It's been a tough year for investment banks like JPMorgan Chase (JPM 1.10%), Goldman Sachs (GS 1.14%), and Morgan Stanley (MS 1.09%). Nobody wants to go public in this market -- at least not with the conditions they've faced in the past year. Goldman Sachs recently announced it would lay off 3,200 workers as its investment bank division slumped.
Inflation, interest rates, and geopolitical uncertainty have all had a hand in creating an unfavorable environment for investment banks. In a hard-to-predict climate, companies are holding off on going public. But hope could be on the horizon -- here's what needs to happen for investment banks to bounce back soon.
How the Federal Reserve's inflation-fighting tactics cause ripple effects in the market
It's been a challenging market that has far-reaching effects on companies raising money. The root of the problem is inflation and the Federal Reserve's actions to bring it down.
Inflation has been running hot for nearly two years, and it wasn't until last year that the Fed began taking action. One way the Fed looks to curb inflation is by raising interest rates. The thinking behind this is that rising interest rates would encourage more saving and less spending, removing cash from the economy and rewarding savers with higher returns.
Elevated interest rates affect debt issuance, especially if companies don't want to take on debt at those higher rates. The rising rates also affect the valuations of companies, as fixed-income investments become more appealing because of their higher, low-risk returns.
Equity underwriting takes a hit as IPO activity plummets
Interest rates have risen at a pace not seen in decades. As a result, we have seen more drastic pricing revaluations across equities, including privately held companies. This has created conditions that make companies uneasy about issuing debt or going public through initial public offerings (IPOs).
We can see the impact by looking at the recent earnings from some of the major U.S. investment banks. JPMorgan Chase's investment banking revenue dropped 52% during the year. Meanwhile, Morgan Stanley and Goldman Sachs saw their IB revenue drop 49% and 48%, respectively.
The biggest driver of these declines was nearly nonexistent equity underwriting because IPO activity plummeted. According to EY, a global professional services firm, IPOs in the U.S. hit a 20-year low in terms of total funds raised. At Morgan Stanley, equity underwriting revenue was down 81%, and JPMorgan saw its revenue drop 69%.
Sentiment and outlook are key to the investment banking industry's recovery
For the investment banking business to pick up, JPMorgan Chase Chief Financial Officer Jeremy Barnum says that people need to get "comfortable with valuation and the level of the market." There's been so much volatility in the past year, and companies would like to see more stable markets before taking action.
If markets stabilize, companies could get more comfortable at valuations, even below previous levels, and finally make a move. Paul Go, EY Global IPO Leader, says that investment banks will likely start slowly in 2023.
However, more favorable conditions could arise in the year's second half. What could bring those conditions about would be slower inflation and smaller interest rate hikes -- or even better, the Fed putting rate increases on hold. Finally, the sentiment would need to improve as companies wait for the right opportunity to go public or raise debts.
According to Barnum, JPMorgan's pipeline for deals is robust, and many companies want to raise capital. When conditions do improve, there will be a good tailwind for the investment banking industry, boosting these companies' stocks in the process.
