Signs of a slowdown in growth are mounting, but it would be a mistake to ignore the silver linings that also come with it. Some very well-known companies, especially semiconductor manufacturers Micron technology (MU -3.69%), Tesla (TSLA 0.20%)and Google owner alphabet (WELL -5.81%) (GOOGL -5.63%) have already taken note of the difficult conditions ahead. Let’s take a look at what happened and why this isn’t all bad news for the markets.
slowdown is coming
Semiconductors are always considered a canary in the coal mine. So when chip customers see that end-user demand for their products is falling, the first thing they do is try to cut orders from chipmakers because they don’t need to replenish semiconductor inventories at the same rate. That’s why the market came under so much pressure when Micron’s third-quarter earnings report came out in late June.
Micron sells memory and memory chips to a wide range of customers including data center, smartphone, personal computer, industrial, automotive and other markets. When management said, “Recently, the industry’s demand environment has weakened and we’re taking action to moderate our supply growth in fiscal 2023,” it was time to worry.
Commenting on the earnings announcement, CEO Sanjay Mehrotra said, “Towards the end of the fiscal third quarter, we saw a significant decline in near-term industry demand for bits, mainly due to weakness in end-demand in consumer markets, including PC and smartphone .”
The setting slows down
When end markets slow, CEOs tend to respond to the end market slowdown by cutting capital expenditures (particularly growth investments) and cutting hiring plans. Not only is this a bearish indication of current conditions, it also bodes ill for consumer spending – unemployment and job insecurity are not good for consumer spending.
Unfortunately, the CEOs of Tesla and Alphabet are lowering their hiring plans. According to Reuters, Tesla’s Elon Musk plans to cut the company’s workforce by 10%, with new hires unable to offset the cuts, meaning the total headcount would drop by 3.5%. Musk also raised concerns about the possibility of an imminent recession. The development is all the more worrisome as Tesla is struggling to meet its production targets for 2022 — not normally the time to downsize.
It’s a similar story at Alphabet, where CEO Sundar Pichai recently told employees Google isn’t “immune to economic headwinds” and will slow the pace of hiring in 2022. Given that Alphabet is expected to be sitting on $140 billion in net cash by the end of the year and (based on current Wall Street estimates) generating more than $260 billion in free cash flow over the next three years, that’s it a somewhat confusing development. Arguably, a company should be in Alphabet’s position invest in a slowdown to create value for long-term investors. Still, the drop in hiring speaks to Pichai’s view of the economy.
It’s not all bad news
The above news is not positive, but it does have some silver linings. There are three main arguments for this optimistic theory, all of which relate to real-world issues facing businesses in 2022:
- Lowering chip prices and increasing availability will help companies that have previously struggled to secure them at reasonable prices.
- Cooling labor and transportation markets will make it easier for some companies to attract and retain employees.
- A slowdown in the economy will reduce commodity cost inflation on key materials (in fact, it’s already happening).
Therefore, some of the problems that many companies are facing in 2022 will soon be resolved. For example, Boeing CEO David Calhoun recently told investors that a slowdown could make it easier to recruit and retain employees. Likewise industrial companies Johnson Controls (JCI 0.04%) lowered its full-year earnings guidance after failing to overcome supply chain difficulties and component shortages (including semiconductor shortages) — a situation that may now be easing. Transport costs (container freight rates) and raw material prices have also fallen sharply in recent weeks – this should also reduce cost pressure in the future.
The long-term view
While it’s a mistake to underestimate the impact of a demand slowdown, it’s also a mistake to ignore that it’s likely to ease some of the stresses businesses face in 2022. That could be a good thing in certain quarters and lead to a weak spell that turns out to be shorter than the market might expect. While it is impossible to know when the market has bottomed out, if the benefits of lower transportation and raw material costs and greater availability of labor and components prevail, that point will be reached sooner rather than later.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), and Tesla. The Motley Fool has a disclosure policy.