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Several American companies are again readying their recession playbooks as rapid inflation and geopolitical factors raise the risk of another economic downturn.
The Conference Board’s measure of CEO “confidence” showed a sharp decline in optimism over the economic outlook in the second quarter of 2022, falling to levels not seen since the beginning of the pandemic.
Executives across industries have painted bleak pictures on future earnings. In the market for tools, Stanley Black & Decker (SWK) said on May 26 it is doing “scenario planning” to evaluate the impact of a 5 to 10% drop in volume. In the gaming space, Take-Two Interactive (TTWO) warned on May 16 that “the entertainment business will be affected by an overall economic slowdown.”
The culprits behind this gloomy sentiment? It’s all macroeconomic: COVID-related shutdowns in China, disruptions linked to the Russian invasion of Ukraine, and the contraction in easy-money policies from the Federal Reserve.
This current cocktail of macroeconomic concerns has pushed companies to lower guidance, and investors have responded by dumping stocks.
For investors, the concern isn't just how profitable a company is in the current quarter, but how profitable they will be in the future.
So: how do these factors specifically affect the business outlook?
Companies with a large presence in overseas markets saw a massive disruption from the Russian invasion of Ukraine. A war in eastern Europe not only disrupted the supply chain for metals and grains, but raised the price of oil and gas as well. In China, a zero-COVID policy led to shutdowns across large portions of the world’s second largest economy.
Cosmetics company e.l.f. Beauty (ELF) and speaker manufacturer Sonos (SONO) are among the many companies with portions of their supply chains in China, and cited the shutdowns as a major challenge in their recent quarterly results. Both geopolitical issues have also broadly raised materials and shipping costs, which increases expenses for companies.
Uncertainty over the timing of a resolution in eastern Europe or new surges in COVID have pushed companies to lower their forecasts regarding margins for the quarters ahead.
“Our outlook assumes an estimated impact of approximately $500 million relating to Russia and China COVID lockdowns,” chip designer Nvidia said on its earnings call held May 25. The company reported $8.3 billion in revenue in the first quarter of the year.
Inflation remains the big story for the U.S. economic outlook, with prices increasing at paces unseen since the 1980s.
The concern for corporates is that inflation will erode the purchasing power of U.S. consumers if it outpaces wage increases for an extended period of time, potentially cutting off spending growth and economic activity.
For now, Americans continue to spend at high levels, which has in part enabled companies to juice earnings through the pandemic recovery.
But the Federal Reserve, the steward of the U.S. economy, has made it clear it needs to ratchet borrowing costs higher to quell the demand. The Fed began raising rates earlier in the year — which lifted mortgage rates and other borrowing rates — and has made it clear that further increases will be coming.
This new rate environment could end the current period of high margins, and the severity of any margin contraction will depend on how well the Fed can manage a so-called "soft landing," or slow the economy without triggering a recession.
Fed Chairman Jay Powell said May 4 that “we have a good chance to have a soft or softish landing.”
Companies certainly hope so as well.
"We have lived through some really tough times," industrial supplies company DXP Enterprises (DXPE) said on May 10. "And we all hope that our Federal Reserve gets this right in balancing [a] soft landing."