Was THAT the BOTTOM?!? VCs and Traders Say Maybe-Yes.
Multiple sources in the past week said that Tier 1 VCs are gearing up to deploy capital (invest) in the April/May timeframe, expecting the IPO markets to open up by Year End 2023.
Why?
Yes, we had a strong rally led by high risk assets (crypto and tech) in January, following an oversold market in December.
Yes, stocks are cheaper, but not cheap.
So, why?
Money managers don't get fired for underperforming in downturns....
Money managers get fired for underperforming in upturns.
This includes VCs.
Bill Gurley has said all the upside VCs get is at the end of long upcycles, the real froth time, thus, in order to have competitive numbers, they have to play the game from beginning to end.
Thus, they HAVE to err on the side of participating in bear market rallies, ESPECIALLY as we get later in the bear market.
Do they have a crystal ball? No
But they risk their career if they miss it. And they can always reverse course (get to know the companies and just not send the money if the public stock market reverses course over the next 4 months)
But they can't miss the bull runs. Same with public market money managers. This psychology drives stronger bear market rallies.
How do you know when you have passed the final bear market bottom and started a new bull market?
Just like predicting whether a lion charging at you is using a false charge or a real charge, you only know when she stops, and in markets, you only know by looking back.
But there are also hints when you are in the thick of it.
Hints of the real bottom are NOT what you might think:
They're not bad news (bulls need it to climb the wall of worry)
They're not everyone celebrating capitulation in unison
They're not a clear signal that we are in the clear
Market bottoms are:
Different each time but follow historical patterns (history rhymes)
The time when you are tested the most to think independently.
By definition, market bottoms leave no one unscathed.
Semis as an example:
From 1996-2003, I covered semis and was within 4-5 days of every semi cycle market bottom (bottom in the stock prices, NOT the bottom in the semi cycle).
For the purposes of this newsletter:
We care about making money in the stock market, not being right on cycles.
You can care about being right on cycles, just be clear what you are optimizing for. Investors have lost a lot of money thinking they are the same thing.
Semis are in everything, and have approximately 2X the beta of the stock market. You are more likely to not buy a car/PC/phone when your money runs low rather than cut back on toothpaste and toiled paper. Thus, in different economic climates, demand for semis changes more than demand for consumer staples.
But that's not the full picture.
Supply comes on in big lumps.
Add a factory, add billions of chips to supply. You have to look at it as the percentage of total supply of those chips worldwide, but either way, adding a factory adds supply in a step function.
All manufacturing based businesses are cyclical because supply comes on when a new factory is built, creating an instant supply glut and a down cycle in pricing.
New supply ramps... it doesn't all come on at once, but incrementally it creates oversupply and pricing pressure.
Because of this supply dynamic, all cyclical industries have more downturns than the economy overall.
Demand may be fine. Geopolitical winds may be fine. But when supply comes on, inventories rise, companies need to sell those chips, so prices come down, and thus revenues (price X quantity) go down, thus a down-cycle begins.
That is what we are seeing in the larger economy as we head into official recession. Inventories in the broad economy rising. Demand for PCs declining 30%. Microsoft and Intel sounding alarm bells.
Yes, employment is strong, but that is a lagging indicator.
And we are not betting on the economy bottoming, we are looking for the market bottom.
What did I see in all those semi bottoms?
Broad-based cancellations
Despair that there would never be another upturn
Moving businesses to only ordering to keep the lights on
Investors saying they would never buy semis again
Rock bottom valuations
What did we see in 2003 and 2008 overall market bottoms?
Rock bottom valuations (attractive to VALUE buyers - ie tech companies for sale for less than cash on their balance sheet - summer 2003)
One sector lead the market down and got completely get washed out. 2003 it was tech. 2008 it was banking and housing. 2023 it is more broad based, but tech has fallen the farthest from the most extreme high valuations, so it's probably the right sector to watch.
Individual investors losing all interest in investing. 2003 they went into real estate and closed accounts in droves. 2008 they went into cash.
So, if that was the bottom... it wasn't what I have seen before.
Really smart people may say we have seen the bottom, but think independently and look at the incentives they face.
Then make up our own minds!
What's next?
We have just run an extended bear market rally, so the fuel is running low (less bargains, less oversold conditions)
We are heading into earnings season for smaller companies who typically have less financial flexibility on their balance sheets and less loyal "sticky" customers than large companies (remember the saying "No one gets fired for buying IBM"?).
We have a significant escalation of the US-China relations, and the Fed has said they will keep raising, with the move to 25bps behind us (that was the good news), now we have to see how long they keep raising.
My thought is the above list is less a wall of worry for the market to climb, and more a set of challenges the market will likely roll over in the face of.