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Q2 2022 Capital Markets Watch

Capital markets take a breather 

US capital markets are seeing the much-anticipated pullback from the historic bull market run of the last decade. Q1’s volatility continued into Q2 as investors sold securities amid persistent inflation, rising interest rates and geopolitical instability. Disruptions in some supply chains appear to be resolving, with select consumer inventories recovering. However, high global energy prices continue to ripple through the economy. Stock markets in the US dipped into bear market territory, with the S&P 500 down 13.7% for the second quarter and down 17.9% for the year. However, seasoned investors may view this retreat as a healthy valuation reset.

Real GDP growth for the first quarter declined at a 1.4% seasonally adjusted annual rate, dragged down by inventories, government spending and a widening trade deficit. US growth is expected to rebound in the second quarter. Consumer spending has slowed but remains resilient, fueled by a tight labor market and strong household balance sheets, even after accounting for recent asset price declines. However, with tail risks rising and higher inflation continuing to erode consumer purchasing power, US growth is expected to slow sharply in coming months. The risk of a recession is more elevated now than it usually is at this point in the economic cycle. While a recession is not our baseline expectation, the near-term outlook continues to call for heightened vigilance. Our baseline projection is for real GDP growth to slow to below 2% in 2022, a sharp deceleration from 5.7% in 2021.

Given our view that a recession is not inevitable, it is possible that valuation resets could provide a floor for investors seeking value-based returns, and we could see stock market indices grow. A broad-based recession could technically still take place in a growing stock market, which could open up capital markets later this year and into next year.  

The short-term outlook for debt remains tempered, as most borrowers secured funding ahead of the Fed’s quantitative tightening program. Looking further ahead, mergers and acquisitions (M&A) and leveraged buyout (LBO) activity will support capital raising.

Capital raising themes that are likely to impact US markets include the increasing influence of private capital, such as private equity and private debt, with even more private capital piling up if special purpose acquisition company (SPAC) equity is redeemed. Energy prices are likely to remain elevated due to a number of factors, including the Russia-Ukraine conflict. Environmental, social and governance (ESG) remains a major theme for capital markets, with investor demand and regulatory scrutiny increasing the urgency to adopt ESG initiatives. Looking forward, for capital markets to reopen, we would look to see a return to commodity price stability, positive earnings reports and reductions in volatility. Other factors to watch include onshoring of the supply chain, positive bumps to consumer sentiment and increased visibility into the Fed’s upcoming policy. 

“Recent IPO pullbacks are reemphasizing investors’ focus on profitability.”

Doug ChuWest Coast Capital Markets Advisory Leader, PwC US

Market downturn puts IPOs on pause

  • After a five-year low for initial public offerings (IPOs) in Q1, the IPO market pretty much closed down in Q2 with just eight traditional IPOs. Uncertainty and volatility, which increase market risk, have lowered market valuations compared to recent quarters. IPO issuance has all but paused as companies grapple with potential lower valuations.
  • Pharma and life sciences (PLS) led traditional IPO volume in the second quarter, with four IPOs raising $974 million.
  • The outlook for IPOs is positive in the medium term, as there is still a strong pipeline of IPO-ready companies primed to access public markets, including more than 600 unicorns. Assuming historical exit trends, about half of those unicorns could IPO.
  • IPO candidates with a proven track record of growth or profitability and reliable institutional ownership are more likely to succeed in this market.

Investors wary of SPACs as US markets trend downwards

  • Investors are losing interest in SPAC IPOs as the private company merger market is extremely competitive now, with $140 billion in dry powder.
  • Given recent difficulties in SPAC mergers and post-merger stock price performance, SPAC investors are hesitant to consummate mergers, which contributes to increased SPAC redemption rates.
  • Recently proposed SPAC regulations seek to level the playing field by increasing transparency and incorporating many of the same regulations already in place for public companies.
  • With 18-24 month investment horizons, many SPACs are approaching expiration. 

Slowdown in venture capital investment as valuations are hit by return to fundamentals

  • Venture capital usually lags public market trends, so despite the 17.9% YTD decline in the S&P 500, VCs continued to raise new funds and invest at the more normalized level prior to the 2021 boom.
  • Venture capital invested $59 billion dollars in Q2, down 27.1% from Q1 2022 but still a historically strong quarter as many VC firms reset their investment focus and criteria.
  • Venture capital continues to hold near record amounts of dry powder, with over $200 billion.
  • With the current market volatility, we have seen a change in investment focus toward a clear path to profitability among VC investors.

Rising rates slow US debt markets as borrowers move to the sidelines

The US debt capital markets were hampered by inflation, the Fed’s quantitative tightening programs and geopolitical concerns in the second quarter. Lenders showed significant risk aversion amid the economic backdrop, and issuers paused as rates and yields made borrowing more expensive. Leveraged finance volumes suffered with the high-yield bond market having its worst non-December month (May) since 2014. Notably, a number of deals were brought forward in Q2 as borrowers opted to secure financing for future transactions — often far into the future. Looking forward, there is a relatively healthy pipeline with more than $60 billion in institutional loans and high-yield bonds earmarked for M&A and LBO transactions.

  • There was a steep decline in issuance with only $385 billion of issuance across the investment-grade, high-yield and leveraged loan markets in Q2 as borrowing became more expensive and risk aversion increased.
  • The predominant use of proceeds in the leveraged finance market was for acquisitions and LBOs, with $62 billion. Yields have surpassed their 10-year averages amid the expectations and beginning of the Fed’s quantitative tightening plan.
  • Looking forward to Q3, it is likely that a contingent of issuers will make concessions to close deals funding M&A and LBOs.
  • As the year progresses, we expect primary markets to pull back issuance in line with historical norms. Those who issue will be more focused and intentional as the cost of debt and potential volatility will be higher.

Please note: IPOs with deal values of less than $25 million, best efforts offerings, oil and gas royalty trusts, business development companies, pricing on OTC Bulletin Board and OTC Pink Sheets are excluded from this narrative. Data as of 6/24/22.

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Mike Bellin

Partner, Consulting Solutions, US IPO Co-leader, PwC US

Doug Chu

West Coast Capital Markets Advisory Leader, PwC US

Rob Cohen

Debt Capital Markets Advisory Leader, PwC US

David Ethridge

IPO Services Co-Leader, PwC US

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