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No Mercy / No Malice: Every Seven Years

14 July 2017

by

No Mercy No Malice

Every Seven Years

Jamie Dimon’s (CEO of JPM) definition of a financial crisis is “something that happens every five to seven years.” It’s been eight since the last recession. As you get old enough to observe cycles, as actual cycles, you begin to recognize the economic time you’re in is a point on a curved line and, sooner than you think, the direction of the line will change. Better or worse.

An asset bubble is a wave of optimism that lifts prices beyond levels warranted by fundamentals, ending in a crash. I promised myself that I’d be smarter the next time. “Next” meaning on the cusp of a pop or recession. So, how do you ID when we’ve entered the danger zone, and should you adjust your behavior / actions?

There are several hard metrics for why we may be nearing full-monty bubble, including things my NYU colleagues spend a great deal of time thinking about, and understand much better. But you don’t need a Nobel to see the similarities between 1999 and 2017. (Btw, NYU Stern has three active Nobel Prize winners… We. Rule. But that’s another post.)



I spend more time thinking about softer metrics that, in my view, signal we’re about to get rocked. Some signals that feel so 99:

— Mediocrity + two years tech experience = six figures. Kids who can code and are two years out of school, who are mediocre, are making 100K+ in the market. What’s worse is they believe they’re worth it. If you can code, yay for you. But if you have no real hard skills or management ability, not recognizing you’re overpaid means you won’t have the funds to avoid your parents’ basement when shit gets real.

— Bidding wars for commercial real estate. Firms investors believe are the next Google, armed with cheap capital, roam the streets of NYC and SF, driving up commercial real estate. They are also competing with the Four (Amazon, Apple, Facebook, and Google), who are leasing super blocks in NYC.

— Gross idolatry of youth. I was invited to The World Economic Forum’s annual meeting in Davos when I was 32, pre-crisis, as internet entrepreneurs were the new masters of the universe. I met with several CEOs who wanted insight from me on business, as clearly I had unique insight. No, I didn’t. I was a reasonably talented 32-year-old, who in any other time would have been making only a decent living. Instead, I was Yoda, lecturing more talented business people on what their firms should do. When the dot.bomb hit, I was 34 and returned to Davos, where I couldn’t get arrested — nobody would meet with me.



When times are bad, people look to grey hair for leadership. When times are good / frothy, people look for youth. Evan Spiegel and Jack Dorsey are incredibly talented young men who have built companies that are likely worth hundreds of millions, maybe even a billion dollars, but not tens of billions. Snap, WeWork, Uber, Twitter — combined worth more than Boeing — are run by talented young men who in their next lives will be vice presidents (optimistic) and really grateful. As a former twenty-something CEO of new-economy firms, I can tell you the greatest asset of child CEOs is being too stupid to know you’re going to fail. Young CEOs pursue avenues that are crazy, that sometimes end up being crazy genius. But most are just too stupid (inexperienced) to be running companies that hundreds or thousands of families depend on for their livelihood. There’s a word for what has likely cost Uber $20-40B in value: immaturity.

If the tech boom continues its run, there’s a non-zero probability a teenager will be the founder / CEO of a $1B+ value tech firm in the next decade. When that happens, we really will be on the precipice of the economic zombie apocalypse. If he or she wears a black turtleneck, treats employees like shit, and sports tattoos, or other accoutrements of youth, society will treat them like Jesus Christ. We now worship at the altar of innovation, vs. character or kindness.

Some other signs of a bubble:

— You can’t get a table at average restaurants
— There’s an Uber for private jets
Jay Z and Jared Leto are considered thoughtful startup investors
— The food at your company is … good
— A lot of articles explaining why “this time is different” (here, here, and here)
— You’re introduced to remarkably uninteresting tech people at Cannes, who people think are “fascinating”
Tech CEOs are on the cover of fashion magazines and marrying supermodels
— Founders of tech firms believe it’s their responsibility to put a man on Mars and cure death because … you know, they’re awesome
— Billionaires with undergraduate and graduate degrees pay kids to drop out of college #negligent
— Currencies mined by machines are … currency (I have a better understanding of the chemical underpinnings of a Leonid Meteor Shower than Bitcoin or Ethereum #huh)
— There are CEOs of two firms at once

So, If We’re in a Bubble… What to Do?

Don’t start a company. I’ve founded, or co-founded, nine firms. The factor most strongly correlated to success or failure? When they were started. The successful firms were launched as we were coming out of recessions (1992 and 2009). People, real estate, and services are all much less expensive. My Chief Strategy Officer at L2 joined us, in (2009), and has been the secret sauce of our success, as her offer from a consulting firm was delayed (see above: recession), and my offer of $15/hour was her best option. Note: she makes substantially more now.

Companies started in boom times, struggled. The people our firms have been able to attract in boom times (1998, 2006) were mediocre, as great people were killing it elsewhere. In addition, cheap capital served as a hallucinogen for the viability of our products and services in the marketplace. Right now, stick with a big company who, if you’re good, believes you’ll leave for Pinterest if they don’t pay you well.

If you’re a startup, or any firm for that matter, raise money as if you won’t be able to for a while. If you are raising $1M, raise $5M. In general, you want to raise money when you don’t need to.

Don’t go to business school (will catch heat for this one). Business school has become the domain of the elite and aimless, or a place to take refuge from a recession. If you’re doing well at a good firm during a boom time (now), stay put.

I don’t want to give financial advice, but will discuss what I’ve done in 2017. In sum:

Sold
Or at least assets I don’t expect or want to own for at least ten years. If you’re young, your money in the market can survive gyrations (difficult to time the market). But if you’re an entrepreneur or find yourself sitting on assets that represent a large portion of your wealth, I’m comfortable saying, while this may not be the best time to sell, it’s most certainly not a bad time to sell. We sold L2 this year, as market dynamics trump performance, and, while I was confident about the firm’s prospects, we are eight years into a bull market and due, even overdue, for a correction.

Despite well-publicized examples of people who made billions with extreme concentration of their wealth (Bezos, Gates, Zuckerberg), assume you are not one of these people and pursue one of the truisms of investing / accreting wealth: diversification. If you’re fortunate to have one asset (stock, a house) run up so dramatically that it represents the (vast) majority of your wealth, get as much of that asset liquid as possible. If there is pressure not to sell, ask yourself if the people (board, investors, market, media) pressuring you are already rich, and ignore them. Most times I’ve had a substantial runup in one of my assets (usually stock in one of my companies) and not pursued liquidity, the market steps in and diversifies for me via a crash in the value of Prophet / Red Envelope / CSCO. You want to be the arbiter of diversification, not the market.

Cash
I’m 80% in cash, which most reasonable financial managers will tell you is stupid. Even if it’s stupid, it doesn’t get near the medal podium of stupid things I’ve done (like turning down $55M for my first firm at 32, which was doing $4M in revenues; being 100% in tech stocks, etc). So, there’s that. Every time the bubble popped, I wished I had dry powder (lots of it), as the market becomes the anti-corollary to Snap — good companies at low valuations (Williams-Sonoma at $5/share, Apple at $12, etc.). I’m willing to give up gains, as I so badly want to be on the right side of the street when the recession hits this time. Note: again, smart financial advisors will tell you to always be in the market. I just can’t help it … mattress time.



Anchor
We anchor off how we look when we’re 37 (mental image of our looks regardless of being 50, 60, or beyond). Every time I look in the mirror it’s a mix of horror and fascination at all the fucked-up things happening to my body. Backfat … who’d have known? Anyway, we tend to anchor off of the good times, and believe that is normal. No, it isn’t.

Humility and Solace
It’s key, if you’re doing really well, to realize that much of it isn’t your fault — you’ve been swept up in a boom. This humility will result in your living within your means and preparing you financially and psychologically for the next card. And when the next part of the cycle shows up, and it will, you can take solace, as (again) it’s not your fault, and you aren’t the idiot the market claims you are.

Life is so rich,
Scott

  • B.Anderson

    Great content (as usual), I see similar trends and can not help but fear for our country. I wish you had more influence and reach, to educate individuals.
    We are in a cycle and its time for a hard reset.
    I think your losses have helped many others to learn from your mistakes and lessons. I appreciate your research and personal opinions.

  • Maria Petrova

    Thanks so much for this.

  • OG

    Very insightful.

    I know more than a few getting cash ready for the next recession to buy up property, but not many saw the last recession coming. I wonder what this means?

  • Rob

    The S&P 500 does not look like what you show in your chart. It has been going up, not flat.

  • monte

    Thanks again for yet another insightful post. Just curious: do you spend a lot of time on or have a system for introspection and writing? Or are these posts it? It seems like there’s quite a bit of thought behind these ideas and this isn’t your first stab at these topics…so assuming that you do have some kind of program/ritual, would ya be kind enough to share what it is?

  • Chris Downs

    An interesting thing about success and good fortune… As it pertains to people, we simply take that for granted as a stepping stone to the next ambitious endeavor. Unfortunately, this is not sustainable. Your defeat is on the horizon – believe it or not.
    I still think there is a large group of people that think we are not meant to suffer. I think these folks ironically suffer more than most.
    Great idea about taking a short loss of potential gain for longer term financial security.
    As we all know, the market is quite fickle and cannot be timed, so it is preferable to preserve what you can, when you can. Keep on truckin bro.

  • LL

    Reminds me of a documentary on Picasso. Picasso kept his assets in suitcases full of cash. Served him very well during the depression and WWII…

  • LCD

    You may be right about a bubble because a true sign is when tech entrepreneurs start giving investment advice along with the weatherman and Uber driver and new adds from E Trade pop up. 80% in cash – absurd for any one who is not filthy rich and plans to live more than a week.
    I am a big fan but you overreachedon this one.

  • Kerstin Strubel

    I am finding myself literally waiting for your newsletter every week (is there any newsletter in the world people wait for?). Another awesome one, thank you!
    I am deeply disturbed by Tech CEOs dating super models. Really? I would like to judge and to generalize that they cannot be trusted nor can their businesses. But then again, what about Elon Musk? I am confused…
    Would love to see you come back to Davos. Greetings from Switzerland 🇨🇭

  • Ekene Obi

    Don’t agree with you about bitcoin and ethereum. Little knowledge about crypto here , else you would have noted that bitcoin was created as a solution to the financial crisis of 2009 . The bubble is artificial and it’s caused by years of secrey and printing fiats , but Blockchain which is the technology bitcoin is built solves the issue .it is a trustless network of payment , no intermediaries . I suggest you know more about what you write.

  • Peter

    Great stuff. Yes, the key question is “when” not “if”… but we always want to believe it is going to be different this time 🙂
    I want to give it another year …

  • Zack Duncan

    Scott,

    It’s easy to love your posts when I wholeheartedly agree with them. So let me just say that I. Love. This. Post.

    Very thoughtful and honest, which is difficult to find when most people are talking about the market (ever notice how everyone seems to outperform the benchmark?). Even Buffet has recently been a little cagey, talking about how stock price valuation is really not an absolute and can actually fluctuate relative to the interest rate. Since he’s so much smarter than everyone, I personally think he’s doing what he can to get people invested so we get a nice frothy top and then a big dump. He has $80B+ in cash right now BTW, the most he’s ever had by almost a factor of two.

    Anyway, thanks for the great read.

  • george

    Enjoyed reading your take and deep insights. The future is not easy to gauge but as one mentor once advised me, “you will never look like a fool for taking a profit.” Thanks…

  • Rob Farrow, CPA

    Great post!

    I like to think of startup entrepreneurs like baby sea turtles who are racing for the open ocean, trying to evade predators.

    Almost all of them fail to make it. Most of the successful ones believe believe that they are genetically superior to the rest of the sea turtles, Then we have to deal with the interminable “how to make a billion dollar company” from successful entrepreneurs or evangelists for the alt-right and proponents of “trickle-down economics”. Most of these people are proponents of social darwinism – even though many don’t actually believe in evolution.

    It is always refreshing to listen to someone with a more adult perspective and who at least acknowledges the part that timing and good fortune played in his success.

  • Sanjay

    You write some of the best content and i look forward to reading ever friday- been hooked for 2 mos….i hope people dont find you so i can have these incredible insights to myself – #selfish.

  • JR

    Nit pick: “Sold – Or at least assets I don’t expect or want to own” should be “Sold – or leased assets I don’t expect or want to own”. Sorry to nit pick, well not sorry :-). Great article (as usual, but I am anchored by the quality of your output by now). True to your motto (NMNM) and your icon – fucking appropriate here, before the fucking commences.

  • JP

    Enjoy your posts. While I actually agree with your observations and you might actually be right about a market correction being in our near future, your use of gut feelings and anecdotal evidence is not a very good investment strategy. It’s a math thing. You are trying to be rational but markets are irrational, as you so adeptly point out. So when is the market ever really rational? And to quote Keynes, “The markets can remain irrational a lot longer than you can remain solvent.” BTW, hope and pray is not a good strategy either!

  • scott@l2thinktank.com

    Thx Rob. Baby Sea Turtles–like that.

  • scott@l2thinktank.com

    SUPER helpful. “Know more,” will write that down. Yep, great advice.

  • scott@l2thinktank.com

    I have be overreaching my whole life LCD.

  • scott@l2thinktank.com

    My ritual (seriously):
    –Tuesday/Wednesday, I ask Katherine (partner, creative director at L2) if she has any ideas for NM2;
    –I stew on it, and promise (this time) I’ll start writing earlier in the week;
    –Thursday night, around midnight, I freak out that I haven’t written a damn work.
    –1 am, Friday, begin writing;
    –3 am, Friday, send draft to team;
    –6 am, Maria (editor) puts into Google doc and takes starts cleaning up;
    –7 am, Katherine outlines ideas for Kyle (sketch artist);
    –7 am – Noon, back and forth–edits, etc.;
    –Noon Friday, I begin asking why haven’t we sent the damn thing (as day goes on, we lose click throughs);
    –Friday 1pm, team tests links, etc.; and
    –Friday 2pm, send

    Only real insights: team effort; i like to work (late) at night; and deadlines are key.

    Hope this helps, S