Headline Growth Newsletter Q4 2024: Pre-Election Markets, Public Equity Volatility, and Powell’s Posturing
Introducing Headline Growth’s new quarterly newsletter: What On Earth Is Going On With the Economy and How Does This Impact My Growth Stage Company?
We have noticed a trend over the past 18 months: a lot of companies we speak with end the call asking us about our thoughts on the economy. “What do you think of the current macro?” “Should I pay attention to Powell?”
The constant news cycle and volatility of public markets, along with investor sensationalism, makes it impossible to decipher what is happening – and how it will impact growth-stage companies. This is a multidisciplinary endeavor; an attempt to better marry the worlds of research, finance, economics and investing. We are not macro traders – far from it. But we believe that an awareness of big economic trends allows us to make better investments.
We commit to writing a dedicated briefing each quarter, alongside analysis, to help you better navigate the current economic climate. We would love to hear from you with any questions you might want to see answered in our next edition - or in select pieces published in the intervening periods.
We will also accompany these posts with a quarterly fireside chat and happy hour hosted at our SF offices. If you’re a growth-stage company interested in attending, please add yourself to our newsletter distribution list below and we will send out regular invites (space limited).
We hope you find this as helpful as we did to codify it. Thank you also to all of the economists and other experts who helped us inform these narratives.
- The Headline Growth Team
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Introduction
No one seems to understand what is truly happening with the economy right now. At the beginning of August there was a “growth scare”, where a weak US jobs report raised worries that the world’s largest economy was heading for recession. By mid-August, the growth scare had faded, only to reappear at the end of the month. In this piece, we look through the noise. We identify five things about the economy that should matter to growth investors and growth companies alike.
One: The labor market remains bifurcated between tech vs. non-tech
In 2021 and 2022 many businesses, especially in hospitality and healthcare, experienced a huge labor shortage. At the same time tech firms went on a hiring rampage, with internet megacaps tripling their number of job openings.
Then the trends reversed. Labor shortages eased. Meanwhile, tech firms in California and New York cut employment by well over 100,000 positions – not far off what happened after the dot-com bust (see the chart below).
Source: Federal Reserve Economic Data
What’s the situation today? On the macro side, there is a lot of concern about rising unemployment, and slowing job growth. The truth, though, is that the labor market is still very tight at an aggregate level. For every 100 jobs in the US, there are five job openings. See the chart below. This means that for most businesses, hiring is still tricky.
Source: Federal Reserve Economic Data
Tech is a different story. Here, employment remains depressed, though in recent months it appears to be edging back up again. For that reason, there are probably lots of people out there who used to work in tech who no longer work in tech, who would like to get a job in tech. Tech companies looking to hire are seeing lots of candidates – and should expect that trend to continue.
Two: Lower interest rates do not mean higher valuations
In 2021, valuations in private markets were sky-high. Investors were deploying huge rounds. Companies were coming to the public markets at enormous valuations. That has really changed. In 2023 and 2024 (so far) there have been fewer big software IPOs. A big part of this story relates to interest rates. When rates are low, investors are looking for yield. They are therefore willing to pay more for companies with uncertain future earnings. And when they are high, they are not.
Now rates are coming back down. Are valuations therefore going to zoom back up? Don’t bank on it. For one thing, rates are likely to come down pretty slowly. In the US the policy rate is currently near 5%. It may not get back down to zero, where it was during the pandemic, ever again. And even if this does happen, it will take ages. That is because central banks the world over are still concerned with inflation. They do not want to risk reigniting it.
Also, the relationship between interest rates and valuations is far from mechanical. What happened in 2021 was in many ways unique. The pandemic, quite understandably, sent a lot of the world a bit crazy. Some people thought that we would be stuck at home forever. There was irrational exuberance over investments, especially in some software stocks. That is unlikely to be repeated any time soon.
See the scatter plot below for more analysis on the relationship between interest rates and valuations. The relationship between the two is actually pretty weak: as interest rates move up or down, valuations move around pretty randomly.
Source: Federal Reserve Economic Data
Three: Despite worries, consumers are actually doing OK
Especially on the public company side, there is currently a lot of worry about the health of the consumer. In recent results, for instance, Dollar General (an all-purpose store) said that it worried that low-income individuals were cutting back on spending. You’ve probably read your own version of this story in recent weeks.
This would be a concerning trend, if true. Consumers in the bottom half of the income distribution determine the overall health of the economy. When they cut back, it can create extra unemployment. This then creates a vicious circle: of even less spending, even more unemployment, and so on. So this really does matter.
Should we be worried? We think not, at least not yet. Consumer confidence in the US, which not long ago hit all-time lows, has risen. People are not exactly happy with the state of the economy, but they are not quite as unhappy as they once were. Gas prices have come down a bit, leaving more money in people’s pockets at the end of the month. Overall inflation has come down too. As discussed above, labor markets are still strong, meaning that fewer people are struggling to find a job. Wage growth at the bottom of the labor market remains pretty strong, as the chart below (which is measured in nominal terms) shows.
Source: Current Population Survey, BLS, Federal Reserve Bank of Atlanta
The upshot is that, in aggregate, there seems little reason to worry. In the latest round of earnings calls, companies were on average actually decently optimistic about the health of the consumer. Retail sales are not great, but they are not bad either.
Source: Federal Reserve Economic Data
All in all, we are watching the health of the consumer. But as of yet, we do not see reason to worry.
Four: Software investment remains very sluggish
Lots of growth investors put their money in tech companies. These companies have two broad types of customers: consumers (i.e., B2C) and businesses (i.e., B2B). As described above, we are not too concerned about consumers. But businesses are still behaving strangely.
The health of B2B tech companies relies greatly on an obscure part of the GDP figures. This is called “private fixed investment: nonresidential: intellectual property products: software”. This measures investment by businesses in software, including both stuff that is totally off-the-shelf, stuff that they design themselves completely, and everything in between.
During the pandemic, software investment was very strong – in fact, the strongest it has been this millennium. It grew consistently by well over 10% year on year. (This also helped to support tech company valuations, by the way.)
Source: Federal Reserve Economic Data
It has since come down a long way, to more like 5-7%. To be clear, though, this chart underestimates the scale of the slowdown, because the price of software has increased (thanks to inflation). So in terms of the quantity of software being purchased by companies, things actually got pretty bad.
Why did companies pull back on software investment? Partly it was because they overinvested during the pandemic. And partly it was because CFOs got nervous as inflation took off and there were fears of a recession. During an economic downturn, investment budgets are often the first thing to be cut.
There is some good news. Investment in software does seem to be coming back. We will continue to watch this trend closely.
Five: The quality of economic data is still reeling from the pandemic
At a time of great uncertainty, it is tempting to be glued to the news. When it comes to the economy, though, we urge the growth community not to do this. This is because no one truly understands the economy these days. To cut a long story short, economic data is at present a lot less reliable than in the past, for two reasons.
First, the pandemic messed up the “seasonal adjustment” that goes into almost all official statistics. As a result, it is extremely hard to know if a given reading (say, the inflation reading for July) is accurate or not. You can no longer trust month-to-month data.
Second, and partly because of the pandemic, people are a lot less likely these days to respond to surveys, from which the official economic data are derived. See the chart below. This means that all economic data is, potentially, severely compromised. The statisticians are doing their best, but it is very difficult to work with small samples. Increasing sample sizes, as many statistical offices have done, does not overcome this problem. This is because different sorts of people have stopped responding to surveys at different rates, biasing the data in unpredictable ways.
Source: BLS. Note: ATUS = American Time Use Survey; CE = Consumer Expenditure Survey; CPI-Housing = Consumer Price Index Housing Survey; CPS = Current Population Survey.
Our advice, instead, is to take a step back, and understand the slow-moving trends in the economy. This is what we will continue to do for you on a regular basis. We hope you find it useful!