August 18, 2022

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The postmodern age of investment

Dan Loeb’s latest investor letter is out, and Third Point’s surf-glad supremo introduced FTAV to an interesting concept to sum up the current financial environment.

The 1982 non-narrative film “Koyaanisqatsi” takes its name from the Hopi word meaning “life out of balance”. The prescient film juxtaposes striking images of nature with urban scenes depicting the imbalances created by modern technology, set to a haunting soundtrack by Philip Glass. Forty years later, this film and soundtrack makes an apt backdrop for today’s investment environment. “Koyaanisqatsi” neatly captures current market conditions which are, in many ways, a reaction to imbalances.

Obviously, all hedge fund managers love pseudo-philosophical metaphors and references, especially if they are a little recondite. But as somewhere that hosted Jamie Powell for four years, we can’t complain too much about people over-interpreting old films no one has heard of or cares about.

And the truth is that there are signs everywhere that a pretty profound market regime change is upon us, and that people are only starting to grapple with the implications. The Nasdaq has now given up all of its 2021 gains, and many — like Loeb — believe that this is just the beginning of an epic shakeout, rather than the end.

The most vulnerable are still-profitless companies that need the grace of equity or debt investors to stay alive. Loeb hints that many of the more speculative companies that relied on stock options to attract talent might already entering a death loop as the value of their equity withers — something that Jamie wrote about before leaving (sob).

Even after dramatic declines, it is difficult to call a bottom in the high-growth, high-valuation end of the tech sector, especially given that many of these companies relied on stock-based compensation and controversial accounting and reporting techniques. It appears that many of the companies which used this type of compensation to attract employees may have retention difficulties, leading to increased dilution for future stock grants or increased cash wages, which could weigh on margins for analysts who rely on adjusted measures rather than old-fashioned GAAP. We fear Soros’s theory of reflexivity will come into play should such a spiral ensue.

Just gape in awe and amusement at this chart of Goldman Sachs’s unprofitable tech stocks index over the past five years.

When even the permanently profit-shy Uber seems to think it needs to act, you know things are serious. Here’s an excerpt from an email CEO Dara Khosrowshahi sent out to the troops earlier this week, courtesy of CNBC’s Deidre Bosa.

After earnings, I spent several days meeting investors in New York and Boston. It’s clear that the market is experiencing a seismic shift and we need to react accordingly . . . Channelling Jerry Maguire, we need to show them the money. We have made a ton of progress in terms of profitability . . . but the goalposts have changed. Now it’s about free cash flow. We can (and should) get there fast. There will be companies that put their heads in the sand and are slow to pivot. The tough truth is that many of them will not survive.

However, as we’ve been writing, this is clearly no longer something that can be dismissed as a shitco reckoning. IBM is the only big or biggish US tech stock that has held its head above water this year, eking out a 3 per cent gain.

Apple has marginally outperformed the S&P 500, but with an 11.4 per cent loss it’s hardly something to shout about. Only 12 of the Nasdaq 100 index’s 102 members (yes, we know) have seen their stock prices rise this year.

The punishment meted out to heavyweights like Netflix, PayPal, Meta and Nvidia is remarkably brutal. (Apologies for the ugly screengrab from Refinitiv, but our chart-building tool seems to be struggling with this data as much as some growth jockeys are.)

Something big is brewing. Over the weekend Goldman Sachs’ chief global equity strategist Peter Oppenheimer published a report on the dawn of what he called “the postmodern cycle”.

For most of financial history, market cycles were generally short and turbulent, but the past four decades have been characterised by falling inflation, independent central banking, globalisation, generally lower volatility, longer cycles and higher corporate profits. Oppenheimer calls this the “modern cycle”.

However, the coming postmodern market era is likely to be characterised by faster inflation, higher bond yields — both nominal and real — greater regionalisation rather than globalisation, pricier labour and commodity costs, and more activist governments, he argues.

Will the new era will actually look that much different from the last one — at least economically? It’s always tempting but often wrong to over-extrapolate the current set-up into the very long term. Yet the sense of “Koyaanisqatsi” is unmistakable. From Loeb, with our emphasis below.

To be an investor is to live constantly at the intersection of story and uncertainty. We build our mental models, frameworks, and processes to try to accurately price securities and overlay them with a story about the economic, geopolitical, and psychological factors that frame the backdrop to value them. We create data-driven stories to explain our differentiated view of a security that is out of balance within its sector or asset class to justify a variant perception that we think will generate alpha.

Sometimes, however, investors might create a framework that seems sound only to discover that the method is actually no better than a system to “win” at Russian roulette. The key, of course, is to change your framework when the environment changes. Even the most sophisticated quant investors employing hundreds of PhD mathematicians and physicists fin that their models can fall short due to the ever-changing topography of the surface area of relevant data.

Since I started Third Point 27 years ago, I have seen many investors (including myself) stumble after years of success because they did not adapt their models and frameworks quickly enough as conditions shifted. I have said before that they don’t ring a bell when the rules of the game are changing, but if you listen closely, you can hear a dog whistle. This seems to be such a time to listen for that high-pitched sound.

Markets are, for all their faults, pretty good at grappling with these things quickly. But it’s impossible to say how much is already in the price, or yet to come. As venture capitalist Bill Gurley noted recently: “Previous ‘all-time’ highs are completely irrelevant. It’s not ‘cheap’ because it is down 70 per cent. Forget those prices happened.”

But FTAV feels on slightly safer ground in saying that the tech industry itself has been slower to grasp how much things have changed. (Until recently it reminded me a little of visiting Dubai in late September 2008, and being told by an enthusiastic developer that they were definitely building a skyscraper even taller than the Burj Khalifa, despite the recent collapse of Lehman. A year later the developer Nakheel needed a state bailout and the site remains a sandpit to this day.)

As Khosrowshahi’s letter and various Twitter threads show, sentiment is changing quickly. From now on, it’ll be more about ample runways and generating actual profits, rather than fantastical TAMs and semi-annual Tiger-led funding rounds. This CB Insights chart is going to look a lot grimmer by the second quarter, and we suspect there will be more dreaded down rounds and lay-offs to come.


https://www.ft.com/content/8ffed464-ef43-4dcb-babc-39c995e8cc8c