The Recession Chronicles Part III: Probability and Preparation

Have you been reading the financial news? Then you know all about the looming recession fears, and it’s depressing stuff. If last week started to settle your stomach, it’s time to break out the Dramamine. The Dow Jones fell by more than 1,100 points, with major retailers like Target and Walmart reporting a huge drop in earnings. European investors are getting anxious, too: the FTSE 100 is down 2% and the lowest-performing sectors are consumer goods and services, energy, and banks. A few days ago, Fed Chair Jerome Powell dramatically reversed course on his recession prediction, and his latest analysis is much less cheerful.

By now, a 3% swing in the Dow one way or the other has become my lunchtime starter course at least once a week as manic optimism contrasted with panic has been rippling through the 24-hr news cycle on frothing waves of Ukrainian conflict, NATO stress, Shanghai COVID-19, supply chain disruption, energy crises, global warming, and a grim new niche-filler in the pantheon of awful: we’re running out of baby formula.

Baby formula.

OK. Now that we’ve got that off our chests, let’s take a collective deep breath and get to work managing it. After all, you’re in business. Life does not stop and start at your convenience.

Revising Predictions: “If I Were Running a Big Company, I Would be Prepared”

The straight dope from the macrotrend gurus is coming in uncut these days, and it packs a powerful wallop. In early May the Fed raised rates by 50 basis points, which is the highest rate hike in nearly a quarter of a century. That didn’t even happen in 2008, and the hope is that the smoldering coals of inflation and demand will not burst into flames. However, it’s very difficult to find anyone who thinks they’re going to go out anytime soon. Bank of America and Deutsche Bank are all but consigned to a full-blown recession. Wells Fargo CEO Charlie Scharf conceded that, even if we manage to avoid a recession, there is “no question” we are headed for an economic downturn.

First, let’s look at the numbers. Morgan Stanley is currently slightly more optimistic than its peers, with analysts saying there is only (only!) a 27% chance of a recession in the next year, but they readily admit that there are several factors that could revise that number heavenward. Inflation is still sitting above 8% and it has been there since March, although it has dropped off 0.4%. The rate in the United Kingdom rose to 9% and the EU is projected to reach 6.8%. Core inflation however — inflation around goods that are generally less volatile than basic commodities — has done the opposite and gone up 0.6%.

If you’ve been wondering what’s behind increasing prices in rents and medical care, now you know. Moreover, it’s evidence that the inflation trend is being driven less by reactionary factors and more by broad, deep economic strata. Another factor that is transmuting uncertainty into generalized economic tectonics is the diffusion of stock and bond market volatility into commodities and currency. Commodities are still priced relatively high, and as the dollar continues to strengthen it’s putting pressure on importers and emerging markets which are leveraged in American currency. As the reverberations of these stresses emanate through credit and securities markets, we will likely see an increasing trend against risk.

The overall story being written by Morgan Stanley’s analysts — and this is the rosy picture, mind you — is that the best course of action is to find a cave, bury your head, and wait it out.

Another notable opinion came from Goldman Sachs Senior Chairman Lloyd Blankfein — a man who increasingly looks like Wall Street’s self-portrait under a sheet in the attic. A day after his company revised (in this case, revised = gutted) its prediction of US GDP growth from 2.6% to 2.4% this year, and from 2.2% to 1.6% in 2023, he stated in terse terms his company’s vision of a possible recession: “If I were running a big company, I would be very prepared for it.” Blankfein stopped short of saying it was inevitable, granting that Jerome Powell has some very big tools left in its box and it appears that the measures undertaken by the Fed have generated some encouraging signs that inflation and spending are cooling off.

However, the Goldman Sachs doge noted a reality in their report that every company should be thinking long and hard about: a slowing of growth is necessary for the economy to stabilize no matter how bad the crisis gets. That’s the one thing that is assuredly going to happen even in an ideal world. That means businesses had better start doing the things that businesses have always done to cope: reduce overhead, streamline processes, and automate to maximize productivity in the face of employee deficits.

Every business leader will be faced with tough choices in the coming months. Strategies like digital automation can be implemented with relative ease and are a foundational component of any successful business no matter what’s going on with the supply chain. It’s extremely important, if not absolutely essential, for businesses to take advantage of it now before choppy seas settle down into dead-calm economic stagnation for the foreseeable future.

On that note, let’s take a look at how we ended up with no baby formula.

Baby Food for Thought

The formula crisis seemed to tumble out of its crib before anyone even knew we were expecting. Personally, I’d nearly forgotten baby formula existed since it is such a for-granted and indispensable commodity. Now, it’s front page news. As a result, formula has become the premier example of how free market forces that are beyond everyone’s control manifest in volatile and unpredictable environments despite our best intentions for a staple that nourishes quite literally the most valuable thing we have.

In the United States, there are only three companies that make nearly all the formula: Mead Johnson, Abbott and Gerber. The reason there isn’t more competition is because the government program WIC (Special Supplemental Nutrition Program for Women, Infants, and Children) is the largest formula customer by far and that’s who they award their gigantic contracts to. Throw on top of that a host of tight FDA regulations that functionally ban formula imports from the rest of the world for things like label guidelines and a Trump-era renegotiation of NAFTA that makes importing Canadian formula prohibitively expensive, and you’ve got a government-driven bottleneck on free market production.

Cue the 2020 pandemic. As COVID-19 surged in the US, there was a massive run on baby formula. Toilet paper hoarding was definitely annoying and unnecessary, but stockpiling baby formula is understandable given the consequences if you run out. This huge crest in demand led to a trough in supply, so manufacturers did what anyone would do and started churning it out like there was no tomorrow. Frankly, at that time, nobody was sure about tomorrow anyway, so it made sense. However, what they failed to realize was that nobody needed baby formula anymore — because they had stockpiled it. So, it sat on the shelves getting dusty.

In 2021, producers cut production because there wasn’t demand for what they had already made. As supplies withered, a tsunami of demand came roaring in 2022 as everyone burned through what was in their pantry. Toss into that mix a recall for a bacterial contamination at Abbott’s Michigan factory, and here we are in May and Tennessee and Texas stores are understocked by as much as 50%.

Now, people say things like “hindsight is 20/20” for convenience, but I’ve always thought that is a gross miscalculation. Hindsight is much, much better than our mediocre ocular prowess at its best. If the baby formula industry had foreseen what now seems obvious, the problem would have been easily avoided. But that’s simply not the nature of the business world. None of those companies could project how to deal with this novel and massive demand increase, and they didn’t have cameras in every kitchen to see how much people had left. All they knew for sure in 2020 is that formula was flying off the shelves and they needed to make more quickly to keep up.

The formula debacle is just one of many examples on a list that’s as long as the history of business. There were also runs on hand sanitizer and masks that resulted in the same problems in 2020. There was a run on gas after 9/11. If you want to go nuts, Diocletian’s Edicts on Maximum Prices from 301 CE was an attempt to deal with inflation and gouging of both prices and people over the relative values of available coins in the Roman Empire. Yes, you read that right: 2,000 years ago inflation was already a problem.

Prepare Like There’s No (Knowing) Tomorrow

Those bottles of formula that started this mess are long gone, the children who drank it are already walking and talking, and these days most people I know can barely remember what was going on in the world last week. The moral of the story is this: business owners will do well to heed the advice of Lloyd Blankfein and start preparing now. For what? For anything. We’re all hoping, strategizing, and crunching the numbers, but every day we’re revising our forecasts because the truth is, none of us really know what’s going to land on tomorrow’s headlines. The best we can do is optimize and automate so that when those papers roll off the press we have the ballast to ride out the waves.