Opinion: The uncomfortable stock market truth: This late pandemic crash, though 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 not someone sitting on a portfolio of stocks they dreamed of profiting from until retirement, but it has to be said: the current stock market crash is necessary. And unavoidable.

It’s hard to hear, because the pain is very real. But this torture could not be dodged forever, and the longer we lived in a fantasy land, the worse the collapse would be.

It’s now clear to most Canadians that ultra-low interest rates have fueled the unprecedented spike in house prices since 2015 – and particularly since the outbreak of the pandemic in March 2020, when rates were slashed to zero. What is not talked about enough is that the same phenomenon has played out in venture capital and public equity markets.

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

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

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

Who is to blame? Almost everyone, in their own way. But among the top influencers, the prominence of Silicon Valley cannot be underestimated. Returns from unprofitable private companies over the past decade have been so shockingly high that the venture capital mentality of backing startups for years and years to help them grow has spilled over into public markets. .

At the end of 2019, companies like SoftBank, which deliberately flooded its unprofitable startups with endless money, just to help them outlast their competitors, distorted venture capital standards to such a degree that a reckoning was finally preparing. WeWork, a disaster company, tried to go public in the fall of 2019, and public investors balked at its bold attempt.

Then the pandemic hit and the excess set records that were once unthinkable. Western governments and central banks flooded their financial systems with liquidity, much of which turned into financial assets.

And with interest rates back 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 hit a record high of US$936 billion, 70% more than the amount borrowed for investment purposes in February 2020.

With cash flowing like water, venture capitalists were raising unimaginable amounts of it – and deploying it just as quickly. In March 2021, New York-based venture capital giant Tiger Global raised US$6.7 billion. By September, it had already funded 170 seed deals. Public investors bought the hype. They all thought a new economic order was coming. Zoom ZM-Q was the future. Platoon PTON-Q was also.

The negligent attitude, in turn, has helped fuel reckless corporate behavior. Mispriced mergers and acquisitions are among 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 pay too much for offers. The best of them are shy to pay more than 15 times a target’s winnings.

Yet a year ago, just months before the tech rout began, Montreal-based Lightspeed Commerce Inc. LSPD-Tone of Canada’s supposed tech darlings, bought two companies 15 times Sales.

It all went on for so long that it started to feel like there was no turning back. But then the economy caught up, inflation set in, and sheer fear of rate hikes sparked the tech sector rout. Lightspeed’s stock has fallen 83% from its September high.

If rates were the only problem, it is possible that the stock market crash could have been contained. But then Russia invaded Ukraine, and now major Chinese cities are back on lockdown, snarling supply chains again. There is a new economic order for a little while at least, nothing close to what many investors once assumed would play out.

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

“Beneath the surface, two major COVID demand reversals are occurring this quarter,” they wrote. The first is “a rapid shift from large rate-sensitive items (housing and auto) to services, which we believe will be a headwind for S&P earnings.” In other words, restaurant spending does not help the stock market.

The second is a reset in tech valuations — and that’s something seasoned venture capitalists are also starting to publicly warn about.

Late last week, Bill Gurley of Benchmark, a well-known venture capital firm, warned in a series of tweets that “an entire generation of entrepreneurs and tech investors built their entire outlook on valuation during the second half of an incredible 13-year bull run. The process of “unlearning” could be painful, surprising and confusing to many. »

He added: “Previous ‘all-time highs’ don’t matter at all. It’s not ‘cheap’ because it’s down 70%. Forget those prices that happened.

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