Opinion: The Inconvenient Stock Market Truth: This Late Pandemic Collapse, Yet Painful, Is Necessary

Traders work on the floor of the New York Stock Exchange in New York City on May 3.BRENDAN MCDERMID/Reuters

No one wants to hear this, especially someone sitting on a stock portfolio dreaming of milking it in retirement, but it has to be said: the current market crash is necessary. And unavoidable.

It’s hard to hear, because the pain is so real. But this torture could not be dodged forever, and the longer we lived in the land of fantasy, the more severe the breakdown would be.

By now, it’s clear to most Canadians that ultra-low interest rates fueled the unprecedented boom in house prices since 2015, and particularly since the pandemic hit in March 2020, when rates were slashed to zero. What is not talked about enough is that the exact same phenomenon played out in venture capital and public stock markets.

Record levels of venture capital funding, in the midst of a pandemic, never made much sense, because no one knew what the future would look like. The S&P 500 soaring 26 percent in a year, as it did in 2021, was also not normal.

The dream cure would be a soft landing that would rid the public and private markets of their suds. But the uncomfortable truth is that such a thing is almost impossible.

Blame our brains. When investors make 10 percent, they feel good, there’s an extra bounce in their step. But when they lose the same amount, it is as if someone had died. And bad vibes become contagious. That’s why even a venerable company like Netflix Inc. NFLX-Q has seen its share price drop by two-thirds this year.

Whose fault is it? Almost everyone, in their own way. But of the top influencers, Silicon Valley’s prominence cannot be underestimated. The returns on unprofitable private companies over the last decade were so outrageously high that the venture capital mentality of backing startups for years and years to help them build scale bled into the public markets.

In late 2019, companies like SoftBank, which deliberately flooded their unprofitable startups with endless cash, simply to help them outperform their competitors, distorted venture capital regulations to such an extent that a capital tightening was finally brewing. accounts. WeWork, a disaster of a company, attempted to go public in the fall of 2019, and public investors balked at its audacious attempt.

Then the pandemic hit and the barbarity set records that were once unthinkable. Western governments and central banks flooded their financial systems with cash, much of it flowing into financial assets.

And with interest rates near zero, investors could borrow for next to nothing to boost their returns. Many of them were retail traders in their 20s and 30s who had never felt the pain of a margin call. In October, margin debt in the United States reached a record $936 billion, 70% more than the amount lent for investment purposes in February 2020.

With money flowing like water, venture capital firms were raising unthinkable amounts and deploying it just as quickly. In March 2021, New York-based venture capital giant Tiger Global raised $6.7 billion. By September, it had already funded 170 startup deals. Public investors bought into the hype. Everyone thought that a new economic order was coming. Zoom ZM-Q was the future. Platoon PTON-Q was too.

The careless attitude, in turn, helped fuel reckless corporate behavior. Undervalued mergers and acquisitions are some of the worst value destroyers known to mankind; just ask any mining investor who endured the last commodity supercycle. Because of this story, smart executives won’t overpay for deals. The best of them are shy about paying out more than 15 times a target’s earnings.

Yet a year ago, just months before the tech rout began, Montreal-based Lightspeed Commerce Inc. LSPD-T, one of Canada’s purported tech darlings, bought two companies for 15 times Sales.

It all lasted so long that it began to seem like there was no going back. But then the economy caught up, inflation set in, and sheer fear of rate hikes ignited the tech sector crash. Lightspeed shares have fallen 83 percent since their peak in September.

If rates were the only problem, the market decline might have been contained. But then Russia invaded Ukraine, and now major Chinese cities are locked down again, entangling supply chains again. There is a new economic order for the next time at least, but nothing like the one many investors assumed would unfold.

In a note to investors this week, equity Analysts at BofA Securities warned that this coming quarter is the “end of the euphoria.”

“Beneath the surface, two big COVID demand reversals are happening this quarter,” they wrote. The first is “a rapid shift from rate-sensitive big-value items (housing and autos) to services, which we think will be a drag on S&P earnings.” In other words, restaurant spending doesn’t help the stock market.

The second is a reset of tech valuations, and that’s something veteran venture capitalists are starting to publicly warn about as well.

Late last week, Bill Gurley of Benchmark, a well-known venture capital firm, warned in a series of tweets that “an entire generation of technology entrepreneurs and investors built their full views on the valuation during the second half of an incredible 13-year bull run. The ‘unlearning’ process can be painful, surprising and unsettling for many”.

He added: “Previous ‘record highs’ are completely irrelevant. It’s not ‘cheap’ because it’s down 70%. Forget that those prices happened.”

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