The World Might Be Sliding Into Economic Contraction—Here’s What That Could Mean For Business
We don’t often see economic shifts like the ones we’ve had in early 2022.
Throughout the pandemic, the Fed kept interest rates near zero, so liquidity was high. The stock market saw some artificial surges. This, and the fact that it was impossible to leave home safely, enabled people to spend a lot more money than they normally would on goods (think $500 air fryers).
But as COVID-19 recedes into the background, a whole new slew of economic challenges may be on the horizon.
The war in Ukraine has put incredible pressure on commodities and is driving more inflation. To combat this, the Fed has begun hiking interest rates, making capital less affordable. The housing market, which saw record levels of volume during the pandemic, is finally seeing slowdowns in both refinances and purchases.
These aren’t the kinds of problems that get solved overnight.
If the U.S.’s last significant period of inflation—the early 1980s—is any indication, we could be in store for a lengthy recalibration (that took about two years). And just like last time, there will be winners, and there will be losers.
Who might thrive?
- Consumer staples. People buy things like toothpaste, paper towels, and razor blades regardless of the economic climate. In tough times, necessities become priority #1. Remember COVID hoarding? I doubt if we’ll see that level of anxiety-toilet-paper-buying again, but we’ll see a similar instinct spread out over a much longer period of time.
- Low-cost, high-margin products. Low cost and high margin is usually a recipe for success. In times like these, it’s a recipe for survival. Most companies will see rising commodity costs eat into their margins. But the companies with the most COGS (cost of goods sold) padding will absorb the shock.
- Products that aren’t hit hard by commodity price spikes. The less a company depends on scarce commodities, the more easily it can weather a commodity-related storm. (Fortunately, Hydros falls into this category. We use some stainless steel mesh in our filters, but that’s a relatively minor expense.) If you rely heavily on things like metals, oil, and/or microchips, you’ll have a very tough time making it through two years of contraction. The other side is that while your manufacturing costs soar, your market will shrink. I’ve already seen certain brands drastically reduce their prices to try and hold onto their consumer bases. That kind of fix may work for a little while, but not for the long term.
- Mass-market products. Something like Kleenex is essentially consumer DNA. It’s priced in such a way that most people can buy it without a second thought. If your system is geared to this level of spending power, you’ll be fine.
- Experiential products and services. People are ready to get out of the house. They’ll be interested in going to movies, staying in hotels, having experiences, renting Airbnbs, and so on. They might also be buying more cosmetic products and clothing as they spend more time out and about.
Who might suffer?
- Nice-to-haves. The Peloton saga is a perfect illustration. The pandemic turned Peloton into a phenomenon. Demand spiked, so they overbuilt their supply chain, amassed too much inventory, hired lots of people, raised a bunch of money, scaled up, and then cratered when vaccines started circulating. Not only was Peloton geared to pandemic-driven demands, but it’s too expensive to sustain a broad market. As people tighten up their belts, spending thousands of dollars on bikes, shoes, and membership fees just isn’t feasible.
- Mid-market products. In other words, the space between ultra-high-end and mass-market products. Very wealthy people don’t change their spending habits very much, insulating the products at the tippy top of the food chain. And necessities, as we’ve seen, have evergreen value. It’s the products in between that really hurt. Indulgences like $200 digital picture frames or $700 smart ovens. Things that the super-elite aren’t buying (or have already bought) and middle-class people and below can’t afford right now.
Nobody likes economic contraction, especially products built to survive in a super-liquid economic climate. But contractions are part of life, and after a period of difficulty, markets generally rebound.
If there’s a silver lining, it’s that hard times show you which companies are truly solid. If my vision is right, and recovery is a multi-year process, look who’s still standing at that point. It’ll be a good indication of actual value.
My advice to any business operators whose companies fall under the “who might suffer” heading is this: cut or defer any costs you can, consider letting go any nonessential employees, and prioritize any essential parts of cash flow.