The Fall in Netflix's Share Price Might be a Sign of Worse to Come

Despite the lifting of restrictions worldwide, some businesses are becoming increasingly bearish about future earnings. 
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A combination of weaker consumer sentiment and the fear of higher interest rates could mean slower overall growth for the world economy. 

Last week’s 22% fall in the share value of Netflix is a symptom of this pessimism shared by many investors. The streaming giant announced that higher business costs will mean higher subscription fees for its customers and growth projections for the year ahead are being revised downwards as a result. Millions of SME's around the world are also facing rising business costs and even greater pricing pressure from its competitors. Paradoxically, inflation is causing some firms to reduce their pricing just to stay in business. 

So far, 2022 has not been a good year for tech companies in particular. The Nasdaq is down 14% since November last year. Global stock markets have had their worst week since the start of the pandemic. Covid-related businesses that relied on 'lockdown demand' are hardest hit. Netflix, Zoom, and even producers of home gym equipment, Peloton, have recently experienced sharp declines in their share values.

Cryptocurrencies such as Bitcoin and Etherum suffered 27% and 38% devaluations respectively since the end of 2021. These recent corrections in financial markets signal that investors are worried about the future. 

What’s causing these concerns? Firstly, inflation. As input costs rise for businesses, many firms may become less competitive and less profitable. Despite its huge market share, Netflix is no exception. Investors also believe that the end of central bank support and the introduction of higher interest rates will badly effect future returns. Up until recently, equities in particular have benefited massively from low interest rates, low inflation, and cheap borrowing costs since April 2020.

By the end of 2020, the S&P gained 18% despite unemployment in many OECD countries rising to 8%. The following year, the S&P gained a further 26%.

At Goldman Sachs, full-year net profit for 2021 came in at $21.2 billion, more than double what it was in 2020 and the bank's biggest-ever year.

The worry now for central banks is that markets have become overpriced. Worse, inflation in most consumer goods has also risen to unacceptably high levels. Supply chain bottlenecks and an explosion of consumer demand has led average prices of goods and services to soar to over 7%. This is the highest inflation reading in the US for over forty years. If kept unchecked, central banks fear the costs of living could spiral out of control as workers and firms bid up prices in the expectation of even higher prices in future.

In response, the Fed (US central bank) is now withdrawing liquidity from markets by reducing the amount of its asset purchasing. When central banks change their policy from quantitative easing (buying bonds) to quantitative tightening (selling bonds), they create dollar shortages in financial markets and interest rates rise. The less money in circulation, the higher the interest rate. Debt servicing becomes more expensive, business investment falls, and investors choose risk-free rates at commercial banks or government bonds as an alternative to stocks. 

It could take much more than three or four gentle rate hikes by central banks to bring down inflation from 7%, however, especially when considering savings in most developed countries are already at an all-time high. And because inflation is largely supply driven, higher rates may prove ineffective either way.  

So why is the the Fed increasing rates? Partly to dampen inflation expectations and to change the appetite for risk among investors. Being less accommodative in their policy says to markets that 'the party is over and we no longer have your backs.'

If over the next six months, inflation fails to come down and the Fed needs to tighten further, it’s credibility will be tested as they carefully balance the trade-off between a large collapse in markets and achieving their ultimate goal of price stability. Some analysts point out that the Fed came to the rescue in 2019 when, after raising rates by 1-2% in 2018, markets fell by 10%; but they weren't tackling inflation at that time. Emergency stimulus seems more and more unlikely if inflation is not firstly brought under control.

The imbalance in labour markets has also exacerbated inflation. General attitudes towards work have changed due to the pandemic. As is being reported by firms in almost all sectors, the so-called ‘Great Resignation’ is seeing millions of workers quit their jobs or go freelance. The gig economy is expanding. In response, many businesses are offering improved terms to retain staff, namely higher wages and more flexible working hours.

While productivity in most unaffected industries remained high during lockdowns, the concern in the long run would be that time away from the office could cause larger staff turnovers if work-from-home measures become increasingly widespread. Human behaviour is difficult to change once habits are formed. As the demand from workers for more flexi hours increases, while having clear benefits to workers, they may also weaken their connection with their employer and tempt them away from their current positions into new roles elsewhere.

How long will these trends last is the question. Businesses will find it difficult in the meantime. A lack of workers threatens output and can drive up costs. If interest rates rise, this will dampen business investment further and add higher costs to mortgage repayments. While labour shortages have caused wages to rise, wages have not risen as fast as inflation, however. Both businesses and workers could find the next year or two very challenging.

For example, the price of most consumer goods has risen as much as 20% since the pandemic, and even higher when accounting for energy prices. Coffees, sandwiches, meals out, rents, house prices, gas bills, and more recently alcohol, have even eroded the purchasing power of improved monthly pay cheques. These prices wont suddenly fall overnight regardless of an improving inflation situation. At best they will stop rising. 

While inflation has risen across all goods and services, wages in comparison have risen by far less in most SME's. According to the latest Conference Board Salary Increase Budget Survey in the US, firms intend to increase their salary budgets by just 3-5% in 2022.  

Barring even worsening supply shocks or geo-political tensions in Russia or China, as wages fail to catch up with inflation, and government spending slows to normal pre-pandemic levels, global economic growth is likely to slow. While large consumer savings built up during lockdowns may keep the party going for a short while, it's likely that consumers will eventually reject higher prices in the longer term. The antidote to inflation may well be inflation itself.

Growth and inflation need consumer confidence and worker wages to continuously move in unison. In previous decades, high inflation and the boom experienced during the Celtic Tiger era was largely driven by prolonged bank lending and over exuberant public and private sectors. 

​As we move beyond the pandemic, a period of unusually high demand and government spending, the outlook for the economy over the next few years looks more uncertain. 

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