Scenario planning key amid volatility

The Four Horsemen of the Apocalypse have begun to canter since August, when I highlighted the likely crisis ahead (‘Prepare for the coming crisis’, ICB, 5-11 August).  Companies and investors clearly face a very difficult autumn and winter with the global economy now facing a major downturn, as I note in my latest analysis for ICIS Chemical Business.

Scenario planning, based on a wide range of potential outcomes, has therefore become mission-critical given today’s levels of volatility. We can no longer simply tweak a base case to reflect whether we are feeling marginally more optimistic or pessimistic.

The problems began with the supply chain crisis caused by the pandemic. Russia’s war in Ukraine then created a further challenge. And by weaponising natural gas supplies, food prices began to rise as fertiliser costs became unaffordable and the IMF warned of famine. In turn, inflation has now moved back to levels last seen in the 1980s, and caused central banks to start to lose control of global interest rates. Almost inevitably, therefore, housing, auto and electronics markets are starting to take major hits as consumers are forced to cut back sharply.

Survival is obviously the main concern for most companies at this point.  The key need is to focus on the major risks, and move forward quickly with a plan to mitigate them.  Essentially, there seem to be 5 major areas for focus:

  • High and volatile pricing environment for energy, food and other products
  • Interest rates continue rising alongside rising inflation and US$ strength
  • Stock and housing market downturn reduces consumer spending power
  • Corporate earnings start to reduce down the value chain and debt risks rise
  • Plastics industry hit by over-capacity and growing environmental pressure

Each of these would be a major challenge on their own. Together, they clearly create the worst crisis that any of us have faced in the post-War period. But it is also important not to panic. We will come through these challenges, just as our predecessors came through even greater challenges including world wars and depressions. But our planning has to reflect the critical need to expect the unexpected. Essentially this means identifying the likely potential scenarios ahead and the tail risks they create. We can then start to identify in advance how we should respond if/when they start to occur.

Russia’s invasion is a major wake-up call about the danger of assuming business will always be “as usual”. The window for investing in future growth is starting to close. As Hemingway warned in “Fiesta”, major changes (such as Net Zero) occur “gradually, then suddenly”.

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