Over the past decade, years of cheap borrowing fueled the rise of speculative investments and unprofitable business models in the U.S., and stubborn inflation forced the Federal Reserve to aggressively raise interest rates at an unprecedented pace in 2022. Now, in this new era of rising borrowing costs and more cautious lenders — coupled with slower growth and fears of a recession — a once-hot segment of the U.S. economy is freezing.
The initial public offering (IPO) market has largely shut down; tech companies are laying off staff and pausing hiring; the real estate market is undergoing a “reset” after years of meteoric growth; slow down.
But despite the freeze in key sectors and Wall Street’s been predicting doom, the overall economy has continued to grow as the labor market has recovered. In the fourth quarter of last year, U.S. gross domestic product (GDP) grew at an annual rate of 2.9%, beating analysts’ expectations. In December, the unemployment rate fell to 3.5%, near pre-pandemic lows.
However, many economists predict that will change this year. Ellen Zentner, chief economist at Morgan Stanley, said this week that U.S. gross domestic product growth would slow to an annualized 0.2% in the first quarter, while Wells Fargo said Annual U.S. gross domestic product growth is expected to slow to 0.4%. Some CEOs, billionaire investors and investment banks believe a full-blown recession is coming.
It’s unclear whether the freeze in key sectors, under the weight of rising interest rates, will eventually crack – triggering a recession – or unfreeze from the deep freeze – into slow positive growth. But credit markets may have an answer.
Jim Cahn, chief investment and business development officer at wealth management firm Wealth Enhancement Group, told Fortune: “When the credit market pulls back and you can’t get financing for a deal or an investment, that’s when you can’t get financing for a deal or an investment. When the economy is frozen. Credit is the secret weapon that drives economic growth. It has been the engine of economic growth since the formation of credit markets in the early days of the Industrial Revolution 400 years ago.”
Freezing and frozen segments of the economy
A new era of high interest rates, inflation and recession fears has contributed to a sharp slowdown across sectors of the U.S. economy over the past year.
venture capital
The venture capital space, for example, has seen strong growth throughout the pandemic. Global venture capital funding will hit a record $681 billion in 2021, more than double the amount raised in 2019.
“In 2020 and 2021, cheap capital has fueled a growth-at-all-costs mentality, fear of missing out ( FOMO) has also created a surge in investor interest, leading to large-scale investments in startups at various stages of funding.”
But in 2022, as interest rates rise, venture capital investment falls 35%, to $445 billion, according to Crunchbase. Gone are the days when “startups could get sky-high valuations and favorable funding opportunities,” Warfell said, with sentiment in the venture capital space “collapsing” and capital drying up. In his view, U.S. startups needed an estimated $42.8 billion more funding than was provided in the fourth quarter, according to PitchBook.
Logan Allin, founder of fintech-focused venture capital and private equity firm Fin Capital, told Fortune in an interview that he doesn’t think the venture capital sector will fully recover until 2024, in part because It’s the credit crunch. He believes that 2023 may be an extremely challenging year for technology startups.
“Our view is that 2023 will continue to be a year of extreme pain, actually from a private market and public equity perspective in tech, 2023 will be more painful than 2022,” he said.
Allin added that the market’s sharp downturn should “ring alarm bells” to VCs who have developed irresponsible habits during the pandemic and failed to conduct proper due diligence on their investments. He cites the example of the now-defunct cryptocurrency exchange FTX, which Sam Bankman-Fried “dismissed” due diligence because they couldn’t pass it based on a basic “checklist” , they also do not allow independent auditors to see their financials. But other venture capitalists poured millions into the company without even looking at their books.
“They asked for financial data and the team at FTX sent them Excel spreadsheets. It’s just ridiculous,” he said.
But now, with interest rates rising and many smaller VCs exiting the market, Allin thinks the market will return to a more disciplined approach to investing.
“I think the venture capital environment is going to be healthier and more sustainable because we’re investing at more reasonable valuations and price-to-earnings ratios that allow companies to achieve valuations and make profits in a better way. It’s a real comeback,” he said. Fundamentals process and refocus due diligence.”
initial public offering
When U.S. interest rates were near zero and consumers were flooded with cash from stimulus packages during the pandemic, the initial public offering market experienced a surge similar to that seen in the venture capital space.
In 2021 alone, there will be a record 1,033 new public companies in the United States. But amid rising interest rates and a roughly 20% decline in the S&P 500, there will be 50% fewer IPOs in 2022, according to EY’s 2022 Global IPO Market Trends Report. The decline was even more pronounced in the Americas, where the number of initial public offerings fell 86% last year compared to 2021, and total funding was down 96% over the same period.
“Throughout 2022, there has been a sharp drop in deal activity and volume. The IPO market is completely shut down,” Allin said. “The public market has no interest in any company, even one that is potentially profitable.”
Allin said he sees only a “line of opportunity” in the “IPO market” this year, and only those companies that can prove their ability to make money will have the chance to go public.
“Otherwise, the valuations of these companies will drop significantly, like any company that went public last year or in 2021. We still face inflation, high interest rates, geopolitical uncertainty and huge volatility, and we cannot lead the way,” he said. IPOs create a warm market environment.”
real estate
U.S. home prices soared more than 45% from the second quarter of 2020 to the third quarter of last year, as low interest rates and the work-from-home trend fueled a housing boom. But rising rates have pushed the 30-year fixed mortgage rate — the most common type of mortgage in the U.S. — from 3.45% in February 2020 to just over 6.1% today.
There has been a major “reset” in the housing market as higher borrowing costs and high house prices lead to reduced affordability. Last week, mortgage applications to buy a home fell 39% from a year earlier.
Jay Hatfield, founder and chief executive of infrastructure capital advisors, an investment management firm, said it wasn’t just potential homeowners who were being turned away, institutional real estate investors were feeling the pain from rising interest rates . High interest rates and recession fears have caused bank lending to “dry up,” making it challenging for companies acquiring new properties and/or the real estate sector, he told Fortune.
“A small number of private loans are still going on now, but the terms of the loans are too harsh to allow for leveraged buyouts (LBOs), which are when a company tries to buy another company with borrowed money,” he said. Companies like Blackstone that were buyers. They are now more likely to be sellers than buyers. So M&A activity is over.”
Not only are lenders asking for higher rates, but they’re also doing more underwriting — or research and risk assessment — before lending to avoid the risk of default, said Wealth Enhancement Group’s Kahn. It was another example, he noted, that the current freeze in certain parts of the economy was purely a “reflection of credit market conditions”.
“In 2021 and 18 months ago, people were pouring money into anything as fast as they could because there was so much cash, but in 2022, the credit market basically froze up. That’s why you would Seeing these industries freeze up.”
Frozen economy about to collapse?
Will the economy slowly thaw and avoid a recession, or are the cracks created by rising interest rates and high inflation about to burst? It depends on who you ask.
Kahn said his “hunch” is that we’ll be in a recession “sometime in the second half of 2023.” “I think it may be until 2024 before we get back to normal,” he said.
He’s not alone in his pessimistic outlook. Many top investment banks are predicting a “mild recession” this year, and some forecasters believe a “severe recession” or even “another type of Great Depression” could be on the horizon.
“We’re definitely going into an increasingly difficult period from an economic and macro standpoint, and that could be a capital ‘R’ recession or a lowercase ‘R’ recession, but either way it’s going to be bad. said Allin.
While many experts believe a recession is imminent, others believe that this downturn will not be as devastating as past downturns, with frozen sectors of the economy starting to unfreeze by the end of 2023 and 2024. Infrastructure Capital Advisors’ Hatfield said that by the second half of the year, “the IPO market will return to normal, as will M&A and the stock market.”
He argues that the “post-pandemic tailwind” that has kept the labor market healthy — especially in the service sector, where many businesses have struggled to hire during the pandemic — is unlikely without mass layoffs that slump consumer spending. There is a severe recession. He also noted that despite last year’s surge in interest rates, housing inventories are near record lows, which he believes will allow for a year-round thaw in the housing sector.
“However, we need the Fed to pause [rate hikes], and the U.S. could have a quarter or two of negative GDP growth, but not a deep recession,” he said.
Translator: Zhong Huiyan-Wang Fang
After years of cheap money helped fuel the rise of speculative investing and profitable business models in the US over the past decade, stubborn inflation has forced the Federal Reserve to increase interest rates faster than ever before in 2022. Now, a new era of higher borrowing costs and more cautious lenders—coupled with slowing growth and recession fears—has frozen once-red hot segments of the US economy.
The initial public offering (IPO) market is essentially shut; tech companies are laying off workers and pausing hiring; the housing market is experiencing a “reset” after years of booming growth; and the venture capital (VC) space has slowed dramatically, with private market valuations tumbling.
But despite the freeze in key sectors—and consistent doomsday predictions from Wall Street—the economy as a whole has continued to grow alongside the resilient labor market. In the fourth quarter of last year, US gross domestic product (GDP) rose at a 2.9 % annualized rate, topping analysts’ forecasts. And the unemployment rate came in near pre-pandemic lows at 3.5% in December.
Many economists are predicting that will change this year, however. Morgan Stanley’s chief US economist Ellen Zentner said this week that annualized GDP growth will fall to just 0.2% in the first quarter, while Wells Fargo expects a drop to 0.4%. , billionaire investors, and investment banks believe an outright recession is on the way.
It’s still unclear whether key frozen aspects of the economy will eventually crack under the weight of rising interest rates—sparking a recession—or if the deep freeze will thaw—enabling slow, but positive growth. But credit markets could hold the answer.
“When credit markets pull back, and you’re unable to get financing for transactions or for investment, that’s when things freeze,” Jim Cahn, chief investments and business development officer at Wealth Enhancement Group, a wealth management firm, told Fortune. ” Credit is the secret. It’s the fuel of growth. And it’s always been the fuel of growth, since the credit markets evolved 400 years ago at the beginning of the industrial revolution.”
The freezing and freezing segments of the economy
A new era of higher interest rates, inflation, and recession fears have led various segments of the US economy to slow dramatically over the past year.
Venture Capital
The VC space, for example, was supercharged throughout the pandemic. In 2021, global VC funding volume reached a record $681 billion, more than double 2019’s figures.
“[A] growth-at-all-cost mindset fueled by cheap capital in 2020 and 2021 and exploding investor interest caused by a fear of missing out (FOMO) led to large investments into startups across all stages,” Alex Warfel, a PitchBook analyst, explained in a Friday note.
But in 2022, with interest rates rising, there was a 35% decline in VC investment to $445 billion, according to Crunchbase. Warfel said the days of “sky-high valuations for startups and easy fundraising opportunities” are gone, sentiment in the VC space has been “crushed,” and capital has dried up. To his point, the estimated amount of capital demanded by US startups outpaced the amount supplied by $42.8 billion in the fourth quarter, according to PitchBook data.
Logan Allin, founder of Fin Capital, a fintech-focused VC and private equity firm, told Fortune that he doesn’t see the VC space recovering fully until 2024 due in part to the credit crunch, and he argued that for tech startups, 2023 could be a particularly challenging year.
“Our view is that 2023 is going to continue to be a year of extremely acute pain, and actually more painful than 2022 from both a private markets and public equity perspective in tech,” he said.
Allin added the sharp downturn in the market should be a “bit of a wake up call” for VC investors who developed irresponsible habits during the pandemic, failing to do proper due diligence for their investments. He gave the example of the now-defunct crypto exchange, FTX, which he “passed on” because they didn’t get past basic “checklist items” in the due diligence process, including not allowing an independent auditor to look at their financials. But other venture capitalists invested millions in the firm without even looking at their books.
“They were asking for financials and the team at FTX was sending them excel spreadsheets,” he said. “It was just absurd.”
But now, with interest rates rising and many lesser VCs going out of business, Allin believes the market will return to a more rigorous investing approach.
“I think it will be a much healthier, more sustainable venture capital environment now, because we’re investing in valuations and multiples that make sense and that allow the company to grow into them in a much better way,” he said. “It’s a true return to fundamentals. It is a refocusing on real diligence.”
IPOs
When US interest rates were near zero and consumers were flush with cash from stimulus checks during the pandemic, the IPO market experienced a similar surge to the VC space.
In 2021 alone there were a record 1,033 new public listings in the US But in 2022—with interest rates rising and the S&P 500 sinking roughly 20%—there was a 50% reduction in the number of IPOs compared, according to EY’s 2022 Global IPO Trends Report. And in the Americas, the drop was even more pronounced, with the number of IPOs falling 86% last year versus 2021, while total proceeds sank 96% over the same period.
“Deal activity and volume came down preciously throughout 2022. IPOs were completely shuttered,” Allin said. “There was very little public market appetite for anything, even those companies that were potentially profitable.”
This year, Allin said he sees just a “sliver of an IPO window,” and only for firms that can prove their ability to make money.
“Otherwise, they’re going to trade significantly down, as any of the companies that went public last year or in 2021 did,” he said. “We still have inflation, high interest rates, geopolitical uncertainty, and significant volatility, and that does not create a warm market for IPOs.”
Housing
US home prices soared over 45% between the second quarter of 2020 and the third quarter of last year, as low interest rates and work-from-home trends fueled a housing market boom. But rising interest rates have pushed the average 30-year fixed Mortgage rate—the most common type in the US—from 3.45% in February of 2020 to just over 6.1% today.
The higher borrowing costs and high home prices have led to an affordability crunch and a major “reset” in the housing market. Mortgage purchase applications were down 39% from a year ago last week.
It’s not just prospective homeowners who are feeling shut out—institutional real estate investors are feeling the pain from rising interest rates as well, according to Jay Hatfield, founder and CEO of the investment management firm Infrastructure Capital Advisors. Higher rates and recesses feared Lending from banks to “dry up,” he told Fortune, making acquiring new properties—and/or companies in the real estate sector—a challenge.
“There’s a little bit of private lending going on, but it’s at terms that are too onerous to do LBOs [leveraged buyouts] anymore,” he said, referring to when one company tries to buy another company using borrowed money. “And then also , the companies that were buyers like Blackstone. They’re more likely to be sellers than buyers now. So M&A activity has dried up.”
Cahn of Wealth Enhancement Group says that lenders are not only offering much higher interest rates, but they’re also doing a lot more underwriting—or research and risk assessment—before lending money to avoid default risk. He noted that it’s another example that the current freeze in some sectors of the economy is all a “reflection of what’s going on in the credit markets.”
“In 2021, and 18 months before, people were just throwing money at anything as fast as they could because there was so much cash, but in 2022, the credit markets basically froze up,” he emphasized. “And that’s why you’re seeing these industries freeze.”
The frozen economy that’s about to crack?
Will the economy slowly thaw out and avoid a recession, or are the cracks caused by rising interest rates and high inflation about to rupture? That depends on who you ask.
Cahn said his “hunch” is that we’ll have a recession “sometime in the back half of 2023. “I think it’s really, you know, maybe 2024, before we’re back in business as usual,” he said.
He’s not the only one with a pessimistic outlook. Many top investment banks are forecasting a “mild recession” this year, and some forecasters have argued that “severe recession” or even “another variant of a Great Depression” could be on the way.
“We’re definitely going to enter into a harder and harder period from an economic and macro standpoint, that may be a capital “R” recession or lowercase “r” recession, but it’s going to be bad,” Allin said.
While many experts believe a recession is on the way, some argue it won’t be as devastating as past downturns, and the frozen sectors of the economy will begin to unfreeze by the end of 2023 and into 2024. Infrastructure Capital Advisors’ Hatfield said that by the second half of this year “we’ll have a more normal IPO market and a recovery M&A and stock market.”
He argued that “post pandemic tailwinds” have kept the labor market healthy—particularly in the services sector where so many businesses struggled to find workers during the pandemic—and without wide-spread layoffs that crush consumer spending, it’s unlikely there will be a serious downturn in the economy. He also noted that despite the rapid rise in interest rates last year, housing inventories are near an all-time low which he believes will allow that sector to unfreeze throughout the year.
“We need the Fed to pause [interest rate hikes] though,” he said. “And we might get a negative quarter or two [of GDP], but we don’t think we’re gonna have a significant recession.”
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