Two things have jumped out at me over the past few weeks that have larger investment implications. First, the number of large IPOs (namely various tech companies) and second, some new messages from the Fed.
I’ll touch on the Initial Public Offerings (IPOs) first. A slew of pretty large tech companies have been racing to go public this spring. Gotta cash out when the money is hot!
If you’re interested in any of these newly issued companies, in general, it’s typically smart to wait at least 6 months from when they start trading. More often than not a stock will trade lower for the first 6 months until the first lock-up period ends.
The latest companies hitting the market are some of the larger, more well known names like Lyft, Uber and Pinterest. We should also see Airbnb, Slack and The We Company (WeWork) this year. Most of these companies operate at large losses. Some are losing more than $1 billion a year, but hey, they’re “disruptors!” Uber’s S-1 IPO Prospectus is basically 100 pages of warnings that they may never make money. Call me old fashioned but I like to invest in companies that actually do make money.
The bigger story isn’t about any one company in particular but the number of IPOs and the size and quality of the companies. The percentage of companies hitting the market that lose money is now approaching levels last seen during the tech bubble.
We’ve seen a large shift in the investment markets over the past decade. As yields have bene surpassed and stock valuations have risen, investors have been forced into more aggressive asset classes, like private equity, in search of bigger returns. Some of the nations largest pensions have been doubling their exposure to private equity lately. All of this money has lifted private valuations, most of which is usually invested in tech companies, which has also lifted public tech valuations in a “if they’re worth X, then this company is worth at least Y” effect.
This brings up two important points:
- Companies don’t go public for the same reasons they used to. 40 to 50 years ago companies would go public because that was the best way to raise large amounts of money. The companies were much younger/smaller and thus the IPO was far more attractive. Today, it has been so easy for companies to raise money via private equity investors that many companies have no reason to go public except as a way to cash out for early investors. If some of the smartest, most well-connected investors are looking to cash out now, do you really think it’s wise to be buying the shares from them?
- The private equity world enjoys valuations that don’t fluctuate on a daily basis because they don’t trade on a market. The valuation is assumed to be what it was based on the last round of funding. What we’ve seen over the past 5 years or so is that some of the very large investment funds (namely SoftBank with their Vision Fund) have been throwing stupid sums of money at these large tech companies. They pushed up valuations for the entire industry. But if these companies are now going public, and the market disagrees with their latest valuations, the whole complex is at risk of unwinding and this would almost certainly pull down other public tech valuations as well. Definitely one of the larger risks in the stock market right now.
The Fed and Changes to Policy
The Fed doesn’t like to surprise markets so they will typically float trial balloons months before ever making a change in policy. Lately, there have been talks of potentially changing their inflation targeting metrics as well as what to do during the next economic slowdown since the Zero Lower Bound (ZLB) is so close below and QE has been politically charged.
Last week was the second time that a Fed Governor has mentioned yield-curve control as a potential “solution.” This is largely what Japan does and is something the US actually did during World War II. The thought is that they might be able to control longer term yields without actually needing to expand their balance sheet simply by stating the yield they are targeting. For example, if the 5-year treasury yield is at 2% but they want to lower it and peg it to 1%, all they need to do is tell the market they will buy any and all 5-year treasuries until the yield drops to 1%. Theoretically, since they have an endless printing press, they could buy the entire market if they needed to (Japan has done this). But, since markets love a good arbitrage, the yield on the 5-year would almost instantly drop toward 1% without the Fed actually needing to buy any at all. Any time the yield rose a little, say to 1.05%, you would have large funds willing to buy them knowing that they can almost instantly sell them to the Fed at a 1% yield for a small but risk-free profit.
Right now, the Fed only controls overnight lending rates. A change like this would shift them out onto the curve to directly control longer term rates as well. This is the Fed’s way of saying that they know better than the free market. It’s also how they can ensure the bond market doesn’t react the way one would expect if the Fed needed to fund large government deficits.
One of my highest conviction views right now is that treasury yields will be moving lower over the next year or two. There’s even a decent chance that we even see new lows on the 10-year. If I’m right, this will continue to be positive for all yield-related assets.
Thanks for following!
-Nick