We looked extensively Losses in global equity markets this year. After a decade-long bull run, many venture capital funds found themselves holding overvalued shares of companies whose IPO prospects had been eliminated or significantly delayed.
Markets have now become ambiguous, as evidenced by the widespread correlation across asset classes. Structural factors are certainly there to sow the seeds of pessimism, such as hyperinflation; A hawkish US Federal Reserve leading to a global trend of interest rate hikes; the emerging European energy crisis; First land war in Europe in 70 years; various supply chain disruptions; An ongoing global pandemic; Rising global trade tensions, and, to top it off Sunday, a slowly collapsing Chinese credit bubble.
Although public markets have priced in some of these headwinds, their severity and duration remain unclear. As for the US technology sector, the Nasdaq Composite Index is down significantly for the year, price-to-earnings multiples have hit six-year lows and venture funding has slowed significantly. The large-cap public technology company’s revenue and earnings have generally held up year-to-date, but are expected to decline in the coming quarters as a result of Fed-induced, demand destruction.
Despite these current and high-profile pressures, the story of the technology and innovation supercycle remains unchanged, and our view is that many companies are poised for growth. Private technology companies are refocusing on fundamentals and valuations are returning to reasonable levels.
We also believe that the current economic conditions create a unique opportunity for venture capital funds holding dry powder to generate significant returns, similar to the VCs deployed during the 2010-2014 time period.
Although the Fed has prevented a natural three-year transition period from the yield inversion to the golden period, we still believe that the 2023/2024 vintage will achieve golden period status.
A good investment process analyzes both macro trends and fundamental data to assess the likelihood of various potential outcomes. We identify two distinct potential outcomes for the US private technology sector over the next 6-12 months.
Scenario 1: Additional pain before recovery
A few weeks ago, Federal Reserve Chair Jerome Powell predicted that the Federal Reserve’s efforts to curb inflation would include “a sustained period of below-trend growth” that would “bring some pain to households and businesses.”
This suggests a period of low range-bound US equity price stagnation over the next 12-24 months. Such an outcome is possible in the near term if the following adverse economic and geopolitical developments occur:
Aggressive Federal Reserve
An overly hawkish Federal Reserve in the face of deteriorating US economic conditions could cause stagnation in public equity markets and another 20%-25% drop in public equity prices. Such conditions adversely affect top-line performance, depressing price-to-earnings multiples.
While some parts of the economy remain strong, it’s now clear that Fed Chair Powell has had a Volcker moment: single-mindedly focused on breaking the back of inflation, whatever the consequences. Orchestrating a “soft” landing is a “hopeful” strategy that is elusive.
Assuming we see more interest rate hikes in the short to medium term, the prospect of long-term profitability for the US tech sector remains strong, perhaps to the downside. The ability to scale quickly without the additional infrastructure and supply chain ramp-ups required by traditional bricks leads to above-average returns for the underserved market technology sector (especially SaaS & cloud-enabled businesses). and mortar businesses.
High geopolitical tensions over Ukraine
It’s been more than six months since Russia invaded Ukraine, and the economic impact of rising commodity prices is beginning to ripple across Europe. While it is too early to predict the military outcome of the conflict, it is clear that Europe and the US are morally and financially invested in preventing Russia from successfully seizing parts of Ukraine.
Current conditions suggest a deadlock at best. The Ukraine conflict resembles the Soviet-Afghan war of the 1980s, in which the West provided trains and weapons to local combatants in an attempt to pressure the Russian economy and thereby force a withdrawal from the region. A threatened and cornered Russia may resort to last-ditch anger, including nuclear threats, or limiting/eliminating Europe’s access to its energy and material resources.