Software Index

State of the Market

The Consumer Price Index (CPI) increased by 3.5% in March. Total nonfarm payroll employment rose by 303,000 in March, leaving unemployment relatively flat at 3.8%. These results mark the third consecutive month that inflation and employment data have exceeded expectations, indicating a resilient US economy which has absorbed 11 Federal Funds rate hikes since March of 2022. Reflecting these positive indicators, Kipp DeVeer, Head of Credit at Ares, stated on CNBC that there’s “pretty good economic growth” and that “you see companies and consumers adapting to higher rates” and “it doesn’t seem to be too disruptive”.

Notwithstanding, markets have become accustomed to the zero-interest-rate policy (“ZIRP”) and were expecting a soft landing. With inflation being stickier than anticipated, the market consensus is now targeting up to three Federal Funds rate cuts this year versus the six previously anticipated. Federal Reserve Chair Jerome Powell recently stated that “the recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence”. Further, former Secretary of the Treasury Larry Summers continues to be hawkish and recently stated “you have to take seriously the possibility that the next rate move will be upwards rather than downwards”.

What does all this mean? The Federal Funds rate is the interest rate set by the Federal Reserve at which commercial banks borrow and lend to each other. The Federal Funds rate drives the cost of capital and impacts the valuation of all assets, especially high-growth technology companies. If Secretary Summers is correct, then we would expect multiples to contract. In fact, we’re already seeing this in the data as of April 1, 2024; the Scalar Software Index Top 10 Next Twelve Month multiple decreased by 8.4% month-over-month to 15.0X, and the Scalar Software Index Median Next Twelve Month multiple decreased by 1.5% to 6.0X.

In light of the Federal Funds rate uncertainty and the resilience of the US economy, technology companies should continue to employ cost-cutting measures on non-essential expenditures and focus on driving efficiencies through artificial intelligence and sales to drive revenue growth. The best-in-class software companies demonstrate revenue growth even when besieged by uncertainty.