Tech Layoffs and Tumbling Crypto

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It'll be similar to the 1974 recession where you had a slip in economic output or a drop in GDP, but you were actually still adding jobs.

Welcome to the Barron's Streetwise Podcast. I'm Jackson Cantrell in for Jack Howe. The voice you just heard is Jose Torres. He's the senior economist at Interactive Brokers. This week, another wave of tech layoffs as Meta cuts 13% of its workforce. Meanwhile, strong October jobs numbers from the Labor Department. Are the wave of tech layoffs a blip amid a strong job market, or will they soon start to bleed into other parts of the economy? We'll hear from Jose and a top private equity manager and my Barron's colleague, Alex Yule. But first, an update on the latest crypto fiasco. Listening in is our audio producer Meta. Hi Meta.

Hi Jackson.

Now I just wanna make it clear to listeners, you are not laying anybody off. We're talking about Meta, the tech company formerly known as Facebook.

Right.

Okay, well we'll get more into layoffs in a moment, but I first wanted to start with crypto. This week, one of the most prominent exchanges in crypto, FTX completely collapsed. The fallout wiped off tens of billions of dollars in the crypto market and left users of FTX unable to withdraw their funds. Now, the collapse involved two companies, both founded and owned by crypto billionaire Sam Bankman-Fried: one, a crypto exchange called FTX, and two, a crypto trading firm called Alameda Research.

They're separate entities, and he's stressed that plenty of times, that they're kept at arm's length because you can't really have an exchange and a trading shop being too close. But he does own both.

That's Adam McCarthy. He's a reporter at the digital asset publication The Block. Last Wednesday, a leaked balance sheet showed most of Alameda Research's assets consisted of something called FTT. That's a cryptocurrency created by FTX, which is supposed to be separate from Alameda Research.

So while they're kept separate, the fortunes of Alameda kind of relied on the fortunes of this FTT token staying at a high level.

Unfortunately for FTX and Sam Bankman-Fried, FTT did not stay at a high level. The token is neither widely held nor widely traded. So when the CEO of the world's largest crypto exchange and FTX competitor Binance announced it would sell its FTT tokens, the value of FTT plummeted from $20 to below $5. By Sunday, panicked traders on FTX's exchange requested to withdraw over $5 billion from the platform. The problem was FTX didn't have the cash to return their money. The Wall Street Journal reported that FTX had loaned money to Alameda Research using customer funds. Sam Bankman-Fried tried to raise money to rescue FTX by selling the exchange to a rival, but that deal fell through and customers were left in the cold. On Friday morning of this week, FTX announced that both it and Alameda had filed for bankruptcy and that Sam Bankman-Fried had resigned as CEO. FTX and Alameda did not respond to our request for comment.

It seems like if you have money on FTX at the moment, you can't really get it out. It's kind of stuck there. So there's a lot of people trading on FTX. Which still has 6% kind of market share when it comes to exchanges globally. But people are trading with the money as if it's sort of monopoly money right now because they don't know if they'll be able to get it off.

It's not just FTX's users who are out of luck. Back in January, the company raised $400 million at a $32 billion valuation. Other FTX backers included football star Tom Brady and Sequoia, the venture capital fund. In a statement released Wednesday, Sequoia said it was marking down its $210 million investment in FTX to $0. A profile of Sam Bankman-Fried recently disappeared from the Sequoia website, although you could still find it in Internet Archives, and I think it's worth a read. It included an anecdote about Bankman-Fried's pitch for a crypto super app that blew the partners away. Quote, it was one of those your hair is blown back type of meetings. The profile then goes on to say that one partner was even more impressed when he realized Bankman-Fried was playing the video game League of Legends during the entire pitch. It also mentions a, quote, meme round of FTX fundraising that brought in $420.69 million from 69 investors. What would lead investors to participate in something called a meme round? Well, Adam, the reporter at The Block, says one thing that drew investors to Bankman-Fried's FTX exchange was access to FTT tokens. Yeah, the same tokens that helped tank the whole exchange this week. In addition to a stake in the company, FTX's investors received FTT tokens that could lead to a quicker payout.

When they're going out to investors, they'll say, we can offer you this and also offer you FTT token that will vest over time. And, you know, if you believe in us, then you can start selling that FTT token, which is highly liquid. It's quite attractive if you're an investor or VC.

According to The Wall Street Journal, FTX's sister company, Alameda Research, also got into trouble by investing in something called yield farming. That's where crypto users can invest in tokens that pay high interest rate-like rewards in exchange for locking up cash for a period of time. Those yield farms didn't seem to have any trouble paying out interest to the yield farmers, at least as long as the value of crypto kept going up. But when the music stopped, it led to a collapse in crypto firms like Celsius. Here's Adam.

For a guaranteed yield they were promising at the time of like 8 to 10%, At the back end, then they would take that money, and they'd lend it out to borrowers, which happens in traditional banking. But the problem with crypto was that there were so many crypto lenders in the space that some borrowers that are now bankrupt or going through the process of bankruptcy were borrowing it out at way too low rates. Or some lenders told me over the summer that it was a toxic environment for borrowing rates. And they were pushing down the rates, which put pressure on other lenders to push down the rates, which meant that weren't actually bringing in enough money to make these yields. So then some of the crypto lenders had their own internal trading teams trading to try and make up the surplus. And when prices went down and volatility crashed, the whole thing kind of fell in on itself.

Meta, this yield farming seems a bit odd to me. You know, my kind of yield farming, 2-year Treasury bonds, they're paying over 4% right now. Thanks for that, Meta. Now on to tech layoffs. Meta's announcement this week to cut 11,000 workers brings the year's total tech layoffs to 119,000 employees across 776 companies. That's according to the tracking website layoffs.fyi. Amazon also announced a hiring freeze this week. Investors took both moves as positive signs for the businesses. Meta stock was up about 20% this week and Amazon was up about 10%. I thought I could use a tech industry refresher, so I sat down with Barron's deputy editor, Alex Yule. I started by asking about what he learned from last month's tech earnings.

In terms of tech earnings, I think there were a, a bunch of lessons that we were able to take from them. Which is that there really was no place to hide in tech. And we saw that from the big tech earnings, which were largely disappointing. The one area that was thought to be insulated was the cloud, but it turns out that cloud growth is slowing too. You know, it's still growing 20, 30%, but it's not growing what it had been. And that's why we saw these huge sell-offs in the stocks of Amazon, and Microsoft, and even Alphabet to some degree, all of which have these big cloud businesses.

And how important was the cloud to those, the stock moves we saw in those businesses over the last 5 years?

That's a good question. I would say very important, especially for Amazon. You know, what really got Amazon stock moving again in, say, 7, 8 years ago was when the company started breaking out the profits for AWS, or Amazon Web Services. Until then, it was really this unprofitable e-commerce company, and no one knew how much the cloud was worth. But the second Amazon finally decided to show people how much money they were making in AWS, the stock took off and really continued growing right through the pandemic. So I think AWS was the most important piece of Amazon's stock surge in recent years. And we saw a similar thing with Microsoft when they brought on their new CEO, Satya Nadella, back in, I think, 2014 or 2015. He had come from their cloud business, and he really has worked hard to remake the company as a cloud business. Microsoft Azure, which is kind of the number 2 player to AWS, has also become hugely profitable. And, and, and really changed the kind of company that Microsoft is. So in both cases, I, I think for the, the real profits and the real growth was coming from the cloud. I don't think that's gonna end, but we did see for the first time some slowdown in, in the growth, and that really spooked investors.

What did people attribute the slowdown to?

So largely, I think it turns out that the people paying to use the cloud are businesses with employees, and it's bought on a consumption model, essentially, not that differently from how we buy electricity. So if your business is slowing, you maybe are spending a little bit less money in the cloud every month now. And I think that's what we started to see this last quarter, is that the cloud is still a great tool and a great business. But if you're just— if your own business is slowing down a little bit, or maybe you have a few less employees, you're probably going to be spending a little bit less to run your operations in the cloud, to run applications, to do all these other things. And, and that did make a difference.

And were there any other surprises from tech earnings?

I'd say another thing we learned is that one of the weakest parts of tech right now, which is e-commerce, maybe isn't quite as bad as everyone had thought. I mean, Amazon stock took a big dip, but that was largely because of its cloud business. A lot of pure-play e-commerce companies like Shopify and eBay actually had really good quarters. So it's possible that e-commerce has kind of bottomed a little bit and that people are going to still spend money online. I think one thing to be mindful of though is, is as bad as earnings looked right now, the fundamentals still aren't really what's moving tech stocks. And we saw that very clearly on Thursday when the NASDAQ was up more than 5%. It wasn't because suddenly the world of tech and the fundamentals look so much better. It was because the inflation print, the CPI, was a little bit less than expected. If inflation has truly peaked, perhaps that means interest rates have peaked, and if interest rates have peaked, then suddenly this real headwind for tech stocks, which is higher interest rates, may finally be abating. So I think it's important to remember that if you're a tech investor, the biggest headwind in the last year has still been interest rates, not as much the economy. And the biggest tailwind probably for the next few months is going to be a reduction in interest rates if we get it. I still think down the line you've got to worry about the fundamentals, but right now, if you're an investor, the, the thing that is moving tech stocks the most is interest rates.

We've heard from a number of different people that the time to back in, like don't buy back into tech stocks, don't bottom fish until the Fed stops raising rates. Do you agree with that or do you think there's more nuance there?

It's a great question. If rates have peaked, should we now finally be buying tech again? Should we be buying on the dip? I think dip buying is dangerous. This feels a little bit still like a bear market rally to me. I don't think it's rational when stocks and indexes go up 5%. It suggests there's still a lot of volatility in the market and we may not be done with this unhealthy buying and selling pattern. I think it's just as likely we're going to see big falls in the coming weeks again. I do think peak inflation though at least starts to get certain businesses interesting again.

Thanks, Alex. Coming up, an economist who thinks the worst for stocks is yet to come. And a private equity fund manager on why he's investing in truck parts and seafood. That's next after this quick break.

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Tech employment is drifting lower. We are seeing layoffs, but there's so much labor availability in other sectors, so it's safe to assume right now that a lot of those tech workers can find jobs in other areas, right? And if you're a tech engineer in Silicon Valley, you can go work for industrials, for another sector, and that's what we're seeing. You know, almost every other sector, whether it's manufacturing, professional business services, transportation, leisure, and hospitality are showing big labor shortages. So I think that those layoffs and that labor weakness is isolated to the tech sector, and I don't think it's going to spread to other sectors.

Jose says that while the job market looks strong, there are signs that consumers are slowing down their spending, and that will likely hurt company earnings and stock prices.

Credit card bills are piling up rapidly. Consumer sentiment and personal savings are at recessionary levels, levels consistent with the 2008 Great Financial Crisis. So the consumer is certainly under a lot of stress, and eventually the consumer is going to buckle and demand is going to weaken significantly.

I asked Jose if it's time to buy the dip in stocks. He says no. He thinks declining earnings will push the S&P 500 to a low of $3,200 next year. That's about another 20% below where it is today. He says this is not a buy-the-dip market, it's a sell-the-rip one.

Until the Fed gets what it wants on inflation, it's very easy to get into trouble in the equity market. And when you're used to seeing a stock trading at $400 or $500 and now you're seeing it at $100 or $200, it's very tempting to go in there and say, oh, wow, look, I'm buying on sale. But it's very, very difficult to catch a falling knife.

Jose also says rising interest rates will crush the real estate market. He predicts a decline of 20 to 25% from where we are today. He says a pullback in home purchases and construction is starting to drag down other areas of the economy.

Some folks in the economist community believe that real estate is the economy because of all the parts, all the moving parts that need to work and coordinate together so that a construction project gets done or a home purchase gets done. We're talking about materials purchases like lumber. We're talking about commodities, durable goods. Once the house is purchased, folks typically splurge on new beds, furniture, sometimes automobiles, appliances, right? Everyone gets paid when there's a real estate transaction.

I asked about where investors should look over the next few years to find the best returns. Jose says not big tech.

Once this bear market is over, if we're in a new higher-for-longer rate regime, I don't expect big tech to be the leadership of the new bull market. Typically, in inflationary times, you have different leadership. Leadership may come from energy, materials, industrials, pockets of real estate, defense sectors like consumer staples, healthcare, and utilities, sectors that can compete with high fixed-rate payments that the bond market offers. Have a 10-year above 4%, 2-year above 4 or 5, you have to compete with those assets. So when you have a tech company trading at 100 times earnings, you got to wait 100 years theoretically to get your money back. Whereas if you have a bond paying 4%, you have to wait 25 years to get your money back. And that's the simple math as to why higher rates make tech companies look less attractive.

Thanks, Jose. Now, I caught up with someone who invests in the kind of businesses Jose was talking about, companies that make cash right here, right now.

I'm Dave Teya. I run the North American private equity business for Investcorp, and we're buying established businesses that are cash flow positive.

On this podcast, we've been talking a lot about macroeconomic factors like inflation and interest rates. Let's shift to the micro. Investcorp takes an active role in the businesses it buys, so Dave has a window into business trends, consumer demand, and hiring across a number of industries. I asked him about hiring. Most of the businesses he invests in are looking for workers.

Within business services, we invest in a lot of professional services companies, consulting firms, strategic communications, tech services, consulting, etc. So kind of high-end, high-value-add, more white-collar services. And then we also do a fair amount in industrial services and supply chain, which tends to be more of a facility, warehouse facilities, truck drivers, And on both ends of the spectrum, you know, hiring was very, very tight a year ago. And as I said, depending on location and specific role, it can still be quite tight, but not, not nearly as tough as it was a year ago.

I asked Dave if he's seeing any signs of weakness from customers. He said not really. He actually expects some of his businesses to do well as customers pull back, like car and truck parts, which tend to do well when new car growth slows. He says customers in the seafood business are price sensitive, but that's more due to supply and demand than a pullback across the board.

I'll give you another example. Scallops, the price of scallops had gone up dramatically, pure supply demand. So the volume's gone way down. You know, the buyer's basically saying, I'm just going to substitute scallops for something else.

Dave says he's staying vigilant. He expects there to be a lag between when rates rise and when their impact flows through to the economy. He's telling CEOs to continue to budget based on micro-factors like customer demand, but also to look out for leading indicators in case the economy slows. He also says it's important to have free cash.

You have to have liquidity. Cash flow is paramount. I'm not a crypto guy, but this whole FTX thing, I don't understand the details. But again, it seems like another example of some combination of too much leverage and/or too little liquidity. That's what creates a really, really difficult situation. If you have cash, you've got a chance to live to another day.

Thank you for listening. Jack Howe will be back next week. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. Write us a review, tell your friends, tweet @jackhowe, and tell him you miss him. See you next week.

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