No More Free Money (The Year The Music Stopped)

Money is no longer free.

That simple fact, perhaps more than anything else, explains the tumultuous year it’s been for equities, and particularly for growth stocks.

This is a critical point. So critical, in fact, that Goldman’s David Kostin opened with it in his year-ahead outlook for US equities called, aptly, “Paradise Lost.”

I’d be remiss not to note (immediately, given recent events) that the rising cost of real, government-backed money goes a long way towards explaining the demise of dubious, private money. A year ago, money was free. Or basically free. The ripple effects of that conjuncture were dramatic — bizarre, even. On the eve of the first Fed hike, Bored Ape Yacht Club NFTs (digital cartoons of monkeys, for the uninitiated) were going for $400,000 (figure below).

In a testament to the perversions of free real money, you couldn’t purchase one with genuine US dollars, you needed Ethereum.

All of that’s changed now. Bored Apes are still expensive (around $63,000 as of Tuesday morning), but their forest habitat (if you will) is in extreme peril.

Although crypto proponents aren’t enamored with the idea that Fed hikes are ultimately responsible for the hollowing out of the Web3 ecosystem (preferring instead to blame bad actors in the centralized exchange space), it’s not a coincidence that everything speculative — from crypto to profitless tech to so-called “hyper-growth” shares — is beset in a year during which the Fed raised rates by 425bps in just 10 months (figure below).

Over the same period, 10-year US yields more than doubled, as did high-grade corporate credit yields, while five-year US real yields rose from negative 1.63% to positive 1.90% and the cost of equity jumped 80bps.

“One year ago, the weighted average cost of capital for S&P 500 firms equaled 4.1%, close to the lowest level in history,” Kostin wrote, before marveling at the rapidity of the reversal. “During the past 12 months, the cost of capital for US firms surged by the largest amount in 40 years.”

At 6%, WACC is the highest in a decade (figure on the left, below). The figure on the right shows the rate of change.

Too many investors (including one famous “visionary” who’s been busy doubling down on Coinbase shares this month), seemingly didn’t appreciate what the Fed’s efforts to turn the screws would entail. Note that “appreciate” is something different from “understand.” It’s safe to say the crypto crowd didn’t understand it — amusing as this is, the link between free real money and a thriving market for dubious private money wasn’t obvious to them. Folks like Cathie Wood, by contrast, doubtlessly understood it, they just didn’t appreciate how dramatic the de-rating was likely to be, and how long it would last.

“The increased cost of capital has translated directly into lower equity valuations,” Kostin went on to write, noting that the S&P’s multiple dove by 30%. The real pain, though, was in growth shares, where, for example, Russell 3000 firms with projected sales growth greater than 20% saw valuations contract by a median of 56%, according to Goldman.

Kostin went on to describe the impact on private equity. “Many venture capital-backed companies planned to complete IPOs earlier this year but balked when confronted with dramatically reduced enterprise values compared with recently-completed rounds of private capital raising,” he said, on the way to noting that just $6 billion of flotations were completed as of this week, down 95% from last year.

Goldman has an “IPO barometer” which assesses how conducive the macro environment is to issuance. Currently, that gauge sits at 9, a 4%ile ranking going back two decades.