A Market Dichotomy

The Nasdaq is down 9% for the year.

Inflation is up.

Growth is down.

Stagflation is looming.

The real estate market peaked last year and the best we can hope for is a soft landing.

Most hedge funds are having a tough year.

The economy and the capital markets are not a pretty sight.

Yet the venture capital market, particularly for web delivered services, is white hot.

Valuations are up, amounts raised are up, fund formations are up.

This can last for a while, but not forever.

Over long periods of time the venture capital market and the NASDAQ are highly correlated.

As my former partner Bliss McCrum used to say, "when the back up the trucks, they take away all of the furniture."

Comments

[Dan Cornish]

This is a great example of your thinking in real time. A few weeks ago you were wondering if you were not making enough investments. Now you are worried someone will take away the punch bowl. Thanks for being so honest in real time.

[Shivering Timbers]

So the question is....Is the VC market a leading indicator or a trailing indicator?

Experience from the dot-com crash suggests that VC is a trailing indicator (sorry!).

But look at the bright side: if you're enough of a trailing indicator, you become a leading indicator again.

[Bharath]

Making predictions about the economy is an exercise fraught with uncertainty (especially for someone who writes code for a living!). But here goes...

It seems like older economic models that guided conventional wisdom can no longer be relied upon in an increasingly globalized world. For example, the inverted yield curve is no longer reason to proclaim recession (so long as the Chinese continue to subsidize American long term interest rates). The US economy is holding up quite well to the high price of oil which is no longer reason enough to predict stagflation .

Likewise, its hard to say that the current boom in web services will burst even if there is a recession. Why? Because monetization for these companies is primarily ad-driven and they will continue to make money as consumers continue to spend more time online (or using their cell phones and iPods) and advertisers respond to this trend.

The burst of 2000 was not so much about economic cycles as it was about a cycle of greed. The fact that investors this time round are maintaining a laser sharp focus on monetization, makes a burst less likely this time round.

I am not disputing the cyclical nature of the economy. All I am saying is conventional wisdom cannot be used to guide investment decisions.

[vw]

Another way of looking at the VC - Nas relationship may be as causal rather than simply correlated (the Nas then would be a leading indicator). Given the high proportion of exits into a Nas IPO (or acquisition by a Nas listed company feeling better when its shares are more higly valued), the Nas may drive a significant proportion of the returns of many VC funds? Perhaps if the rate of acquisitions of VC backed companies by non-US listed companies increases, we could see the relationship change. Otherwise, it seems logical that the two will move together over the long term... and the 12-month view for the Nas looks flat at best (to me anyway).

[Rick]

We all learned from the last one, so it can't happen again.

[Dave]

Your description of the economy does not seem very accurate to me, and, indeed, is rather pessimistic.

I'll grant you the real estate. Most hedgies I know are having banner years (perhaps I know only lucky ones?) And most equity investors I have spoken with are either up or even over the year.

Inflation is overrated as a concern. Incomes are growing (at least for skilled people).

[howard Lindzon]

Tech stocks are now way underowned and any positive news will lead to a big rally.

Google will not be the only winner and just as everyone says IPO's are deas, I would take the other side of that bet.

Venture seems fine on a deal by deal basis as I think it always is.

[Kamla]

Reading your post reminded me of those sotto voce murmurs going around that the economy is going to witness a downturn. It is here they say and it's just a matter of a few months. 2007 is the chosen year...fasten your seat belt for some kind or degree of descent from the stratosphere. Hopefully, we don't land with a loud thud!

Kamla

[Charlie Crystle]

The economy is softening ad shifting and it has been for months. Leadig economic indicators don't measure consumer ability to spend until it's too late. The economy is 70% cosumer driven, fueled by housing equity ad a huge increase in short-term personal debt. Coupled with increasing costs and stagnating wages (majority), consumers are pulling back because they have no choice. It's starting to show in the IT channels; IT managers are starting to slow spending, which is as much an indicator as anything.

The 2000 drop, people forget, was about y2k and a saturated IT market. Think about it: every organization everywhere in the world had to upgrade hardware and software for y2k, putting just about everyone on the same IT spending cycle for the first time ever. The date passed, everyone had new everything, and spending pulled back, layoffs started, pilot projects ended, and earnings reports pooped out. That started in Q2 1999 and got worse as y2k projects wound down.

A lot has changed since then, and this is more of a typical recession than the last. How it effects VC markets I don't know aside from the M&A markets, but there's still a vc fund overhang, and I suspect still a vc hangover.

[just.a.guy]

I've run the NASD/VC inflow/outflow correlation analysis and what you find is the NASDAQ lead VC investment from 1990 or so all the way through the bust (as in leading VC investing down) -- until 2004. in that year, normalized VC flows trended upward while the NASDAQ was flat.

[Dave]

Another point bears mentioning: the NASDAQ is a poor proxy for the economy as a whole. I'd look at the performance of the Wilshire 5000 if you want to know how stocks have done.

[Evert]

Quote: "Yet the venture capital market, particularly for web delivered services, is white hot."

It is increasingly frustrating reading these type of statement (which are no doubt true).
I am in the process of raising VC capital in Europe for a WISP starup with a heavy emphasis on delivering web based services instead of just "plain vanilla" broadband and investors here seem to be totally un-aware of these technologies and the possibilties..
If only the European VC market was similar to the US one!

E.

[Observer]

I think a huge bust is coming. It has nothing to do with venture capital this time (there is a bit of web 2.0 froth, but it is immaterial in the larger economic picture).

US economy is heavily imbalanced, due to years of Alan Greenspan's asymmetrical monetary policy, which basically considers asset inflation to be wealth, and relies on tame(d) but useless CPI inflation numbers that have no meaning in the real world at all.

Venture capital is just a smaller symptom of the larger credit excess in the economy. Hedge funds and mortages, whose magnitudes dwarf venture capital, show how excessive this credit cycle got. A credit bust, which is all but inevitable, is not going to be pretty. It will alter the complacent world-views of all of us.