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opinion

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 stock portfolio they had dreams of milking through retirement, but it must be said: The current market crash is necessary. And unavoidable.

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

By now it is clear to most Canadians that ultralow interest rates fuelled the unprecedented housing price boom since 2015 – and particularly so since the pandemic erupted in March, 2020, when rates were slashed to zero. What isn’t talked about nearly enough is that the exact same phenomenon played out in venture capital and public stock markets.

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

The dream cure would be a soft landing that rids private and public markets of their froth. But the uncomfortable truth is that such a thing is next to impossible.

Blame it on our brains. When investors gain 10 per cent, they feel good, there’s an extra bounce in their step. But when they lose the same amount, it’s as if someone has died. And the bad vibes become contagious. Which is why even a venerable business such as Netflix Inc. NFLX-Q has seen its share price tumble by two-thirds this year.

Who’s to blame? Pretty much everyone, in their own way. But of the top influencers, Silicon Valley’s prominence cannot be underestimated. Returns on unprofitable private companies over the past decade were so outrageously high that the venture capital mentality of backstopping startups for years and years to help them build scale bled into public markets.

By late 2019, the likes of SoftBank, which purposely flooded its unprofitable startups with endless cash, purely to help them outlast their competitors, warped venture capital norms to such a degree that a reckoning was finally brewing. WeWork, a disaster of a company, tried to go public in the fall of 2019, and public investors balked at its audacious attempt.

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

And with interest rates back to near-zero, investors could borrow for next to nothing to torque 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 per cent more than the amount borrowed for investing purposes in February, 2020.

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

The careless attitude, in turn, helped fuel reckless corporate behaviour. Mispriced mergers and acquisitions are some of the worst value destroyers known to humankind – just ask any mining investor who endured the last commodity supercycle. Because of this history, smart executives won’t overpay for deals. The best of them are timid to pay more than 15 times a target’s earnings.

Yet a year ago, mere months before the tech rout started, Montreal-based Lightspeed Commerce Inc. LSPD-T, one of Canada’s supposed tech darlings, bought two companies for 15 times sales.

It all went on for so long that it started to seem as though there was no turning back. But then the economy caught up, inflation set in and the mere fear of rate hikes ignited the tech sector rout. Lightspeed’s stock has tumbled 83 per cent from its peak in September.

If rates were the sole issue, it’s possible the market crash could have been contained. But then Russia invaded Ukraine, and now major Chinese cities are back in lockdown, snarling supply chains all over again. There is a new economic order for the next little while at least, just nothing close to the one many investors once assumed would play out.

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

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

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

Late last week, Bill Gurley at Benchmark, a well-known VC firm, warned in a series of tweets that “an entire generation of entrepreneurs & tech investors built their entire perspectives on valuation during the second half of a 13-year amazing bull market run. The ‘unlearning’ process could be painful, surprising, & unsettling to many.”

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

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