Capital Markets Downturn and its Effects
Craig Cecilio
Start-up CEO & Serial Entrepreneur; Life-long learner committed to personal and professional evolution.
Capital markets channel investments between suppliers and those needing capital, like startups and businesses. However, capital markets are subject to downturns as a natural part of the investment process. These tips and strategies can help you successfully manage your investments and business ventures to survive a capital market downturn.
Capital markets are the spaces where savings and investments are channeled between the suppliers and those in need of capital, like startups and businesses. Financial institutions like banks or investors typically provide the money. The most common capital markets are the stock market and bond market. However,
“We’re in a time when capital markets are drying up, and investors are hesitant to invest.”
It’s becoming harder for entrepreneurs to gain capital. Downturns are a natural part of the market. Still, for your investments or startup ventures to survive, it’s essential to know the effects of capital market downturns.
What are capital market downturns, and what are some of the effects? How can you position yourself to survive during a downturn? Here is what you need to know.?
What Are Capital Markets?
Capital markets are the?venues for exchanging funds ?between suppliers — banks or investors — and those seeking capital. Those seeking capital can include businesses, governments, or individual startup ventures.
Capital market is a rather broad term covering in-person and digital spaces where?financial instruments , like cash, are traded. Capital market venues include the stock market, bond market, and foreign exchange (forex) market. Most are concentrated in major cities like New York, London, and Hong Kong.
Capital markets typically provide financial tools like equities and debt securities. Equities are stocks providing shares in a company, while debt securities are bonds and bear interest. Some of the?suppliers of this capital ?include insurance companies, corporations, individual investors, banks, and retirement funds, to name a few.
“Capital markets serve as a venue for obtaining that money, leading to more economic development over time.”
When offering capital, investors usually intend to make gains when their investment grows. However, providing capital also earns them other perks like dividends and ownership rights.
Capital markets are valuable in the general economy and the world of startups and business ventures. New ideas and initiatives almost always require money to materialize.
Types of Capital Markets
With the term capital market being so broad, these markets are divided into?two separate categories :
#1. Primary Markets
The Primary Capital Market, also known as the New Issues Market, is where a company publicly sells new stocks or bonds for the first time through an initial public offering (IPO).
Securities trading in the primary market is subject to strict regulation by the Securities and Exchange Commission (SEC). As the spot for all first-time trades, the primary market also sees increased price volatility.
#2. Secondary Markets
The Secondary Capital Market, called the stock market, is where already-used stocks are traded between investors. Here, investors sell securities they already own instead of buying directly from the seller like in the primary market. Secondary markets are the New York Stock Exchange and the Nasdaq. They aren’t bound by IPOs like within the primary market.
Examples of Capital Providers
Capital can come from various sources, whether large, established firms or wealthy individuals. Some key examples of capital providers include:
#1. Private Equity Firms
Private equity ?is an investment class that invests in companies that aren’t listed on the public stock exchange.?Private equity firms ?essentially serve as the venue for managing these funds and investments and earn their money by charging investors fees. Though private equity funds mainly deal in private company investment, they can also engage in buyouts of public companies.
As the U.S. experiences significant inflation and a looming recession,?private equity can outperform public markets ?in the face of capital market downturns. The benefits are enhanced access to capital, flexibility, and lower valuations.
#2. Venture Capital Firms
Venture capital ?(VC) is a form of private equity funding. Investors provide it to startups and small businesses with strong long-term growth potential. Typically, VC funding comes from wealthy investors, investment banks, and other financial institutions.
VC funds can also be pooled in?venture capital firms , which are groups of investors who gather income from wealthy individuals looking to make more money. The VC firms then take these funds and make investments — typically riskier ones than what a traditional bank would take on.
In times of economic uncertainty, the startup community gets hit hard. It can struggle against economic and capital market downturns, especially as VC funds dry up. In the face of a downturn, if your startup relies exclusively on VC investments, you may?struggle to stay afloat .
#3. Family Offices
Family offices are private?wealth management ?advisory firms that serve extremely high-net-worth individuals or HNWIs. Family offices offer various personal wealth management services to one or a small number of high-net-worth families, including budgeting, insurance, investing, charitable giving, wealth transfers, and tax services.
Obtaining capital from family offices is a lesser-known method than private equity or venture capital. Still, it can be?a beneficial route . For example, suppose a wealthy family made their fortune in the tech industry, and you’re looking for capital to fund your tech business. In that case, they may be more likely to invest in your ventures.
Plus, family offices often provide the family member’s knowledge and expertise in the field along with capital, which can be an added benefit for you as the entrepreneur. Family office clients respond to capital market downturns and swings depending significantly on their assets. Those with more assets may?boost their investments ?and take advantage of market volatility, while others may pull back.
#4. Retail Investors
Retail or individual investors are?non-professional market participants ?who typically make much smaller investments than more prominent institutional investors. While trade in the retail investment market generally occurs on a much smaller scale, the market is vast. It can include retirement accounts, brokerage firms, online trading, and robo-advisors.
Most retail investors primarily invest much smaller amounts in the equity and bond markets. However, wealthier retail investors can participate in alternate investment classes like private equity and hedge funds. Because retail investors are less sophisticated and have a much smaller purchasing power, they’re typically the first group to stop investing during capital market downturns. While they may pause investing in companies, retail investors have been seen?putting money toward real estate ?during downturns.
Understanding Capital Market Downturns
A capital market downturn is a period when the market continuously declines. These downturns can lead to recessions and bearish markets. However, a?bear market ?occurs when market prices drop by more than 20% and is usually accompanied by negative investor sentiment and poor economic prospects.
Bear markets can be cyclical or long-term, lasting from a few weeks to decades. However, downturns don’t always result in full-on market crashes or depressions.?Market downturns ?occur when traders react negatively to factors like rising interest rates, political events, and wars. It often causes the market to decline, which then sends other investors into a panic.
“When investors panic, some begin selling their stocks, which can tank the market even further.”
This can lead to issues where too many investors are trying to sell their stocks simultaneously. The chain reaction can cause investment companies to issue?margin calls ?and force investors to sell their stocks at a much lower price. A stock or capital market downturn can last for a few weeks, months, or even years. However, much like the economy tends to rebound over time.
Effects of Capital Markets Downturn
Though the market always tends to bounce back over time, a downturn can have significant negative impacts on both investors and those seeking capital. Three notable effects of a capital market downturn include:
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#1. Harder to Fund Business Ventures
When there’s a lack of capital for entrepreneurs to obtain, it can be hard to?fund new business ventures ?or get a startup off the ground. Many businesses and startups have only been able to become fully realized because of the money they’ve raised by selling stock or connecting with investors early on.
Capital is necessary for entrepreneurs just getting started. Still, investors often provide funding later in a business’s life cycle for new ventures, ideas, and general growth and development. But when the market is down and no one is investing, acquiring funding becomes much more complicated and can feel impossible.
“If a business’s stocks are worth less during a downturn, investors may be inclined to invest because they may see it as a deal or sale price and take advantage of it.”
However, as a business, you won’t be reaping the full benefits of your stock’s actual value outside of the downturn.
#2. Difficult to Grow Business
Similarly, it is much harder to?see growth ?when capital is lacking, and it becomes harder to fund business ventures. In a capital market downturn, your business stocks will be worth less. Typically, the value of the reserve serves as an indicator of the company’s market value on paper; this number means a lot to businesses and startups looking to gain investors and funding.
#3. Decreased Liquidity
Liquidity is significant ?to trading securities. Liquidity refers to the ease with which an asset or security can be converted into cash without affecting its market price. Cash is often referred to as the most liquid asset, and the stock market is characterized by having a high level of liquidity.
“When markets experience a downturn, liquidity decreases, or the market dries up.”
If markets aren’t liquid, it’s much harder to sell or convert assets or securities into cash. For example, suppose you owned a rare item appraised for $500,000. In that case, it could become irrelevant in a market without liquidity, resulting in you losing money.
Therefore, it’s important to always maintain reliable liquid assets, like money markets, time deposits, or even gold coins. These can often be converted into cash quickly and easily amid a capital market downturn.
Surviving a Downturn
“Realize market downturns are a natural part of the investment process.”
It’s bound to happen, likely multiple times in your investing career. You must come to terms with and learn to navigate.
It’s also helpful to remember that downturns don’t last forever. Even if it takes a while, there’s a rebound on the horizon. On top of keeping calm and avoiding panicked, knee-jerk reaction selling, there are a few other tips and strategies to employ when looking to?survive a downturn :
#1. Look for Opportunities
Just because the market is experiencing a downturn doesn’t mean you can’t invest. During a downturn, defensive stocks like consumer staples and businesses with high-quality balance sheets can pose solid investment opportunities. You could also investigate higher-quality stocks that pay dividends, boosting your return when stock prices fall.
#2. Rebalance Your Portfolio
In a long-running?bull market , your equities may likely appreciate or depreciate differently than your bonds or cash holdings. This can result in a portfolio that may not be aligned with your preferred or planned asset allocations.
A downturn, or bear market, could be the perfect time to rebalance your portfolio. You can sell some of your stocks and reposition your investments. That way, your portfolio is in the shape you want it to be when the market picks back up.
#3. Connect with a Financial Advisor
“Financial advisors are always available to help when you’re stuck.”
These advisors can review your approach and offer professional advice. They help limit the downturn’s effect on your short- and long-term financial goals. You can also keep a financial advisor on board after the market recovers to ensure you stay on track, meet your goals, and pivot over time as needed.
How Fintech Is Transforming Capital Markets
Technological advancements in the financial sector have been making big waves in the industry for the past several years. These tech advancements allow companies to streamline their processes and serve people more efficiently, adding ease to the overall investing strategy.
Financial technology , or fintech, integrates technology and offerings from financial services companies. Generally, fintech seeks to improve and automate the delivery and use of financial services and helps companies and individuals better manage their financial operations using technology.
Fintech is an expansive industry that focuses on?creating new value propositions ?and improving existing ones. Within capital markets,?fintech ?provides ample opportunities for innovation and efficiency in the future.
There are a variety of ways in which fintech can be valuable in the financial industry. Within capital markets specifically,?fintech ?can?reimagine standard workflows . It also offers new ways to solve challenges, complete basic operations, and the following:
#1. Automate Tasks
AI, or automation in general, is increasingly more prevalent in finance. Financial services companies often have tons of backend tasks to complete that, while tedious and not front-facing, are crucial to their success and effectiveness.
“Fintech ?software solutions can be used to automate tasks within capital markets.”
Not only can this make workflows quicker and more efficient, but it also creates a fully digital process. This eliminates the need for manual workflows, eliminating the possibility of human error.
#2. Keep Up with the Market
One of the most significant?achievements of fintech ?is its ability to keep up with the market. Tech advancements are everywhere, with new ones popping up almost daily. Taking advantage of?fintech ?could be the necessary step to keep you ahead of the tech curve.
Companies and individuals in the capital market can use fintech to keep up with market trends through?specialized software and algorithms . Leveraging tech in this way allows for better financial operations and processes management. This means that using?fintech ?to ensure your finances and assets are in a suitable place could put you in a better position in the case of a market downturn.
#3. Accessible and Convenient
Fintech is widely accessible , as it’s even available on smartphones. This accessibility ensures that financial information is always at a person’s fingertips, increasing transparency.
Fintech offers more convenience ?within the finance sector. It makes general operations more manageable and more convenient. Companies that adopt fintech solutions like AI, machine learning, and the blockchain offer better, more reliable consumer experiences.
Conclusion
Capital markets are the spaces where savings and investments are channeled between suppliers and those needing capital, like startups and businesses. Downturns are a natural part of the market. Still, for your assets or startup ventures to survive, it’s essential to know the effects of capital market downturns and how to position yourself for success.
Capital markets serve as a venue for obtaining that money, leading to more economic development over time. They are valuable in the general economy and the world of startups and business ventures. New ideas and initiatives almost always require money to materialize.