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Comment by nostrademons | Hacker News Reader

The stock market, interest rates, and advertising spending are leading indicators, while unemployment is a lagging indicator.

Business leaders know the financial structure of their company, and many of them know that they can't survive at 2% rates, let alone 5 or 10% rates. The gloom from business leaders is forward-looking. They're fine for now, while consumer spending holds up and they can run on old debt. But as soon as they need to roll over their debt, everything collapses. They'd need to increase revenues by 2-5x, and they can't.

My prediction is that we drive off a cliff. CEOs know their companies can't survive high rates, so they manage as if a Fed pivot is coming. If the expected Fed pivot happens, they bank windfall profits and get huge stock bonuses. If it doesn't, they go bankrupt, everybody is out of work, and it is not their problem anymore.

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> But as soon as they need to roll over their debt, everything collapses. They'd need to increase revenues by 2-5x, and they can't.

That would imply that debt-servicing is their dominant cost. That seems wrong (e.g., a grocery store presumably spends a large fraction of its revenue on purchasing groceries from wholesalers).

Debt servicing is a constant thing for businesses to be able to make payroll and acquire inventory for later resale or processing.

Based on your thoughts here I'm going to assume you haven't worked at a small business before. If you have it must have been awesome to work at a place that didn't have to borrow money constantly.

I've worked in small start ups before, but all boot strapped out of pocket / revenue. Wouldn't having to borrow money constantly be a red flag that the business is bad / not profitable?

Depends. If your income comes in 90 days post invoice, but you pay monthly then borrowing some money to smooth over cash flow makes loads of sense. If you need to buy loads of stuff to sell, it also makes sense. Software businesses are pretty weird in the lack of capital costs.

An alternative to borrowing to achieve that smooth cash flow is treasury savings.

Being able to is actually a green flag. Banks wouldn't keep lending it if the companies didn't pay it back. This isn't VC we're talking about here.

Interesting, I can see this as lending implies some due diligence into a companies financials. At the same time, at the personal level, I know I can get lines of credit that would be very tough for me to pay back. Is corporate borrowing much more stringent?

That isn't quite right. What it implies is that debt service is a significant fraction of their margins, which is a subtle but actually quite significant difference.

If a grocery store makes 1% profit on each item it sells, and its debt service cost is 1% of its revenue (making it roughly "1% of its cost") a doubling of debt service cost wipes their margin to zero.

But only requires 1% increase in revenue to sort out.

No! A 1% increase in revenue in this situation does make you profitable again, but only barely, and only with some possibly invalid assumptions.

Say you make $100 in revenue and $1 in profit, and $1 of your $99 in costs is debt service. Your debt service increases to $2, your profit drops to zero.

Now your revenue increases to $101, presumably your debt costs stay fixed (this is not a guarantee - revenue expansion costs money), but your non-debt-service costs scale as well, and they are now 0.98 * $101 + $2 in debt service = $101.98. Congratulations, your profits are positive again, but they are $0.02.

I am eliding here the general difference between fixed costs and variable costs, and so it's probably not true that your costs would scale quite this much with revenue, but it's much closer to the truth than that you'd be back where you started, esp. in a low margin business.

There's a reason margins are what they are in a competitive market. "Your margin is my opportunity," as Lord Bezos famously said. Only companies that have captured their market get to raise prices to cover new costs, and all it does is induce people who want to own that margin to find flaws in the business model. This is how Netflix wrecked Blockbuster, and how Amazon killed off chain bookstores.

The companies that are going to hit hardest are going to be in stuff like commercial real estate. That's where people have been flipping loans over at 1% interest rates in order to survive, living on the margin. As rates go up their debt service balloons and they'll no longer be able to survive given their vacancy rates.

That'll spill over into losses for the financial sector, possibly a CMBS meltdown and a financial crisis, which will spill over into the real economy.

All the job losses in housing and real estate and the hit to the financial sector will result in unemployed people who are no longer buying stuff so you'll see a contraction in everything consumption related. That'll lead to much lower ad buys, so that'll hit the ad companies. They'll all layoff staff which acts as a positive feedback loop.

Right now mostly we're just seeing companies whose CEOs see this coming down the pike who are laying off some staff early and trying to position better for the recession.

It isn't correct to say that e.g. Google's business is reliant on them flipping over loans cheaply, but they are certainly dependent upon other businesses in the economy being able to flip over loans cheaply.

Google the term "zombie company"; you'll find a lot of interesting stuff.

Bear in mind HN's view of the business world and profit margins and expenses is heavily skewed by the industry we work in, which remains one of the most profitable in the world across a wide variety of subsectors. The profit margin an incredibly profitable grocery or shipping company might have would be considered a danger flag for a tech company, and I don't just mean the big ones, either. A profit margin of 5% is not uncommon and 10% is doing extremely well for most businesses. It's easy to look at numbers in the millions or billions and think they can take anything because in absolute terms on a single human's scale they've got more money than you can imagine, but it doesn't necessarily take very much by percentage points before the profits of a normal company go "poof".

>they manage as if a Fed pivot is coming

We can't argue this both ways. You can't argue that business leaders are acting as if the fed will pivot away from the current course when the parent is pointing out that they are all tightening in preparation for more to come.

Sure you can. They are expecting the tightening to be short lived. As they said, the companies can survive a few years but if rates stay high longer than that and don't come down it'll be bad.

It's different business leaders. The ones who expect their companies to survive are tightening their belts now, to give themselves the runway to survive. The ones that understand that their companies are dead anyway if borrowing costs skyrocket are spending like they won't skyrocket, because otherwise it doesn't matter. The former group is preparing to lose the latter group as customers.

You see this in the media too - some business leaders (often in tech, or finance) are predicting doom and gloom, while others (like in retail or experiences) are saying that it's business as usual and they haven't seen a downturn yet.

This seems overly pessimistic. I'm sure a high rate environment isn't ideal for a lot of businesses, but we've had much higher rates in the past and most businesses survived it just fine.

You're totally right that business can thrive in a high rate environment, but we have a LOT of them right now whose existence has been sustained due to the low rates, extending all the way down to proper zombie companies. A lot of those will be killed by rate hikes, but that's actually a good thing in the long run.

Those businesses were the ones that were either created in that environment, or who survived it long enough. The last time rates were this high, they were this high for decades.

I fear the cliff scenario because a lot of business models now were built on a foundation of crazy-cheap debt. The tide is about to go out. Eventually the business environment will re-adjust to the new cost of money, but the transition will be tough.

What rates are you referring to?

https://fred.stlouisfed.org/series/fedfunds

Last time fed funds rates were as high as they are now was Jun 2019. And then a few more times before that.

Look at the 3-month (90-day) commercial paper rates. They're split into different data sets on the FRED site[0][1], changing in 1997.

I combined them into a single chart here: https://ibb.co/h7c7DJS

(Is ImgBB a good site? I stopped using imgur after too many dark patterns)

[0] https://fred.stlouisfed.org/series/WCP3M

[1] https://fred.stlouisfed.org/series/DCPF3M

Seems like it came down after 2007 and 2000 highs at similar levels. But who knows, maybe US government will leave it high. Maybe they will bring it back down to juice asset prices. Maybe the parameters of the world have changed to not allow that.

> maybe US government will leave it high

Although the Fed can backstop commercial paper in emergencies (and they did so at the beginning of the pandemic), it's extremely unlikely that they start taking on enough to move rates in the medium term (like they did with mortgage backed securities). So this is not a rate that the government controls except very indirectly.

We had a taper tantrum in Jun 2019 - the commercial paper markets almost seized up, and the Fed started dropping rates then, a good 9 months before COVID. That's what business leaders remember. We couldn't service 2.5% rates in 2019 (actually more like 2%, it takes time before companies need to rollover their debt), it seems extremely doubtful that we can service 3.25% now.

What do you mean by crazy cheap debt? If you have a loanable funds model where all money that is not being spent is being saved then the interest rate is 0%.

The fact that people don't save the money they don't spend has more to do with how cash works and how it makes it pointless to save.

>many of them know that they can't survive at 2% rates, let alone 5 or 10% rates.

From your perspective, what is the underlying reason they cannot survive without excessively low rates?

Your last statement feels like it's primed to hold the Fed hostage, which is worrisome.

I would say it's like the panicking homeowners that took variable rate mortgages(business take on a lot of debt to expand) and now their mortgage payments doubled(and also the bank demands extra lump sum payments in addition, because the monthly is only enough to payoff the interest not the principal). Now they need to make x2 of their current salary otherwise they loose the house.

I'm not the OP, but there is an idea in bushiness that a company has to have a percentage return on the equity invested. That rate goes up when interest rates go up. Otherwise you could just sell the equity and buy corporate debt instead.

If too many companies can't survive and start to go bankrupt, the Fed will pivot. If we enter a major recession, high inflation will most likely be over.

Easy enough to see which public companies have this debt, when their debt obligations are due, and what their historical expenses, revenue, and cash on hand are.

Could probably script this and build a report. I'm not going to do this (I'm working hard and can't afford to be nerd sniped), but please share if you build this. After buying your own positions, of course. :)

You are thinking of nominal rates, but you should be looking at the real rate, which is the spread of the interest rate over inflation. They can survive 5-10% rates just fine if inflation is 8%. They don't need to raise revenue 2-5x to make coupon payments, because interest isn't their entire cost structure.

Some can - the ones with pricing power. Inflation hits the economy unevenly. Firms with few competitors can raise prices at will to soak up all the extra money floating around. Firms in highly competitive markets cannot raise prices, because as soon as they do everyone moves to a competitor.

The problem is that the ones with pricing power are generally not the ones with high levels of debt, because if they had pricing power, they wouldn't need debt. They may be customers or suppliers of companies with pricing power, though, which forces the latter group to assume lower revenues in the future because some of their customers may go bankrupt.

This is a very spot on analysis. I was wondering why the stock market keeps closing green, when high interest rates discount future values/cash flow. You'd expect it to close red, but as you mention the markets are hoping for a Fed pivot. It is effectively a soft pivot by the Fed.

Is there any indication that ad spending LEADS consumer spending?

I can't imagine why anyone would turn down ads while ROAS is blazing.

Marketers / ad people - is this common? If so, why?

When companies start trimming their budgets ads are first on the block. I've been in an advertising adjacent field for over a decade and ad spends always decreased prior and at the start of economic downturns and recovered earlier than other macros. My personal experience currently is that budgets and projects are down quite a bit at the moment (a small uptick currently but some of that is seasonal).

This. As someone who analyzes ad spend as part of their job I cannot imagine a scenario in which we would turn down ad spend prior to a downturn in consumer spending? If we're getting good ROAS we aren't turning off the hose.

To give OP the benefit of the doubt. Maybe what OP means is that Ad Spend is one of the first lagging indicators to show up. Consumer demand weakens, companies turn down ad spend, and then a few months later the reduction in revenue shows up in the quarterly report. So as an indicator it leads earnings reports and share price drops but lags actual consumer spending.

It's not a boolean answer. Businesses have the capacity to respond without completely going out of business.

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