Tag: Investing

I wasn’t familiar with TDM Growth Partners out of Australia until someone posted their recent missive to LPs on the seemingly confusing tech crash or lack thereof.

First, they clearly outline where the crash is and where it isn’t:

Furthermore they looked at EV / Sales metrics for the BVP Index and dropped a few major outliers representing nosebleed valuations that have persisted and the result is EV / Sales is basically within spitting distance of the long term average:

They go out to outline reasons why, with an appreciable acknowledgement of their basic of call of maybe this time is different, what is demanded of these businesses by the stock market today in terms of growth isn’t aggressive, and that it potentially indicates downright cheapness. Furthermore they go on to make accommodations for higher rates, lower exit multiples, etc. and continue to think that today’s prices are attractive.

The only thing they don’t fully acknowledge, in my opinion, is the potential for capital scarcity in the economy. Said more plainly, if the economy slows and the Fed has withdrawn its dramatic firehose of liquidity. The early 70s are symbolic of a time in which dramatic undervaluation in the market was persistent but no capital wanted to enter the market. But that is a scenario that may affect all types of businesses, not just technology. A pessimist may argue that tech stocks have further to drop in a downside scenario. An optimist, however, may rightfully say that ignores the dramatic upside that may exist.

To that end, tech stocks don’t typically pay material dividends to their shareholders, and in many cases for good reason. However it doesn’t fit my process and to that end, while fun to keep tabs on the economy broadly speaking, these stocks ultimately aren’t a fit for me.

News is abuzz with the latest inflation figures clocking in at 7.5%. The US 10-year government bond yield crossed into 2% territory in response to the data. The barrage of news questioning whether the root causes are transitory or secular.

What is especially interesting about interest rates and inflation moving around is lots of assets in the market had reset to pricing reflective of very low yields. In practice it means that people would pay more for cash flows that may materialize far into the future than they would if interest rates are high, and returns today matter more than they did in the past. The net result is a lot more volatility as the market tries to guess what the Federal Reserves actions will be over the course of this and next year to combat inflation.

What is one to do to navigate this environment? The most simple blanket action one can consider is not own assets with very long dated cash flows that make up the vast majority of the cash flows. In plain English, own assets with reasonable cash yields on today’s earnings. Say a 7.5% earnings yield or more. Second, own things that may benefit from a higher rate environment. It’s no surprise that financials and energy have posted positive returns this year while technology has posted losses. Third is to fight the urge to “do something drastic” in light of a lack of simple decisions / investments to make. Keep a shortlist of companies / investments that straightforward purchase decisions, keep a reasonable amount of dry powder available, and continue cautiously investing excess cash flows regularly.

Yesterday (or perhaps late in the prior day), the ECB joined the Federal Reserve in signaling a change in policy towards fiscal tightening, specifically going backwards on its prior multi-year regime of supplying low rates and plenty of liquidity to support the global economy through the pandemic (the UK central bank also raised rates yesterday).

The million dollar question in the near term is – will a rising rate environment paired with monetary tightening (suspension of open market government bond purchasing) hurt the economy but tame inflation, help the economy and tame inflation, or hurt the economy and not tame inflation. Every tends to think about the outcome with respect to what their “book” is.

One investor group, VCs and Growth investors, talk of a central bank induced recession on the horizon. Why? In part, because the companies they own are valued (or were valued one quarter ago) at rich valuations. When rates go up, valuations decline, but rich valuations decline far more than cheap valuations broadly speaking. Simplistically, if rates go up 1% and a company traded at a 1% earnings yield (100x earnings), the valuation of the company would drop by 50% if it traded at a 2% earnings yield. If rates go up by 1% and a company trades at a 20% earnings yield (5x earnings), the valuation of the company would drop by 5% if it traded at a 21% earnings yield.

Of course, there are examples across the spectrum ending with constituents that cheer rate increases and do not believe it’s possible to have a recession given how strong the consumer, unemployment, and other core data are looking.

To that end, the reality is the vast majority of constituents across the opinion spectrum don’t truly know what will happen, chiefly because the world is a complex adaptive system that constantly evolves / morphs as inputs change. It’s not a machine that has predictable outputs with the same inputs.

The best medicine for this is understand how one’s current situation is positioned for all outcomes and avoid the worst potential spots, which in this case I believe are assets that are (1) speculative beneficiaries of high liquidity or (2) highly valued or (3) very sensitive to consumer demand.

A few short data points before discussion.

Yesterday, one of the largest companies in the world by market value dumped ~$200B+:

Furthermore, Snap, had an unbelievable whipsaw in the same day due to blowback from FB and a positive earnings release post-close:

While movements like this tend to prompt the crowd to skewer the efficient market hypothesis in the short run, it does resurface a number of questions for the individual investor:

• Is the occasional wild swings in publicly marked enterprise value a feature or a bug?
• Does a public markets investor have adequate information to make high-ish probability wagers on the enterprise value of the company?
• Are most public markets participants suited to participate in the venue?

Of course, I have thoughts on each, and there are no right answers. But they pertain to the marriage of my personality to the characteristics of public markets (both features and flaws). Your personality may merit a different set of answers.

That said, on a daily basis via Twitter, I see countless investors’ thoughts and actions provide strong implied answers to the above questions. Especially on days when the above swings in market values are extreme. Most often – investors:

• Take price momentum as a directional indication of the quality of corporate strategy
• Believe that their insight based on analysis of publicly available data is equal or better to the broader marketplace
• Lack conviction when fundamentals and public marks aren’t going “up and to the right.”

Mind you, these investors I am referring to often include fiduciaries, fund managers, analysts, etc. The natural question of the reader is, does this author believe he is above the crowd and master of the universe?

No. As I laid out in a prior musing, I don’t invest (for the most part) in “businesses” explicitly. I invest in broad mandates with an investor at the helm. I’m an LP. Why? Specifically I believe that I fail the second bullet point / question I posed. But that’s okay. I carved out my niche and love the vantage point by which I can spectate and participate. The question, reader, is have you taken the introspective time to figure out what your niche truly is?