Markets Swoon And Risk Looms For Firms’ Cross-Border Commerce
PYMNTS.com
October 18, 2018
Whiplash: The stock market — or markets, be it Dow Jones Industrial Average, Standard & Poor’s 500 Index or tech-heavy Nasdaq — is in freefall one day, skyrocketing the next.
At this writing, stocks ended Wednesday (Oct. 17) with what seems to be the one constant: volatility. They finished down slightly after gapping lower in intraday trading, especially as measured against last week, when marquee tech names plummeted single-digit percentage points on several days. The question remains: How confident are investors, and what might be the ripple effects of the stock market gyrations?
Blame rates, in part, and blame a trade war for the seismic activity, and for what may be a re-examination of the companies that are tied to those same stock prices. Rising rates and trade wars mean the cost of doing business gets, well, costlier for firms of all sizes across all manner of verticals, especially for those that depend on cross-border transactions.
In an interview with PYMNTS’ Karen Webster, Chief Market Strategist Karl Schamotta at Cambridge Global Payments said the impact to these international players comes as the era of easy money — the kind used to fuel growth efforts or get newer firms off the ground — dims.
“I suspect what has happened over the last week and a half is that investors around the world have sort of woken up and said ‘OK, well, wait a second. A large segment of the corporate population is [dependent] on cheap money that they’re getting from financial markets. As that source of cheap money goes away, or the cost rises, some of these business models could be under stress,’” he told PYMNTS.
Interest In Interest Rates, Trading On Trade Wars
It’s no secret that rates have been on the rise. The latest boost to the federal fund rate, which is the amount that is levied on banks as they lend money to one another, came at the end of last month. The Federal Reserve boosted that percentage to 2.25 percent, up 25 basis points. It should be noted that borrowing costs are coming off historic lows, but will, of course, be felt along top and bottom lines if (or maybe when) consumers and investors pull back.
At the same time, the trade war between the United States and China has been heating up. Tariffs make cross-border commerce more expensive. As the dollar rises (in tandem with rising rates), export activity grows in cost, and FX volatility becomes a factor of daily corporate life. (It can be noted, too, that the International Monetary Fund [IMF] recently shaved several basis points off its global growth forecast.)
Schamotta said that both the knee-jerk reaction of trading in the stock markets and the plummeting equities seen over the last several sessions have lowered the odds of there being, what he termed, “a rapid increase” in interest rates, at least through 2019 — or that there will be three or more rate hikes in the offing. That’s because the Fed is wary of boosting rates so quickly that economic growth stalls. It’s the famous “punch bowl” argument, that rates should get a boost only at the peak of economic activity. Determining, though, just where the peak is, or has been, is a bit of an art.
The Business Impact
The impact to businesses and supply chains is being felt, however, regardless of the rate hikes’ timing.
“You’ve got a more dangerous operating environment for American companies than we have seen in a very long time,” Schamotta said. “You are looking at a situation where your access to cash is beginning to diminish.”
It is less easy to go out into the market and borrow funds or issue shares, he said — or, with inexorably rising rates, get a good return on those corporate actions.
“The other issue when we see a sell-off like this is … a repricing of [Treasury bills (T-bills)]. Then, there is volatility in the FX markets,” he stated. The pool of capital that may begin to dry up is one in which both large public companies and any number of small private companies have been swimming.
Schamotta continued, “There is still a lot of money available; there is an ocean of capital in the markets. But investors are demanding higher rates of return over time,” so this means lower rates of return on the capital that is deployed. Firms have to be more strategic on how they deploy what they do, why they borrow and how they invest, he told Webster, especially internationally.
“When you have to make payments in the future, you are exposed to downside risks in the event that those payments become more expensive in exchange-rate adjusted terms,” he said. The American firm that is dependent on exporting into global markets must reckon with the possibility of revenue flow getting crushed as the dollar rises.
When asked to weigh in on the trade war outcomes, Schamotta stated that officials on both the China and U.S. sides are aware of a “mutually assured destruction” scenario that could be disastrous for economic growth. He added that both administrations have the incentive to compromise and reach agreements that would support both the Chinese and U.S. economies.
“To some extent, there is a lot of fear out there that may, ultimately, be misplaced … I would bet that trade continues to grow quite robustly,” he told Webster.
Fighting Fires, Small Or Large
On a large scale, though, the volatility may have some far-reaching positive effects, noted Schamotta, in terms of clearing away dead wood. Looking at the financial system in general, the stock markets in particular and the era of easy money, “we have not had big forest fires and have not had things really burn down. A lot of the rational behavior that we need to see is absent at this point,” he said, as money has been shoveled out to firms with little regard to risk.
As a result, verticals can become crowded and inefficient. For example, he cited restaurants. Consider the fact that, as he said, “if you have an innovative chain restaurant concept, you can go out and get billions of dollars in venture capital or money directly from the markets. You can go out there, run a chain of restaurants that doesn’t actually make money and compete against restaurants that have been running on a sustainable basis for decades.”
Those older players can go out of business under the sheer weight of the plethora of less-than-established business models — well-funded, but untested. As always, though, those upstarts that promise to change the way commerce is done can get crushed, too. (Remember Pets.com and Webvan?)
Once the economic cycle turns, the result is a hollowed-out competitive landscape — if left unchecked or left irrational.
Here, then, is a silver lining: “The cost of capital rising,” he said, “should help rationalize some of that behavior.”
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