Risk Factors Threatening the Economic Recovery
(Ongoing) Pandemic Risk: While rising vaccination rates seem to have the US on the backside of the COVID-19 pandemic, the spread of new variants threatens to unleash a fourth surge in the coming weeks – replete with tightening and/or extended restrictions in select states and municipalities. Further, as it will likely take many months – if not years – to fully vaccinate the populations of many poorly developed countries, the unfortunate reality is that COVID-19 will continue to disrupt global supply and distribution chains for a long time to come.
InflationRisk: Across-the-board, prices have substantially increased since the beginning of the economic recovery. With experts predicting GDP growth as high as 8% this year, inflation is becoming a legitimate concern in the US for the first time in years. The Federal Reserve appears committed to keeping interest rates low for the foreseeable future; however, a material increase in the rate of inflation will likely force a contractionary monetary response – which could easily bring about a fresh recession.
Political Risk: Domestic political risk remains unusually elevated in the US, though the tension appears to have eased somewhat since January. Historically, the stock market has remained largely unmoved by civil unrest; however, the effects of such disturbances on the real economy are often potent and long lasting. Internationally, the US remains locked in a trade war with China – its largest foreign supplier of goods. Beyond China, geopolitical risk as a whole remains elevated – from the strained relations between the US and Russia, Iran, and North Korea to cyberwarfare, immigration, and the climate, just to name a few of the most obvious.
Currency Risk: The US dollar has declined in value relative to most major currencies over the last year – most notably relative to the RMB. The value of the RMB is carefully managed by the People’s Bank of China to protect Chinese exporters; however, it has appreciated relative to the USD by roughly 10% in the past twelve months – mostly due to the damage wrought by COVID-19 on the US economy. The effect of this shift is to raise the prices of Chinese-made goods which dominate many consumer categories in the US.
Price risk: Market participants in the US seem to be taking unusual risks – with prices moving ever higher across most asset classes: stocks, bonds, real estate, and alternatives. Many are trying to capitalize on low interest rates and a booming residential real estate market while others are exploring more abstract speculative opportunities in the areas of contingent claims, cryptocurrencies, and NFTs. In recent months, unprecedented absurdities have gripped equities markets. Of particular note is the rather audacious group of retail investors who allegedly conspired to execute a short squeeze on GameStop – contributing to historic deviations between market and intrinsic values which remain ongoing.
How to Protect Your Business
Some businesses are more sensitive to these and other risk factors relative to others; however, there are quite a few common-sense steps that you can take to protect yourself and your business from harm:
Keep your cost structure in check
Decrease leverage (debt) levels
Prioritize cash flow
Keep an eye on current events
Maintain cash reserves
As a whole, 2021 shows quite a bit of promise; however, there are a number of legitimate reasons for entrepreneurs and managers to be concerned enough to actively de-risk – at least, to some extent.