President Xi Jinping of China has called Vladimir Putin his “best friend” and colleague. These public statements bely history. For example, in 1969 unprovoked Chinese attacks on Russian soldiers which lead to a border clash.
In recent history, the border discrimination against the Han race exemplify racial tensions and mistrust between the Russian and Chinese people.
For the time being, the public relationship with Xi Jinping makes sense for Putin as it gives ease to Chinese investment and undermines leadership as world leader. In addition, US Congress derived sanctions against Russia and Trump’s trade war on China have brought the two countries closer together.
When diving deeper through Putin is fighting a political battle with Chinese interests in corporate boardrooms, Silk Road initiatives and manipulative economic practices.
What will likely drive tensions between Putin and China are land encroachments on Russia’s eastern region bordering the Pacific Ocean. Chinese military leaders already consider specific regions owned by China. As seen in Vietnam, the Philippines, India, and Japan, China will flex it’s military and financial muscles to it’s own benefit. It seems inevitable that China will demand revisions to the Czar’s border treaties or at least “land-lease” rights. The Russian policy has between to deter aggression by the threat of nuclear retaliation.
The current Russian political paradigm is post-imperial and it no longer seeks to conquer new countries. Instead, it’s diplomatic paradigm is to insure the balance between the US and Chinese powers. In the mid-2000s, the Shanghai Co-operation Organization (SCO) was built to forge a collaboration between China and Russia against NATO and the US.
From the Chinese perspective, the policy is for Russia to neither collude or collide with the US. First, China is aware of the US Foreign policy strategy exemplified by Secretary of State Hilary Clinton to encircle China. China’s worst fear is for Russia to join forces with the US. On the other hand, it is against Chinese interest for their to be any tensions between Russia and the US such as in the 2008 war in Georgia.
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Brexit may be the catalyst that crashes the entire global economy.
On June 2016, 17.4 million voters in England opted for Brexit. The UK official left the European Union (EU) on January 31, 2020. Areas effected include law enforcement, data sharing and security, aviation standards and safety, access to fishing waters, supplies of electricity and gas, and licensing and regulation of medicines. Currently, the UK is in a transition period till December 31, 2020 and must negotiate a new trade agreement with the EU by this date. If a trade deal is not negotiated, the UK could be facing tariffs to the EU.
How did Brexit happen? Because of the Great Crash in 2008, European debtor nations sustained severe austerity problems that lead to massive unemployment and economic malaise. In addition, political refugees from Syria, Somalia, Bhutan, Iran, and Afghanistan fueled massive racism as well as escalate social service spending. The growing divide between the rich and poor and racial tensions have stoked the fires of populism and anti-EU sentiment.
As a result of Brexist, the sterling pound should massively devalue. Unlike the last major sterling pound devaluation in 1992, the Bank of England this time around will not be able to cut interest rates to soften the severity of the devaluation. In addition, the UK has a current account deficit that it didn’t have in 1992 and is very sensitive to the whims of the global bond market. A vicious cycle will also be created by the sterling pound devaluation. The 27-countries of the EU will feel threatened by deflationary pressures from super cheap English exports and likely start a trade war with the UK.
In this nightmare scenario, the US after unilaterally altering the Iran deal will not have the ability to eliminate the trade war. However, the Fed will be able to lower interest rates to soften the blow of sterling pound devaluations. China current sits on a leverage bubble similar to the US prior to the Great Crash 2007; a EU trade war could bring down the Chinese economy.
Brexit is eerily similar to the currency devaluations in 1921 in Germany followed by the sterling pound devaluation that followed. Currency wars lead inevitably to tariffs and a breakdown in global trade and lead to the Great Depression in the 1930s.
In March 2000, Barrons predicted massive tech failures in an article titled “Burning Up; Warning: Internet companies are running out of cash—fast.” The Federal Reserve raised interest rates which lead to an inverted yield curve. March 10, 2000 is the day the Dot.com bubble popped. In April 2000, the Nassau crashed by 34.2% and hundreds of tech companies nose dived more than 80% in valuation. $8 trillion in wealth vanished overnight.
Back in 1999, everyone seemed to know that a market crash was coming. Stock advisors told their clients that tech stocks were overvalued. 1999 reminds me a lot of 2019.
The major cause of the Dot.Com Bubble was the Taxpayers Relief Act Of 1997 which lowered the maximum tax rate on capital gains for individual investors from 28% to 20% for equity held for more than 18 months. This law incentivized average investors to speculate on the super hot tech stocks.
In addition, bubbles are always caused by easy capital, speculation and innovation. Today’s innovation buzzwords include the “internet of things,” blockchain, artificial intelligence, virtual reality, machine learning and the Gig economy.
In 1999, tech stocks rose as fast as 300% to 1900% as opposed to 350% increases in 2019. In 1999, 550 tech companies went IPO, cashing out billions for venture capital funds. Venture capitalist made over $43 billion between September 1999 and July 2000. The losers were average people; the average 401k lost 25%-35% of it’s value.
In 1999, the cyclically adjusted price-to-earnings (CAPE) ratio of the S&P averaged 45 compared to long term averages for the traditional 12-month rolling PE (price-to-earning) ratio of 16. When earnings are low, the traditional P/E jumps up and makes shares look overpriced. When profits are high, they make the traditional P/E look like a great buy. Cyclically adjusted P/E (CAPE) ratio corrects the “illusion” caused by fluctuating earnings.
The problem with the stock market today is that profits are being driven by unsustainably low-interest rates and over $8.8 trillion in corporate debt. For example, the corporate growth rates have been outpacing GDP growth.
It is alarming that the cyclically adjusted P/E (CAPE) ratio today hovering around 30 is almost exactly the same as the eve of the 1929 crash. In fact, the greatest economist in the world reknown Yale economist Irving Fisher resolutely predicted that if a correction came it would look like a harmless slump because the tradition P/E (price to earning) ratio was along historical averages.
On October 15, 1929 (just days before the Great Crash), Fisher predicted that stocks prices were in alignment to corporate earnings and “what looks like a permanently high plateau… I expect to see the stock market a good deal higher within a few months.“ Fisher lost his reputation by making the same mistake as economists today who are overlooking the cyclically adjusted P/E (CAPE).
The tech bubble will pop. It’s impossible to know when precisely but it will happen in the near future.
If the Dot.com serves as a predictor, over 200,000 tech workers will lose their jobs after the crash, the stock market may lose 30%-40% of it’s value and venture capital funding will dry up.
Prior to the 2000 Dot.com collapse, startups were racing with time to go IPO (Initial Public Offerings) to gain huge exits for their investors. During that time as a 23-year-old tech entrepreneur and world traveler, I remember getting my Aussie ex-girlfriend’s mom Bernie all excited about buying Cisco, Microsoft, and Amazon stocks. Bernie ended up buying a ton of tech stocks in the frenzy, but she like many other amateur investors ended up selling it in the “tech bloodbath” that was to follow.
I lived in Geelong, Australia for two years while working diligently on my first software startup. If the tech market kept it’s franactic pace, I never would have jumped ship into real estate. After 9-11 and the tech bubble collapse, the herd of investors looked for safer places to park their money… namely real estate.
During the Dot.com era, companies raised massive amounts of capital from their IPOs and used it to try to buy traffic to jumpstart a network effect. Today, I see the same exact phenomenon occuring with two notable exceptions. The first difference is that the source capital is not coming from IPOs but rather from institutional investors and sovereign wealth funds. The source of the capital is 20:1 leverage with low interest rates. In fact, corporate leverage alone now exceeds $8.8 trillion usd. The second difference is a valuable lesson that VCs learned during the Dot.com debacle… the importance of getting to product-market fit quickly.
Silicon Valley has also formulated it’s “winner-take-all” strategy. Dot.com startup Amazon exemplified the “winner-take-all” approach of that era. Jeff Bezos believed that losing money could be the ultimate competitive advantage if you can raise enough capital to sustain it, as it prevents others from entering the space or gaining market share. When competitors are wiped out, then you can raise prices back up to profitability.
Examples of no-revenue companies are Uber valued at $120 billion usd and Lyft valued at $15 billion usd. It doesn’t matter to Uber that it lost $4 billion usd in 2018 and $4.5 billion usd in 2017. First, Uber raised over $22 billion usd. Uber has made a ton of money for it’s early stage investors in it’s recent IPO. Second, Uber’s traction is such that it will be “bailed out” by an acquisition. It’s possible that Uber will survive the market collapse that I forecast will be coming soon.
But here is the problem with a company like Uber… it lacks sustainable differentiation.
Network effects have no value if they don’t create monopolies. Uber will never make a profit in the rideshare business because it has no sustainable differentiation over competitors like Lyft. Raise rideshare prices and customers migrate over to Lyft. To win, Uber must beat Lyft and this doesn’t seem feasible or realistic. Alternatively, Uber needs to use it’s capital to create secondary models in markets such as supply-side logistics (aka Uber trucking). As a side note, I think Uber is trying to scare riders with “sexual assault” stories with the goal of allowing Uber to record driver / passenger conversations (obviously valuable data and a major violation of consumer privacy rights). If I were Uber, I would use Uber’s higher market valuation to buy Lyft. All the drivers who drive for both Lyft and Uber will then be working for the same company!
Uber is an example of a unicorn… defined by venture capitalist Aileen Lee as a startup who exceeds a $1 billion market cap. The number of unicorns has been on the decline since 2014. So here are the numbers… 42 unicorns in 2014, 43 in 2015, 16 in 2016, 33 in 2017, and 35 in 2018. In addition, a recent study by the National Bureau of Economic Research argues that the average unicorn is 50 percent overvalued.
Silicon Valley’s “winner-takes-all” approach works great in bull markets. However, I believe that the “winner-takes-all” fails miserably in bear markets. In a bear market, startups with free cash flow will survive. Ironically, free cash flow during bear markets may win the “winner-take-all” as no-revenue companies fight for their survival.
I think the groupthink in the Bay Area is missing another major blind spot. Prior to the Dot.com bubble, IPOs for tech companies took an average of 4 years. Today in our current “app bubble,” it’s taking 11 years for tech startups to IPO. Ladies and gentleman, this is a math problem. If you visit the history of American financial markets, bull markets tend to last either 5-7 years or 11-14 years. If IPOs for tech companies take an average of 11 years, this is like playing Russian Roulette. Better to look for 5-7 exits and being mindful of the economic credit boom and bust cycles.
So I am sharing my insights as to why VC tech investing is super risky in 2019. However, I don’t see the makings of a real estate collapse. Keep in mind that after the Dot.com Recession, tech workers lost their jobs and it temporarily effected the real estate market. But from my perspective, real estate “megacrashes” like 2007 have economic indicators such as subprime lending, mortgage fraud and over-construction. In a nutshell… I am expecting a 2000 Dot.com crash and not a 2007 real estate crash (well unless the currency collapses).
In 2001 with my first software startup on the ropes and hanging on for dear life, I shifted my focus to real estate investing. After the “app bubble collapse,” I’d bet that people go back to speculating on “hard assets” such as homes. In others words, I am expecting a two year bear market proceeded by a 5-6 year record breaking bull market.
From this discussion, it’s pretty clear how risky venture capital investing can be. Even if you pick the right founders in the right market, you’re still rolling the dice on market timing and competitor risks.
If you’re tech investing in 2019, find experienced founders who can quickly get to product-market fit, change your paradigm from “winner-take-all” to free cash flow as a near term survival strategy, and do your best to time the markets (which can be nearly impossible to do). Beware!
Investors remain anxious about the trade war between the US and China as well as Brexit. Deutsche Bank’s chief economist, Torsten Slok, predicts slow growth for China and Japan which projects to appreciate the US dollar. If the UK Labour Party wins with promises to nationalize utilities, this could send trembles throughout the global economy.
DISCLOSURE: Nothing on this blog is meant as investing advice… just mere educational pontification on my part. Oh ya… and all the photos on this blog are taken by my iPhone.
According to the International Monetary Fund (IMF), the global economy has been downgraded to a “synchronized slowdown.” Housing price crashes are occuring in Australia, Sweden and Canada.
Corporate valuations are not yet overinflated like we normally see in most market corrections with a price-to-earnings (PE) ratio of 15 and 4.5% dividend yield on the FTSE 100. However, the PE ratios can increase if corporate earnings decrease and reduce share buybacks. Corporate earnings forecasts are projected to be lower in 2020.
Because of worries about the US/China trade wars and Brexit, corporations are returning earnings to shareholders through dividends, buying back shares to reduce the PE ratios, and focusing on cost-cutting versus future reinvestment. This five year pattern could possibly affect earnings growth in 2020.
Historically, a signal of a coming recession is the inverted yield curve which occurs when the two-year Treasury yields more than the 10-year Treasury. When the bond market is in trouble due to inflationary concerns, the party may soon be over.
“We are dealing with a fiscally unstable long-term outlook in which inflation will take hold,” says another former FED chair Alan Greenspan. “There are two bubbles: a stock market bubble and a bond market bubble.”
Inflation would trigger massive defaults in the record $8.8 trillion corporate debt markets.
Low inflation driving interest rates and unprecedented levels of debt combined with Trump tax cut stimulus has created one of the greatest bull runs over the last 10-years. Many of the catalysts mentioned above could bring down the house of cards.
It all reminds me of the 2000 tech bubble. Some experts like chief investment Officer Scott Minerd at Guggenheim Partners expect a 40% hit in S&P 500. That’s comparable to the loses in the 2007-2009 Great Crash. After the stock market tanks and people lose their life long savings, expect a return to “real assets” like real estate.
When the market crashes, I’m expecting the Fed to overreact, lower rates and flood the markets with “bail-out liquidity” which will lead to a housing bubble pop an estimated 5-7 years after the recovery. All the signs of a real estate bubble will re-emerge… subprime lending, mortgage fraud, and overbuilding in construction. In my opinion, the next real estate market crash will be the biggest crash in the history of America.
In addition, expect massive overregulation in cryptocurrency and hemp/cannabis after the next crash. Many of the scammy ICO (Initial Coin Offerings) will go under and the SEC will look to “save the day” by instituting regulations. Cannabis/hemp markets are currently valued incorrectly. Investors pour money into cannabis and hemp mistakenly thinking that these are scalable tech companies, whereas cannabis and hemp are commodities. It will be common knowledge after the next crash that 145 PE ratios in Canadian cannabis companies are insanely speculative. When it comes to cannabis and hemp, the only metric that matters is free cash flow.
Based on my personal pontification about the market, I am being way way more careful in deciding what to invest in. Media Tech, Ad tech, tv and film content, and the entertainment sector content historically are less affected by recessions although leverage and acquirers could vanish. I’d expect influencer marketing platforms to increase during tough times, as companies want more “bang for their buck” in customer acquisitions. I’m interested in real estate services software solutions in anticipation of a housing bubble albeit it being short-lived. Interestingly, I am more interested in real estate software than real estate itself.
Sometimes the best thing to do when anticipate a market crash is to sit on the sidelines and wait it out. Another view point is to focus more on companies with the potential for free cash flow that can “ride out” the storm.
I’m writing this blog post from Wall Street (NYC) and it’s a good time to talk about market cycles.
Around 2002 six years prior to the Great Crash Of 2008, I read an article by Prof. Fred Foldvary who wrote in 1997: “the next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.”
Foldvary’s prediction was based on a book that he wrote analyzing real estate crashes since 1800. The economics professor concluded that real estate crashes about every 18-years (give or take 3-4 year variations) with the exception of world wars (no real estate crash in the 40s) and currency collapses (there were two crashes in the 70s due to Bretton Woods).
The insight that the real estate market would crash in 2008 was invaluable… although I was not fully prepared for how the crash would effect my loan and realtor commissions as well as the negative effects on my construction company.
DISCLOSURE: Nothing on this blog is meant as investing advice… just mere educational pontification on my part. Oh ya… and all the photos on this blog are taken by my iPhone.
Unfortunately (or maybe fortunately for those that pay attention), the Fed does not seem to pay attention to the Austrian Economic School Of Thought. They should adjust for Credit Expansion and Credit Contraction Cycles and not just the consumer price index.
The Fed should pay attention to the rate of growth in nominal final sales to U.S. purchasers and look for deviations. The last three deviations from normal trends on nominal final sales measure of aggregate demand were the October 1987 stock market crash, the Asian Financial / Russian Rubble crisis (and collapse of Long-Term Capital Management) in 1998, and Fed’s liquidity injection to fight a fictitious deflationary collapse in 2002.
What the Fed did in those three deviations can be described as being irrationally exuberant over false indicators. The Fed over reacts to an economic crisis and over inflates liquidity into the markets that cause irrational exuberance in the real estate markets.
That the Fed uncannily does this in a consistent 18-year pattern is remarkable.
But I use these trends to my advantage. I look at investing like a NFL Football game. The first 4-5 years are Quarter 1 and would include the period 2009 to 2013. During this time, banks have collapsed and mortgages are not available. So goes my rule of thumb, “Buy real estate when no one can get a loan, and sell when everyone can get a loan.” I only acquire real estate in Quarter 1 and always sell in Quarter 4. For me, real estate is not a long term investment.
Other indicators are when purchase prices fall below replacement cost (the value that an insurance claim will repay) and when cash-on-cash returns over 24%.
SIDE NOTE— despite common belief to the contrary (and as a former top realtor this is almost sacrilege to say), your personal home is not an investment. You may have heard Robert Kiyosaki say this and it’s true. However, I still recommend you buy your dream home in a luxury area because of the prosperity identity that it provides. Read my last blog post for a discussion about the reptilian brain and limbic system.
In Quarter 2 (2014 to 2018) and Quarter 3 (2019 to 2023), it’s possible to make good money but also very risky to flip and land develop. From my experience, the risk comes from paying high interest rates IF utilizing hard money lending combined with delays from government interference, environmental issues, and permits. If you have the cash to avoid leverage with high interest rates, this could be a decent strategy. In Quarter 2 and Quarter 3, I prefer to be the hard money lender and invest in tech via my venture capital fund. Historically, keep in mind that we experience 1-2 stock market crashes in Quarter 2 or Quarter 3.
Finally, I’d be careful to invest in Quarter 4 (2023 to 2027). Indicators of Quarter 4 are zero-down subprime lending, mortgage fraud, and overbuilding by developers. Quarter 4 is the time to sit on the sidelines and wait. If you have long positions in companies, hedge your bets by simultaneously shorting these industries. You’ll need the help of a seasoned securities attorney to make sure that you’re 100% compliant with our laws.
Today… according to my perspective, we are in Quarter 3.