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Reading recession tea leaves: Editor’s note

Lewis Jackson  |  03 Jun 2022Text size  Decrease  Increase  |  
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Welcome to the Editor’s note. We’re trying something a little different. Each week I’ll explore an issue investors need to know about. Expect jaunts across equities, funds, economics and personal finance. (Almost) anything goes as long as it’s interesting. Email comments or suggestions to: lewis.jackson@morningstar.com. Let's get into it.

Redundancies loom

Investors are worried about the possibility of a global recession. Attending the Morningstar Investment Conference on Thursday, I was struck by the number of advisers and fund managers listing an economic downturn as their number one fear. Silicon Valley may hold some clues to the likelihood one eventuates.

Layoffs and hiring freezes are hitting the battered US technology sector. Trading platform Robinhood is cutting 9% of full-time staff. Indoor exercise bike phenomena Peloton cut 2,800 staff and ditched its co-founder as people went back outside. Uber’s chief executive warned staff hiring was a “privilege” in a letter last month.

Venture capital funds are tightening purse strings. Giants Sequoia, Y Combinator and Andreessen Horowitz are all advising portfolio companies to assume the brace position and prepare for a harder time raising money, if they can at all. The value of Australia’s star unicorn, Canva, was marked down by Franklin Templeton by 58% in less than six months.

“No one can predict how bad the economy will get, but things don’t look good” said Y Combinator in a May email to its fledglings.

Slowing growth and rising costs are seeing larger tech players retrench too. Netflix fired about 2% of its workforce in May. Facebook said it would slow or pause mid-to-senior level hiring the same month. Twitter is freezing recruitment. Having swelled to roughly 1.6 million employees during the pandemic, Amazon told investors it was “overstaffed” in April.

Why should investors in St Leonards or St Kilda worry about unemployed coders in California? Because they could be coal mine canaries for the health of the US economy.

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Interest rate changes take years to flow through an economy, but with business models premised on breakneck growth, many of these companies are sensitive to minute shifts in conditions.

Rising borrowing costs and fading risk appetite are throttling the flow of cheap money that unprofitable companies like Uber depend on. Giants like Facebook have plenty of cash—US$43 billion at last count—but are warning investors the pace set during the pandemic is easing as prices rise and macroeconomic conditions worsen.

As central banks try to curb inflation without crashing the economy, trouble in the technology sector may indicate how well the “hire wire act” is going, says Stephen Miller, an investment strategist at GSFM in Australia.

“To the extent that these tech companies are the canary in the coalmine, it tilts the balance of risk towards the economy going into recession. This could be a harbinger of that,” he says.

“If a recession were to happen, this is how it would look at the start. It’s not axiomatic that a recession will happen, but if it were to happen, this is how it would happen,” he adds.

For now, the labour market is still red hot in the US and here. Most analysts believe the US Federal Reserve will engineer a soft landing, a minor recession in other words. I’m a little sceptical. A new paper from Alex Domash and Larry Summers—who correctly warned about inflation risk way back in early 2021—argues the economy is too hot for anything except a crash landing into recession.

On the other hand, the ‘tech wreck’ popping of the dot-com bubble two decades ago demonstrated technology stocks could crater without inflicting major pain on the wider economy.

Jun Bei Liu, lead portfolio manager at Tribeca Investment Partners thinks the pain is likely to stay contained to US tech. It’s bad news for local firms in the tech supply chain, such as Appen, but broader contagion is unlikely.

Were a recession to hit the US, it would be a different story. While growing Chinese stimulus is a potent offsetting force, the ASX tends to flag if the US does, she says.

“If the US goes down, we tend to follow. If that share market is under pressure, that’s more pressure for the rest of the world. It’s hard to see us growing strongly if the other market is slowing.”

More from Morningstar this week

The S&P 500 snapped a seven-week losing streak for the week ending 27 May. Morningstar’s Mark Lamonica and Peter Warnes remain cautious. Beware bear-market rallies, says Warnes, pointing to warning signs in the US housing market. In the fifth and final edition of his Bubbleville series, Lamonica sees more pain on the horizon and recommends investors use the downturn to define a personal investing philosophy.

Mike Cannon-Brookes scored a win this week after AGL’s board shelved controversial plans for the demerger of its coal assets. With the company’s future in limbo, shareholders are worried that may sell valuable assets at knock down prices to repay its banks. Elsewhere, Graham Hand explores why the conventional narrative about fossil fuel obsolescence requires closer scrutiny.

For those looking to catch up on what happened this week, my colleague Nicola has you covered.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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