Playing with fire: Why the markets have descended into chaos

Playing with fire: Why the markets have descended into chaos

Even the titans of the tech sector — Amazon, Meta Platforms (parent of Facebook), Microsoft, Alphabet (parent of Google), and to a lesser extent Apple — have seen their share prices fall.

Amazon is reportedly laying off about 10,000 of its employees, Facebook is laying off about 11,000, Microsoft “less than one percent” of its employees, and Apple is halting hiring in a reversal of two decades of growth.

FTX’s demise has thrown the entire crypto sector into question. Recognition:PA

Big tech has had a good pandemic as lockdowns, the shift to working from home and a sharp rise in consumer cash balances fueled a tech-focused investment and spending frenzy thanks to governments’ ‘facilitation’ and stimulus spending.

But tech companies were actually in for a good decade or more, thanks to central bank response to the 2008 financial crisis, a response that was amplified when the pandemic hit.

The US Federal Reserve, for example, expanded its balance sheet and pumped cash into the US and global financial system to keep it functioning in the face of the financial crisis.

Its “quantitative easing” — buying bonds and mortgages — was maintained for almost a decade before it began shrinking a balance sheet that had gone from about $900 billion before the crisis to about $4.5 trillion a year year 2018 was swollen.

With liquidity sloshing through all markets and risk appetite evidently guaranteed by central banks, it wasn’t just valuations that were boosted. The apparent environment of negligible interest rates into the distant future and the glut of cash encouraged investors to take ever greater risk.

When the pandemic hit, the quantitative easing program restarted, and that balance quickly rose to about $9 trillion before the Fed ended it and began a year-long process of returning to more normal conditions in September.

The other big central banks – and some, like the Reserve Bank, not so big – all did similar things. Tens of trillions of nearly free dollars were pumped into the global financial system and had to go somewhere. In real terms (after inflation), investors have been paid, or at least subsidized by central banks, to take risk for much of the last decade.

Interest rates have remained at historically low levels since the financial crisis. In the US, for example, three years ago the yield on two-year Treasury bills was 1.6 percent and the yield on ten-year bonds was only 1.8 percent.

The latter is important because the “risk-free” rate is often used by investors to discount companies’ future cash flows to calculate their NPVs. The lower the interest rate, the more valuable those cash flows will be well into the future.

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Given that tech companies tend to be the fastest growing companies in analysts’ assumptions, and given that the big tech companies seemed to have infinite growth prospects, it was unsurprising that they were the biggest beneficiaries.

Between late 2019 and late last year (the tech sector peaked last November), the overall US stock market rose about 53 percent. The tech-heavy Nasdaq market rose 88 percent over the same period, and the NYFANG index (which includes mega-techs like Facebook, Amazon, Apple, and Google) rose a staggering 170 percent.

With liquidity sloshing through all markets and risk appetite evidently guaranteed by central banks, it wasn’t just valuations that were boosted. The apparent environment of negligible interest rates into the distant future and the glut of cash encouraged investors to take ever greater risk.

Bitcoin’s price surged more than 300 percent from less than $9,000 to nearly $70,000 from late 2019 to late 2021, and the broader crypto asset market exploded, taking the market cap of the entire crypto universe by about Soared from $230 billion in 2019 to about $3 trillion by the end of 2021.

The value of Twitter is decreasing day by day.

The value of Twitter is decreasing day by day. Recognition:PA

In March of this year, when the Fed began raising interest rates and announced it was shrinking its balance sheet in response to a sharp rise in US and global inflation – triggered by a combination of the pandemic’s impact on global supply chains and central banks and the exaggeration of government monetary and fiscal responses to COVID-19 – bubbles in asset markets began to deflate.

Interest rates started to rise. Two-year US Treasuries are now yielding 4.3 percent and 10-year bonds – the benchmark for company valuations – are yielding 3.9 percent, after being above 4 percent last week.

The US stock market is now nearly 20 percent off last year’s highs, Nasdaq about 30 percent and the NYFANG index 42 percent. What’s gone up the most has gone down the most, and essentially almost all of the gains from the pandemic era have been wiped out.

For a leveraged buyout like Musk’s buyout of Twitter, this value implosion – he paid a premium over a pre-bust price for a loss-making company whose income he has since reduced through his own actions and whose interest bill is projected to be less than US$100 million -Dollar up to more than $1 billion thanks to the buyout debt – is an existential threat.

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For other tech companies big and small, this means dissatisfied shareholders, a problem with employee stock-based compensation that tech companies tend to make heavy use of, depleting their founders’ wealth and, if they need to raise new equity, far more expensive capital. For private technology investors, this means significant mark-to-market valuations.

The dramatic change in the crypto-asset’s value may have played a role in FTX’s demise – it may have used client money either for risky trades with Bankman-Frieds hedge fund Alameda Research or to bail out Alameda for losses on that trade – but the combination of the The fall in value and the ongoing scandals, hacks and scams that plague the sector adds another dimension to the broader pressure on riskier assets and higher-yielding stocks.

An end to this cycle of rising interest rates could undercut the stock market and help re-inflate mega-tech share prices to some degree. However, the world of crypto needs to regain some credibility and probably significantly more regulatory oversight before its prospects appear brighter.

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