After spending time in San Francisco, we traveled to Los Angeles to host another dinner. We gathered in Culina at the Four Seasons Beverly Hills. Away from VC circles, a more bullish tone emerged.
As is customary at our dinners, each attendee was requested to bring a chart to discuss with the group. Please find a summary of the charts and discussion below.
Chart 1: Long Denial Uber’s focus on achieving profitability on a free cash flow basis is a sign that valuation perspectives are shifting.
Chart 2: Long Knives “We are in the final stages of the bear market. The most speculative stocks (including crypto) will bottom first.”
Chart 3: Short Degenerates Retail traders are now bracing for further turmoil and turning to inverse funds to bet against stocks.
Chart 4: Short Volcker “It was not Volcker who tamed the 1970s inflation, but rather the supply side response. The Fed has failed to learn the proper lessons. What the world needs is capex, not demand control.”
Chart 5: Short Hawks “Money markets have probably got ahead of themselves. It’s difficult to see the Fed sustaining its 50 basis point rate hikes beyond the end of July.”
Chart 6: Long Chips “No matter what anyone says, America is simply the best place to invest.”
Chart 7: Long Schadenfreude “The fact that bitcoin is still triple its pre-pandemic level is quite astonishing. This is despite the carnage in digital assets.”
Chart 8: Short Douchebags “Be with those who help your being. Don't sit with indifferent people, whose breath comes cold out of their mouths. Not these visible forms, your work is deeper.”
Long Denial
Source: Bloomberg
The average price-to-sales (PS) multiple for the most expensive quintile of technology stocks has dropped by 65 percent, from 17x to 6x. This is still higher than the post-dotcom period’s average (4.5x). “Where will we bottom?” the speaker wonders aloud. This is all he can think about.
It’s worth noting that we’ve witnessed a significant dispersion in the form of a growth to value rotation. The most expensive quintile of tech stocks has dramatically underperformed (down 47 percent) the least expensive stocks (down 8 percent) since November.
Tech valuations at the November peak were not nearly as extreme as in March 2000. However, investment styles go out of favor for long periods of time. Some growth stocks remain popular among investors, despite the recent sell-off, with fund managers still in denial.
Uber CEO Dara Khosrowshahi’s declaration that he will now focus on achieving profitability on a free cash flow basis, according to one participant, is a sign that valuation perspectives are shifting.
“The worst-case scenario would be Microsoft from 2000,” he said. “Earnings nearly tripled over the following decade, but the stock was still down 50 percent from its dotcom peak in 2012 due to an 80 percent drop in the price-to-earnings multiple.”
More technology startups crossed $1 billion in valuation in 2021 than in the previous 5 years combined. With the bear market in full swing, the speaker said that he is seeing extraordinary opportunity in the secondaries market. Founders and employees are looking to offload shares to crystalize some gains.
Long Knives
Source: Bloomberg
This is a chart of Amazon and Cisco between 1999 and early 2003. Amazon was the poster child for high-flying growth stocks at the time, while Cisco was the “safe” megacap tech bet. The speaker points out that Amazon reached its top earlier, in December 1999, and trailed Cisco substantially until the Nasdaq reached its peak in March 2000.
This is similar to the cascading sell-off we’ve experienced over the last 18 months. Cathie Wood’s Ark Innovation fund (speculative growth) peaked in February 2021, the SaaS stocks (expensive tech) topped in November 2021, and Apple (safe megacap) reached its peak in January 2022.
“Now that even the safe megacap tech names are breaking down,” the speaker said, “we are in the final stages of the bear market.” He expects the most speculative stocks (including crypto) to bottom first before the market makes a final low.
“By the time the dotcom bust ended in October 2002,” he continued, “Amazon had more than tripled in value from its low in October 2001.” Cisco kept sliding with the market.
An attendee who was successful in shorting at the highs stated that he is fearful of being overly bearish. The share of investors who believe the stock market will fall over the next six months is at its highest level since March 2009, according to the American Association of Individual Investors.
In a study of 1,720 tech companies listed on the stock exchange between 1980 and 2002, Morgan Stanley discovered that just around 2 percent, or less than 50 companies, accounted for nearly 100 percent of net wealth creation.
“While every tech stock rose in the past cycle,” one attendee noted, “picking the winners will become increasingly difficult.”
Short Degenerates
Source: Reddit
Surveys estimate that 10 to 15 percent of the pandemic stimulus money, around $100 billion, was immediately invested in the stock market. This fueled the explosion in retail trading. Subscribers to the r/WallStreetBets forum on Reddit surged from 1 million at the start of 2020 to 12 million today.
Given the market downturn, the speaker finds it odd that those numbers haven’t fallen. Retail traders have been notably less active in the stock market in recent days.
Call options trading among retail investors has dropped to its lowest level since December 2019, reversing the rise in activity following the pandemic. Selling of single stocks by retail investors is nearly in line with March 2020.
“As is so often the case, did the retail army get sucked into the last stage of the bubble?” the speaker pondered.
One of the attendees shared how Jesse Livermore portrayed the period leading up to the 1916 top as one in which, in the words of the late H. H. Rogers of the Standard Oil Company, “a man could no more help but make money than he could help but get wet if he went out in a thunderstorm without an umbrella.”
It was the most well-defined bull market Livermore had ever seen, and it had proven to be extremely rewarding for the public—at least for a while.
“The stock market winnings during 1915 were more widely distributed than in any other boom in the history of Wall Street,” Livermore observed. “That the public did not turn all their paper profits into good hard cash was merely history repeating itself.”
Among the casualties has been Cathie Wood’s Ark Innovation fund. Morningstar, a fund-rating company, has downgraded ARKK to “negative” from neutral, calling Wood’s approach “perilous” and her returns “wretched.” ARKK is down 61 percent year-to-date. She thinks we could be in a global recession.
Retail traders are now bracing for further turmoil and turning to inverse funds to bet against stocks. SQQQ (a 3x inverse Nasdaq ETF) posted a record weekly inflow of $918 million. That’s 4-times higher than at the 2018 market bottom. This is bullish from a contrarian standpoint.
“Retail has puked.”
Short Volcker
Source: Clocktower Group
When it comes to inflation, investors overestimate the relevance of monetary policy, according to the speaker. “It was not Volcker who tamed the 1970s inflation, but rather the supply side response,” he remarked, particularly the great oil rush of the 1980s.
Remember that the price of oil soared over tenfold in the seventies, from $3.50 to $39, as a result of the politics surrounding the Yom Kippur War (1973) and the Iranian Revolution (1979).
Volcker’s shock tightening, which resulted in the worst economic downturn since the Great Depression, was unnecessary since it delayed a capex response to the supply problem. The speaker is concerned that we are repeating the same mistake.
“What the world needs is a capex boom to resolve supply problems, not demand control,” he said. “The Fed has failed to learn the proper lessons.”
It’s really just a matter of Fed officials wanting to take credit for the subsequent decline in inflation and believing their own hype about the perceived monetary errors that led to inflation running out of control: failing to “anchor inflation expectations” or not tightening policy because of “fiscal dominance.”
“All this is to say that a recession is becoming a possibility in mid-2023 to early-2024,” said the speaker. “Does this mean equities are toast?” an attendee asked.
“Not necessarily,” he replied. “Yield curve inversion normally precedes a recession, but often with up to a two-year lag. Instead, it usually signals a peak in Fed hawkishness and therefore a march to all-time highs.”
Given Fed hawkishness, paradigm-shifting inflationary prints, and elevated geopolitical risk, he admitted this will feel like picking up pennies in front of a steamroller. He laughed, “Alas, that is our collective and chosen professional risk.”
Short Hawks
Source: Bloomberg
“The Fed is past peak hawkishness,” said the speaker.
Financial conditions have tightened almost 300 basis points since September (a faster pace than seen in 2015 and 2018); market-based measures of inflation expectations have fallen sharply; and yet the forward 12-month rate hikes are the steepest they’ve ever been.
“Money markets have probably got ahead of themselves,” he added. As the economy slows down and as President Biden’s re-election prospects begin to hinge on the economic cycle lasting longer, it’s difficult to see the Fed sustaining its 50 basis point rate hikes beyond the end of July.
Long Chips
Source: Bloomberg
The speaker’s chart shows the total market cap across time of the 100 biggest global companies. They amount to $35.4 trillion or 30 percent of the global market cap today ($118 trillion).
The number of American companies in the top 100 has increased from 32 in 2007 to 62 in 2021. “No matter what anyone says,” said the speaker, “America is simply the best place to invest.” European companies in the top 100 declined from 40 in 2007 to 15 in 2021. China stayed constant at 11.
“Even if leadership in the coming decade changes from technology to commodities,” the speaker continued, “the US looks great with a robust natural resources industry, including energy, natural gas, and base metals.”
An attendee stated that he sees a tech rotation from software to hardware, with semiconductor companies being a key beneficiary. TSM (ranked 9), Nvidia (12) and ASML (39) will move up in rankings from their current spots.
Long Schadenfreude
Source: Bloomberg
The speaker’s chart compares an index of the crypto market cap (ex-bitcoin and stable coins) with the ARK Innovation ETF. He’s surprised at how well crypto is doing relatively despite the global selloff in risk assets.
The crypto index is still down 60 percent from the highs versus 75 percent for ARKK, but while the latter is trading at 2018 and 2020 lows, the crypto index is flat on the year. The NYSE Fang+ Index is down 28 percent over the same period.
Total crypto market cap peaked at $2.90 trillion in November and has since dropped to $1.25 trillion, a loss of 56 percent. Bitcoin’s value reached $67,802; ethereum was worth $4,800. They are now down 57 percent and 62 percent, respectively, from those levels.
“The fact that bitcoin is still triple its pre-pandemic level is quite astonishing,” said a participant. “This is despite the carnage in digital assets.”
Some attendees were peeved by this since they either missed out on the opportunity or see cryptocurrencies as nothing more than a ponzi scheme. They feel gleefully vindicated after Terra Luna’s collapse. Schadenfreude has set in.
“Coinbase is dead,” another participant predicted, noting a recent statement by the crypto exchange that its customers might be considered general unsecured creditors in bankruptcy. SEC chair Gary Gensler warned that anyone trading on a crypto exchange no longer owns their crypto assets.
“If we match up the peaks of the two charts,” a participant added in, “it appears that crypto is following in the footsteps of ARK and that a significant decline is on the way.”
Short Douchebags
Source: iPhone
“Truly we belong to God, and to Him we return.” This, according to the speaker, is the most important thing he knows.
“It puts everything in perspective,” he said, “the meaning of my own existence, the exercise of human responsibility, and how to treasure this God-given life and environment.”
He turned to an attendee who recently celebrated his 50th birthday and asked, “What’s the most important thing you have learned?”
“You gotta live your life,” he replied. “Don’t be negative. Be present and enjoy the moment.”
Everyone’s gaze was drawn to the next attendee.
“I learned how important it is to be honest with yourself, and how much effort it takes,” he shared. “I began my career with enthusiasm and lots of certainty. Over time, I became accustomed to saying ‘I don’t know,’ and I was able to recognize when I was being defensive. It’s so important to just listen.”
Another attendee agreed, “The older I get the less confident I get.”
One of the participants who was able to disconnect and go to the mountains during the pandemic discovered that he was a different person than he thought he was when he was simply office-bound. “It’s important to spend time in solitude,” he said.
“Life’s a rollercoaster and you can’t get off,” said another attendee. “Get used to the highs and lows.” We are wired to avoid, rather than mindfully embrace our emotions. He fights his escapist inclination by urging himself to “stay invested.”
An attendee shared that he’s tuning into his body and the signal it sends. “Our body is super intelligent,” he stated, “but we’ve been taught to avoid it by focusing on our brains and keeping our bodies in seats all day.”
The body can play a role in thinking and decision making. A full body yes happens when you are fully aligned with your whole body (head, heart and gut) and there is a bodily sense of well-being as you consider a choice.
After many years of working alone, one participant shared his experience of building a team and attempting to get the culture right. It was far more difficult than he had anticipated. For the first time in his life, he sacked two people. They didn’t turn out to be a good match.
“It reinforced the importance of spending time with those with whom you see eye to eye in a deep, fundamental way,” he said. “I also have a greater appreciation for companies that scale up and can maintain the correct culture.”
There was one person left. “I’ve got two things to share,” he said. “First, it’s the rate of change that matters.”
The value of the second derivative was a lesson he learned from his first employer. For example, if inflation is high but declining month-on-month, that’s positive. If the economy is in a downturn, but the growth rate is slightly less negative, that’s positive.
“The same lesson can be applied in life,” he remarked. “If I’m trying to quit smoking and instead of smoking 12 cigarettes a day, I’m only smoking 10, that’s a positive behavioral change.” By making little incremental improvements, bad habits may be overcome and good ones can compound.
“What’s the second lesson?”
“YOLO!” he said, banging his hand on the dinner table. “I just turned 40 and I don’t want to surround myself with douchebags!”
Everyone laughed. An attendee closed the evening by quoting Rumi:
Be with those who help your being. Don't sit with indifferent people, whose breath comes cold out of their mouths. Not these visible forms, your work is deeper.
A chunk of dirt thrown in the air breaks to pieces. If you don't try to fly, and so break yourself apart, you will be broken open by death, when it's too late for all you could become.
Leaves get yellow. The tree puts out fresh roots and makes them green. Why are you so content with a love that turns you yellow?
