Crisis Act Two: Navigating a Period of Asymmetric Risk

Risk, Reality and Reward: A Navigation Playbook

“In economic life and history more generally, just about everything of consequence comes from Black Swans.”
– Nassim Taleb

Since the initial shock of the COVID pandemic, often characterized as a Black Swan event, business leaders have been challenged by a relentless series of downstream repercussions and surprising upsets that have made a return to normal seem out of reach. In just the past year we have endured blocked canals in the Middle East, sawmill shortages in North America, 100-year freezes in Texas, overloaded ports, throttled pipelines, labor shortages and skyrocketing transportation and energy commodity prices. These events, in combination, have brought both producer and consumer price indexes to levels not seen in 30 years.

There is a natural human tendency to treat these events as independent occurrences that have predictable linear outcomes. These expected outcomes can then be addressed with management attention, price increases, safety stock, new capacity/debottlenecking and, well, better luck.

The inherent risk of this taxonomy has been revealed during this recent procession of Black Swans. What if the events are not independent and random but are linked with compounding and second-order effects? What if consumer demand collapses with higher prices? What if new supply cannot keep up? The Fed and debt markets project receding inflation rates over the next two years. What if they are wrong?

We believe that the risk of persistent inflation has been vastly understated. This paper is the first of a series to present our view on what private equity owners and portfolio company management can, and should, do to prepare.

Why Should PE Investors Be Concerned?

The peak economic impact of COVID on global GDP was estimated at 7.3 percentage points of lost growth by the St. Louis Fed. As the gaps with 2019 closed, public market valuations have been buoyed by the economic resurgence coupled with unprecedented liquidity. Due to the enormous liquidity, there is substantial risk that has not been priced into the market.

READ THE FULL PAPER HERE

READ MORE FROM THIS SERIES:

• Preparing Organizations in the Midst of a Storm
• Black Swan Siblings: How Should Private Equity Investors in Manufacturing Companies Respond?