| comment (1) in Forest Finance & Economics, Forest Strategy, Risk Management, Timber Market Analysis

Coronavirus Case Study, Part I: Putting Risk in a Box

In a February 26th post related to asset values and the coronavirus, I noted, in reference to U.S. Treasuries, that “a low risk-free rate expresses market pessimism and concern rather than economic health, stability and the potential for rapid growth.” Then, on March 3rd, the Federal Open Market Committee (FOMC), the branch of the U.S. Federal Reserve that oversees the money supply and interest rates (monetary policy), decided to reduce its target range for the federal funds rate by ½ percentage point (50 basis points).

To me, the FOMC press release, which opened with “the fundamentals of the U.S. economy remain strong,” read like the dreaded “feedback sandwich” in a poorly conducted performance review. “Hey Percy, let me start by saying you showed up to camp in great shape. But we’re sending you back to the minors. Keep up the good work!”

Markets responded similarly. The S&P 500 ended the day 3% lower and U.S. 30-Year Treasury yields closed March 3rd at 1.64%, down 29.6% since the start of 2020. The rate change by the Federal Reserve, which occurred between scheduled FOMC meetings for the first time since 2008, signals worry about recession risks. Okay, message received.

For those of us who prefer work over worry, how should we think about this productively? How can we frame potential economic disruptions specific to the coronavirus?

In 2018, we shared our framework for thinking through potential disruptions generally and applied this to the forest products and timber industries. We use versions of this framework for studying markets and evaluating business strategies. When thinking through the means and mechanisms by which disruptions affect timber markets and forest investment cash flows, I start with two simple questions rooted in economic fundamentals:

  • Big or small? In other words, how impactful, whether positive or negative, would we expect this disruption or change to be on forest supplies or wood demand?
  • Long or short? What is the likely duration, whether positive or negative, of this disruption or change on supplies or demand (in the market or industry)?

Then we address a third issue as big changes can affect us locally, globally, or both. For strategy and planning, we want to specify the context – which gives us a box to work in – of the disruption to best understand its absolute and relative risks, whether positive or negative. We have little, if any, control over systematic (global) risk, while unsystematic (local) risk can be mitigated and managed through diversification, insurance and operational competence.

In Part II, we apply this framework and introduce scenarios.

Comments (1)

Leave a Reply

← Back to blog