David Foster Wallace in his seminal commencement speech in 2005 said, “There are two young fish swimming along when they meet an older fish who asks them ‘How’s the water?’. After swimming along awhile, one of them looks to the other and asks ‘what the hell is water’?”
We live in a world where living standards have steadily increased, but incomes are less predictable. Financial markets are increasingly erratic, and even though competition has spawned and inspired new technologies at breathtaking pace, the economic adaptability that has come along with it seems to inflict the very insecurity we deplore.
Hardly any company is immune from large-scale layoffs, which is now what is underway in much of the technology space, along with other industries as inflation has reared its head. Asset prices have become fragile and subject to shocking selloffs as seen last week, because of liquidity dry ups.
Long used to an environment of zero interest rates (where asset gains were acting as the engine for consumption, even as salaries and wages more or less flat-lined), employees now face increasing uncertainty as business models return to the first principles of a ‘cost plus’ mentality, where bottom-lines matter again, undoing the earlier mantra of ‘extend and pretend’.
Job insecurity has moved up the income scale (previously confined to only blue-collar workers). The percentage of college graduates that have lost their jobs in the last two recessions has nearly tripled and encompasses all professions from accountants to analysts. Inflation, which stagnated asset values from 1965-1981 in most of the Western world, now threatens to repeat the cycle, leaving businesses scrambling for cash, as private equity funding dries up on the back of compressing valuations.
Illusory value gains
Against this backdrop, SMEs and individual investors (grappling with higher borrowing costs and mortgage rates) have made a dash for higher yielding assets, both in the capital markets as well as real estate. But there is little doubt as resources get squeezed, there will be a dampening impact, not only on asset prices but also in terms of the pace of innovation we are so used to.
In Dubai, despite liberalization of the labor markets, along with reforms to reduce costs of business enterprise, the pricing power certain SMEs feel that they may have experienced in the last year due to supply chain disruptions appears to be largely illusory as inflation continues to be stubbornly high. The paradox of valuing companies that showed losses as far as the eye could see was facilitated by a monetary environment where these risks could be taken.
Need to show profits
A glimpse back into the early days of technology reveals that when stalwarts like Apple, Microsoft, Lotus 123, etc., went public, they were already profitable, because that was what was expected by investors. Subsequent distortions in monetary policy led to the ‘new-new’ business model where profits didn’t matter anymore. It appears as if we are back full circle.
In the UAE, we have seen a pioneering spirit of these first principles being put into effect, where not only are SMEs being encouraged to tap public and private capital markets, but increasingly, listed companies are moving to offering higher cashflow yields for investors to protect their income streams. This is critical as the building blocks of the pension industry is put into place.
Comfort of predictable returns
Whilst there can be no protection from asset price gyrations, there can be comfort provided from investing into income streams where returns are predictable and can offset the corrosive effects of inflation. No one knows how long inflation will persist, but it does appear that the standard economic paradigms of moderate to even high price growth have returned.
Investors would be well advised to take cognizance as they plan for both household spending, on an individual level, as well as capital outlays on the SME front. There is a recognition that finance - which has become internationalized - is at the center of any economic growth engine, and access to these pools of capital democratizes the spread of wealth, insulating the sector from the virulent impact inflation creates.
Asset valuations are unlikely to match the torrid pace of the past, but with cashflow spigots, the UAE is creating an environment not only more equitable but also more sustainable for the median household. The message is clear: Cash (and profits) is the ‘new’ water.
- The writer is Managing Director at Global Capital Partners.
