Recent political developments have increased uncertainty across the globe. Both the British exit from the European Union (Brexit) and the U.S. election of Donald Trump are likely to bring change to both the respective countries and the globe.
Yet the direction of the change is not entirely clear. The unwinding of the United Kingdom’s membership in the EU will take at least two years. The unfolding of the Trump administration over the next several months and years is virtually certain to bring changes in its wake.
As a general rule, corporations and stock markets do not like uncertainty. Projections and valuations are much more difficult to make in periods of uncertainty, and the realization of projections and valuations are correspondingly less bankable.
So how should corporations invest in periods of uncertainty, in products, divisions, and portfolios?
Enter the scenario – or, more likely, multiple scenarios. Suppose your corporate portfolio is highly invested in companies that have embraced climate change accords. A Trump administration might withdraw the U.S. from the accords. Part of the move might open new areas to oil, gas, and mineral exploration – and perhaps, correspondingly, remove funds for and focus on solar and wind energy.
Yet withdrawal is not certain since considerable political energy exists to move forward on the accords.
An investment portfolio, then, might draw up 3 scenarios. In the first scenario, investments in companies benefiting from climate change accords, particularly those in the research and development stage, might be drawn down until the political picture is clearer, but not eliminated entirely.
In the second scenario, investments in energy exploration companies might be augmented, and political winds either favoring or not favoring such exploration explored.
In a third scenario, however, those research and development companies might be augmented for the long term, on assumptions that climate change accords will affect businesses worldwide.
How Companies Think About Scenarios
The balance between short-term and long-term scenarios is key. Companies tend to focus on one of three potential scenario-building focuses. The first is termed by Wharton School at the University of Pennsylvania professor Paul J. H. Schoemaker “zero-future.” No attempt is made to project beyond the short term, largely because the months out seem unknowable and unpredictable.
The second option is to focus on just one scenario that a given company considers likely. The advantage is that it is easily communicated and soothes jitters. But if the one scenario doesn’t pan out … the company has placed all its eggs in a basket, rather than multiple baskets.
Scenario building requires a third option, in which corporations analyze what is and is not known about the future. From there, they should hypothesize at least several options for what the future might hold.
Businesses deciding on investing need to identify the key questions underlying potential changes. From there, an analysis often called STEEP can be done – it explores the Social, Technological, Economic, Environmental, and (geo)Political impact of each.
As of this summer and fall, much of the world is facing uncertainty. Scenarios will be needed to guide the way.