Threats to Global Growth & How Investors should Position | Barita Insights | February 14, 2022

Analyst Insight

Threats To Global Growth & How Investors Should Position
At the start of 2020, the world as we knew it, pivoted into an unknown, with ever-changing variables. Over time, these variables have shifted how investors maneuver the markets, their understanding of the role of fundamentals in the valuing of securities, as well as the need to explore investments outside the realms of traditional investing. As investors search for opportunities to maximize returns within the new norms, there exists several underlying risks to global macroeconomic stability that inherently hinder growth acceleration within the global economy. The nature of these risks includes geopolitical risk, inflationary risk, interest rate risk, and supply chain risk, to name the most prominent ones faced at the moment. All these risk factors compound to create an environment that has the potential to drive significant downside for investors who are not able to carefully mitigate these risks. In this article, we delve into the most topical issues that fall within these stated risk buckets.

Geopolitical Risks
The situation developing in Eastern Europe between Russia and Ukraine seems to be escalating quickly, with Russian troops at the Ukraine border now reaching 130,000. The US has stated that they have strong intelligence indicating that they expect a Russian attack on Ukraine before the end of the winter Olympics; which is slated to end February 20,2022. This poses a significant threat to the global economy and capital markets, as the uncertainty surrounding stability in Europe negatively affects capital market developments and ultimately affects the deployment of capital by investors. Russia is the third-largest oil producer globally and if the country is actively engaged in combat, this may reduce its ability to maintain oil production which may result in the global supply of oil being lowered. This scenario would result in higher oil prices which may lead to further inflationary pressures as oil is a major commodity used in many facets of life. A reduction in output by Russia could lead to increased fuel prices in Jamaica. Petrojam currently uses the US Gulf Coast as a reference point. Lower overall global output could result in the Jamaican consumer experiencing even higher fuel costs. With oil and gas being a major constituent of many production processes this could result in increased costs being associated to other products as manufacturers may not be able to absorb all these costs.

Supply Chain Risks
With the onset of the pandemic, the world has been suffering from supply chain disruptions and dislocation which have been crippling several retail and manufacturing companies. This has been brought about as a result of shorter working hours due to lockdown restrictions, lower productivity due to sickouts from the virus, and the shortage of raw materials that are needed for several manufacturing processes. The disruptions in the global supply chain network has resulted in the Jamaican consumer having to spend more for goods and products, as companies pass increased costs onto customers. In many cases, while costs have been passed onto consumers, some costs have been absorbed by companies, resulting in lower margins as compared to the pre-pandemic era. Richard Pandohie, CEO of Seprod, and former President of the JMEA, has stated that the new operating paradigm that we operate in now consists of delayed lead times, increased shipping costs and increased fuel prices. All these realities have resulted in companies reporting lower gross margins. The reduction in gross margins has the ability to erode shareholders’ value as this ultimately results in reduced profitability; thus lower returns for shareholders.

Inflation and Interest Rate Risk
As commodity prices and production costs increase, manufacturers and retailers have had to pass on these costs to their customers which, when coupled with supply chain issues, has been a major driver of heightened inflation. To combat these inflationary pressures, central banks have taken a hawkish stance; marked by raising rates and reducing liquidity to combat the rising inflation. These rate increases may result in the cost of capital via debt and even equity, increasing, and as such may hamper the growth and expansionary prospects of companies as well as increase their interest expense, as the cost of loans or credit facilities become greater and as such, presents the potential for earnings erosion. Taken together, these can ultimately reduce companies’ profitability and ultimately decrease shareholder value.

Conclusion
As investors navigate the new paradigm, it’s prudent to analyze the degree of exposure that their underlying assets have to these risk buckets and as such, limit this exposure across the various risk areas identified. When selecting investment opportunities, investors should target companies based on their exposure to geopolitical influences and ability to sufficiently navigate these. More specific to the current challenges, focus must be given to those companies’ ability to mitigate supply chain disruptions, how leveraged the companies are and how significantly interest rate increases would affect their earnings. Typically, companies best positioned to mitigate increasingly challenging times such as these, are those with strong balance sheets that are also well positioned in their respective industries.