From the Ash's

This post is just a quick note to comment on some recent trends in the markets.  I think at this point, few of us are still trying to call a bottom.  If that's really become the case, then we're a step closer in what Barron's Mike Santoli calls the market's "capitulation".  That is, investors giving up, getting scared, and moving money to the sidelines.

I guess that's necessary and part of the cycle.  However, it's created loads of very low-risk deals.  You can find any number of stocks with dividend yields now well above those of corporate bonds.  That means that you're getting an almost guaranteed rate of return on equity that's higher than the almost guaranteed rate of return on bonds, which are a safer investment due to their placement in the capital structure.  This return is not without its risks, of course, as the dividend relies on good earnings and the board of directors not deciding to cut it.  However, I think there are plenty of stocks for which it is the case.

Most importantly, to most people who would argue with me, the question is not of calling a bottom, but rather, as Warren Buffet pointed out in his recent op-ed in the NY Times, of deciding at what price you're willing to own the stocks.  Some good deals may go away, others will not.  I'm in it for the long haul, so I'm happy to jump on a good deal when I see it.  If it drops 10% in the near term, so what?  Maybe I'll buy some more to average down on my cost basis.  However, I'm confident, along with Buffet, that in 10 years time these stocks will be worth more than their weight in gold, and I'll have been paid handsomely to hold them the whole time.

Posted by ash.dyer at 08:39 AM | Permalink | Comments (0) | TrackBacks (0)

There's been an absolutely profound breakdown in the mortgage lending process.  I would contend that the "subprime crisis" is misnamed, as it's really the "no-doc crisis" that's been the root of the problem.  No-doc loans are predicated on the idea that credit scores are sufficient to establish credit worthiness, and we have significant data establishing historical default rates for various credit categories.  For example, 56% of loan recipients with <600 FICO scores defaulting on their auto loans within two years (data as of 2005, Standard & Poors), you have to wonder why lenders would finance anyone in that category, let alone at only an 11% interest rate. 

This article presents a very interesting alternative view: http://www.basis.wisc.edu/live/amabrief07-09.pdf. Loans to all borrowers have the potential to help them.  However, banks need to realistically price that assistance.  If 56% default within two years, then a 28% coupon will just break even (not including inflation & assuming all loans are the same size).  In fact, banks might actually start high and DROP the interest rates over time as borrowers prove they can keep up with the payments, which might provide better incentives to continue payments and reduce the "moral hazard" problems of borrowers who do not actually intend to pay the loans.

The show 60 Minutes presents another side of the story: http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml.  The fact that people don't want to pay simply because the "price or the value [of their house] is going down" is reprehensible.  Boston's tax assessor's database lets me pull annual historical housing values for the last 20 years on any property in the city.  A quick look at properties in my neighborhood shows that from 1991-2000 house prices were "underwater": http://www.cityofboston.gov/assessing/search/default.asp?mode=value&pid=2203905000 (I have no affiliation with this property, I just used it as an example because it's currently on the market - for above the assessed price!).   That's happening again now in parts of the country, especially in historically weak markets like Stockton and Phoenix (the Dorchester neighborhood of Boston, too).  In fact, in 2007 the number of foreclosures in just Stockton, CA (~2,400) was higher than all of the foreclosures in the Commonwealth of Massachusetts (~2,100).

The worst is yet to come and despite the federal stimulus package and other reforms, we will not see the bottom for 3-4 years.  That's based on a rough look at historical housing prices from the Boston assessor's database.  I'll also note that house prices moved independent of the dot-com boom in the late '90s, which might have caused values in some places (SF Bay Area, for one) to turn up, but certainly wasn't a rising tide.  It was only after the dot-com bubble that things really started to get going in housing.

My advice: stay short anything to do with housing.  Yes, Blackstone is starting to get long mortgage lenders.  They have the luxury of a long time horizon, deal & management fees, and aggressive recap methods to which individual investors do not have access.  Think twice about buying a home unless you're planning to hang onto it for more than 10 years.  The Boston bottom didn't occur until 1994-1995, and at it's bottom prices were 28-33% below the peak.  The $50,000-$100,000 in lost value is far more than 2-years' rent, so you'd do well to wait out this plunge.

Finally, ride the commodities tide.  I believe that commodities are the next asset class to be inflated (after stocks, then housing).  We started to see the rise, mostly in oil, beginning in 2005 and 2006, and I think it will continue as housing loses its luster.  Gold will definitely hit $1,000 this year - probably in the first half - and other commodities will continue to rise as well.  It helps that more people throughout the world can afford them, but it's chiefly because people pile into markets one after another.  When your taxi driver or favorite celebrity says to invest in commodities, it'll be time to sell.

Posted by ash.dyer at 10:06 AM | Permalink | Comments (0) | TrackBacks (0)

Hey Folks,

     Just a quick post this morning.  Most people watching the markets this morning are probably frantically pushing the sell button.  I'm just popping on the record today to say, take your hand off the sell and start thinking about holding it over the buy button.

     I don't think we'll see the markets turn up immediately, but we've displaced more than just the speculative inflation that follows most common stocks (a la Ben Graham).  People are freaked and your best short-term investment is probably the VIX (options volatility index).  I'd also suggest snapping up some longterm corporate bonds - anything with a spread of >5% from US Treasuries or LIBOR.  Global inflation's going to be a bit higher in the future, but it's unlikely it will rival the ~10% coupons that some stable corporations are offering right now.

     We're on the precipice of a crash, so avoid irrational moves and wait 'til after to take major stakes.  At the latest (least risk), we'll see Congress step in with new legislation - likely after the new President takes office next Jan. - to clean things up (eg. CDOs, CLOs, and SIVs) and make sure it never happens again (yeah, right...)  Just as Sarb-Ox tried to spit-shine corporate accounting in '02.

    Them's the news.  So for now, ride the crash down (or step aside and let it crash), then look to ride the rally back up!

Happy (deal) hunting!

-A

Posted by ash.dyer at 09:40 AM | Permalink | Comments (0) | TrackBacks (0)

Scalability is the question that plagues everything in business.  Do the operations scale?  Do the systems scale?  Does the organizational structure scale?  Better phrased: What does it take to scale this business?

Scale is often cited as a major determining factor in the output of various business models.  Consulting, law, and accounting are examples of businesses that scale as a factor of people.  As in, the company's production is directly governed by the number of employees.  Since the only physical products of these industries are documents, it's fair to say that output is entirely contingent on people.  Therefore, to produce more you must hire more people, which is difficult and expensive.

Contrast that with Google, the epitomy of hosted services.  The company essentially provides hosted software, which is monetized through ads.  It employs roughly 10,000 people, mostly developers, and serves hundreds of millions of users.  That's a massive scale, although they have their own problems based on maintaining sufficient revenue per user.

Here's one way to think about scale: 

Say you have a web company, XYZ.com.  XYZ.com earns $1 per user per month and has 100,000 regular users.  That means they're making $1.2 million per year.  That's enough to support a staff of 15 at an average salary of $80,000 (assuming no other costs), or really a staff of 12 at that salary with $240,000 in annual web hosting costs.

What's the incremental cost of scaling to support 1,000,000 users?  You'll have to add a couple more servers at your hosting facility, say doubling the cost to $480,000.  Will you need to add more employees? 

Possibly, but you won't really need more programmers, and if you run a service like Google's, you won't need more customer support staff because there's almost no tech support.  Therefore, your hosted solution virtually eliminates your scaling costs. Incredible, isn't it?

Continue reading "Scalability 2.0" »

Posted by ash.dyer at 04:02 PM | Permalink | Comments (0) | TrackBacks (0)

After a volatile month, it seems that everything's cooled down both in the oil sector and in the Middle East (aka, the oil sector), and Wall Street's psyched.  But hang on to your hats, boys and girls, because the rollercoaster ride is not over yet.  In fact, it's just starting.

Let's look at why our market fundamentals are indicating that this trend in volatility and increased oil prices isn't going away any time soon.

1. A loose Federal fiscal policy for the last two presidents (~14 years) means that our government debt has gone nowhere but up - financed not by the U.S. but rather by foreign central banks.
2. Investment in hedge funds and private equity has more than tripled in the past five years.
3. Investment in energy commodities, especially oil, has more than tripled in the past three years.
4. The ratio of P/E ratios between large and small-cap stocks in the S&P 500 is way off its mean and approaching an all-time, 30-year low (which correlates with negative future returns in the S&P 500).
5. The index of CEO performance expectations is below 0.50, contrasted to record profit margins across most of the U.S. market.

That's quite a laundry-list of items there... so, you might ask, what does it all mean?  Simply put: a high risk of stagflation!  But Ash, didn't we kick that back before you were born when Reagan and Volker threw out Keynesian economics?

NO!!!  We've been falling back into New Keynesian economics since the early '90s.  It seems that the allure of the "tools" offered by Keynesian economics, like the IS-LM model, were too much for economists to pass up, so they "reconciled" them with the monetarism that has proven so right in the last 25 years.  No wonder I dropped Macroeconomics...

New Keynesianism is just as wrong as Keynesianism was in the last century.  It proves great for a while - the Go-Go 60s or late 90s - but it doesn't last, and we're about to see that again.  Mid-East violence is resurgent, and the world's oil supply is stretched more thinly than it was in the 70s thanks to added consumption, not only in the U.S., but in Eastern Europe, India, and (the 800-pound Panda) China.  That means that smaller shocks have bigger ramifications in the world market.

Those shocks have been exacerbated by the entry of large quantities of hedge fund and private equity capital in these markets.  Thanks to a loose fiscal policy and too much money in the market, this extra capital has driven prices up beyond anything that OPEC or anyone else can control.  And despite what most of Wall Street currently believes, this capital is not a result of unparalleled prosperity... IT'S A RESULT OF POOR FISCAL DISCIPLINE!!!

That's a harbinger of inflation... in point of fact, it's the textbook definition of it: Too much money chasing too few goods.  The markets just haven't put two and two together yet.  Why?  Simply put, inflation is the hardest thing to get right.  People don't believe predictions about shifts in inflation until they perceive shifts in inflation (thanks Dad for that epiphany!).  That means that they don't expect it until too late.

So why am I so bearish if I'm not suppose to be believing in inflation yet?  Simple: I don't have a lot of money, and I remember just 6 years ago when gas in San Francisco, California - the most expensive region for gas in the country - was only $1.75.  I don't think you can tell me that the price of gasoline doubling in only 6 years is not going to create added inflationary pressure in the economy, especially not when the price of crude oil has not just doubled but tripled in that time.

What this means for the economy is a lot of pain.  We haven't been taking our medicine, we've been driving big cars, running up astronomical debt on our houses (according to The Economist, the housing bubble, as a percent of GDP, is half-again the size of the dot-com bubble), and purchasing everything in sight... all while that nasty cancer has been growing under the surface.

It's okay... that's just human nature.  However, it's coming time for the Chemo to start.  We might lose our hair for a while, maybe we'll pull it out, maybe it'll fall off, but it'll grow back eventually.  The question is now not if, but how long?  And that, my friends, nobody knows.

Posted by ash.dyer at 08:19 AM | Permalink | Comments (0) | TrackBacks (0)

Recently, my father sent me a Wall Street Journal article that I had been staunchly avoiding.  Feeling bad about deleting it outright, I briefly skimmed it before sending him a verbose reply explaining my rational for avoiding the piece.  In fact, my actions are likely to shock both my father and many of my friends.  I am an avid Journal reader and consume about as much information about personal finance as I possibly can.  Why then would I refuse to read a Journal article about personal finance?

The answer is simple: BECAUSE IT'S SO WRONG!

That's right.  Even the Journal's authors can be quite wrong when it comes to topics that they know little about.  They just fall into the same trap that most other media outlets fall into... annointing their columnists as so-called "experts" when they really have no business talking about that subject.

Take, for example, this author's comment that one should not begin "seriously saving for retirement" until after age 30.  They couldn't be more wrong.  Analysis has shown that someone who puts away a fixed amount every year from 20 to 30 and stops will have almost twice as much in the bank at 65 than someone who puts away the same fixed amount from 30 until 65.  That's the power of compound interest!

Good financial advice will tell you that.  In fact, it's one of many questions I use to triage whether or not somebody knows they're stuff about finance.

Here's another question: when are student loans good?  The answer is two-fold: 1) when you need them to finish school, and 2) when you can make a rate of return from investment that is significantly higher than your interest payments.  Student loans are somewhat unique because they tend to have more generous terms than most other loans, including lower interest rates.  That in turn makes it possible to use money from student loans for investments in securities, which enables you to reap the difference between the two rates (rate of return and interest rate).  The caveat: don't try this unless you know how to invest... you're taking on extra risk so you need to be confident that you're not going to actually lose the money (although, better to do it in your 20s than when you have a family to care for).

The first thing that you need to ask when you're getting financial advice, is whose advice are you getting?  In other words, why is this person qualified to give you advice?

Let's break it down: what types of professionals are qualified to offer advice?  Bankers?  Financial Advisors?  Columnists?  Economists?  Successful Businesspeople?  Successful Investors?

The correct answer is only the last two - successful businesspeople and successful investors.  People like Robert Kiyosaki and Warren Buffet, who have whethered all sorts of financial changes and crises, and made hundreds of millions or even billions over decades.  If you're not willing to go that course, than financial advisors may be right for you... they know what they're doing in terms of savings and helping you meet modest goals.  They won't generate millionaire returns, but they'll give your kids a college education and you a comfortable retirement.

So if you're keen to start getting advice from the right people, or at least test the water, what should you do?  First, take the advice of one of my best friend's fathers, a man whose made many millions in his lifetime, run down to your local bookstore, and buy yourself a copy of Rich Dad, Poor Dad by Robert Kiyosaki.

Now, I've noticed a lot of people have read this book without really reading it.  So, what I want you to do is read it once kind of quickly.  Then, pull out a pen, pencil, or highlighter and read it again slowly, chapter by chapter.  Highlight or underline key points and make notes in the margins.  Never read more than a chapter in a day, and if you want extra credit keep notes on a notepad.  Get a couple of your friends who share your interest to do this with you and discuss it regularly.  This method of studying will help you internalize those lessons.

When you're done, go out and buy another book from a real expert and start scouring the Internet for articles from real experts.  They're out there.  Robert Kiyosaki writes a column for Yahoo!Finance, Warren Buffet has produced a number of books, some successful mutual fund directors, like the Hussman Funds, regularly publish columns about investing on their websites.

The information's there.  GO GET IT!!!  And remember to always ask yourself: is this person really qualified to give me advice?

Posted by ash.dyer at 07:46 AM | Permalink | Comments (0) | TrackBacks (0)

As congress departs for its summer recess, one of the most prominent bills left on the table is the permanent change to the "estate tax".  Why is this such a contentious bill, and, more importantly, why are Republicans so wrong on this one?

Estate tax has evolved greatly since its inception in 1916.  However, right now it still retains its initial purpose: reducing the income divide between America's younger generations to prevent the emergence of entrenched socioeconomic classes that Europe has been plagued with for millenia.  To this end, the tax has been reasonably effective: America has the highest rate of transitions between socioeconomic classes of all developed nations.

On the other hand, as we have seen with the Rockefellers, Carnegies, Kennedys, Bushs, and the like, there is a growing entrenchment of an American upper class.  The Republicans current efforts to reduce and repeal the estate tax serve simply to increase this entrenchment - not to help the economy or any other purpose (look at Europe's stagnation!)

What's the difference?  By taxing estates valued at over one million dollars (fluctuating wildly over the next five years), we reduce the amount of money that upper middle and upper classes can inherit without negatively impacting the transfer of monies between generations of the lower, lower middle, and middle classes - as in, protecting the American Dream.  That means that we promote a meritocracy because each generation has to work anew to reach high socioeconomic stratum.

That's not to say that those children whose parents are already in high socioeconomic stratum will be even with those whose parents are not.  Quite the contrary, they have access to the education and networks critical to rapid success.  However, what it does mean is that these children must still work extremely hard to enjoy the same success as their parents because they are thrown into competition with more of their peers from other socioeconomic backgrounds.  This competition is particularly evident in schools - the profusion of scholarships in elite private high schools and universities, as well as the judicious use of standardized tests and the notorious "tell us how poor and disadvantaged you are" essay questions means that the students accepted to these institutions are rated on their merit as well as their parents' wealth.

What do merit and competition mean for society?  EVERYTHING!  Economies grow through competition, hard work, and the pursuit of riches.  While everyone laments the overinvestment in dot-com companies, the fallout is not as bad as everyone believes - in less than a decade, more well more than a decade's research and development was achieved and the productivity gains resulting from it will continue to propel the global economy for decades.

The evidence is all around us.  The 40 hour work week exists only for a very small portion of the population.  For example, I'm penning this essay on Sunday.  With many companies establishing offices across the globe, it is not uncommon for people to come into the office at odd hours of the morning or night to participate in teleconferences.  Work on most projects runs around the clock as offices pass off projects to each other based on their timezones.  The proliferation of modern communications tools means that people bring their work home, and continue it on the road as well.

This means that Americans must work both harder and smarter in order to maintain our preeminence in the global workplace.  In the face of more competition abroad, we must also make efforts to step up competition at home.  Thomas Jefferson is famous for saying "The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants."  The truth of this saying has never faltered.  However, another, parallel, statement has emerged to be just as truthful: The tree of economic growth must be refreshed from time to time with the blood of the meritorious and the wealthy.

So what's the fallout from all of this?  Well, as part of a broader effort this alteration to the tax code risks killing something all (or almost all) Americans believe in: The American Dream.

Continue reading "Meritocracy in Democracy" »

Posted by ash.dyer at 01:00 PM | Permalink | Comments (0) | TrackBacks (0)

There is no doubt in my mind that we're entering a new energy market, and that our experience in the last oil shock in the 1970s does not apply to the new rise in energy prices.  This fact stems from the rapidly increasing demand in places like India and China - a demand that oil production cannot hope to meet with current energy prices - that did not exist in the 1970s.  This knowledge has led a lot of people, particularly investors, to seek opportunities in renewable energy technologies.  However, most of these are doomed to failure for the same reasons they were the first time, and - as noted by my friend Kurt Keville - it is important to realize that most of the old players from the 1970s renewable energy field have decided to pass on this opportunity.  If nothing else, that should tell you something.

Ethanol is the darling-child of renewable energy buffs everywhere.  However, it has a long way to go before it will ever be a serious force in the marketplace.  Here are some reasons why:

• Distribution of oil moves in a river-delta format - it starts with a fat pipe at an oil field, moves down the pipeline to a refinery, the refinery pipes to a distributor which then sends it down the tendrils to all of the gas stations... only at the end do the logistics leave serious arteries.  Bio fuel must first aggregate from a number of small sources then disseminate, roughly doubling the logistics involved.
• Ethanol is significantly more corrosive than gasoline, which means it is ill-suited for use in normal vehicles, even as more than a 10% additive.  Aside from the corrosion, when it's concentration in fuel is greater than 10%, toxic fumes from the ethanol will seep from the fuel system of most cars.
• Modern, non-flex-fuel cars are optimized for gasoline consumption.  Switching the fuel will significantly degrade both the performance and the fuel efficiency (not including ethanol's reduced power-per-gallon in the next point) of those vehicles.
• Ethanol has significantly less power-per-gallon, which means that you have to burn more of it to get the same performance - even in the best of conditions.  It also means that a full tank won't get you as far down the road, so there have to be more fueling stations and it will take more of people's (already dwindling) time.  Hybrid technologies may find a huge opportunity in improving the performance of ethanol vehicles, but this application is likely close to a decade away.
• There is a chicken and egg problem inherent in this industry.  In essence, the petroleum companies are asking the question: "If we build it, will they come?".  Note, this isn't the case for American car manufacturers because there has been a long standing tax break to encourage them to produce "flex-fuel" cars, which is a hold-over from the fallout of the oil shocks of the 1970s.
• There is not enough production capacity, nor even potential production capacity (ie. all arable land), in the world to produce the corn crops necessary to shift all vehicles to ethanol and other biofuels.  Hence, the "ethanol economy" is inherently a non-starter.
• Many non-vehicle technologies, such as plastics and fertilizers, require petroleum for production.  Ethanol won't be able to replace petroleum in fulfilling the needs of these industries.

These seven reasons are just some of the top ones for why ethanol is a non-starter.  However, other darling-children of the renewable energy crowd are also doomed to a supporting role.  Solar power, which relies heavily on metals and silicon for the production of solar panels (not to mention, extremely toxic chemicals), has too low a power density to replace lots of energy generation systems.  Also, throw in the fact that you have to extract the silicon and metals needed for its production from mines, which requires petroleum. 

Likewise, wind power has a limited role, since the average windspeeds required for consistent power production make only a small percentage of available land well-suited to wind production.  Used in concert, all of these technologies will help ease the stress on current energy supplies; however, they're not going to solve the issue.  Ever.

So where does the path lie?  Well, in the short term it's simple: conservation.  There is incredible inefficiency everywhere in the world, borne of oversupply of power for so many years.  That means that we can reap a lot of value out of getting better at keeping what we have.

What else?  This is going to make me pretty unpopular: nuclear.  There are new nuclear technologies, pioneered in part by my alma mater, MIT, that are completely safe and very efficient.  Such technologies offer the energy densities necessary for practical use in a macroscopic application.  I predict that China, and maybe India, will be front-runners in exploring the use of new nuclear technologies... Why?  Simply because they need it for growth, and they have to be more pragmatic about their situation than the populations of developed nations.

I also predict that the new oil - the new driver of our economy - is something we haven't seen yet, or have relegated to the back of our minds.  It's obvious with just a few BOTEs that current renewable energy technologies are not going to meet our energy needs, so it's time for savvy investors to look farther out into the fog to see what's really going to save the day.

Posted by ash.dyer at 08:34 AM | Permalink | Comments (0) | TrackBacks (0)

This article is recorded first-hand from the MIT Enterprise Forum global broadcast, Forecasting Markets: The Capital Update for 2006.  

Moderated by Bob Crowley  

Broadcast can be found at: http://enterpriseforum.mit.edu/network/broadcasts/200601/index.html.

Martin Hansel, CEO of Texterity.

Three types of forecasts: Market Forecasts, Entrepreneurial Forecasts, Investor Forecasts

Market Forecast: Always optimistic - vehicles for consultants to sell their services.

Entrepreneur Forecast: Always optimistic - chomping at the bit, "the time is now".  Usually ahead of the market - markets take longer to develop and mature than the entrepreneurs believe.

Investor Forecast:  Investors don't forecast, they scan.  They're always asking questions and sponging up information.  They're concerned about understanding macro trends in the market.

Startup companies almost never end up serving the market they had planned to serve.  However, 90% of being a small business owner is showing up and absorbing the information and ideas that are out there and along the way, winning small businesses will find a market.

Most investors are long-term and the relationship between entrepreneurs investors is very important.  The best investors make sure to reward the entrepreneurs even if they're not perfect (ie. miss a couple numbers but still build a successful company).

Claire Wadlington, Partner and CFO of FA Technology Ventures

One of the major things VC look at is how entrepreneurs view and present their market.

2005 VC-backed IPOs dipped significantly from 2004, 2005 Merger & Acquisition deals rose from 2004.

$25B in new funds raised in 2005, highest in last 5 years. 

Mezzanine and Revenue-stage funding increased in 2005 - almost a linear trend starting with 2002.

Continuing Trends:

• Open Source
• Web 2.0
• Recurring Revenue Business Models
• Wireless/The Third Screen
• Energy Technology (Again)
• Robots for Unstructured Environments
• Biology/Engineering Co-development (Biotech joined w/ High-tech - not a megatrend)

Advice to Entrepreneurs about Approaching VCs

Really strive to get a good, "warm" referral to the VC.  Also, research the VCs as much as possible and understand their portfolio and how your company fits into it.  Focus on presenting business plan and how the technology can be used to build a business plan.  Credibility is important - VCs invest in the management team.  Show a deep knowledge of your market and your competition.  Finally, find a champion at the firm who will promote you and your company within the firm.

Ned Hazen, Managing Director of Lighthouse Capital Partners

Discussing Venture Lending or Venture Debt market, a little known market for lending capital to VC-backed companies.  Use debt capital to leverage the equity capital raised from VC.

Venture debt lending approaches lending in the same way that VC approach equity funding.  Look into the way that the startup will use the debt to pay for hard assets, as well as a "cash runway".  Gives an entrepreneur extra time to pursue product development.  However, venture debt has an interest rate, and the debt will have to be paid back in the future.

Benefits

Debt is less delutive than VC funding - they do take a small "warrant" or option to participate in the upside potential of the company.  Provides a safety net for meeting valuation milestones in the case of slipping development schedules.

Material Adverse Change

Entrepreneur beware!  Can range from "we're not giving you anymore money" to "give it all back to us, now".  Important to strongly negotiate during contract negotiations, and critical to involve competent, professional counsel in those negotiations.

Also, be concerned about laws concern immediate repossession of funds by creditor if a case is made for the entrepreneur breaching the contract (can happen overnight or over a weekend).

T. L. Stebbins, Head of U.S. Investment for Canaccord/Adams

Canaccord/Adams is a Canadian-based investment for focusing on Small Cap investments.

Market last year was roughly flat and tremendously volatile.  Small Caps led the market last year.  U.S. markets underperformed every other market in the world.  Dollar-adjusted against other markets, graphs indicate an improving strength in the American dollar.

56 venture-backed IPOs, up from 31 in 2003, but still well below the 200+ in 2000.  Average IPO market cap >$200 million.  The market has moved away from Small Cap stocks and focuses on volume.  Sell margins have diminished, reducing the analytic coverage of Small and Micro Cap markets.  NASDAQ is not performing for companies with market cap under $400 million, and has now been superceded for Small Cap stocks by the London Stock Exchange.  Stebbins believes we will see a migration of Small and Micro Cap offerings to overseas markets.  The AiM market is now the place to be for Small and Micro Cap companies.  The average market cap on AiM is $66 million versus an average market cap of over $1 billion on the NASDAQ.  Significantly more equity traded in London than New York.

Domestic recovery will flatten in 2006, the dollar will remain weak, and international markets will remain anti-American.  Interest rates are going to continue to rise, real estate is likely to fall, and China and India will continue to grab more marketshare.  "A year of struggle for US capital markets with great volatility and risk."

Questions from the Audience

T.L. Stebbins: Most people are of the opinion that the real-estate market increases are staying.  However, he sees good potential for

Claire Wadlington:  Early-stage VC valuations are down in 2005 versus 2004.  M&A transactions and later stage valuations are getting pushed higher.  However, early-stage is not responding to the rising later stage valuations. 

Ned Hazen:  Some hedge funds and private equity funds no longer have the market opportunity for which the money was originally raised and part of the money from those funds have found their way into the venture capital industry, mostly in the later stages.

T.L. Stebbins:  America needs to put together a business model to provide services to Small Cap companies.  These issues are partly due to Sarbanes-Oxley and partly due to a lack of "soft-dollar research" being provided to Small and Micro Cap companies.

Have not yet seen the full impact of the strain on natural resources, both the energy sector and other raw materials (copper, silver, zinc, etc.), caused by increasing demand in the Far East.

Claire Wadlington:  Open source companies hard to value - most VCs still don't understand.

Ned Hazen:  Open source companies need to clearly understand their revenue model and distribution method in order to present a compelling investment.

Hole in market for angel-backed companies who want to raise debt in the <$10 million.

Continue reading "MIT Enterprise Forum - Forecasting Markets: The Capital Update for 2006" »

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The general consensus of the U.S. populace, including "experts" at Harvard Business School, CNBC, and of course those that stand to benefit most: REITs is that real-estate is a new asset class, liquid in the same way as stocks and bonds.  What the hell?  Do you mean to tell me that I can trade my home on the NYSE?  Of course not!  While REITs have certainly been securitized, thereby reducing the risk to investors who by shares of the REIT (because many are now traded on stock exchanges), the inherent risk to most investors in real estate is still the same.

Let's look at it.  Real estate is an illiquid investment: you pay a purchase price for it, which sets the value of the property, then every couple of years the property is appraised based on the sale prices of other properties in the area and the size, quality, and amenities of the property.  If you decide you want to get out of the property, you have to put up a "For Sale" sign, call a real estate agent, and wait until you get a few offers.  Then, after you've got some offers, you have to accept one and negotiate the terms of the sale (and there are lots).  This process is pretty different from the sale of a stock or bond!

A wise man once said, "If you see everyone doing something, do the opposite there's money to be made".  Think about it: when people got excited about the Dot.Com bubble, the money had already been made.  As more and more people flocked to Dot.Com stocks, returns diminished.  The same is happening to real estate: people think it's a sure-fire investment because so many people have made money in the past few years.  Oops!  Let's forget market fundamentals, forget that the Federal Reserve is raising interest rates at every meeting, forget that half of all mortgages are Adjustable Rate Mortgages or Interest Only Loans, forget that the national average mortgage rate has risen over 180 basis points in the last year.  What do we have then?  Well, rent right now in most major U.S. cities is 45-60% the cost of an equivalent mortgage, residential properties in great locations are sitting on the market for over 4 months, there's a ton of properties for sale in New England in the middle of January.  That doesn't seem like opportunity to me, it seems like a peak in the market.

The major question is how is the downturn going to come about?  Will it be quick or a gradual process?  And how can you capitalize on this knowledge?

The easiest way to capitalize on this market is simple: stocks and bonds.  During the Dot.Coms bonds were the place to be.  Did you know that the bond market outperforms the stock market virtual every year, even during the Dot.Coms?  With interest rates on the rise, you might want to think of how you can trade bonds to capitalize on this market.  Maybe it's time to take out a long-term loan and start planning on how to use that margin to make money elsewhere.  On the other hand, you can always just negotiate IOUs when the time comes to make a purchase, which is probably safer, although it only works for real estate.

Andrew Kessler says "go into the Fog".  The Fog is that place where no one else is, so it's uncertain - you can't see anything, just shadows and illusions - but if you can make out a distinct object before anyone else does, you're going to make a lot of money.  I like to relate it to my youth sailing in the San Francisco Bay.  We went into the fog all the time.  It's part of racing in the Bay.  The trick was to identify the super-freighters in the fog before it took a radical action to avoid them.  The racing teams that make the course adjustment the earliest usually win because they don't lose time and distance from evasive maneuvers.

Fear

On the other hand, sometimes a ballsy skipper could win by going in close to the freighter.  If the wind was right it could be extremely profitable.  But even still, that skipper knew ahead of time that the freighter was there.  He planned ahead to use his competitors' fear of the freighter against them, either leading the pack towards the freighter until they had to engage evasive maneuvers (a devious technique) or simply going where no one else wanted to go.

This is an important lesson in fear.  Most people are driven by fear, whether they realize it or not.  Why is real estate so hot?  "Oh, duh, it's the lure of get-rich-quick."  Is it?  Look deeper: people are getting rich in stocks and bonds every day, just look at Google.  So is it the hype of easy opportunity, or is it the fear of uncharted territory?  Stocks and bonds make more sense to invest in, but the market's scary to people because the Dot.Com crash still burns bright in their memory. 

All of the sudden, by avoiding the "lure" or the song of the sirens you can conquer your fears and make a ton of cash doing it!  In fact, in conquering your fears you're going to realize that you've found safer territory than everyone else.  Real estate looks safe, but it's not, the fundamentals (I'll go into this in a later article) indicate that it's ready to tank - in the next 3 yrs count on it.  So frankly, the stock market is a better place to be.  All of those companies with strong fundamentals will suddenly look attractive to all of those mainstream people who are about to get burned in the real estate market.  It's called value-investing and it's how Warren Buffet, the greatest living investor, made his money (more on this later too).

So for today I'll leave you with this: go into the fog and approach your fear.

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