This Unlikely Disconnect Reveals an Irrational Market

Last year started off OK for venture capital ('VC')...

VC companies raised almost $45 billion in the first quarter of 2023. That was higher than the $32 billion they raised in the prior quarter... although still way below the $85 billion average from 2021.

Then, VC megabank Silicon Valley Bank collapsed.

Not long after the bank run, VC firm NFX conducted a survey of 870 founders. Nearly 60% said Silicon Valley Bank's collapse would make it tougher to raise funds in an already tight market.

And 22% worried they wouldn't be able to raise any funding at all in 2023.

Their bearish outlook was right. VC fundraising fell to roughly $31 billion per quarter through the rest of last year.

Stocks and VC typically move in tandem... because they tend to thrive in similar environments. From that standpoint, it should come as a surprise that the market did just fine last year.

As we'll explain, this disconnect is further proof that investors aren't thinking clearly today. They're treating two very similar investments as if they're completely different...

When inflation is low, interest rates tend to be low, too...

And young companies – like those funded by VC – thrive when they can borrow cheap debt.

VC funding reached an all-time high of $345 billion in 2021... before pulling way back to $241 billion in 2022, as the Federal Reserve started raising rates.

Like VC, stocks tend to soar when inflation and corporate tax rates are low. With less money going toward costs, taxes included, it leaves more cash to go into investors' pockets.

As VC enjoyed a banner year, the S&P 500 was up 27% in 2021. It fell about 20% amid the Fed's rate hikes in 2022.

This correlation between VC and stocks is typical... and rational. Two asset classes benefit from similar environments. So they both tend to do well at the same times.

Except last year, investors got irrational. The two markets diverged.

It's no secret that the S&P 500 had a great 2023...

The index was up 24%, spearheaded by the rise of AI and Big Tech giants like Nvidia (NVDA).

Following the normal pattern, you'd expect VC startups to have done well in 2023. Yet that couldn't be further from the truth. Around 3,200 startups failed last year, destroying more than $27 billion in venture funding.

And this break with tradition is still going strong. Money is rushing out of startups... and into the biggest stocks.

While the VC market falls apart at the seams, the S&P 500 is up about 9% year-to-date. And 45% of those gains are thanks to the "Magnificent Seven" tech stocks.

Stocks shouldn't be doing well today. Inflation still hasn't come down to the Fed's target 2% levels. Interest rates are expected to remain high through the remainder of the year.

The stock market can't keep rallying blindly... Something has got to give.

Regards,

Joel Litman
March 20, 2024

Editor's note: The rush out of startups isn't just hurting the VC industry. A lot of other small stocks are already feeling the pain. And Joel says if you don't understand what's going on, you're already miles behind the Wall Street "pros"...

Next Tuesday, March 26, Joel will team up with none other than Porter Stansberry – founder of our corporate affiliate Stansberry Research – for a deep dive into this rare market setup. They'll explain why you'll only see this scenario "once or twice in a lifetime"... and exactly how to profit while there's still time. Save your spot for free right here.