By Michael McElroy and Lindsay Rusczak | Photography by Eric Waters
At the root of all business great and small, optimism grows wild. It’s an essential element of any healthy entrepreneurial ecosystem. Who would start a business without it? Who would pour all their time into a company in the tech, life science and other booming industries here unless there was real hope that their products could change lives, or that their ideas would generate perpetual growth?
Last year again suggested Durham’s optimism was warranted.
According to Downtown Durham Inc.’s 2019 annual report, the city continues to draw investors and talent. Some 23,000 people work downtown, an increase of nearly 5,000 over 2018. Downtown’s population increased by 2,200. Investment grew by some half-a-billion dollars, and Class A Occupancy rates remain over 90%.
The national economy numbers are seemingly just as sunny. Unemployment is at a historical low. Interest rates are low. And the Dow and S&P hit record highs to close out 2019.
But, there are other signs that dark clouds might be on that national horizon and that a storm might very well be coming.
Recessions reflect a world of infinite and volatile variables. Potential for a no-deal Brexit, trade wars with China, potential real wars with Iran, retiring baby boomers and a shrinking workforce – such widespread and diversified uncertainty tends to infiltrate the market.
But, the most alarming indicator of a potential recession was an arcane metric called the yield curve. The yield curve compares interest rates on short-term and long-term government bonds, essentially measuring the relationship between near-term and long-term confidence. The curve inverted last year, meaning that investors are less sure about tomorrow than they are about today, just like it did in the last seven recessions. And it inverted before the Great Recession in 2008, a collapse of financial institutions that drove people from their homes and jobs.
Even as the economy has now recovered, and even as Durham got through it relatively well, wounds heal slowly. But scars can also bring wisdom. And wisdom can temper fear. So, if a recession looms again, and the scars from 2008 still burn, then what can a company do to protect itself this time? We went straight to experts for some advice.
Campbell R. Harvey, professor of finance at Duke University’s Fuqua School of Business, established the yield curve as the prime indicator of recessions in a 1986 dissertation and is a founding director of the Duke-CFO Survey. Recent surveys show that more than half of CFOs nationwide expect a recession sometime in the next 18 months.
Though there were some warnings before the housing bubble burst in 2008, it still caught most people in the industry by surprise.
“The curve inverted in 2006,” he said, but “no one paid attention to it.”
When the crisis hit, he said, and “firms get hammered [and] start slashing employees, they go to their shareholders and say, ‘Look this was completely unexpected, we’re blindsided.’ And then all the CFOs say the same thing, and there’s safety in the crowd.”
That won’t happen this time.
“If there is a recession,” he added, “the CFO and CEO can’t say, ‘It was a surprise, we’re unprepared.’”
While business leaders can’t control the global forces like trade policy and the rate of growth, “they can have their firms in a position to have maximum resilience,” he said. “And they will be judged on that. They will be judged on their planning.”
What does readiness look like?
“If a company is thinking of expanding to a new plant or a new location, and they need to take significant debt to do that, they might want to rethink that decision,” Harvey said. “Is there a way to limit the amount of debt, which in a downturn would potentially put your firm at risk? One way to do this is to really take a look at your leverage and do a scenario analysis in terms of a sizable recession. It’s also possible to extend the maturity of your debt.”
Planning for a prolonged recession is sound advice, he said, but companies should not take talk of a smaller slowdown as a reason for inaction.
“It might be a regular recession, it might just be slower growth, it might be no recession,” he said. “It doesn’t matter. This is the time to take action, to have a strategy. The worst possible management is where you’re reactive, and you have to improvise in a crisis.”
A company should also “have liquid assets” and not be lulled by a selective look at economic indicators.
“Illiquid assets are really hard to sell in a recessionary environment,” Harvey said. “You take a deep discount. So, assets that are relatively liquid can be used to fill some gaps when the negative downturn occurs.
“Economic growth is relatively strong, the stock market is pretty high, everything looks really good. But it always looks good before a recession.”
He added: “If you are thinking of hiring new people, you might hire less or defer the hires. Like capital expenditures, capital is expensive. You scale back in these areas, and if enough companies do that, you actually get the self-fulfilling prophecy; this actually leads to slower growth. But this is the interesting thing: Suppose these firms just ignored these signals. They carry on, they borrow. Then they get hit with a recession. Then they have to slash employment, or they go out of business.
“Yes, this could be a self-fulfilling prophecy, and, what is meant to stave off a recession could lead to it. But that is better than a global financial crisis. Risk management can result in a soft landing.”
Joan Siefert Rose, the CEO of LaunchBio, which “identifies, counsels and supports high-growth, high-impact life science and biotechnology companies.” The Durham office holds monthly, widely attended Larger Than Life Science networking events at The Chesterfield.
The biotech and science industries are dependent on raising large sums of money and spending that money to develop their complex products, a model seemingly at odds with the guidance above. Does this calculus pose a risk during a recession when investors may be more selective, and companies are told to slow spending?
Perhaps, perhaps not, Rose said. The key, she said, is cash.
“Having cash on hand is crucial to being able to keep working on your science and to keep your team motivated. I don’t think it should come as a surprise that many science/tech companies have been focusing on fundraising last year and probably this year. You can’t just put everything on hold and then come back to it at a later date. You need to keep advancing the science.”
That also means securing relationships with existing investors and partners.
“That is probably what we are seeing most companies focusing on right now,” she said. “People are perhaps looking to do another round of fundraising while they can, while investors still have money to put into these companies. There is still a lot of activity out there right now.”
So plan, she said, but stay focused on what matters most.
“It sounds boring,” she said, but “what I saw in the last recession was that companies that continued to focus on their scientific advancements, managed their cash wisely, didn’t overextend themselves and maintained their relationships with existing investors are the ones that really came through.
“And in a lot of ways, they were stronger as they emerged from the downturn.”
Jurrien Timmer, director of global macro at Fidelity Investments, says that if a recession does come, it might also be an opportunity.
Some of the recent unease is, at least for now, smoothing, Timmer said. There’s a preliminary trade deal. War with Iran no longer looks minutes away. And the yield curve, tentatively, is no longer inverted.
“Most of the talk last year about recession risks were not really based on anything happening in the real economy,” Timmer said. “Unemployment is at a 50-year low, wages are growing at [more than] 3%, there’s very little problem with household debt: There is really nothing to point to on the consumer side.”
The yield curve was the big one, and now “that signal has been snuffed out.”
Partly as a result, the New York Federal Reserve has dropped the odds of a recession from around 40% to just over 20%.
“That doesn’t mean there won’t be a recession,” he said. “It just means perhaps there is hope for a short-term recession or that there might be opportunities if there is one.
“People extrapolate the past,” he said. “And because the last recession was such a bad one, people are still traumatized by that. People think, ‘We’re overdue for a recession, and look how bad the last one was, so therefore I’m going to get really nervous.’ But, to me, that is an oversimplification, because there are many recessions historically, but some are very minor that were barely felt in the real economy. Not every recession has to be a financial crisis.”
There are big differences between 2008 and now.
What turns a recession into a financial crisis, he said, “is when there is lots of pent up leverage and excesses, like we had in 2008. The banks had way too much debt, the households had way too much debt.”
“We don’t really have that this time. The households are clean. The banks are super clean.”
The growth in private equity is another key difference.
“There are more unlisted companies owned by private equity firms than there are listed companies in the stock market,” he said. “That used to be the other way around. Over the past 10-plus years there has been a very strong trend toward startups getting funded not in the public capital markets, but privately. There is still dry powder totaling $2 trillion waiting to be deployed in the private equity market.
“If we get a recession, there’s going to be a lot of players out there that are going to be waiting to scoop up these businesses. Because they have all this money waiting to be deployed, and a lot of them are just waiting for something good to come along.”
LaunchBio’s January event at The Chesterfield, “Looking Back, Looking Ahead,” seemed tailor-made for discussions about the fears of near-term slowdowns. But, bolstering Rose’s earlier point, the attendees seemed focused not on potential threats to their work, but on why it’s so important the work endures.
There was Erich Huang, assistant dean for biomedical informatics at Duke School of Medicine. He told the crowd that artificial intelligence was the future of health care. To get to that future, however, more work is needed, because while one day it might perform surgeries, today an AI surgeon would more likely cut off an arm.
And there was Samira Musah of Duke’s Musah Lab, which is utilizing stem cell technology to create model human organs, called “organ chips,” that can mimic the function of the real thing and be used for testing in the fight against kidney disease. The crowd nodded along, engaged.
Someone asked if these engineered organs could replace the real thing in sick patients.
Not now, Musah said. But one day? If some optimist chooses to pursue this particular future, courts investors, manages risk, survives whatever setbacks may come, great and small?
“Yes,” she said. “I could see that happening.”