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A Looming Recession

Pexels Mikhail Nilov 6962990

A post-pandemic supply shortage and labour crunch, coupled with the ripple effects from international sanctions on Russia, created the perfect storm for high inflation this year. As central banks around the world raise rates to keep skyrocketing prices under control, a new concern arises – a looming recession. Any good economics student will point out the constant tug-of-war between low and stable inflation and economic growth, referring to the Phillips curve as empirical evidence. The fine line between the two macroeconomic targets is exactly what the Fed and ECB are treading now.

 

Across the Atlantic, former Goldman Sachs CEO Lloyd Blankfein warns of a “very, very high risk” of US recession. Closer to home, growth in UK manufacturing and services has slumped to its lowest rate since the beginning of 2021. As businesses become increasingly cautious about their outlook and consumers cut down on spending amidst rising costs and economic pessimism, the economy is entering a downward spiral of deep-rooted growth fears hindering business activity, which in turn reinforces those fears.

 

The ramifications of recession fears present themselves in the stock market, where big tech companies have seen nearly $2.6tn of market value wiped off in a matter of months. The 26% decline for the five biggest tech stocks is twice that of the Dow Jones Industrial Average. This will be a worrying trend for tech firms, especially those looking to enter the public market or raise capital privately. Given bearish sentiments, the growth and revenue forecasts for these businesses will take a significant cut, which in turn lowers their valuation and increases their cost of capital. For companies with no profits and still in prototyping and pre-order stage, especially early-stage companies that have went public through a Spac demerger, further downside risks are much higher given little fundamentals supporting a stock price floor.

 

The gloomy market outlook may lead one to think that tech companies should exercise financial and commercial prudence in a period like now, by cutting back on investment plans and lowering costs to preserve cash flows. However, past experience has taught us the opposite. During the 2008 financial crisis, Intel doubled down on R&D and recruitment, with a strong conviction that the market will bounce back just as quickly and the company has to be ready for a smooth recovery. The demand for technology will be here to stay for the foreseeable future, so short-term setbacks such as an imminent recession should on aggregate have little effect on the growth of tech companies.

 

Going back to the earlier point on tamed valuations, a recession actually presents the best opportunity for tech companies to acquire competitors at a cheap price. From 2008 to 2010, big tech companies like Apple, Google, Microsoft and Facebook bought over 150 companies and thousands of new intellectual properties (IPs) from smaller companies that were forced to close down. As a result, a recession usually leads to market consolidation in the tech industry, with big players getting bigger and smaller players dropping off.

 

That being said, each recession comes with a unique set of circumstances which makes predicting outcomes extremely hard. For instance, the 2008 financial crisis caused by the subprime mortgage crisis had little to do with the tech industry fundamentally. However, if the next crisis is a result of a trade war that impedes the free flow of important components such as computer chips, then tech firms will face a much trickier problem navigating supply chain issues and ballooning costs.