This is a very stupid question - but can someone explain what the "interest rates" and "no more free money" replies mean? Is it because reddit isn't profitable so relies on constant money supply from investors? Or is it something else
Ahh, thank you. That helps a lot. I suppose it's interesting that the return from companies is even remotely comparable to the return from bonds. That's probably a dumb realization but I don't know much about this stuff.
Not dumb, this stuff isn't really taught unless you explicitly pursue it.
One note: the return on some companies may be higher and others lower, the issue is that the risk for money in companies is higher.
Very simplistic example: the US government can offer you a flat 5%, a company investment offers 10% half the time, 0% the other half.
One is a sure thing, one is a gamble. The more the 'gamble' the more risk and that is a driving factor in investments. People are willing to take huge risks if the payoff is very large (Look at Michael Burry and the big short)
You can roughly calculate yield from a stock investment. If a stock has a P/E ratio of 20 (i.e. the value of all stocks issued is 20x its annual earnings), divide 72/20 to get a yield of 3.6%. If US government bonds offer 1% yield this stock looks like a deal, but when safer government bonds yield 4% this stock now looks unattractive.
Of course this is a gross oversimplification: earnings can grow, stocks can pay dividends, companies can go bankrupt, and companies have to pay their own bondholders as well as stockholders. But hopefully it shows that a tradeoff between stocks and bonds does exist.
Bonds are much less risky too. So when interest rates were low, it made sense for investors to put money into companies because with bonds you got a tiny return guaranteed vs a high risk but potentially large payoff.
Now, bonds are guaranteeing a 5%+ return, so a non-profitable business is much less attractive as a proposition.
Actually, the Fed sets the Federal Funds Rate, which is the rate at which commercial banks borrow and lend their extra reserves to one another overnight. Increasing the Federal Funds Rate increases borrowing costs across the board, which subsequently will tend to decrease the money supply.
I believe that U.S. bonds are priced at the market.
It's not all about rich people switching their portfolios around. When rates rise, operating expenses for companies go up, and so they pass that cost down. This is a bigger deal for companies perennially in debt than startups.
> Is it because reddit isn't profitable so relies on constant money supply from investors? Or is it something else
Roughly.. but more accurately even if they are profitable they are not profitable enough.
Its not just that Reddit (Twitter, Twitch[0], etc) needs the money, the investors likely also have loans that need to be repaid sooner-than-later (or just other places with better returns). As such there is a large push for higher short term profit, to get higher short term share price, to "diversify" some of their Reddit stock.
The reality is none of these people care about the long term of Reddit. They have effectively "pumped it", they now need a good way to quickly "dump it". I'm sure none of them have any explicit motivation to destroy Reddit's future cash flows in the process, but that long term health is definitely not their focus.
[0] Twitch as an Amazon subsidiary doesn't exactly fit this model. However, the execs within Amazon do have Profit targets to meet for their orgs. This directly reflects in their bonuses, size of orgs, etc. So likely a similar enough analog.
The Federal Reserve, the central bank of the United States, has been raising interest rates very aggressively for the past year and a half to fight inflation. This has ended a very long-lived policy of near-zero interest rates which has been in place since 2009, the Great Financial Crisis.
When you borrow money from the bank, i.e. to fund the operations of a money-losing site like Reddit, ultimately the interest rate you pay on that loan is affected by the interest rates set by the Federal Reserve.
While interest rates were near zero, investors in money-losing companies like Reddit could justify just borrowing more money to keep the companies going, as the money was cheap.
But now with higher interest rates, the investors in Reddit, and other money-losing ventures, can no longer afford to just borrow more money to make up for the money they lost last year, they actually have to show a return or at least cut the losses to a level that the investor will tolerate. That means monetizing everything they can.
So this is more along the lines of what I was thinking, where borrowed money had higher interest, but many other replies in this thread make it seem like because treasury bills are better people are just investing in that instead.
Is it both of these factors combined? Is it more one factor than the other?
Based on your comment I think you may be missing one aspect:
The money you get lent at the bank is the money people are investing.
Both of the things you describe in this comment are two halves of a market. There's someone borrowing money and someone lending money. The borrowing becomes more expensive because the lender has better alternatives.
Ahhh, do you know what's funny is after I wrote that comment I went to the bathroom and while peeing I basically had the intuition they were 2 halves of the same thing, but I couldn't even articulate it. I was going to come back and try to ask again and I saw this comment. Thanks!
All this stuff I've tried to learn a few times and it's just so open ended, my mind is very more technically oriented and vague hand-waving statements on investopedia drives me crazy. Other people seem to understand it so easily but after the multiple attempts that I have made, I just have given up.
3 month T-Bills are 5.2% (was .04%). 2 years are 4.7% (was .15%). Hypothetical future profit for companies that have been around for 10+ years is no longer good enough.
Rates are low: I can borrow money at 1% interest and my bank pays me 0.1% interest on any money I leave in my account. I'm getting basically no return on my money in the bank, so it makes sense to start a project that might make me money. If I have to borrow money, I only need to make a 1% return for it to be worth it.
Rates are high: It now costs 7% to borrow money and my bank pays me 4% on any money I leave in my account. 4% is a decent return and if I borrow money I need need a project that returns >7% for it to be worth it. Leaving my money in the bank seems like a much better option now.
How this applies to Reddit: VCs and investors are trying to figure out which projects are worth putting more money into, but the bar to make an investment worth it is much higher. Reddit (and many other companies) now need to show that giving them money is more profitable than leaving money in the bank (or other "safe" investments).
Imagine you could have $1 now or x 1 year from now. How big would x have to be in order for you to prefer it?
Well, if you were planning on buying a $1 savings bond at a 2% interest rate than x would have to be 1.02 or bigger. If the interest rate increased then x would need to increase as well. In other words, an increase in the interest rate is a decrease in the future value of money - it takes more future dollars to be worth the same amount of present dollars.
When interest rates are low, companies prefer earning money in the future. They prefer growth. When interest rates are high then companies shift their preference to present dollars. What we are seeing is companies choosing to pursue money now rather than money in the future because of what interest rates are doing.
