Q&A … With Stephen Penn

Q: Lots of talk about a recession coming or, as a technical matter, already here. Can you give us something of an overall view of current economic conditions and how your clients are responding to them?
A: There is a consensus that we are in a recession, or if we’re not already in one, we’re on the cusp of one. There is also a consensus that we aren’t set up for a really deep recession, although the risk has moved to the downside. On the continuum, businesses increasingly think the risk of a deeper recession is growing. But I actually think there is less concern about the recession than inflation, though the two go hand in hand. There is more concern about getting inflation under control and trying to keep it from becoming “sticky.” There seems to be a belief, or maybe just an acceptance, that a mild recession may be the necessary cure. It feels like most business folks are increasingly accepting that’s what it will take.

Q: A big part driving inflation over the past year has involved the supply chain, and we’re seeing some metrics suggesting that the bottleneck may be easing. Your take?
A: Yes, we are seeing shipping and warehousing much cooler than a year ago.

Q: When you look ahead to 2023, what fundamentals have your attention?
A: We generally hear from businesses that they are focused on labor—or, actually, the lack of labor. The labor market is still tight, and that’s been an issue. While we are beginning to see some better economic numbers, the strong labor market persists. Businesses are also starting to think about liquidity, though there’s not a specific concern. Rather, there’s an awareness that when these cycles happen, sometimes they are exaggerated by liquidity issues. I think people are in a better spot now than last time (2007-09), but prudent companies are always getting cash when they can, not when they need it.

Q: What’s your take on office real estate’s recovery, and how has that played out for KPMG in the post-COVID era, if we’re not jumping the gun with that term?
A: Commercial real estate is moderating, but it’s still unsettled and it’s lumpy. It certainly has not returned to pre-pandemic levels and is somewhat random. Most companies are still figuring out what their commercial footprints are going to look like. For us, we are using space differently and using our space in more collaborative ways. Our office footprints are generally the same as before, but as leases renew, that space may shrink somewhat. But we are using office space differently; when our people are in the office, it’s more intentional. We’re increasingly utilizing a hybrid model; folks are generally either in the office or at our client sites for part of the week and remotely working the rest of the week.  We recognize the importance of coming together to collaborate and learn, all while balancing flexibility. I suspect some version of hybrid is here to stay.

Q: We’ve talked with business owners who feel that the economy’s excess cash, driver of inflation, has been wrung out, especially with manufacturing. We also hear that there’s too much cash still floating around. Your assessment?
A: There is still excess cash out there. The issue is where the excess cash is. The excess that existed at lower-income levels, the lower wage earners, has largely worked through the system.  

Q: So what’s left?
A: The excess that remains is mostly in the hands of higher-wage earners. We’re also seeing higher credit-card usage, higher balances, and similar trends, which may be more indicative of financial stress than higher consumer demand. The excess savings of lower-end wage earners are generally gone.   

Q: Is there a lesson in that for those who might one day propose further stimulus spending?
A: I think we have a lot of lessons to learn around stimulus spending and government policies enacted to get the economy going, with a notion of getting the grease back in the economy to induce spending without a thoughtful recognition of the potential hazards.

Q: Are you optimistic that the Fed has adopted the right strategy in terms of timing and scope of interest-rate adjustments? To borrow from the Goldilocks model, has it left things too hot, too cold, or just right?
A: The task is bigger than it is normally; it is unprecedented. Whether they started too late, are going too far, or need to do more is up for debate. What we do know is that the Fed’s actions are so different from normal because they’re dealing with a problem that is so different from normal.

Q: What are the most frequent questions you’re getting from business owners about how they need to position themselves in the event of a full-on recession? Is there a sense of hunkering down, or is there a greater sense that we could be looking at a rare opportunity to build market share with the right strategic moves?
A: I think there’s cautious optimism there. There’s still some interest in acquisitive activities. Certainly, the IPO and those markets are basically non-existent, but companies are still taking advantage of opportunities. They are being strategic in their thinking about how they are positioning themselves. Not all companies are hunkering down to ride out the storm; many are being strategic, albeit cautious.

Q: Are individual investors’ concerns fundamentally different from those of business? That is, are they behaving more cautiously?
A: People are just being more selective. They’re also cautiously optimistic, trying to take advantage of some strategic opportunities. It’s interesting; I have heard several folks in the last few weeks talking about how much of their personal wealth is sitting in cash, waiting until they feel like things have sort of hit bottom. But for the right opportunities, there is still interest and demand. To that earlier point around trip wires, whether it’s geopolitical risks, events in the UK, or some other unforeseen event in the U.S., there’s a risk that some market or liquidity event prevents the Fed from executing, which creates a mini-crisis. If concern is the right word, it’s a concern of what you don’t yet know about.

Q: Back to business moves for a moment—what guidance are your folks giving corporate clients regarding more effective debt management as interest rates continue to rise?
A: Companies have already adjusted and are generally making different moves. Many of the debt structures they considered a year ago are off the table now. They are more focused on servicing the debt they have. They’re just not positioning themselves the way they were a year ago.  

Q: What factors are driving decisions?
A: Some of what we saw previously was refinancing transactions, repositioning to take advantage of rates before they went up, and some didn’t get it done in time. Some transactions were contemplated around acquisition activities, and rates may have impacted those. We’re certainly seeing that on the personal side; the changes in rates within the housing market have really brought that out. Our view is that—nationally—housing is already in a recession. That has a big impact on everything else, given how much of our economy is tied to home ownership. When people are getting new homes, they’re also getting new appliances; they’re remodeling—the follow-on spends from home purchases or refinances, when you take that capital out, it rolls over. There’s a multiplier effect. While the remodeling demand has persisted somewhat, the overall pressure on the housing market clearly is helping to cool things down.

Q: The voting is done, even if the vote counting continues. In your view, will the resolution of the 2022 federal elections bring any stability to business considerations? If Congress, for example, is divided between the parties, can business leaders anticipate a fairly stable policy environment for the next couple of years?
A: Well, if that holds up (GOP control of the House), Kevin McCarthy will have a heck of a lot harder time than Nancy Pelosi did as speaker; whatever your views of Pelosi, she was able to herd cats pretty well. Historically speaking, though, business has favored gridlock. There are some impacts to that. If the Democrats held on somehow, held the House, and increased their numbers in the Senate, there could have been some chance of resurrecting Build Back Better or another stimulus, but I think now, that’s going to be difficult, if not completely off the table. 

Q: What else might you anticipate?
A: There are several provisions within the 2017 tax cuts that are going to sunset. A divided Congress is going to make extending those difficult. Any changes in corporate rates and some of the things Democrats had been talking about are not likely now. A more challenging (and near-term) issue may be coming to an agreement to fund the government between now and the end of the year with a lame-duck session and razor-thin margins in Congress.

Q: Do all of these disconnected elements affect the business landscape? Is the task of getting the economy back on track more challenging in this environment?
A: It’s a challenge, but it’s manageable. The risk is that we can’t get inflation under control or some sort of liquidity or market event happens that prevents the Fed from getting inflation in check, and it persists longer at these levels. If we go through a mild recession and it has the effect of getting inflation in check, I feel it will be manageable.  

Q: Anything else about a potential downturn this time that might deviate from past experiences in the cycle?
A: Downturns vary by what causes them. Housing in 2008 was different. In the current cycle, the rise in inflation and the downturn have been caused in large part by the tight labor market, along with the issue of labor productivity. Add to that immigration policy and those related pieces of the puzzle, along with our aging demographics and all of what goes along with it, and we have a lot of challenges to solve. It’s not going to be easy.

Q: How much of a downturn are economic fundamentals, and how much is the result of, for want of a better term, talking ourselves into a recession?
A: I don’t know what President Esther George at the Fed would say, but I have always believed there’s an element of self-fulfilling prophecy with downturns and talking ourselves into a recession. I don’t know how much of that applies now; this recession is different, impacted by labor shortages, and was, as you know, exaggerated by the pandemic. That said, if we can talk ourselves into one, then why can’t we also talk ourselves back on track?