17 ms·

The Bubble Question

236 points by DanielRibeiro 12y ago

7Figures2Commas 12y ago
> It’s hard to sustain a bubble for four years. Says who? As Wilson observes, "Since the financial crisis of 2008, policy makers in the developed world have kept interest rates at or near zero. They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses." It's kind of amazing that he doesn't see how years of unprecedented coordinated central bank action could drive and sustain bubbles. > It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low. As an investor, there is no doubt that DFTF and BTFD has been very profitable, but the implication that a weak global economy and low interest rates is essentially responsible for sustaining the good times should be disturbing to anyone with exposure to the venture capital asset class given what it is supposed to represent. Incidentally, I think it's somewhat amusing that VCs are asked the "Are we in a bubble question?" in the first place. When you ask market participants who can only play the market in one direction using a single asset class, you tend to get the least insightful answers in my opinion.
- dgreensp 12y ago
  Interestingly, he didn't answer the question with a no. He described a situation that, to some readers, may be a yes. "It's hard to sustain a bubble for four years, but here we are," in essence. He explains that the demand for stock in certain companies is artificially high, driving up valuations by a multiple.
- hadoukenio 12y ago
  "Markets can remain irrational longer than you can remain solvent."
- macco 12y ago
  Absolutely. The thing with market trends is, no one can predict them. It's a guessing game, that no one can predict. Sometimes the bubble last very long, sometimes not.
- mcmullen 12y ago
  Great post; I agree with everything here.
kevin818 12y ago
This may sound subjective but at least in my opinion when the rate of IPOs starts to rapidly increase and the companies behind those IPOs don't really seem promising, then you begin to worry about a bubble. Back in the 90s it seemed like if your company wasn't going IPO something was wrong.
kunle 12y ago
This is pretty spot on. We in the SFBA don't think about rates much but in a past life it was all I did. The moment the markets price in a long term expectation of rates rising, a lot of the current behavior we are seeing (eye popping salaries/valuations/home prices/rents) will correct themselves. It won't mean the businesses are bad - just that they're priced less richly. Until then, they are making hay while the sun shines and they're probably wise to do so.
- rdl 12y ago
  Aren't a lot of those levels "sticky"? I could certainly see rate of increase going to zero very quickly, but actual decreases in salaries, leveraged assets like homes, etc. are a much bigger step.
  - michaelt 12y ago
    I agree it's unusual that an employer will cut someone's salary - but there's another way to decrease average salaries. If the cost of money rises, companies that are only viable while the cost of money is low go out of business, and their employees' salaries drop to zero.
    - kunle 12y ago
      Absolutely spot on
  - kunle 12y ago
    They are sticky, but part of the rate of change is driven by people moving between companies and getting raises and such. That will just happen less and attrition over time will do the rest.
  - kokey 12y ago
    I don't know about SF, but it certainly didn't stick in London (UK) post the dotcom bubble. Many people ended up either with no work in tech or taking voluntary pay cuts, and the hourly rates for contractors dropped dramatically only to get back to previous levels in GBP terms 10 years later. Many tech workers left London because they couldn't afford to live there any more. New properly developments around certain parts of London didn't find tenants, rents dropped making it more attractive to buy a few years later.
rajacombinator 12y ago
VCs don't understand markets, and market guys don't understand VC. It's foolish for either to opine in the other's territory.
sz4kerto 12y ago
The _really_ scary thing is that as rates are moved close to 0, inflation seems to slow down. This is true both in the US (almost 0 rates, low inflation) and in the EU (a bit higher rates, but almost 0 inflation in the last few months). If deflation kicks in, then this flood of free money will evaporate very quickly.
- clxl 12y ago
  If deflation kicked in, why wouldn't the fed fight with increased QE?
- gizmo 12y ago
  The Eurozone is looking at mild deflation, and it will do a lot of damage. Deflation in the US is nearly impossible, because the FED will just purchase assets until the problem of low inflation goes away. Deflation in the Eurozone will be bad mainly because it will make the personal and public debts of the debtor nations unbearable. Not because "money will evaporate very quickly".
  - tonyedgecombe 12y ago
    Deflation will be bad because nobody will by something today when they think it will be cheaper tomorrow.
    - gizmo 12y ago
      That effect isn't very strong in an already depressed economy (where people only buy the bare necessities anyway).
    - kenster07 12y ago
      That's a bit of an overstatement. Many purchases are time-sensitive to the extent that expected deflation would have to be very high.
    - zurn 12y ago
      This is why I try not to buy computers with my own money :)
nutjob2 12y ago
"This is not the bubble you're looking for..." "Move along..." The VC can have a strong influence on the weak minded.
mcmullen 12y ago
Cheap money (or, low rates with "safe" bond markets) + high growth tech = sky high valuations - got it, Fred. Just, one more thing... how did he go from the 10% yield ($100M / 10M = 10% yield) to "if interest rates are 5% instead of 10%, then you would pay $200mm for the business ($10mm/$200mm = 5%)." Is he simply interchanging the word "yield" with "interest rates" or actually talking about the central bank?
- badamson 12y ago
  (s/b 10M / 100M = 10%). He is interchanging the terms and he should have written things differently to avoid confusion. It s/b "yield = annual earnings/purchase price", not "interest rates = annual earnings/purchase price". (He does correct himself later in the paragraph.)
  - mcmullen 12y ago
    Thanks for the clarification!
ajkumar25 12y ago
This is so awesome. Great Work.
hoodoof 12y ago
Nothing like some well argued logic with supporting numbers and formulas to ease the anxiety. Ahhhhh.
mactitan 12y ago
Well, this chart focuses on tech but Robert Schiller also thinks the overall market is bubbly. I'm amazed that interest rates could have been held down so long and this is the real danger: how the heck can they ever normalize? If they do it will wreck havoc so the fed is trapped between the proverbial rock & hard thingy. Lo interest also hurts older people who rely on savings (But theyre not going to be here long anyhow...but Peter Schiff argues savings is the only real form of investment ) Bottom line is interest rates can only be held low because alternatives around the world don't exist. I'm also amazed how alot of people think the fed saved the economy & created more wealth : as Jim Rogers says they only know how to print). Finally, I think the derivatives were around 600bill upto Lehman downfall. I was astonished to find that they're now a quadrillion! Buffet called derivatives financial weapons of mass destruction. I think this world might experience this interesting concept. http://www.pinnacledigest.com/blog/dscaroknight/chart-below-illustrates-massive-tech-bubble-one-astounding-chart-created-sentiment http://www.pinnacledigest.com/blog/dscaroknight/chart-below-...
- hnnewguy 12y ago
  >If they do it will wreck havoc No they won't. Rates don't magically rise in a vacuum; rising rates coincide with improved economic conditions or rising inflation. Or, most likely, both. The Fed Board of Governors, unanimously, predicts interest rates of ~4% beyond 2016[0]. They certainly are not infallible, but they have the tools and the mandate to get there. Do you claim the market isn't pricing this in already? >Lo interest also hurts older people who rely on savings If anyone is to blame for the financial wrongdoings and shenanigans of the past 20 years, it's these same old people. I'm not terribly sympathetic. Besides, no one has ever said you're entitled to a magic return on your cash for glorified mattress-stuffing (savings account). This is a capitalist society, put your capital to work. >I was astonished to find that they're now a quadrillion! Notional value. [0]http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140319.pdf http://www.federalreserve.gov/monetarypolicy/files/fomcprojt...
  - mactitan 12y ago
    When the fed raised rates the last time ,stepwise & slowly it didn't work as planned and I think they're going tohave a helluva time normalizing. 2)Keeping savings is putting money to work . (sure I'd rather be a VC) I just believe Peter schiff on this. That notional value didn't help AIG. The pt. Is that nothings changed in the financial system. 1 quad means things are riskier than ever.
netcan 12y ago
One interesting thing about the high valuations of tech startups now is where the money is coming from. It's not stock markets. At or near the bottom (or is it top?) of this "bubble" funnel a lot of high valuation investments from "private" money acquisitions & other supposedly smart money, like the recent AirBnB investment. Were $10bn valuations possible without public markets before recently? Does that make us daffier if this is a bubble? IE, is this proper risk capital that is less fragile and sensitive to death spirals? Facebook has been aggressively scaling up (in my opinion successfully) their ad business since the IPO. Facebook has/had 2 big make-or-break risks: (1) losing popularity/users (2) failing to turn users/visits into into ad revenue. There was also some risk that in trying to fix #2, #1 would break. Risk, reward, uncertainty. Nothing unusual here. Risk #1 is constant ambient risk. Risk #2 is/was more of a "what's under that rock" risk. The rock is being turned as we speak and so far the news has been good. FB value has roughly doubled in the last 9 months and IMO, that's the product of "information" about the viability of facebook as an advertising platform. Here is the subtle point.^ They could have turned that rock just as eerily before IPO. They could have worked on the ad platform sooner or they could have delayed the IPO. I think that move was deliberate. Facebook chose to make that unavoidable, but timeable risky step after the IPO. As an analogy, imagine a widget company. They get investment design & manufacture a warehouse full of widgets. Then they pause, take some more investment, don't spend it and go public before finding out if their widgets sell. What role does this pre-IPO money play? FB didn't seem to need it to operate. ^I'm not sure about this. It's a speculation and I don't know or understand enough to be confident at all about it.
- mcmullen 12y ago
  One of the later episodes of the a16z podcast featured Marc Andreessen and Benedict Evans. They were discussing technology valuations and made some good points. Though I disagreed with their "no bubble" consensus, they were right in mentioning the classic "Russian oil money" and "new players" argument. Previously, most tech investing was done by U.S. venture capitalists. (One of the reasons why non-U.S. start-ups find it hard to fund themselves.) However with multi-billion dollar technology floats like Facebook taking place - many, many people are taking notice and bringing lots of money with them. This, obviously, increases demand which in-turn increases prices. That's all. If, or indeed when, the bubble pops and people realise that these businesses aren't worth the price paid, I suspect it won't lead to the type of crisis that occurred in 00/08 - just lots of rich people with less money.
rexreed 12y ago
While it is certainly true that valuing a business with an ongoing (and somewhat predictable) revenue stream, the typical yield approach is earnings / purchase price, this is not as applicable in situations where there is either no revenue (such as in the case of Oculus Rift) or little predictable revenue (WhatsApp). What exactly is the yield rate on the Oculus Rift acquisition when earnings are near zero? Much of the acquisition activity that is driving exits, which is in turn driving VC activity (exits motivate investment), is coming from land grabs in expectation of FUTURE potential significant markets. Facebook grabs OR because it believes that the $2B purchase price now will be far outweighed by the potential for VR in the future, same for WhatsApp. It would be simplistic to say that valuations that drive acquisition activity comes simply from comparing yield levels. That being said, where does Facebook get the money to make the acquisitions they do? From the public market. The public market is mostly driven not by individual investors, but by major market movers, which are few in number compared to the "retail" investor market, but significant in influence. And Goldman Sachs and the like might be motivated to keep pushing money into Facebook because the alternatives are weak, given the current low yield environment. If yields improve, then GS and the other market movers might shift from equities to other asset classes (fixed income, equities, maybe even CDOs again), and then as the money stream starts to taper for folks like Facebook, their acquisition activity will slow, and then valuations will start to decrease, and then Venture Capital activities in those sectors will also dampen, because the exits will be seen as less lucrative. It would seem to me that exit activity drives valuation more so than current yields, but current yields might impact the money flow that drives those acquisitions.
brc 12y ago
>They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses. That has not worked particularly well but it has worked a bit. I would argue that it hasn't worked at all, given all the bad things that are yet to come from it.
- rjtavares 12y ago
  "Bad things that are yet to come" aren't a given...
  - deleted 12y ago
    [deleted]
  - brc 12y ago
    Well, yes they are. The can has been kicked down the road. Few things have actually been repaired. Printing and borrowing money only temporarily solves a current problem, and pushes other problems down the track.
tpeng 12y ago
I generally agree with fred that monetary policy is driving valuations. However, I think it's not quite as simple as he describes (although he may be intentionally simplifying for his audience). It's true that financial assets compete with each other for investors. So when the Fed reduces the yield on Treasurys or MBS, the marginal investor will rotate to a riskier asset. This will create a chain reaction that eventually raises equity prices. However, it's not the case that earnings yield (Earnings/price or the inverse of P/E) is going to be equivalent to the interest rate on Treasurys (T-bills). Typically the way that investors think about it is earnings yield = Treasury rate + equity risk premium. So at an equity risk premium of 5%, even a Treasury rate of 0% would result in an earnings yield of 5% or P/E of 20, not infinity. This isn't too far from the market multiple of the S&P 500 right now. (The historical average ERP over the past century has been 4.2%.) So the market multiple implies that the overall market is not in a bubble, but that doesn't eliminate the possibility that some sectors are in a bubble. The Fed's influence on the market goes beyond their impact on interest rates. One reason for the sharp rise in markets is that investors are fearful of inflation. Although CPI inflation has remained low, investors would rather hold scarce assets such as equities and real estate than a rapidly diminishing percentage of the money supply (i.e., cash) that results from money "printing". While money creation is nothing new, and in a sense, unconventional money creation is not that different than conventional easing, the sheer scale of our current monetary policy is unprecedented. This lack of precedent creates a high degree of uncertainty in the ultimate outcome. The final reason for the strength of the markets is a widespread belief that the "Fed put" is back. It is almost universally believed that the Fed has taken on a third, unstated mandate of stable and rising equity markets, by easing and talking the market up when it declines. I don’t know to what extent this is true, but the mere notion has created a hidden source of instability in the market by giving investors unusual confidence. While there is no reason to believe that markets will crash, it's also not out of the question. The Fed has announced that it will "taper" QE purchases from $75 billion / month to $55 billion / month. At the current rate of taper, QE purchases could reach zero by the end of the year. One key question for investors is whether this may reverse any of the three dynamics listed above.
- hnnewguy 12y ago
  >investors would rather hold scarce assets such as equities and real estate than a rapidly diminishing percentage of the money supply (i.e., cash) Do you have any data to back this up? It is my understanding that the demand-for and holding-of cash (specifically the USD) reached epic proportions in 2008 (as happens during financial crises, hence the need to print) and remains very high.
rguzman 12y ago
> It’s hard to sustain a bubble for four years. I don't think so. The housing bubble that popped in 2008 lasted a lot longer than 4 years.
mathattack 12y ago
It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low. The discounting is what's propping up the market. It's a strange phenomenon in that the market is betting that earnings will hold or grow, but the economy will be weak enough to discount future cashflows at a low rate. This is why signs up recovery that suggest tightening cause the market to tank.
- porter 12y ago
  More on the discount rate here: http://www.propertymetrics.com/blog/2013/09/27/npv-discount-rate/ http://www.propertymetrics.com/blog/2013/09/27/npv-discount-...
hagbardgroup 12y ago
This is the most honest article that I've seen from a mainstream financial figure about why valuations are so high. ZIRP (zero interest rate policy) means that money is near worthless to financial institutions that can run the carry trade on Treasuries, or other carry trades involving foreign exchange. VCs manage money for those guys, along with pensions and other enormous concentrations of capital. What you want are equity stakes (control) of productive assets. The cash that you use for that is not that useful except to normal suckers like you and I who need to hand over a bunch of paper tickets every month to the landlord, the grocer, and the government. The guys who issue the tickets are generally above those concerns, but they still need to get a return on their capital. I would rather own stock than a pile of green tickets. Stock is, again, just another kind of ticket, but they're more expensive tickets that grant you rights to a productive asset. It is a safe bet to dump your green tickets into speculation because, while the speculation may work out, you know for a fact that those tickets are going to depreciate. You will not see interest rates go up if the Fed can help it, because to do so would provoke an immediate fiscal crisis. Bubbles result from rational allocations of funds based on a certain set of assumptions. It is a good assumption that the US government will not permit rates to rise as long as there is zero public appetite for a major reduction in government spending. Once that reality changes, the structures that rely upon that environmental state will either need to adapt or will fail. Startup-land is a greenhouse arrangement that thrives so long as the temperature remains high. When the guy who owns the greenhouse cuts the power, most of those plants are gonna die. If you want to be resilient to that risk, you must leave the hothouse. However, the hothouse plants have a lot more access to capital in the near term, so it is rough to compete with them directly. That is the trouble with bubbles: you can't really escape their effects by being 'prudent,' because low interest rates make prudence imprudent. In order to raise rates, the US would probably have to either confiscate a lot of assets (which would harm its international status as the cleanest dirty shirt), raise taxes, raise retirement ages, implement means testing on medicare + social security, and cut military pensions/VA expenses. There is no real solution that does not involve provoking some sort of major crisis, so it is much easier for everyone to keep the carnival going as long as possible until something snaps internationally. The federal government can't afford even a slight rise in rates without having an immediate cash flow crisis.
- 12y ago
j_baker 12y ago
This sounds like a perfectly reasonable take on the situation. As a general rule of thumb, expansionary monetary policies benefit smaller companies. Now that the fed will likely start tapering back some, I think we'll start seeing larger companies (Apple, Google, maybe Facebook) having good years. There's one thing I can guarantee though: we are almost certainly in some kind of bubble. It may not be a tech bubble, but bubbles are just a fact of economic life.
jpmattia 12y ago
> It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime. > I have no idea when and if that will happen. Apparently, neither does anyone else, including the Fed itself who's been predicting a rise since 2010 or so: http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/04/forward%20guidance.JPG http://www.zerohedge.com/sites/default/files/images/user5/im...

236 points by DanielRibeiro 12y ago

> It’s hard to sustain a bubble for four years. Says who? As Wilson observes, "Since the financial crisis of 2008, policy makers in the developed world have kept interest rates at or near zero. They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses." It's kind of amazing that he doesn't see how years of unprecedented coordinated central bank action could drive and sustain bubbles. > It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low. As an investor, there is no doubt that DFTF and BTFD has been very profitable, but the implication that a weak global economy and low interest rates is essentially responsible for sustaining the good times should be disturbing to anyone with exposure to the venture capital asset class given what it is supposed to represent. Incidentally, I think it's somewhat amusing that VCs are asked the "Are we in a bubble question?" in the first place. When you ask market participants who can only play the market in one direction using a single asset class, you tend to get the least insightful answers in my opinion.

dgreensp 12y ago
Interestingly, he didn't answer the question with a no. He described a situation that, to some readers, may be a yes. "It's hard to sustain a bubble for four years, but here we are," in essence. He explains that the demand for stock in certain companies is artificially high, driving up valuations by a multiple.
hadoukenio 12y ago
"Markets can remain irrational longer than you can remain solvent."
macco 12y ago
Absolutely. The thing with market trends is, no one can predict them. It's a guessing game, that no one can predict. Sometimes the bubble last very long, sometimes not.
mcmullen 12y ago
Great post; I agree with everything here.

kevin818 12y ago

This may sound subjective but at least in my opinion when the rate of IPOs starts to rapidly increase and the companies behind those IPOs don't really seem promising, then you begin to worry about a bubble. Back in the 90s it seemed like if your company wasn't going IPO something was wrong.

kunle 12y ago

This is pretty spot on. We in the SFBA don't think about rates much but in a past life it was all I did. The moment the markets price in a long term expectation of rates rising, a lot of the current behavior we are seeing (eye popping salaries/valuations/home prices/rents) will correct themselves. It won't mean the businesses are bad - just that they're priced less richly. Until then, they are making hay while the sun shines and they're probably wise to do so.

rdl 12y ago
Aren't a lot of those levels "sticky"? I could certainly see rate of increase going to zero very quickly, but actual decreases in salaries, leveraged assets like homes, etc. are a much bigger step.
- michaelt 12y ago
  I agree it's unusual that an employer will cut someone's salary - but there's another way to decrease average salaries. If the cost of money rises, companies that are only viable while the cost of money is low go out of business, and their employees' salaries drop to zero.
  - kunle 12y ago
    Absolutely spot on
- kunle 12y ago
  They are sticky, but part of the rate of change is driven by people moving between companies and getting raises and such. That will just happen less and attrition over time will do the rest.
- kokey 12y ago
  I don't know about SF, but it certainly didn't stick in London (UK) post the dotcom bubble. Many people ended up either with no work in tech or taking voluntary pay cuts, and the hourly rates for contractors dropped dramatically only to get back to previous levels in GBP terms 10 years later. Many tech workers left London because they couldn't afford to live there any more. New properly developments around certain parts of London didn't find tenants, rents dropped making it more attractive to buy a few years later.

rajacombinator 12y ago

VCs don't understand markets, and market guys don't understand VC. It's foolish for either to opine in the other's territory.

sz4kerto 12y ago

The _really_ scary thing is that as rates are moved close to 0, inflation seems to slow down. This is true both in the US (almost 0 rates, low inflation) and in the EU (a bit higher rates, but almost 0 inflation in the last few months). If deflation kicks in, then this flood of free money will evaporate very quickly.

clxl 12y ago
If deflation kicked in, why wouldn't the fed fight with increased QE?
gizmo 12y ago
The Eurozone is looking at mild deflation, and it will do a lot of damage. Deflation in the US is nearly impossible, because the FED will just purchase assets until the problem of low inflation goes away. Deflation in the Eurozone will be bad mainly because it will make the personal and public debts of the debtor nations unbearable. Not because "money will evaporate very quickly".
- tonyedgecombe 12y ago
  Deflation will be bad because nobody will by something today when they think it will be cheaper tomorrow.
  - gizmo 12y ago
    That effect isn't very strong in an already depressed economy (where people only buy the bare necessities anyway).
  - kenster07 12y ago
    That's a bit of an overstatement. Many purchases are time-sensitive to the extent that expected deflation would have to be very high.
  - zurn 12y ago
    This is why I try not to buy computers with my own money :)

nutjob2 12y ago

"This is not the bubble you're looking for..." "Move along..." The VC can have a strong influence on the weak minded.

mcmullen 12y ago

Cheap money (or, low rates with "safe" bond markets) + high growth tech = sky high valuations - got it, Fred. Just, one more thing... how did he go from the 10% yield ($100M / 10M = 10% yield) to "if interest rates are 5% instead of 10%, then you would pay $200mm for the business ($10mm/$200mm = 5%)." Is he simply interchanging the word "yield" with "interest rates" or actually talking about the central bank?

badamson 12y ago
(s/b 10M / 100M = 10%). He is interchanging the terms and he should have written things differently to avoid confusion. It s/b "yield = annual earnings/purchase price", not "interest rates = annual earnings/purchase price". (He does correct himself later in the paragraph.)
- mcmullen 12y ago
  Thanks for the clarification!

ajkumar25 12y ago

This is so awesome. Great Work.

hoodoof 12y ago

Nothing like some well argued logic with supporting numbers and formulas to ease the anxiety. Ahhhhh.

mactitan 12y ago

Well, this chart focuses on tech but Robert Schiller also thinks the overall market is bubbly. I'm amazed that interest rates could have been held down so long and this is the real danger: how the heck can they ever normalize? If they do it will wreck havoc so the fed is trapped between the proverbial rock & hard thingy. Lo interest also hurts older people who rely on savings (But theyre not going to be here long anyhow...but Peter Schiff argues savings is the only real form of investment ) Bottom line is interest rates can only be held low because alternatives around the world don't exist. I'm also amazed how alot of people think the fed saved the economy & created more wealth : as Jim Rogers says they only know how to print). Finally, I think the derivatives were around 600bill upto Lehman downfall. I was astonished to find that they're now a quadrillion! Buffet called derivatives financial weapons of mass destruction. I think this world might experience this interesting concept. http://www.pinnacledigest.com/blog/dscaroknight/chart-below-illustrates-massive-tech-bubble-one-astounding-chart-created-sentiment http://www.pinnacledigest.com/blog/dscaroknight/chart-below-...

hnnewguy 12y ago
>If they do it will wreck havoc No they won't. Rates don't magically rise in a vacuum; rising rates coincide with improved economic conditions or rising inflation. Or, most likely, both. The Fed Board of Governors, unanimously, predicts interest rates of ~4% beyond 2016[0]. They certainly are not infallible, but they have the tools and the mandate to get there. Do you claim the market isn't pricing this in already? >Lo interest also hurts older people who rely on savings If anyone is to blame for the financial wrongdoings and shenanigans of the past 20 years, it's these same old people. I'm not terribly sympathetic. Besides, no one has ever said you're entitled to a magic return on your cash for glorified mattress-stuffing (savings account). This is a capitalist society, put your capital to work. >I was astonished to find that they're now a quadrillion! Notional value. [0]http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140319.pdf http://www.federalreserve.gov/monetarypolicy/files/fomcprojt...
- mactitan 12y ago
  When the fed raised rates the last time ,stepwise & slowly it didn't work as planned and I think they're going tohave a helluva time normalizing. 2)Keeping savings is putting money to work . (sure I'd rather be a VC) I just believe Peter schiff on this. That notional value didn't help AIG. The pt. Is that nothings changed in the financial system. 1 quad means things are riskier than ever.

netcan 12y ago

One interesting thing about the high valuations of tech startups now is where the money is coming from. It's not stock markets. At or near the bottom (or is it top?) of this "bubble" funnel a lot of high valuation investments from "private" money acquisitions & other supposedly smart money, like the recent AirBnB investment. Were $10bn valuations possible without public markets before recently? Does that make us daffier if this is a bubble? IE, is this proper risk capital that is less fragile and sensitive to death spirals? Facebook has been aggressively scaling up (in my opinion successfully) their ad business since the IPO. Facebook has/had 2 big make-or-break risks: (1) losing popularity/users (2) failing to turn users/visits into into ad revenue. There was also some risk that in trying to fix #2, #1 would break. Risk, reward, uncertainty. Nothing unusual here. Risk #1 is constant ambient risk. Risk #2 is/was more of a "what's under that rock" risk. The rock is being turned as we speak and so far the news has been good. FB value has roughly doubled in the last 9 months and IMO, that's the product of "information" about the viability of facebook as an advertising platform. Here is the subtle point.^ They could have turned that rock just as eerily before IPO. They could have worked on the ad platform sooner or they could have delayed the IPO. I think that move was deliberate. Facebook chose to make that unavoidable, but timeable risky step after the IPO. As an analogy, imagine a widget company. They get investment design & manufacture a warehouse full of widgets. Then they pause, take some more investment, don't spend it and go public before finding out if their widgets sell. What role does this pre-IPO money play? FB didn't seem to need it to operate. ^I'm not sure about this. It's a speculation and I don't know or understand enough to be confident at all about it.

mcmullen 12y ago
One of the later episodes of the a16z podcast featured Marc Andreessen and Benedict Evans. They were discussing technology valuations and made some good points. Though I disagreed with their "no bubble" consensus, they were right in mentioning the classic "Russian oil money" and "new players" argument. Previously, most tech investing was done by U.S. venture capitalists. (One of the reasons why non-U.S. start-ups find it hard to fund themselves.) However with multi-billion dollar technology floats like Facebook taking place - many, many people are taking notice and bringing lots of money with them. This, obviously, increases demand which in-turn increases prices. That's all. If, or indeed when, the bubble pops and people realise that these businesses aren't worth the price paid, I suspect it won't lead to the type of crisis that occurred in 00/08 - just lots of rich people with less money.

rexreed 12y ago

While it is certainly true that valuing a business with an ongoing (and somewhat predictable) revenue stream, the typical yield approach is earnings / purchase price, this is not as applicable in situations where there is either no revenue (such as in the case of Oculus Rift) or little predictable revenue (WhatsApp). What exactly is the yield rate on the Oculus Rift acquisition when earnings are near zero? Much of the acquisition activity that is driving exits, which is in turn driving VC activity (exits motivate investment), is coming from land grabs in expectation of FUTURE potential significant markets. Facebook grabs OR because it believes that the $2B purchase price now will be far outweighed by the potential for VR in the future, same for WhatsApp. It would be simplistic to say that valuations that drive acquisition activity comes simply from comparing yield levels. That being said, where does Facebook get the money to make the acquisitions they do? From the public market. The public market is mostly driven not by individual investors, but by major market movers, which are few in number compared to the "retail" investor market, but significant in influence. And Goldman Sachs and the like might be motivated to keep pushing money into Facebook because the alternatives are weak, given the current low yield environment. If yields improve, then GS and the other market movers might shift from equities to other asset classes (fixed income, equities, maybe even CDOs again), and then as the money stream starts to taper for folks like Facebook, their acquisition activity will slow, and then valuations will start to decrease, and then Venture Capital activities in those sectors will also dampen, because the exits will be seen as less lucrative. It would seem to me that exit activity drives valuation more so than current yields, but current yields might impact the money flow that drives those acquisitions.

brc 12y ago

>They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses. That has not worked particularly well but it has worked a bit. I would argue that it hasn't worked at all, given all the bad things that are yet to come from it.

rjtavares 12y ago
"Bad things that are yet to come" aren't a given...
- deleted 12y ago
  [deleted]
- brc 12y ago
  Well, yes they are. The can has been kicked down the road. Few things have actually been repaired. Printing and borrowing money only temporarily solves a current problem, and pushes other problems down the track.

tpeng 12y ago

I generally agree with fred that monetary policy is driving valuations. However, I think it's not quite as simple as he describes (although he may be intentionally simplifying for his audience). It's true that financial assets compete with each other for investors. So when the Fed reduces the yield on Treasurys or MBS, the marginal investor will rotate to a riskier asset. This will create a chain reaction that eventually raises equity prices. However, it's not the case that earnings yield (Earnings/price or the inverse of P/E) is going to be equivalent to the interest rate on Treasurys (T-bills). Typically the way that investors think about it is earnings yield = Treasury rate + equity risk premium. So at an equity risk premium of 5%, even a Treasury rate of 0% would result in an earnings yield of 5% or P/E of 20, not infinity. This isn't too far from the market multiple of the S&P 500 right now. (The historical average ERP over the past century has been 4.2%.) So the market multiple implies that the overall market is not in a bubble, but that doesn't eliminate the possibility that some sectors are in a bubble. The Fed's influence on the market goes beyond their impact on interest rates. One reason for the sharp rise in markets is that investors are fearful of inflation. Although CPI inflation has remained low, investors would rather hold scarce assets such as equities and real estate than a rapidly diminishing percentage of the money supply (i.e., cash) that results from money "printing". While money creation is nothing new, and in a sense, unconventional money creation is not that different than conventional easing, the sheer scale of our current monetary policy is unprecedented. This lack of precedent creates a high degree of uncertainty in the ultimate outcome. The final reason for the strength of the markets is a widespread belief that the "Fed put" is back. It is almost universally believed that the Fed has taken on a third, unstated mandate of stable and rising equity markets, by easing and talking the market up when it declines. I don’t know to what extent this is true, but the mere notion has created a hidden source of instability in the market by giving investors unusual confidence. While there is no reason to believe that markets will crash, it's also not out of the question. The Fed has announced that it will "taper" QE purchases from $75 billion / month to $55 billion / month. At the current rate of taper, QE purchases could reach zero by the end of the year. One key question for investors is whether this may reverse any of the three dynamics listed above.

hnnewguy 12y ago
>investors would rather hold scarce assets such as equities and real estate than a rapidly diminishing percentage of the money supply (i.e., cash) Do you have any data to back this up? It is my understanding that the demand-for and holding-of cash (specifically the USD) reached epic proportions in 2008 (as happens during financial crises, hence the need to print) and remains very high.

rguzman 12y ago

> It’s hard to sustain a bubble for four years. I don't think so. The housing bubble that popped in 2008 lasted a lot longer than 4 years.

mathattack 12y ago

It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low. The discounting is what's propping up the market. It's a strange phenomenon in that the market is betting that earnings will hold or grow, but the economy will be weak enough to discount future cashflows at a low rate. This is why signs up recovery that suggest tightening cause the market to tank.

porter 12y ago
More on the discount rate here: http://www.propertymetrics.com/blog/2013/09/27/npv-discount-rate/ http://www.propertymetrics.com/blog/2013/09/27/npv-discount-...

hagbardgroup 12y ago

This is the most honest article that I've seen from a mainstream financial figure about why valuations are so high. ZIRP (zero interest rate policy) means that money is near worthless to financial institutions that can run the carry trade on Treasuries, or other carry trades involving foreign exchange. VCs manage money for those guys, along with pensions and other enormous concentrations of capital. What you want are equity stakes (control) of productive assets. The cash that you use for that is not that useful except to normal suckers like you and I who need to hand over a bunch of paper tickets every month to the landlord, the grocer, and the government. The guys who issue the tickets are generally above those concerns, but they still need to get a return on their capital. I would rather own stock than a pile of green tickets. Stock is, again, just another kind of ticket, but they're more expensive tickets that grant you rights to a productive asset. It is a safe bet to dump your green tickets into speculation because, while the speculation may work out, you know for a fact that those tickets are going to depreciate. You will not see interest rates go up if the Fed can help it, because to do so would provoke an immediate fiscal crisis. Bubbles result from rational allocations of funds based on a certain set of assumptions. It is a good assumption that the US government will not permit rates to rise as long as there is zero public appetite for a major reduction in government spending. Once that reality changes, the structures that rely upon that environmental state will either need to adapt or will fail. Startup-land is a greenhouse arrangement that thrives so long as the temperature remains high. When the guy who owns the greenhouse cuts the power, most of those plants are gonna die. If you want to be resilient to that risk, you must leave the hothouse. However, the hothouse plants have a lot more access to capital in the near term, so it is rough to compete with them directly. That is the trouble with bubbles: you can't really escape their effects by being 'prudent,' because low interest rates make prudence imprudent. In order to raise rates, the US would probably have to either confiscate a lot of assets (which would harm its international status as the cleanest dirty shirt), raise taxes, raise retirement ages, implement means testing on medicare + social security, and cut military pensions/VA expenses. There is no real solution that does not involve provoking some sort of major crisis, so it is much easier for everyone to keep the carnival going as long as possible until something snaps internationally. The federal government can't afford even a slight rise in rates without having an immediate cash flow crisis.

12y ago

j_baker 12y ago

This sounds like a perfectly reasonable take on the situation. As a general rule of thumb, expansionary monetary policies benefit smaller companies. Now that the fed will likely start tapering back some, I think we'll start seeing larger companies (Apple, Google, maybe Facebook) having good years. There's one thing I can guarantee though: we are almost certainly in some kind of bubble. It may not be a tech bubble, but bubbles are just a fact of economic life.

jpmattia 12y ago

> It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime. > I have no idea when and if that will happen. Apparently, neither does anyone else, including the Fed itself who's been predicting a rise since 2010 or so: http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/04/forward%20guidance.JPG http://www.zerohedge.com/sites/default/files/images/user5/im...