Of Unicorns and Bubbles

In addition to profiling the story of the Oculus acquisition by Facebook, Vanity Fair recently featured articles about Unicorns (billion-dollar valuation start-ups), and the technology bubble. Current valuations are (again!) brought about by 7 years of easy money, where you have too much money chasing after assets. This can be good and bad: the abundance of capital has encouraged more people to come out to build companies; however, those that truly add value to our economy, or are profitable, are few and far between.

For an idea of how bubbly the sector is, take Jet.com. The brash four month old e-commerce startup out to take on Amazon.com raised $225m at a $600m valuation, and is going for another round at a $3b valuation! (See WSJ article)

If this is not a bubble, what is? The names are not without reason: Unicorns are mythical and bubbles have to pop sometime. What investors could do would be to understand the companies' business models and financials, if they are truly sustainable and defensible. Are the companies going after something faddish, that can be done without, or something essential, a technology that has the potential to change the world? The man on the street should also ensure that his income is not fully dependent on errand running start-ups, taxi disrupters, or freelance internet work. 

Around half of dot-com era companies such as Amazon and ebay survived the last crash to emerge as the tech behemoths they are today. Perhaps the best test for the companies would be the bursting of this bubble with more rounds of financing, as it would purge the wannabes or "unicorpses", and leave the strongest standing. Another way would be for them to be to go to market, where they will have to reveal their performance numbers and investors can then ascribe a true value to them. The rest of us will just have to be wary as we watch this bubble grow. 

The ills of easy money

The US and Europe have been trying to revive their economies through Quantitative Easing(QE) policies. However, we are now witnessing the repercussions of their actions. See interview with billionaire activist Carl Icahn.

In the past 7 years, the money created has flooded financial markets in the guise of higher stock prices, but have hardly permeated the real economy, or got to the Man on the Street. Property and stocks have been inflated by excess money chasing after limited assets, and borrowing against inflated assets will only make this bubble even bigger.

Note that the job of the Fed is to manage inflation, but not assets. However, this misguided effort has led mainly to the inflation of assets, but not demand or prices. John Burbank of Passport Capital hit the nail on the head with this remark:

"QE had caused a misallocation of capital across the world, while the end of QE last year triggered a dollar rally with consequences that were only now beginning to be realised. The wrong people got the capital — emerging markets countries and corporates and a lot of cyclical companies like mining and energy, particularly shale companies — and this is now a major problem for the credit markets,” he said.

QE has in fact, gone against its purpose, leading to declining prices from an imbalance between an excess of supply from Asia and a drop in demand from the West - Overleveraging has led to overcapacity that is driving down prices (read: China).

So, where will real growth come from? And what can we put our bets on? I will highlight some of these promising sectors in my next post...

This time is different?

Bloomberg came up with a very relevant article on why where we stand is different from the Asian Financial Crisis of 1997.

In a nutshell, here is the gist of it:

What is happening?

The recent devaluation of the RMB and a strengthening USD, in anticipation of a rate hike (that didn't happen) has resulted in SE Asian currencies such as the Indonesia rupiah, Malaysia Ringgit, and Vietnamese Dong tumbling to levels seen during the 1997 Asian Financial Crisis.

How is this time different?

• These countries have lower external debt burdens.
• Exchange rates are now flexible; they were fixed and indefensible in 1997.
• They have more dry powder this time - higher foreign currency reserves - to shore up their currencies if required. In Indonesia and Thailand, for instance, there is room for further rate cuts, while Jakarta and Bangkok have announced higher domestic spending to boost their economies. Meanwhile, Kuala Lumpur has also announced a higher spending plan.
• Current account surpluses for these countries - exports are greater than imports.
• Asian banks are stronger - higher quality loan portfolios and regulations

In light of the above factors, analysts say that the drop in currencies is actually a healthy realignment that would help boost exports amidst a commodity slump. However, I'd like to add that there are now new factors in the equation:

What's new this time?

• It is a matter of time before the US starts raising rates, thereby exacerbating the outflows from emerging markets in search of safer havens and higher returns. 
• The slump in commodity prices have added on to the woes of Indonesia (coal) and Malaysia (oil).
• Loss of confidence in the Indonesian and Malaysian governments could lead to further political turmoil.
• China's slowdown, exporting deflation with it. 

All this volatility in the markets is not helping confidence, which is a prerequisite to boosting much needed investment and consumption. Surprisingly, 7 years from the crisis, we are still hearing about massive job cuts (read Deutsche, HP, Standard Chartered) with the only bright spot coming from Silicon Valley, widely touted to be approaching bubble territory. 

All eyes will be on the US and Chinese governments if they can bring their economies out of the deep end. It would also be crucial these new factors do not throw their economies out of balance; because this time it may be different ... a different crisis. 

US Fed - To raise or not to raise?

Come September 18, the most hotly debated decision will be known: whether the US Fed will raise its interest rates. Here is my cow sense on what will happen and why:

The Fed is likely to raise rates, if not this time, at least by 2016. Rates have been held close to zero since December 2008. Amidst a lamentable recovery, the Fed's dual mandate of employment and price stability have been about met: Unemployment has halved to 5.1% since its peak in 2009, and inflation, at 0.2% (for the last 12 months till Aug 2015) is slowly approaching its target of 2% (Inflation for a large part of 2014 was nearer 2%).

In addition, assets are reaching "bubble" territory. In her July 15 semi-annual testimony to the Senate Committee, Janet Yellen has alluded to this herself by warning that she sees signs of asset price bubbles forming in some markets such as those for leverage loans and lower rated corporate debt, while indicating that stocks aren't overvalued. Car sales are rising at the quickest pace in a decade (also fueled by low pump prices), while commercial real estate prices are going through the roof.

Detractors (i.e. the World Bank, Lawrence Summers, Lloyd Blankfein) claim that raising rates would hurt a fragile recovery and impact emerging markets; the higher interest rates would cause outflows from emerging markets into the US. However, as pervasive as the impact of this decision may be, the US has to tend to its own backyard in order not to sow the seeds for runaway inflation and asset bubbles, as during the Greenspan era.

Whatever the case, it is most certain that a rate raise will happen; if not in September, at least within 6 months. Should it happen on September 18, it will be largely priced in as the Fed has done a good job of preparing the markets for it. If it doesn't, the markets will likely continue with its upward trajectory.