How to take stock of Corporate America’s ‘Risk Factors’
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A version of this post was originally published on TKer.co.
Publicly traded companies provide lengthy lists of “Risk Factors” that affect their businesses in their 10-Q and 10-K filings, the quarterly and annual financial reports publicly traded companies are required to file with the SEC. (You should check these out. They can be very interesting.)
Over my career, I’ve thumbed through hundreds (if not thousands) of these. While these risks aren’t listed in any particular order, companies tend to lead with risks that are intuitively most impactful to their business operations. Here’s a sampling of the first risk identified by some big companies:
“The Company’s operations and performance depend significantly on global and regional economic conditions and adverse economic conditions can materially adversely affect the Company’s business, results of operations and financial condition.“ - Apple
“We Face Intense Competition.” - Amazon.com
“We are subject to complex and evolving global regulations that could harm our business and financial results.“ - Visa
“Economic conditions.” - Exxon Mobil
“The Company’s businesses operate in highly competitive product markets and competitive pressures could adversely affect the Company’s earnings.“ - Johnson & Johnson
“Failure to successfully execute our omni-channel strategy and the cost of our investments in eCommerce and technology may materially adversely affect our market position, net sales and financial performance.“ - Walmart
“Unfavorable general economic and geopolitical conditions could negatively impact our financial results.“ - Coca-Cola
“If we fail to estimate, price for and manage our medical costs or set benefit designs in an effective manner, the profitability of our risk-based products and services could decline and could materially and adversely affect our results of operations, financial position and cash flows.“ - UnitedHealth Group
“Global economic conditions could have a material adverse effect on our business, operating results and financial condition.“ - Nike
As you can see, the language is often vague. Some are risks are more specific than others to the industry in which these companies operate.
When I was thumbing through Berkshire Hathaway’s 2022 annual report released last week, I was taken aback by what the conglomerate identified at the top of their list. From the filing:
Terrorist acts could hurt our operating businesses.
A cyber, biological, nuclear or chemical terrorist attack could produce significant losses to our worldwide operations. Our business operations could be adversely affected from such acts through the loss of human resources or destruction of production facilities and information systems. We share the risk with all businesses.
Cyber security risks
We rely on technology in virtually all aspects of our business. Like those of many large businesses, certain of our information systems have been subject to computer viruses, malicious codes, unauthorized access, phishing efforts, denial-of- service attacks and other cyber-attacks. We expect to be subject to similar attacks in the future as such attacks become more sophisticated and frequent. A significant disruption or failure of our technology systems could result in service interruptions, safety failures, security events, regulatory compliance failures, an inability to protect information and assets against unauthorized users and other operational difficulties. Attacks perpetrated against our systems could result in loss of assets and critical information and expose us to remediation costs and reputational damage…
These risks are a bit more jarring than what you typically see at the top of most lists. They explicitly involve bad actors seeking to do harm and create chaos in the world.
To be fair, they’re appropriate for Berkshire Hathaway. As a globally diversified conglomerate with a presence in most industries, it would be vulnerable to mass shock events like the ones identified. Furthermore, Berkshire is a massive player in insurance and resinsurance, which means they could be forced to pay for the associated damages incurred by the companies they cover.
But it’s notable that Berkshire only began ordering its list of risks like this with its 2020 annual report. In its 2019 report, Berkshire led with: “We are dependent on a few key people for our major investment and capital allocation decisions.“ This made sense as the company is led by Warren Buffett, arguably the most successful investor in history. (This risk is now listed right below cyber security risks.)
Buffett certainly has made no secret that terrorism — specifically terrorism in the form of cyberattacks — worries him.
“There is, however, one clear, present and enduring danger to Berkshire against which Charlie and I are powerless. That threat to Berkshire is also the major threat our citizenry faces: a “successful” (as defined by the aggressor) cyber, biological, nuclear or chemical attack on the United States.“ - Buffett in 2016
"I don't know that much about cyber, but I do think that's the number one problem with mankind." - Buffett in 2017
“Cyber is uncharted territory. It’s going to get worse, not better.” - Buffett in 2018
“I think cyber poses real risks to humanity.” - Buffett in 2019
Buffett and Berkshire could’ve done like Apple and Exxon Mobil and led with a generic statement about “economic conditions,” which arguably encompass the effects of terrorism and cyber attacks. But they didn’t.
Why are we talking about this?
To be clear, I have no idea if the world is in imminent danger of a crippling cyber attack.
But I do think the risk is not to be totally ignored.
If you’ve been following business news, the most talked about concerns have been about inflation, monetary policy, fiscal policy, recession risks, and the effects of the war in Ukraine.
However, known risks that are top of mind tend to be at least somewhat priced into the markets.
And according to TKer Truth No. 8: “The most destabilizing risks are the ones people aren’t talking about.“
Sure, Buffett may be talking about cyber threats. And so is the White House. But you don’t often see it identified as a top concern in the investor community.
All of this is to say that the mere fact that cyber currently garners so little attention could be in itself a reason to be concerned as a stock market investor.
Managing risk in the context of investing means finding balance between “hoping for the best” and “preparing for the worst.” How you decide to position your portfolios in this context is between you and your financial advisor.
For more investor wisdom:
Warren Buffett reminds us how picking winning stocks is very hard 🤓
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
That’s interesting! 💡
From Delta Dental (via Axios): “According to new Delta Dental findings from its 2023 Original Tooth Fairy Poll®, the average value of a single lost tooth during the past year increased 16% from $5.36 to $6.23… Since the poll’s inception, the average cash gift left by the Tooth Fairy has surged 379% from $1.30 to $6.23 per tooth. At this rate, in 2048, the Tooth Fairy would be leaving a whopping $30 under the pillow for a single tooth.“
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
👍 Businesses are investing
Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — climbed to a near-record $75.2 billion in January.
The backlog of unfilled core capex orders was at $267.2 billion in January.
For more on this massive economic tailwind, read: 9 reasons to be optimistic about the economy and markets 💪
📈 GDP growth estimates are rosy
The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.3% rate in Q1. This is up considerably from its initial estimate of 0.7% growth as of January 27.
For more on the improving economic outlook, read: Economic forecasts are getting revised up, and people aren't thrilled about it 🙃
👍 Survey says services are hot
The ISM’s Services PMI stood at 55.1 in February, down slightly from 55.2 in January. A reading above 50 signals expansion in the sector.
Notably, the employment subindex jumped to 54.0 in February from 50 the month prior, signaling an acceleration in hiring.
🤨 But survey says manufacturing is cooling
The ISM’s Manufacturing PMI ticked up to 47.7 in February from 47.3 in January. A reading below 50 signals contraction, which suggests manufacturing activity continues to deteriorate but at a decelerating rate.
For more on the conflict between hard data and soft survey data, read: What businesses do > what businesses say 🙊
⛽️ Gas prices are down
From the EIA: “U.S. average price for regular-grade gasoline on February 27, 2023 was $3.342/gal, DOWN 3.7¢/gallon from 2/20/23, DOWN 26.6¢ from [a] year ago.“
For more on energy prices, read: The other side of the surging oil price story 🛢
🚢 Shipping costs are down
From Apollo’s Torsten Slok: “The price of transporting a container from China to the US is basically back at pre-pandemic levels, and this is boosting manufacturing production and putting downward pressure on goods inflation.“
For more on the improving supply chain, read: We can stop calling it a supply chain crisis ⛓
🏠 Home prices are down
According to the S&P CoreLogic Case-Shiller index, home prices fell 0.8% month-over-month in December, the sixth consecutive month of declines. On a year-over-year basis, prices were up 5.8%, down from 7.6% the month prior. From S&P DJI’s Craig Lazzara: “The prospect of stable, or higher, interest rates means that mortgage financing remains a headwind for home prices, while economic weakness, including the possibility of a recession, may also constrain potential buyers. Given these prospects for a challenging macroeconomic environment, home prices may well continue to weaken."
For more on the housing market, read: Why home prices and rents are creating all sorts of confusion about inflation 😖 and The U.S. housing market has gone cold 🥶.
📈 Mortgage rates are up
According to Freddie Mac, the average 30-year fixed-rate mortgage rose to 6.65% last week: “As we started the year, the 30-year fixed-rate mortgage decreased with expectations of lower economic growth, inflation and a loosening of monetary policy. However, given sustained economic growth and continued inflation, mortgage rates boomeranged and are inching up toward seven percent. Lower mortgage rates back in January brought buyers back into the market. Now that rates are moving up, affordability is hindered and making it difficult for potential buyers to act, particularly for repeat buyers with existing mortgages at less than half of current rates.“
👎 Consumer confidence ticks lower
From The Conference Board: “Consumer confidence declined again in February. The decrease reflected large drops in confidence for households aged 35 to 54 and for households earning $35,000 or more… And, while 12-month inflation expectations improved—falling to 6.3% from 6.7% last month—consumers may be showing early signs of pulling back spending in the face of high prices and rising interest rates. Fewer consumers are planning to purchase homes or autos and they also appear to be scaling back plans to buy major appliances. Vacation intentions also declined in February.“
👍 Labor market confidence improves
From The Conference Board: “17.8% of consumers said business conditions were ‘good,’ down from 19.9%. 17.7% said business conditions were ‘bad,’ down from 19.0%.“
💼 Unemployment claims remain low
Initial claims for unemployment benefits fell to 190,000 during the week ending Feb. 25, down from 192,000 the week prior. While the number is up from its six-decade low of 166,000 in March 2022, it remains near levels seen during periods of economic expansion.
For more on low unemployment, read: That's a lot of hiring 🍾, You should not be surprised by the strength of the labor market 💪, and 9 reasons to be optimistic about the economy and markets 💪.
💵 Tax refunds are up but below pre-pandemic levels
From UBS: “Between 2016 and 2019, February refunds averaged $118 billion with little volatility, ranging between $111 and $125 billion. Similar to 2022, this year February refunds were below the pre-pandemic average with a total amount paid of just $94 billion ($85 billion in 2022).”
🚗 Car sales are trending up
Light vehicle sales came in at an annualized rate of 14.9 million units in February. From JPMorgan: “ Through some of the volatility in the monthly readings, it looks like sales have been trending higher in recent months, with improving inventory dynamics likely helping facilitate car buying. Clearly there are sector-specific issues related to autos that are not indicative of broader economic conditions. But we do think several key economic indicators will show similar pat- terns in activity across recent months to the auto sales data, with moderation in February following strong increases reported for January.“
For more on cars, read: What rising auto loan delinquencies tell us about the economy 🚗
🏢 Offices are still pretty empty
From Kastle Systems: “Last week, office occupancy exceeded 50% for only the second time since the start of the pandemic. Occupancy rose by three tenths of a point to 50.1%, according to the Back to Work Barometer. Despite the data only measuring four days due to the Presidents Day holiday, seven of the 10 tracked cities saw moderate increases, while only three cities — New York, San Francisco and San Jose, Calif. — fell by a point or less. The week’s daily high was Tuesday at 57.2% occupancy, and the low was Friday at 32.4%.”
For more on office occupancy, read: This stat about offices reminds us things are far from normal 🏢
Putting it all together 🤔
We’re getting a lot of evidence that we may get the bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“
Nevertheless, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to continue to tighten monetary policy, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations). All of this means the market beatings may continue and the risk the economy sinks into a recession will relatively be elevated.
It’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
As always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a terrible year, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the previous TKer macro crosscurrents »
A version of this post was originally published on TKer.co.
Sam Ro is the founder of Tker.co. You can follow him on Twitter at @SamRo
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