Market Update -
A Fuzzy Crystal Ball
In our last newsletter, we highlighted the impact of rising interest rates on heightening uncertainty across the financial ecosystem. As this uncertainty persists, the market appears to be in a prolonged state of limbo. In October 2022, economists at Bloomberg actually predicted a 100% chance of recession within the next 12 months. A year later, economists are more measured in their assessments and are softening their recession predictions. Today, the consensus among economists seems to be that there is no consensus regarding whether and when the economy may achieve a soft landing.
The economy has certainly taken some interesting turns in the last year. Despite higher interest rates, consumer spending has been surprisingly strong. Consumer spending rose at an annual rate of 4.0% in the third quarter, representing the largest increase in spending since the fourth quarter of 2021. GDP grew at a seasonally and inflation-adjusted annual rate of 4.9% in the third quarter of 2023, which is more than double the GDP real growth rate of 2.1% observed in the second quarter. This is the fastest that the U.S. economy has grown since 2021. Despite strong consumer spending and GDP moving in the right direction, significant political turmoil in the United States and far-reaching geopolitical events abroad cause predictions around the Fed’s next steps to be almost impossible..
While positive economic reports continue to throw proverbial curveballs, some expected themes continue to trend within the venture market. Access to capital across the venture funding environment is still measurably more restrictive from both an equity and debt perspective compared to early 2022. Many investors are more selective in their allocation of capital and are exercising more judicious investment decision making. Median deal sizes are decreasing across all deal stages, and down rounds are becoming more prevalent. Despite a significant valuation compression in the public markets, in a general sense, we feel we have yet to see a corresponding compression in the earlier stages of private market funding.
We would be remiss to neglect the impact of AI on market sentiment, both in terms of excitement for its use cases and skepticism, or in some cases, concern, of how it will impact our society and economy. We view AI as a tool that will undeniably be embedded into various day-to-day workflows and are excited by its potential, in the industry in general and more specifically, across our portfolio companies’ operations and the companies we evaluate for investment. The proliferation of AI is undeniable and represents yet another step change in technology that will have significant impact on the economy and society.
The push-and-pull effect of surprisingly positive economic data and potential productivity boosts from AI, offset by restrictive access to capital and market uncertainty, exacerbates the already difficult ability to pinpoint in which direction the venture market may beheading. While a wait-and-see approach may feel uncomfortable, SMC believes the way forward is to continue to rely upon our fundamental investment principles of backing companies that solve real problems with differentiated technological offerings. Regardless of what the future may hold, we feel confident in the ability of our portfolio companies to navigate various environments and look forward to identifying compelling new opportunities able to adapt in these changing market conditions.