preparing for a recession

[luciuse]

okay, now that I got your attention, let’s rephrase that: preparing for an economic slowdown. I don’t pretend I can predict whether we’re heading for a recession - but we are definitely heading for a slowdown, because that’s exactly what the Fed is trying to engineer - reduce demand, slow down economic activity, cool down the ‘red hot’ labor market. At least that’s my understanding. A recession by definition is just a more pronounced slowdown. This is not black and white, but by now I think everyone agrees that the economy will cool down somewhat - which means less hiring overall, it means that more companies will struggle and consequently will look for savings, some won’t make it at all.

So what is that going to do to the stocks we are following here?

Zoominfo: I expect less hiring, so less demand for the core of Zoominfo: slowdown of growth

Bill.com: when more companies are struggling (and the smaller companies where BILL recruits its customers typically struggle more and quicker), the last thing they’ll entertain is a system integration that’s providing savings down the road. In that situation, you’re looking for sure, immediate savings, and your focus is on the survival of your business: find sales, cut cost. You don’t look for systems that promise to make your administration more efficient, you’re simply reducing personnel. That may not be the wisest decision, but it’s business reality: you KNOW it helps your P&L right now if you don’t spend or reduce headcount. Versus implementing Bill is an investment that will take attention you can’t afford right now, and the saving is just an assumption.

Monday: similar in my mind - they benefit from their high Net Dollar Retention Rate with existing customers, but I do believe one of the first things CFOs will look at is to stop discretionary spending, maybe take a harder look at the number of seats really in use (I know my company does, for Asana), and they certainly will reign in on the roll-out of new tools (i.e. new Monday customers)

Upstart: ok, let’s not even go there. Enough posted already

So what I would deem safe places are

• data security, monitoring etc. like SentinelOne, Crowdstrike, Zscaler, Datadog
• anything that helps companies to do more of their business (sales) or become more productive doing so, like Snowflake, Amplitude. And to a degree also Zoominfo as it’s branching out into Sales/marketing related activities.
  Let’s make no mistake though - an economic slowdown affects the ENTIRE economy. These companies have incredibly strong business models, but regardless, they will grow faster in a growing economy than a slowing economy. So they also will be impacted somewhat, but hopefully not much.

Based on this reasoning, I decided to close my Monday and BILL positions today. I am convinced that the market in general has ways to go down further, and I expect these two companies’ growth rates to be materially affected by the economic slowdown. We know how the market responds to that, now worse than ever.

I’m not sure Monday will already report a slowdown next week, but in the current environment it’s hard to imagine an earnings report that WOULDN’T result in a sell-off.

I’m not usually trying to time the market, but I’m forced to de-risk my portfolio at this stage, and this appears the best approach for me. As always, draw your own conclusions and act accordingly.

[jgrothaus]

Luciuse,

I appreciate your write up here, it’s always good to think critically about how recession-proof our companies are at any given time.

I wanted to clarify your thoughts on ZI.

You mention that ZI is “branching out” into sales/marketing related activities, but this is the core of what ZI has always offered.

They only recently acquired Comparably, which is a recruitment platform. But you wrote you expect less hiring, so less demand for the core of ZI.

From this I’m wondering if you perhaps have the primary product offering somewhat mixed up? Do you see them primarily as a recruitment tool instead of a sales tool? If so, I kindly challenge your assumption on that. Recruitment is only 8.5% of their stated TAM, while sales/marketing intelligence makes up the remaining 91.5%.

I agree with your sentiment that when you’re focusing on finding sales and cutting costs to help your business survive. But many modern sales orgs open up ZoomInfo first when they need to find a new lead to make a sale.

During the 2020 recession, ZI was still growing >50% YoY with a NRR of 108% (down only 1 point from 2019’s 109%, and still up from 2018’s 102%.) In 2021 that NRR grew to 116% with their new product offerings, indicating to me their product has become even stickier and more recession-proof than it was in 2020.

[CMFSoloFool]

I don’t pretend I can predict whether we’re heading for a recession - but we are definitely heading for a slowdown, because that’s exactly what the Fed is trying to engineer - reduce demand, slow down economic activity, cool down the ‘red hot’ labor market. At least that’s my understanding. A recession by definition is just a more pronounced slowdown.

I don’t pretend to be able to predict recessions either, but I follow some economic metrics to have some idea what is happening in the macro environment. In the classic definition; a recession is when there is significant decline in economic activity for two consecutive quarters as reflected in GDP, and usually accompanied by declining employment, incomes, wholesale-retail pricing, and industrial production. Typically in a recession you see GDP drop below zero, like we saw in the first 2 quarters of 2020 when COVID broke out - which was effectively an exogenous event followed by extraordinary monetary intervention, which is why the economy bounced back so strong.

This is the Govt’s GDP site: https://www.bea.gov/news/2022/gross-domestic-product-fourth-…

In the current economy the issue is demand driven inflation, caused by a few different factors I’ll explain further on. But the key metrics are that unemployment is at 50-year lows, with about 2 jobs available for every 1 unemployed person, wages are rising, and the average S&P 500 corporate net profit margin is over 12% after taxes, which is the highest profit margin relative to GDP in the past 80 years. These are not recession-type figures.

The events of the past two years were in uncharted territory. The Fed caused the 2008 recession, at least in part, or at minimum they made it worse by under stimulating and moving too slow. With that backdrop the Fed overreacted when COVID hit. Without going into too much detail, they over stimulated, and the combined effects of the stimulus (with nowhere to spend the cash), plus massive layoffs from the shutdowns, plus the pent-up demand after nearly 2 years of being shut-in caused a massive spike in consumer demand for goods and services. Corporations couldn’t scale up fast enough to deal with the spike, so supply fell short of demand.

Common supply and demand economic theory, taught in schools, tells us when demand is greater than supply, prices go up. Adding to the supply shocks, after the Oil crash of 2018-2020, a lot of Oil producers went bankrupt, and the oil cartels are refusing to pump more oil, so demand/supply = higher prices. Add in the war in Ukraine, and you have more pressure from rising energy costs. But there’s even more still! The Federal minimum wage has been $7.25 since 2009, a poverty level compensation even back then. So with the stimulus cash in their bank accounts, the great COVID resignation ensued, and others simply refuse to go back to work for poverty level wages, so corporations have to pay higher wages, which further fuels inflation.

To tame inflation, the Fed is raising rates and unwinding their bond buying, which are the only levers they have. But Wall Street thinks the Fed will overshoot. As the saying goes, bull markets never die of old age, they are killed by the fed. Realistically, interest rate hikes take about 3-6 months to work through the system, but because they are behind the curve the Fed is being hawkish and vowing to move fast to vanquish inflation. Ergo, Wall Street thinks the Fed will crash the economy and cause a recession. But it is not a foregone conclusion, in fact, there is reasonable doubt that a recession is imminent. Yet, there is enough uncertainty for Wall Street to shun risk and head for safer ground until the dust settles.

[gerrard87]

I think the market has simply priced in a “soft landing”, but it doesn’t seem so sure anymore.

“Powell Warns Soft Landing Could Be ‘Quite Challenging’”
https://www.cnbc.com/2022/05/12/powell-says-he-cant-guarante…

The next meeting is in June? That will cause growth stocks to fall further. Be prepared with your great growth stocks!