
The Bubble Question - DanielRibeiro
http://avc.com/2014/03/the-bubble-question/
======
7Figures2Commas
> 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
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.

------
mactitan
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-...](http://www.pinnacledigest.com/blog/dscaroknight/chart-below-
illustrates-massive-tech-bubble-one-astounding-chart-created-sentiment)

~~~
hnnewguy
> _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/fomcprojt...](http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140319.pdf)

~~~
mactitan
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.

~~~
hnnewguy
> _When the fed raised rates the last time ,stepwise & slowly it didn't work
> as planned_

You mean how when they raised rates in part to prick the housing bubble? How
did it not work "as planned"? When the economy heats up and inflation is a
risk, rates will rise. This is the business cycle.

> _I just believe Peter schiff on this._

Being as how he's been wrong on just about every public prediction he's made,
and his hedge fund gets crushed both _during_ the crisis (which he
"predicted") and since, I think you'd do better to expand the borders of your
economic prognosticators.

~~~
mactitan
Well my 1st expansion was looking at the bandwagon of ( Rogers, faber,
schiff,...) I was about to invest at the peak of dot com but reading them kept
me out Didn't buy during house bubble- I was wary of what this group was
saying - but I couldn't convince my condo flipping acquaintances - my chicken
little perception faded a bit. I do notice that it's very hard for analysts to
be flexible , thus titles like perma bear/bull...

------
netcan
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
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.

~~~
pyoung
"just lots of rich people with less money."

My original take on the "bubble" was somewhat in line with this. However, the
more I think about it, the more I am inclined to believe that this will
"trickle down" in many ways. Fewer investments will lead to fewer jobs. In SV,
this could lead to a cooling down (or worse) of the labor market. The
established players (Google, Apple, Amazon, etc) will probably pull through
alright, but the VC money will thin out. If I was a software engineer and I
wanted to hedge my bets, I would probably try get a job at one of the bigger,
more stable companies in the next year. If things do cool down, I imagine that
programmer jobs and salaries will be the most noticeable side effect.

Of course I could be entirely wrong. It's possible that VC money makes up only
a small fraction of the demand for software engineers. After all, almost every
industry under the sun is shifting towards (or wants to shift towards) higher
levels of automation and efficiency using computers and software.

~~~
mcmullen
You're absolutely right that "trickle down" occurs. Basic logic suggests that
if lots of businesses have lots of funding, and that funding dries up, there
will inevitably be job losses because they have to be funded from somewhere.

However, I wouldn't worry too much because technology is clearly the future
and the need for technology professionals will continue to grow. These
stupidly high valuations are for, I hope, decent businesses. By that virtue,
they will get the funding they need - just not the scale that we have seen.
Hence, I used "just lots of rich people will less money" because the people
set to lose out are the huge investment vehicles who seem to be huddled around
the Valley at present. The highly skilled engineers needn't worry because the
likes of Mr. Wilson and Mr. Andreessen aren't going anywhere, and the average
Joe Bloggs needn't worry because their pensions aren't at risk. The people who
should worry are those who watched the Facebook float and said, "Shit, I need
some of that action!"

As always, it's the stupid that lose out. Fortunately, the stupid ones aren't
providing our mortgages or issuing our credit cards this time. (Namely, Royal
Bank of Scotland, Bank of America, et al.)

But, hey - I'm just a 24 year old CS grad come IT consultant, what do I know?

------
tpeng
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
> _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.

~~~
leoc
At the same time as this tech boom, S&P 500 companies are (I'm told) busy
borrowing fistfuls of money in order to pass it on to shareholders through
dividends and share buybacks. That seems to suggest that investors are happy
to have cash right now; it also puts the complaints about excess or
wastefulness against the current SV boom into some perspective ...

~~~
mahyarm
Isn't that borrowing more because of US tax policy causing vast amounts of
money to just sit there in foreign bank accounts for those SV companies?

------
kunle
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
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
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
Absolutely spot on

------
hagbardgroup
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.

~~~
debt
Can you offer a good book on that coherently explains US federal monetary
policy? You have a good handle on what's going on. I still don't quite
understand it.

~~~
mactitan
Paul Volcker shines in secrets of the temple

~~~
ganeumann
Seconded. _Secrets of the Temple_ by Greider is pretty accessible (if biased,
as they all are).

[http://www.amazon.com/Secrets-Temple-Federal-Reserve-
Country...](http://www.amazon.com/Secrets-Temple-Federal-Reserve-
Country/dp/0671675567)

Also, the EconTalk podcasts are awesome:
[http://www.econtalk.org/archives/money/](http://www.econtalk.org/archives/money/)

E.g.

\- David Laidler on Money
([http://www.econtalk.org/archives/2013/09/david_laidler_o.htm...](http://www.econtalk.org/archives/2013/09/david_laidler_o.html))

\- Sumner on Money, Business Cycles, and Monetary Policy
([http://www.econtalk.org/archives/2013/03/sumner_on_money_1.h...](http://www.econtalk.org/archives/2013/03/sumner_on_money_1.html))

\- White on Hayek and Money
([http://www.econtalk.org/archives/2010/02/larry_white_on.html](http://www.econtalk.org/archives/2010/02/larry_white_on.html))

\- etc.

~~~
crazy1van
I second the EconTalk podcasts. I've been listening to them for over 5 years.
They are hour long interviews on a wide variety of subjects. The host, Russ
Roberts, does a great job of letting the guest get his or her point across
even when you suspect he disagrees. The tone is polite and non-
confrontational. It is more about accurately presenting a position than
debating, although there is some point/counter-point.

I cannot exaggerate how much I've learned from EconTalk. Plus, there's even an
episode with Paul Graham about ycombinator and startups:

[http://www.econtalk.org/archives/2009/08/graham_on_start.htm...](http://www.econtalk.org/archives/2009/08/graham_on_start.html)

------
rexreed
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.

------
rguzman
> 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
_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
More on the discount rate here:

[http://www.propertymetrics.com/blog/2013/09/27/npv-
discount-...](http://www.propertymetrics.com/blog/2013/09/27/npv-discount-
rate/)

------
mcmullen
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
(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
Thanks for the clarification!

------
brc
>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
"Bad things that are yet to come" aren't a given...

~~~
brc
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.

------
sz4kerto
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.

~~~
gizmo
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
Deflation will be bad because nobody will by something today when they think
it will be cheaper tomorrow.

~~~
brc
This is standard excuse trotted out. Of course it is incomplete at best and
grossly misleading at worst.

Deflation is the opposite of inflation. One is an increasing value of
currency, and the other is a decreasing value of currency.

People deal with deflation every day - both in their own national economies
and internationally - when your currency is rising (gaining value) why would
you purchase something today when it is going to be worth more tomorrow? The
answer is because the value of having the thing today is worth more than
having the money tomorrow - which is how we base _all_ our purchasing
decisions.

It's true that deflation will have effects that are not good - but mild
deflation is no horrific thing. Most people have been told deflation is a
scary monster in the same way that they have been told marijuana is a scary
drug. There are circumstances and reasons when that is true, but it's not
generally true and generally overblown. Both high deflation and high inflation
are runinous to an economy, but mild deflation and mild inflation just produce
different classes of winners - savers vs creditors.

~~~
michaelt
What people actually mean when they say "buy something" is "invest in
something".

When an investor chooses whether to invest in something, the question they ask
themselves is "will this make more money than the best alternative investment
on offer to me?"

When the value of currency is falling, it becomes relatively more appealing to
invest in things that are not currency. For example, new machines for the
local factory - those machines make widgets, and with 2% inflation those
widgets are worth 2% more every year.

When the value of currency is rising, it becomes relatively more appealing to
invest in things that are currency, like keeping my money in the bank. Glad
I'm not one of those suckers who invested in the widget factory, because of
the 2% deflation those widgets are worth 2% less every year.

Me, I think our economy would be better off with more invested in
manufacturing and less in financial services.

~~~
hnnewguy
> _because of the 2% deflation those widgets are worth 2% less every year._

Also, the value of your loan increases in real terms, as does the labour-share
of input costs (because the workers aren't going to give back wage gains in
times of deflation). Your return is hampered.

These are some of the problems with deflation.

------
kevin818
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.

------
jpmattia
> _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/im...](http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/04/forward%20guidance.JPG)

------
j_baker
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.

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

------
nutjob2
"This is not the bubble you're looking for..."

"Move along..."

The VC can have a strong influence on the weak minded.

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

