“The further backward you look, the further forward you are likely to see.”

            -Winston Churchill

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Despite the allusions to the economy being a unidirectional jet on its final approach to a soft landing, perhaps a more relevant moniker would be that the economy is an uncontrollable hot air balloon – it may be soft, but good luck planning the landing. Where the wind blows, so blows the balloon.

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There is a prevailing zeitgeist that we are currently rotating through various stages similar to previous periods of economic uncertainty, be it the “Volker Era,” the dot-com bust, the financial crisis, or any number of other crises. While historical reflection is prudent, no matter how tempting, it is worth keeping the divergences from reality in check. Is this really the time it will all be different, and we are ready for the inflation-is-over, a recession-is-no-longer-coming, and rates-will-be-cut narratives? Considering economics is how human beings operate in their given nature to allocate scarcity, create abundance, and meet human needs, history says not yet. Not one of those motivations has ever effectively been controlled, much less the outcomes from all of them working in tandem. History is replete with hapless nincompoops with Manichean economic views who have tried and failed…miserably.

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Nevertheless, while history does not necessarily repeat it often does rhyme, particularly over the long view, and has considerable relevance as a guide. Simply put, there is really nothing new under the sun, and cycles, particularly economic ones, are part of a reality that drives growth and progress. For economic systems to approach maximum efficiency, which is rightfully asymptotic given the balance of human ingenuity with myopic short-sightedness, at different points in an economic cycle the system naturally kicks out entropy that must be dealt with by professionals experienced with distress. The current entropy is arguably the outcome of the capital misallocation into tight or no cash flow businesses funded by unrealistically low-interest rate capital. Given the recent changes in economic conditions, for every great tech company that has found a way to profitability, there are countless Little Suzy’s Cupcake Shops disappearing with no chance of becoming Little Debbie because they cannot sustain margin compressions and increased debt service. Their investment capital is, and needs to be, redeployed into a more efficient economic system with normalized rates.

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If there is any merit to the idea that we ultimately revert to the mean, we may be nearing an event horizon as interest rates return to more homeostatic levels. If you look at the chart above, over the last 700+ years, average nominal interest rates clocked in at 5.98% with inflation at 1.59%. For comparison, the current risk-free rate is 5.30% with inflation at 3.18%. Granted, this comparison is global history versus what is currently happening in the US, and there have been considerable advances in contemporary economic systems, but the results are reasonably similar to the path of the Fed’s stated goal. Is it relevant? Who knows. But what is certain is that although we are not there yet, we are amidst a pendulum swing that will naturally return us to a range within our own mean. If history is a guide, barring a real crisis, this return to normalcy is inevitable, likely not to reverse anytime soon, and ultimately a good thing.  

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Stayin-aliiiiiiive-iiiiive-a-a-iiiiive-ive (you know the tune)

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A slogan is making its way into conversations with entrepreneurs and business owners along with their consultants, M&A advisors, lenders, and others – Stay Alive ‘til ‘25. The irony of the slogan is not only its hopeful grasp that challenges between now and then will have been met, but also its reflection of the past – perhaps not deliberately, but it is a slight variation from the 1983 film and song, Staying Alive, that featured as the US and the world were emerging from a recession. Perhaps more ironic is that the film was the sequel to an equally relevant film reflecting the times in 1977, Saturday Night Fever. Not only was there an economic fever, but the Fed was embracing the reality that you don’t stop an antibiotic cycle a third of the way through just because you start feeling better. After reversing from 12.3% in December 1974, inflation dipped to 4.9% in January 1977 before roaring back and peaking at 14.8% by March 1980 as a recession began. History may portend what is around the corner.

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Nevertheless, to stay alive ‘til ’25, or indefinitely for that matter, it is prudent for businesses to go through a reality check, voluntarily or otherwise, and get to work. We have entered an era of cash flow necessity where cash holes can’t be covered up. An era where sales don’t fix all problems and oftentimes create new ones. An era where profligacy leads to bankruptcy. An era requiring more sophisticated operations with working capital management and optimized asset efficiency. An era of optimal capital structures with access to cash. An era where the best businesses clear double-digit interest rate sensitivity testing hurdles while generating enough cash flow to manage margin compressions.

 

And an era where EBITDA multiples used as a basis for valuations will rise as buyers are willing to pay more for better.

 

Despite how the hero narratives have read in the past, entrepreneurs have arguably gotten us out of every economic crisis we have endured. The future will be no different. But like all bad hangovers, you can take all the magic pills to clear the haze and ease the pain, but endurance and time are the ultimate and inevitable cure. Be it ’25 or beyond, those hoping for the best but preparing their business for the worst will not only survive but thrive.