Tech Recession – How Bad Can It Get?

The last few months have taken a toll on the technology industry globally. Valuations are down in some places in excess of 70 percent, and it’s not clear that the worst is over. The recent turmoil drew to a close an unprecedented period of prosperity for tech companies large and small – it’s furthermore not certain when such prosperity will return or what things will look like in the coming years. But as with many cycles, it’s this author’s view that this may become a defining moment for those companies that have the resilience to survive and seize opportunities amid the current storm.  

What has happened in the last nine months? Beginning with a climb that we can probably trace back to the end of the Great Recession in 2009, technology has been growing pretty much unabated for over a decade. The bull run really picked up as today’s mega-technology companies (e.g., “FAANGs”) increased momentum in the mid-2010s – particularly with the emerging dominance of social networks such as Facebook, app-platforms such as Uber, and the inexorable growth of mega-platforms such as Google and Amazon. The 2010s began with an assumption that tech wasn’t for serious businesspeople; the decade ended with a rage for tech unseen since the dot-com era in the late 1990s.  

But things changed in the decade of the here-to-now Roaring 2020s. In 2019, there were indeed excesses in equity funding, exemplified by bloated firms such as WeWork. But those excesses were few in number and funding was still largely tethered to intrinsic business value and investors’ judgment that there was a good chance of economic success in the long-run. Such sobriety went out the window with COVID. The combination of massive fiscal stimulus following COVID-19 across much of the world and near-negative interest rates led to huge inflation in public equity valuations and corresponding inflows into venture capital, which led to overcapitalization across the board. Excesses and bad ideas (the worst of which emerged alongside cryptocurrencies it now seems) unfortunately gained prominence, setting investors and organizations up for failure.  

With the tide now going back out to sea, we can expect a few things – and a few of them are unique to Latin America versus the broader global economy. Recessions often if not usually lead to reductions in capital availability, even for strong businesses. The dotcom crash in the late-1990s torched funding for startups and the Great Financial Crisis obliterated debt capital markets for all but the least-risky corporate borrowers for years. Unsurprisingly this time around, capital already has grown scarce for many, yet likely in new ways. Along with young, unprofitable companies suffering from excessive burn for their stage of maturity, it appears that cryptocurrency-related firms will be profoundly impacted by a newfound lack of capital access for some time to come. This follows the pattern from prior crises in which “new” asset classes (i.e., tech in the 1990s, junk bonds in the 1980s, and securitization in the GFC) are most negatively impacted following a major crisis. Capital available for technology investment has also been negatively affected by the new conditions, but there’s nuance to the drawdown – specifically, later-stage, pre-IPO funding has fallen most precipitously, while earlier-stage (pre-Series B) funding remains available to companies with strong teams and good prospects.  The tide has gone out but not everyone is naked – and it’s apparent that the tide will come back in due time.  

In technology in particular, the new normal has been accompanied by cost-cutting measures in firms mature and immature, alike. Prominent examples abound in the US, and even powerhouses like Facebook and Google have indicated that they will likely have to prune costs in the near future. This is ultimately healthy because technology companies had largely postponed profitability and healthy earnings too far into the distance in the all-too-powerful low-interest rate environment. Stable, stronger bottom-line earnings performance will indeed be among the key factors that will lead investors back to bullishness when the business cycle turns for the better in coming months (or years). 

But as usual, Latin America is not in perfect lockstep with the rest of the globe. With some prominent exceptions, equity funding in Latin America never reached such nosebleed heights, gross excesses never became so routine, and costs never reached such bloated extremes, compared to Latin America’s developed-economy peers. At the same time, headwinds have accelerated in China and East Asia due to geopolitical reasons. The upshot is that investor sentiment has persevered in Latin America, particularly Brazil and Mexico. But the region is not monolithically puppies and unicorns. There are indications that Latin American technology firms have been too sanguine about the depth of contraction and it appears that cost-cutting measures among Latin American tech firms have been shallow and idiosyncratic. It’s likely that more pain lies ahead for these companies, although a faster return to bullish investor sentiment could cushion any blow. At the same time, this presents an opportunity for great companies to snap up talent and grow with less competition. 

Other dynamics complicate what’s happening in Latin America compared to the global economy. A predictable flight to quality – as always to US Treasury bonds, but stronger than usual – has created an atypical surge in the value of the US dollar, which is destabilizing some economies where US currency reserves are thin and imports are significant. And some political developments in South America are creating pessimism for entrepreneurs and investors alike – particularly in Chile and Colombia. Yet not all is foul in Latin America, and positive trends are at work in some important instances. For instance, nearshoring – a recent surge in the creation of supply-chains in the Americas due to geopolitical risks in Asia – is driving meaningful growth in US-adjacent markets, particularly in Mexico. It is likely that the 2020s offer a unique opportunity for secular, economic growth in Latin America due to resource scarcity and some geopolitical good fortune for these natural neighbors and allies of the US.  
Of course, we can’t know exactly what will happen even in the near future. It feels likely that the actions of the US Federal Reserve will perpetuate financial anxiety worldwide, which will lead to, at best, tepid results operationally for most tech and nontech companies. Some knock-off weakening in corporate earnings due to diminishing consumer and enterprise budgets appears likely for the next few quarters too – and stock indices could fall further as a result. But much of the damage is already done. Some companies will fail, yet in some markets, falling competition presents a real opportunity for resilient companies. When we look back on this moment, it seems likely that at least some well-positioned firms will seize this unique moment to grow amid retreating competition, and the hallmark companies of tomorrow could emerge in due course. Amazon’s emergence from the rubble of the dotcom era could be a pattern that recurs in the near future. And as some wise man has said, the key to success in business is to not go out of business. Perhaps it’s true that only the strong will survive today’s challenges, but also that those that survive may indeed become stronger as a result.