By Michael D. White, author and freelance writer
In 2018, North America was home to the largest concentration of businesses in the professional services market, accounting for about 37 percent of the global market share with the world’s leading professional services companies located in the United States serving the country’s expansive and thriving U.S. corporate sector.
By the end of that year, foreign direct investment in the professional services industry was nearly $749 billion, directly supporting 1.4 million U.S. jobs.
Despite a sluggish first three quarters in 2019, the U.S. services sector—which comprises almost 70 percent of the U.S. economy—roared back in October, with the Institute of Supply Management’s non-manufacturing report jumping to 54.7 percent, up from 52.6 percent the month before, and beating expectations.
But a shock of unprecedented impact was waiting in the wings to knock the U.S., and global, economies, off track.
Enter the COVID-19 which, since earlier this year, has surged to disrupt social and economic life around the world, and, according to consultancy McKinsey & Company, may have an economic impact on the U.S. that could well exceed anything experienced by the country since the end of World War II.
According to a recent report from New York-headquartered McKinsey, the U.S. and Eurozone economies could take until 2023 to recover from the impact of the virus with the global economy experiencing what the consultancy calls a “muted” economic recovery.
“While the global economy would recover to pre-crisis levels by the third quarter of 2022, the U.S. economy would need until the first quarter of 2023 and Europe until the third quarter of the same year,” the report says.
Like falling dominoes, large-scale quarantines, travel restrictions, and social-distancing measures drive a sharp fall in consumer and business spending until the end of Q2, producing a recession, according to McKinsey. Although the outbreak comes under control in most parts of the world by late in Q2, the self-reinforcing dynamics of a recession kick in and prolong the slump until the end of Q3.
“Consumers,” the consultancy says, “stay home, businesses lose revenue and lay off workers, and unemployment levels rise sharply. In turn, business investment contracts, and corporate bankruptcies soar, putting significant pressure on the banking and financial system.”
The company adds that, “Monetary policy is further eased in Q1 but has limited impact, given the prevailing low interest rates. Modest fiscal responses prove insufficient to overcome economic damage in Q2 and Q3. It takes until Q4 for U.S. and European economies to see a genuine recovery. Global GDP in 2020 will fall slightly.”
What follows are snapshot analyses of the impact of COVID-19 on several key component areas that comprise the U.S. service sector.
According to professional services consultancy Deloitte, as the impact of COVID-19 is expected to continue to evolve, entities in the accountancy field should “carefully evaluate information that becomes available after the reporting date but before the issuance of the financial statements. The amounts in the financial statements must be adjusted to reflect events that provide evidence of conditions that existed at the end of the reporting period.”
Additionally, the consultancy notes that there are a number of other areas in the financial statements that might be affected by the COVID-19, including: derivative and hedging considerations; insurance claims; the appropriate recognition of employee termination benefits resulting from a workforce reduction; the probability of meeting performance vesting conditions under share-based payment arrangements and the probability of meeting performance targets in business combination arrangements, rebate arrangements with customers or suppliers, variable considerations, commission accruals; the appropriate accounting for modification of contractual arrangements, for example a reduction or deferral of lease payments granted by a lessor to a lessee; the tax considerations, such as the impact of a reduced flow of goods and services on transfer pricing agreements; and the recoverability of deferred tax assets.
The American Institute of Architects published a comprehensive report in late March that outlined the immediate, and long-term, impact of the COVID-19 pandemic on architecture firms in the U.S.
The report, based on a survey of the Washington, D.C.’s membership, found that 50 percent of architecture firms reported fewer new design projects for March—as of the March 23 survey date—as compared to their expectations entering the month.
“Like most other businesses, U.S. architecture firms are heading into uncharted waters regarding what the economy holds in store for them as the COVID-19 pandemic plays out globally,” said AIA Chief Economist, Dr. Kermit Baker. “Different businesses are feeling the impact of the slowdown differently.”
Beyond billing activity, just under half of firms (48 percent) indicated that all, or almost all, of their staff are now working remotely, while 31 percent reported that some of their staff are working remotely. Few firms reported a major impact to their staff due to family/personal reasons, but 15 percent of firms said that at least some of their staff are currently unable to work at all.
Though modern technology such as teleconferencing has transcended communicating over distance, consulting is, ideally, a face-to-face activity wherein professional or expert advice is given to address a particular issue in a particular field.
But, in the new world we live in, U.S. based-businesses of all sizes will gradually have to adjust to a new “social distancing” reality.
While in-person gatherings will be curtailed, the use of more sophisticated methods to communicate will rise with online education and business meetings becoming more and more common.
Moreover, say analysts, at some stage, regardless of the extent of the toll on the economy and face-to-face human interaction, the effects of COVID-19 will fade and life will return to normal. If 2020 is the year of the virus, 2021 will likely mark a first year of recovery.
The rapid increase in remote working and the impact of social distancing requirements due to the COVID-19 pandemic “are likely to require increased usage of telecommunication services and data storage services, which is likely to benefit industry operators,” says Australian business consultancy, IBIA World.
Conversely, the company says that industries that rely on in-person patronage and are unable to make up for this loss of revenue through online sales…are likely to be damaged by the coronavirus epidemic.
In addition, firms that provide telecommunications and data hosting services may face additional strain on the capacity of their infrastructure due to increased usage.
Many U.S. states and municipalities have shut down construction projects, while others have deemed construction an essential service, according to the Associated General Contractors of America.
Even when not mandated, “an increasing number of owners are halting or cancelling projects. This may be to help enforce social distancing and other efforts to slow the spread of the virus, or because demand for the project has dried up, at least temporarily, or because the owner’s financial situation doesn’t allow it to proceed,” says Ken Simonson chief economist at the Arlington, Virginia-based trade association.
Simonson expects that engineering and construction “will be less affected than other industries in the short term, but there could be a longer lasting impact. It will take individuals, businesses and governments longer to commit to new construction once the pandemic recedes than to start up many other types of spending and activity.”
Chicago, Illinois-headquartered Mayer Brown is a global law firm that serves as an advisor to some of the world’s largest financial service institutions.
The company advises that it is imperative that any ad hoc measures to adapt to the current situation—which may include alternative work arrangements which may affect confidentiality, conflicts of interest, and other financial crime risks, and/or reduced capabilities for monitoring, reporting and controlling operations—are considered in the broader context of the existing compliance framework.
In all circumstances, however, data quality and reporting accuracy and timeliness cannot be compromised.
Additionally, the firm adds, “Proper centralized governance procedures should be put into place, including documenting and clearly articulating decisions by authorized personnel if faced with potential derogations from ordinary levels of monitoring and control due to the current situation.”
The company adds that applying a coordinated approach with clearly defined rationales and targeted timelines can be an effective compliance practice for a financial institution, not only in the event of a future audit or regulator inquiry but also for the benefit of its clients and the stability of markets.
According to multiple sources, the insurance sector will be one of the service areas most significantly impacted by the influx of the COVID-19 virus as it’s already shifting the way insurers will need to think about the valuation of their investments and liabilities.
There is a concurrence among industry analysts and trade groups that insurance companies will continue to see sharp spikes in service requests, regardless of their market segment or role in the distribution channel as claims may increase, especially for long-term care, life and disability insurance.
The American Property Casualty Insurance Association, for example, estimated that losses for U.S. businesses with 100 or fewer employees could cost between $220 billion and $383 billion per month.
“Even though specific losses may be excluded, some carriers could see a surge in claims involving health, travel, event cancellation, business interruption and supply chain policies,” says London-based Pricewaterhouse Coopers (PwC).
At the same time, government jurisdictional decisions may spur medical and workers compensation claims, while web and phone traffic may surge, creating operational constraints or disruptions.
The company adds that valuation and price discovery, may become a challenge because of market volatility and a possible decline in liquidity for certain products. [Insurers] may face challenges in assessing the value of investments, hedges or insurance liabilities, particularly with distressed or forced-liquidation sales.
“Credit quality will continue to deteriorate throughout the global economy,” says PwC, “with some insurers possibly needing to address asset impairment and expected credit losses in their portfolios. In certain industries or geographies, for example, you may need to determine whether market events have triggered an impairment charge based on revised forecasts. Reinsurers, in particular, could face mounting losses that may increase credit risks on recoverables.”
The U.S. Federal Reserve and the federal government have begun implementing a series of policy measures to address the economic and financial fallout of the COVID-19 pandemic.
The Reserve has loosened monetary policy by cutting rates and restarting the quantitative easing for government and mortgage-backed securities; activating several liquidity facilities directed toward different parts of the economy; and creating ways to provide financing on a medium-term basis to the non-financial corporate sector, particularly by leveraging up resources provided by the Treasury Department and by the COVID-19 Stimulus bill passed by Congress and signed by President Donald Trump in late March.
At the same time, the Federal Reserve also launched a temporary lending facility that will allow foreign central banks with accounts at the Reservce to convert their holdings of Treasurys into dollars, its latest bid to alleviate strains in global markets.
That program will allow foreign central banks and other international monetary authorities who maintain accounts at the New York Fed to enter a lending arrangement called a repurchase agreement, or repo, in which borrowers temporarily exchange their Treasury securities for U.S. dollars.
According to the Institute for International Finance (IIF) in Washington, D.C., the Fed largely “is making use of its authority under Section 13 (3) of the Federal Reserve Act to provide this financing.”
In the past two months, the IIF said in March, “Congress has passed two fiscal packages and is negotiating a third that is costed at over $2 trillion—greater than 10 percent of GDP. These packages cover a wide range of social safety net, stimulus, and support for medical needs, including providing funding to hospitals—roughly $132 billion—and approximately $150 billion to state and local governments, and to workers who have lost their jobs or do not work for companies that provide paid sick leave.”
The economy was very healthy entering 2020, with low inflation, low unemployment and slow and steady economic growth.
That fact, and the reality that the virus became a significant global issue late in the first quarter, “makes it likely that the first quarter will still see solid real GDP growth,” says J.P. Morgan Asset Management.
Even the effects of COVID-19 on the economy in March could be mixed, the company says, “with very strong sales of grocery and warehouse stores as people stocked up, offsetting growing weakness in the travel and entertainment industries.”
However, in the second quarter, the negative impacts of social distancing should begin to hit the economy hard, with very sharp declines likely in cruises, airlines, hotels, casinos, sporting events, movies, theatres and restaurants among other industries. This will likely result in a negative quarter for real GDP growth both in the U.S. and globally. A second quarter of negative growth could come from knock-on effects on employment.
“While many companies will want to postpone layoffs, some will have no choice,” the analyst said. “In addition, broad hiring freezes will likely result in net payroll job losses for a number of months to come. History suggests that when the economy enters recession, the unemployment rate rises at a pace of two percent per year. However, the suddenness and severity of this slowdown could make unemployment rise at a faster pace this time around, with only slow growth in the working-age population limiting its climb.”
The COVID-19 crisis confirms, once again, the value of a diversified portfolio as gains in Treasury bonds have, to some extent, offset stock market losses and reminds us of the value of high-quality assets. A crucial first step for any company to thrive in a rebound is to be able to survive a downturn.
“The crisis,” Morgan said, “should prove the value of active managers, as skilled investors adjust portfolios both to weather the storm but also to take advantage of the altered economic and social landscape that is likely to follow.”
Finally, it concluded, “the crisis will underscore the importance of valuations across financial assets. The last few years – relatively calm years from an economic perspective – have allowed some valuations to become unhinged from others with investors generally paying a premium for hopes and dreams and demanding a discount for prudence.”
The COVID-19 crisis “reminds us that no single aspect of an investment is as important as the ability to get in at a reasonable price at the start. No matter how volatile financial markets are in the weeks ahead, opportunities will emerge for investors who can think and act with discipline in an increasingly emotional environment.”
Michael D. White is a published author with four non-fiction books and well more than 1,700 by-lined articles on international transportation and trade to his credit.
During his 35 year career as a journalist, White has served in positions from contributor and reporter to managing editor for a number of publications including Global Trade Magazine, the Los Angeles Daily Commercial News, Pacific Shipper, the Los Angeles Business Journal, International Business Magazine, the Long Beach Press-Telegram, Los Angeles Daily News, Pacific Traffic Magazine, and World Trade Magazine.
He has also served as editor of the CalTrade Report and Pacific Coast Trade websites, North America Public and Media Relations Manager for Mitsui O.S.K. Lines, and as a consultant to Pace University’s World Trade Institute and the Austrian Trade Commission.
A veteran of the United States Coast Guard, White has traveled in both Japan and China, and earned a degree in journalism from California State University and a Certificate in International Business from the Japanese Ministry of Trade & Industry’s International Institute for Studies & Training in Tokyo.