Tuesday, May 3, 2016

VCs and "Dirty Term Sheets"

A recent blog post by Bill Gurley, "On the Road to Recap," has been getting shared lately. It is well worth reading. The topic is the current excesses in venture capital, which appear to be in the process of deflating.

In particular, Gurley explains "dirty term sheets," which keep up the appearance of high valuation for a so-called unicorn.

There can be clauses in the terms of later-round capital raises that beggar earlier rounds, if certain contingencies come to pass. For example, the ownership percentage of those investing in the last round can go up (costing earlier investors) if the company does not make a public offering by a certain date. Such terms make valuation look higher on paper than it really is, because it is hard to make appropriate (downward) adjustments to a company's value for the presence of such contingencies. Human nature is to overlook them, as the post explains.

Gurley is saying that terms of this kind are a form of structured finance -- but for venture capital, rather than for mortgages. That is a really interesting way to think of this.

This is a likely area in which more problems will surface. Also, the post makes a persuasive case that there is pent-up demand for going public in Silicon Valley.

Wednesday, April 20, 2016

Nice Global Shiller CAPE Tool

This page from Star Capital in Germany is a great tool that shows the Shiller 10-year CAPE (and more) for markets all around the world.

There is a related page that turns the valuation into expected long-term returns.

Thursday, April 7, 2016

Wisdom on Sanders and Trump, from 1837

History doesn't repeat itself, but it rhymes, as the saying goes.

American politics today is a decent rhyme for events from 180 years ago. When you read the following, replace "Republican" for "Whig," and think of the financial crisis of 2008:
There were immediate reasons for youthful rhetoric and high drama in 1837. Throughout the spring, just as Martin Van Buren inherited the presidency, a terrible panic gripped the American economy. The price of cotton fell precipitously in the South, while banks suspended specie payments and unemployment climbed in northern cities. The panic severely shook public confidence and galvanized Americans to take sides, defining themselves both politically and in a generational sense. Whigs and Democrats bitterly blamed each other for the disaster. But for many young Americans, the Panic of 1837 exposed the bankruptcy of all American politics, and an older generation conducting its affairs selfishly.
The text is from the book Young America, by Ted Widmer, published by Oxford Univesity Press. I am quoting from the 1999 edition. Ted is a smart guy: he got his Ph.D. at Harvard, is formerly the librarian of Brown University, worked in the White House, and is currently a fellow at the Center for American Progress.

For a more timely view, I recommend Paul Solman, the economics correspondent for the PBS NewsHour. He recently interviewed Robert Reich, a liberal, and Charles Murray, a conservative, about the economic forces behind the rise of Sanders and Trump. What Reich and Murray say is consistent with 1837: there is now a general disillusionment with the establishment, grounded in economics, that transcends party, and that helps explain why the two breakout candidates are off to either side of mainstream. Paul's interviews with Reich and Murray, linked here and here, are well worth watching.

By the way, returning to the quoted text: Ted Widmer, its author, who is a friend of mine from college, used to play heavy metal guitar for a semi-famous rock band, The Upper Crust. In the linked video, Ted is in the red coat, singing the second song. The band may be the answer to the musical question, what would Paul Revere and the Raiders sound like, if they had graduate degrees? Recommended listening.

Tuesday, February 16, 2016

Jamesian Platonism

This is post is going to be at the wholesale, rather than retail, level. It applies to investing, and to anything else that requires understanding.

I would describe my philosophical stance these days, for the past decade or more, as Jamesian Platonism.

This is a school of thought that, to my knowledge, contains only one adherent. He happens to be the guy who blogs here.

So, what do I mean by the name, Jamesian Platonism?

From Plato, I take the idea that what we see and experience is perception, which only dimly, and only in part, reflects reality. Reality itself is always beyond our reach. And probably, reality is abstract and more like math than like daily life. If it makes any sense to speak of "ideas in the mind of God," I imagine them to be more like equations than prose. That is a way of thinking about something that is really beyond what our brains are capable of handling, so, do not take me too literally.

From William James, I get the idea that there is no reason to commit to any one school of thought. Somewhere, but I don't recall (or much care) where, James or one of his adherents says that philosophy is best thought of as a hall with classrooms on either side. We should not spend all of our time in one classroom. Use idealism when it helps; materialism when it works better. The whole idea of pragmatism is the willingness to use each philosophy insofar as it is useful, but not farther. Poke your head in and out of the various classroom, if, when, and as they are relevant.

OK, those are the ingredients. But, again, what do I mean by Jamesian Platonism?

I think in some deep sense that Plato is right, that we can't see things as they really are. But because of that, we need all the tools we can to get a grip. So I take a Jamesian approach to trying to get the best grip on reality that I can.

My friend Josh May (gated Financial Times link) tells me that I need to give an illustration or two. Josh is rarely wrong.

So: an example in daily life would be that if you are navigating, there is no need to attached to any particular map. A map of Nashville is useful only if you are in Nashville, not Miami. And, for that matter, each map of Nashville will have certain flaws, and has to leave things out. Some show you where roads are; some show population density; some show tourist attractions, etc. Nothing can show it all, because the only truly accurate 3-D map of the city is the city itself, and that is too big to carry around in your pocket.

In investing, an example is the different ways of valuing the stock market as a whole. To pick just a few interesting ones, there is the Shiller 10-year P/E, the ratio of market value to GNP, and the ratio of market value to replacement value (Tobin's q). You can look at each of these assuming that alternative investments in the bond market are rationally priced, or you can assume that bonds may be mis-priced as well. The key is having some sense of the insights and limitations that characterize each method.

Wednesday, November 4, 2015

The Other Shoe

My quick-witted friend, Josh May, is a close student of central bank policy in the US and abroad. More than once, he has opened my eyes to something that I was missing.

I told him recently that the side effects of years of super-easy money are not known yet, and that I am expecting the other shoe to drop, some day. This seems, to me, like a pretty safe bet.

He replied, “What if the guy upstairs only has one leg?”

I still think a central bank has two, but, hmmm...

Saturday, October 31, 2015

Quote of the Day: Science is Not Advanced by Polling

But such exercises are futile: science is not advanced by polling. If it were, we would still be releasing phlogiston to burn logs and navigating the sky with geocentric maps.
E.O. Wilson, in this NYT piece from 2012.

Wednesday, October 7, 2015

Is monetary policy a science?

No, it's not. So says William White, in an interview earlier this year.

White is the formerly the head economist at the Bank for International Settlements, in Basel.

Read the whole thing, but here is a short excerpt:
What would help to improve monetary policy? 
I’ve become more and more convinced that the fundamental problem with the central banks – and for that matter with the broader economic community – is this insistence that the economy is a kind of machine that you can describe with many equations.
The reality is, that the economy is a complex adaptive system. Like a forest. The distinction between the monetarists and the Keynesians is nothing compared to this. The difference between all of these models and the kind of insights that you get from working with economies as complex adaptive systems are totally different. That is not yet accepted. 
How does a complex adaptive system function?
If you accept this complexity, then you have to accept a number of things that most central banks have not yet fully incorporated into their thinking. One of them is: these systems break down all the time. If the economy is the most complex adaptive system that mankind has ever created, it will break down on a regular basis. 
Historically it has broken down on a regular basis. And, like the boy scouts, we should be prepared for it. Fact of the matter is, when we went into this crisis, we were not prepared for it. And it’s not much better now. There was no bank insolvency regime, no deposit insurance, no memorandum of understanding – all these things that should have been in place, but they just weren’t.