The 'Recession' From a Trade Creditor Economist's Perspective
In comes a big order from a regular customer that Sales has been chasing for months. But this customer took a terrible beating in 2020 and is still fighting its way back. And now they're looking for extended terms. What to do? We asked Chris Kuehl, Managing Director of Armada Corporate Intelligence and widely acknowledged as the dean of trade credit economics.
Credit Today: What are the economic fundamentals underlying the current market situation?
Chris Kuehl: We're coming off an eight-year aberration. Interest rates have gone up but they're still very low compared to where they used to be. We're so used to having them at zero that this feels awful. It's 2.25%, which before 2008 would have been considered rock bottom. Credit managers in general called that recession, and they could see it coming from a mile away. They knew it was going to be rugged because it was affecting the bank's credit and it took forever to come out of it.
The one that we seem to be in now is a lot more traditional, and it's probably going to be a lot more temporary because it's really being driven by inflation. But this is non-traditional inflation coming from artificial energy and supply chain crises.
These are both very real, but they're not predictable.
Already today, the Europeans are starting to back off those sanctions. They're saying, “Okay, this isn't working. You're not leaving Ukraine.” Meanwhile, we are seeing unbelievably high energy prices, and winter is approaching so maybe we don't want sanctions anymore--which is what Russia has been counting on. And, if they do indeed back off the sanctions, the per barrel price of oil drops $60. All of a sudden it's “What energy crisis?”
So, the oil sector doesn't know what to do. The supply chain mess is because China still thinks it can test 1,400,000,000 people every day. At some point, they're going to realize that's not possible. “We need to get those tens of thousands of shipping containers moving.” And they can't. They are growing at .04 which for China is disastrous.
CT: So, what is the credit manager supposed to do under these circumstances?
Kuehl: What I have been telling people is that you have to have two strategies in mind at the same time. One that is very protective. The other is preparing to open up in a hurry when things change. You have to be focused particularly on who you're going to be doing sales with. The sales department will suddenly get a lot of activity. They're going to be telling you, “We've been waiting for a year and a half for this. These people want to buy now.”
You're thinking, “You haven't even talked to me for a year. Now, all of a sudden, you want approval, and I don't even know whom I'm dealing with.”
It's like waiting for the flood gates to open.
CT: What about rising interest rates and rumors of recession?
Kuehl: I don't think interest rates are going to get crazy. They are talking 3 to 3.5 percent. That's high compared to what it used to be, but not ridiculous.
Some signals of a recession that everyone was getting excited about—the two consecutive quarters of lower GDP—are misleading. What people are forgetting is that they are looking at 28 variables involved in predicting a recession, and most of those are still positive. Sure, GDP has fallen, but that's mostly because the dollar has been so strong.
That's the challenge with the sound-bite media now. There's lots of detail that never get expressed, and, for credit managers, it's all about details.”
CT: How do you analyze risk in this situation?
Kuehl: You need to get reliable information quickly. It's a lot easier with domestic accounts than with international. But it's a serious challenge because we still tend to look at an account like we did in 2008, and so many were wounded in 2020. But many have come back. Their financials still look bad, so you're stuck with having to wade through that. You have to consider how much of this is because everyone got creamed in 2020. And you have to determine how much of it is that is because the customer company specifically is in trouble--or not in trouble--and what is happening with the industry.
You're stuck with trying to understand how the different industries are behaving right now, for instance… automotive is growing again very quickly, but aerospace is not.
You have to be very attuned to the industry you're operating in and make sure that you have the most accurate data you can get about the company requesting credit. It's the old dilemma: “We have to do this to get back on track. Yeah, but it's not a sale until we get paid.” We don't want to approve all of them when there is still so much uncertainty.
CT: So, what you're really trying to calculate is the future activity?
Kuehl: I've been advising credit managers to sort of ignore what is going on this year and to focus on the first and second quarters of 2023. Our research is showing a rebound in the second quarter on the industrial side. Unless we get another unexpected black owl, we're probably going through the worst of this now. Recovery won't be rocket speed, but it will be more stabilizing.
I advise looking two or three quarters ahead for long-term decisions. In the short term, just engage in credit management caution: “We're not going to give you 120 days. How about 30?”
This is less dangerous than in 2008 because there is no credit crunch. This isn't being fed by banks that have lost their minds. It's commodities based. But it's a similar experience to 2008 when everything went south in a hurry, and no one was sure when it would settle down. Credit managers were faced with all of the data telling them to hunker down and be ultra-cautious, and their companies were telling them they could not afford to be ultra-cautious: “We still have to do these deals!”
CT: What would the scenario be if sanctions are dropped?
Kuehl: The first thing that would happen is that oil prices would drop dramatically, even though it would take weeks if not months for the production to make it to market. Initially, it would mean very cheap oil, but the next thing would be that the marginal producers who were trying to make up for the lack of Russian oil, would be forced out. So, the pattern would go from a flood of oil creating a glut, to chasing out some of the new producers.
Assuming that the sanctions would begin to move in the next month or two, producing really cheap oil prices for a few months, then prices would begin to creep back up to the $80 or $90 level by mid-2023. The industry is still trying to figure out how serious people are about EVs.
With the drop in oil prices, would come a sharp increase in purchasing globally because, along with oil, a lot of other commodity prices would drop. Gas and food would react the same way. The timing is good because farmers in U.S. and Canada will be harvesting soon. From a credit management perspective, customers' success is closely connected to these commodity prices.
We work with rail and trucking companies, and demand is huge. But the cost has been a problem because of the price of diesel. If diesel comes down while demand is still up, those companies are going to do very well. They'll come back to the credit manager saying they need to buy 10 more trucks, and you say, “Okay, I think I can go there.”
You couldn't have done that two or three months ago. You'd be willing to take more risks. But it wouldn't be instantaneous. It would take a while before things settled down. The prices would change, but there would still be issues with the refineries. What it comes down to is that you want to make the deal, but can you go out to 120 to 189 days that some people want?
As with most decisions, 90 percent are made by algorithms. It's the 10 percent where you earn your money.
Orders you turn down could be scooped up by someone else. Because of the shortage of truck capacity, there were 14 loads for every truck on the road. Some 68,000 trucking companies came into existence in the past two years. Most of those will go out. They were one- or two-truck operations, never intending to be there for long.
But some truck dealers decided that under the current environment they would go in and finance these guys. “We know they are not in it for the long term, but they'll make enough money over the next couple of years to pay off the truck. It's good enough for us.”
Contact Information:
Phone: 816-394-3917
Email: chris.kuehl@armadaci.com
LinkedIn: https://www.linkedin.com/in/chris-kuehl-61449b
Chris Kuehl - Managing Director
Armada CI
4015 N. 110th St.
Kansas City, Kansas 66109
(816)304-3017
