Latest Stories

• Diversification, Schmversification: All Correlations to 1.0(-ish)
• GM, California, and America’s Multi-Trillion Dollar Pension Problem
• U.S. Rig Count Passes Super-Spike Peak
• Lumber, Redux: Why So Loved in 2010?
• Readings: Pensions, Brazil, Rigged Markets, IPOs, Lumber, etc.

 

Debate on Financial Innovations

Didn't realize until today that video was online of the Economist debate between Myron Scholes, Jeremy Grantham and Rick Bookstaber about the merits, or lack thereof, of financial innovation.

 

Deleverage This, My Friend

McKinsey has out a new report with some useful figures showing the rise of leverage worldwide, where it must fall, and the corresponding GDP consequences.

 

The Trouble with History

Good quote from Taleb:

It is particularly shocking that people do what is called “stress tests” by taking the worst possible past deviation as an anchor event to project the worst possible future deviation, not thinking that they would have failed to account for such deviation had they used the same method on the day before that past  anchor event.  [Emphasis mine]

 

The Dutch Disease Gets a Brazilian

The Dutch disease – the economic hollowing-out and corruption effects of domestic resource exploitation – has an interesting twist when it happens in Brazil:

Oil windfalls and living standards: New evidence from Brazil
Francesco Caselli, Guy Michaels, 20 January 2010

Does the “resource curse” exist? This column presents new evidence from Brazil. Municipalities that receive oil windfalls report significant increases in spending on infrastructure, education, health, and transfers to households. However, the windfalls do not trickle down and much of the money goes missing. Indeed, oil revenues increase the size of municipal workers’ houses but not the size of other residents’ houses. [Emphasis mine]

 

Moore's Law, Then and Then and Now-ish

Good hundred-years-of-Moore's-Law graphic:

[via Steve Jurvetson]

 

Transcendent Man

The trailer for the Ray Kurzweil biopic "Transcendent Man":

 

Book of the Week: New Edition of Reminiscences of a Stock Operator

I haven't mentioned any books here in ages, so let me redress that by briefly singing the praises of a new edition of the classic Reminiscences of a Stock Operator. Nominally about the experiences of trader Jesse Livermore in the early part of the last century, this classic remains among the best books about the real world of Wall Street, speculation, stock manipulation and trading ever written.

There is a new edition out, annotated by Jon Markman, and containing a closing interview with trader Paul Tudor Jones. The annotations are fascinating, making the new edition a great addition, but the interview with Jones is super is well.

 

Readings: Sovereign Risk, Khosla, Tennis, Chess, Roubini, etc.

• Biggest sovereign risks in 2010 (Source)
• Vinod Khosla boosts venture fund to over $1B (Source)
• The man with the most devastating serve in modern tennis: Ivo Karlovi? (Source)
• Garry Kasparov on risk, innovation, crisis, chess and poker (Source)
• Roubini Says Stock Rally May End Amid Muted Recovery (Source)
• Atul Gawande on checklists as a response to complexity in medicine and society (Source)

 

Fred Wilson and the Venture Capital (Non-)Cartel

When a capitalist says that he is pleased to see profits increase as his competitors disappear and the remainder hold the line on price is that a cartel? How is it different from the CEO of, say, Honda, gloating about the elimination of other auto companies, and then asking the remaining companies to hold car prices?

All these questions came to mind in reading some of the more entertainingly outraged comments to venture capitalist Fred Wilson's post today about the venture capital diet. Echoing my paper from last summer that called for the venture industry to shrink by half, Fred points to the latest industry data and says that we're pretty much there, with annual outlays touching $17-billion. He goes on to worry, however, that Q4 of 2009 saw outlays tick back up to an annualized $20-billion, and suggests people need to pull back.

So, is Fred calling for a cartel to contract VC spending? I don't think so. Fred is one of the good guys, and my position here is public: We need to shrink to have a healthy venture capital business. We have an industry that hasn't delivered a multiple above 1.0 on invested capital since 1997. We have an industry that, as of end of year 2009, sunk to a negative ten-year IRR, with the bubble exits finally falling off the sheet. This is a sick business, and that is understandably leading to fewer investors wanting a part of it, which means outlays are shrinking. Eventually the industry will shrink back to a point where it delivers competitive returns -- and it may even be there now.

Now, two points. First, some may say that venture can fix performance by making better investments. It doesn't need to shrink: We have can have our capital, and our startups too. Fine, but history doesn't bear that out. The modern venture industry has never delivered competitive returns with this much money under management, and you can't point to deals that, had they been invested in, would have fixed that. Yes, absence of evidence isn't evidence of absence, but the heavy-lifting must be on the side of those who would argue the venture biz can deliver compelling returns at higher levels of capital outlay.

Second, others may argue that it really doesn't matter. Venture capital provides a valuable societal function -- job creation, innovation, economic growth, etc. -- and we can't hold venture back when we need all three of those so badly. I understand the inclination, but a venture capital industry no longer tied solely to delivering competitive returns to its investors is newly a quasi-governmental entity, an expanded regional economic development agency, albeit one with your pension money at risk.

Finally, is  it possible that venture is just so badly broken that we have no idea what the right amount of capital is? Yes, it is possible that we could see 10x as many startups and find that it is a distribution with many local maxima, some of which are much more attractive than the current level of investing. To be honest, I would love it if that were true, because it would be wonderful for the economy, and this assuredly isn't physics -- annual outlays is not fixed like Avogadro's constant. Good luck making that case, however, to burned limited partners who have just watched an expanded venture industry deliver the worst returns in its history.

 

The VC Industry Gets Hit by Bank Blowback

While I hesitate to believe that yesterday's ill-described changes to banking regulations will stand as stated, in their current incarnation they would be bad for venture capital. The proposed regulations would prevents banks from "owning, investing in or sponsoring" private equity (a category that broadly includes venture capital).

How big are banks as investors in private equity? From a Preqin release this morning:

• U.S. banks have raised 60 funds since 2006, with a total value of over $80bn.
• 18 new private equity funds are being raised seeking an aggregate $18bn.
• Banks have $50bn in uninvested PE capital
• The most prolific PE-investing banks are Goldman Sachs, Credit Suisse, Morgan Stanley and
  Citigroup.
• Banks account for 5% of investors in the US by number, and represent around 9% of the capital invested in the asset class.

The change could drive more shrinkage in the troubled asset class -- which I have called for and is overdue -- but let's not go too far with this.

 

Growth in a Time of Debt

New research from Reinhart and Rogoff on the relationship between GDP growth and government and external debt:

Growth in a Time of Debt

Carmen M. Reinhart, Kenneth S. Rogoff

We study economic growth and inflation at different levels of government and external debt. Our analysis is based on new data on forty-four countries spanning about two hundred years. The dataset incorporates over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. Our main findings are: First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies. Second, emerging markets face lower thresholds for external debt (public and private)—which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half. Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the United States, have experienced higher inflation when debt/GDP is high.) The story is entirely different for emerging markets, where inflation rises sharply as debt increases. [Emphasis mine]

And where is the U.S.? Sitting with public debt at around 90% of GDP.

 

The End of Poverty

Some thought-provoking new research argues that, absent catastrophe, and despite continuing population growth, we will never see a billion people in poverty worldwide:

World poverty is falling. This column presents new estimates of the world’s income distribution and suggests that world poverty is disappearing faster than previously thought. From 1970 to 2006, poverty fell by 86% in South Asia, 73% in Latin America, 39% in the Middle East, and 20% in Africa. Barring a catastrophe, there will never be more than a billion people in poverty in the future history of the world. [Emphasis mine]

 

More here.

Pinkovskiy M. and Sala-i-Martin X., Parametric estimations of the world distribution of income. 22 January 2010. http://www.voxeu.org/index.php?q=node/4508

 

Google in Five Bullets

I so dig these super-short summaries of quarterly earnings reports. Here is JP Morgan on tonight's Google results:

• Pro forma EPS totaled $6.79. This was slightly below our $6.85 estimate.

• Net revenue grew 13% sequentially. This was slightly below our expectation for 17% Q/Q growth.

• Paid clicks grew 13% Y/Y. This was slightly lower than our estimate for 16% Y/Y growth. CPC improvements were roughly in-line with our expectations.

• US revenue was up 11% Y/Y. This was slightly ahead of our estimate calling for 9% Y/Y growth.

• EBITDA margin came in at 63.1%. This was well ahead of our expectation for 61.9%

My take: Overall solid, but not a blow-out, and more than reflected in the stock.

 

Readings: CNBC, Big Government, Yoga, Robbery, etc.

• Big government: Stop! (Source)
• On Financial Advisors Watching TV (Source)
• Resilient, durable or stable: Which metaphor for the future? (Source)
• Albert Edwards Alleges Central Banks Were Complicit In Robbing The Middle Classes (Source)
• India inmates take yoga to reduce their jail sentences (Source)
• Cool tool for exploring tacit social nets on Twitter (Source)

 

The Market’s “Howard Beale” Moment

My friend Doug Kass has out a lucid musing on the market’s Howard Beale moment. There is a populist uproar in progress, one that people overlook at their peril.

The populist uproar is geared toward the incumbent, toward anyone in power. It does not run on party lines, nor is it focused on health care. It is the zeitgeist of dissatisfaction, a sign of the times. Maybe it's a function of high unemployment or the electorate ticked off at the wealthy and the largest institutions (especially of a banking kind). This dissatisfaction was expressed in the Democratic tsunami that brought Obama the Presidency, and it was seen yesterday in the Massachusetts Senatorial election that brought Brown the Senate seat. In other words, the mood of the country has been changing for a while, and it is being reflected in a very negative view toward those who have not suffered from high unemployment or from wayward derivative bets (and still got paid). And, as I have written before, this will lead to policies that are arguably needed but, generally speaking, are valuation deflating.

…While I recognize that historically political gridlock is generally seen as a market positive, it might not be this time as the nation needs sound direction and leadership, not legislative inertia. Given the complexity and scope of our country's fiscal problems, obstruction and the perception of continued divisive and partisan political agendas and the lack of an overall governmental community (which could thwart desperately necessary legislative solutions) might quickly be seen as a negative.