Notes on the next downturn
It marked the 10th anniversary of the US economic expansion that kicked off in June 2009, in the aftermath of the Global Financial Crisis. This growth cycle is now the longest since data began, way back in 1854.
Legendary investor Howard Marks has characterised the 3 stages of a bull market:
- The first, when only a few forward-looking people begin to believe things will get better.
- The second, when most investors realize improvement is actually underway.
- The third, when everyone concludes that things can only get better forever
He believes the prevailing wisdom in today’s market is firmly centred upon the third stage, which tends to foreshadow a sharp correction. It’s a view I’m hearing again and again in conversations with issuers, dealers and investors.
We find ourselves in an unprecedented situation. Nobody is claiming that the Fed has “abolished boom and bust” (as British Prime Minister Gordon Brown so infamously claimed), but previous downturns have been managed and softened using the big lever of monetary policy – and some creative financial engineering. But with interest rates so low, for so long, policymakers have left themselves with little wiggle room.
Opportunities to prepare for the next downturn have been missed. Central banks globally have failed to normalized their balance sheets, which have expanded to $19.4 trillion, up from $6 trillion at the beginning of 2008. Global government debt has increased 77% since 2008 and corporate debt is up 50%, while consumer debt has only jumped 7% since 2008. It seems our leaders are leading us down a dangerous path. These debt levels depend on a depressed rate environment, but with rates already so low and debt so high, it’s hard to see how further cuts of the magnitude on offer can produce more growth and stave off the next downturn.
Despite this hard reality, talk of a new easing cycle intensified on Wednesday, when the Fed opened the door to an interest rate cut, in a significant shift in tone. The FOMC kept rates in the 2.25-2.5% range, but stated that “uncertainties about this outlook have increased” and that it will “will act as appropriate to sustain the expansion.” QE was the bazooka employed by central bankers to blast away at the last downturn. What will they have to invent for this one?
Of course, there is always fiscal stimulus, but this is politically complicated and America’s finances can hardly be described as healthy. Like the UK back in 2007, the land of hope and dreams approaches the next downturn without the financial firepower required to slash taxes or spend its way out of recession.
How are markets responding to this depressing but sadly inevitable picture? The general public doesn’t get excited by bonds, and the stock market continues to test new highs – albeit remaining vulnerable to a deterioration in economic data. But the yield curve doesn’t lie, and its current inversion portends a hard landing for those who believe what goes up must not come down. This economic anomaly has historically been a reliable predictor of recessions in the past half century. In the US, whenever the yield curve has inverted in the past 60 years – with one exception in the late 1960s – a recession has followed.
Set aside a moment the underlying economic drivers of this distortion – the signalling impact alone is a significant driver of negative sentiment and behavioural change amongst banks, businesses and consumers.
Viewing this with my tech founder hat on, the fact that central banks are looking to be dovish again is positive in the short run. But it’s worrisome in the long run.
Lower rates mean more money going to alternatives. This we know. But the link only works as long as animal spirits are high. Every step of the value chain, from angel/seed investors, to Series A VCs, to growth stage, to late stage, to Softbank, to the final destination of public markets, needs to be sustained to see valuations continue their ascent. If central banks cut rates but the economy falters (not unlikely, since it’s the reason they’re cutting in the first place and many traders see rate cuts as profoundly negative signals), public markets could stumble and the pain will be felt all the way down through the value chain.
For Origin, this doesn’t change anything, as we’ve always been cost conscious, and capital conscious too. Prioritising venture money over revenues might seem strategic, but it leads to short-termism. Instead, we’ve concentrated on the job in hard – helping participants in capital markets to grow their businesses. We’ve built up our community of nearly 100 dealers and issuers globally with a small, highly talented team, and we remain hyper-focused on cashflow and growing revenues. Sometimes it feels like we miss out on some of the limelight by being so conservative. But we believe that in the long run, focusing on the customer rather than dubious startup growth metrics is a strategy that will succeed.
If all this sounds laughably basic, that’s because it is. In business, as in life, sometimes it pays to keep things simple.