A Turn In The Capital Cycle
Everywhere we look, there’s news of doom and gloom in ‘the market’.
LinkedIn down 50%, losing $10bn of value in one day
Yelp down more than 10% on earnings report and amidst CFO departure.
Zenefits CEO resigning in disgrace and recrimination, followed by it’s biggest customer walking.
Things don't usually go down in a straight line like this...
All this happening against a ‘macro backdrop’ that looks more and more grim:
Chesapeake fell 50% the other day, but in context it's like…who cares…it’s already dead
So what’s going on here?
A Scramble For Liquidity
When a person sells an asset, it is because they decide they prefer the liquidity of cash to the return from holding that asset. If enough people decide to sell on the same day, the buyers in the market begin to run low on liquidity to pay for what people are selling. This leads to them to lower amount of liquidity they are willing to exchange for assets, which is reflected in lower prices. Lower prices convince more people to sell, and all of a sudden we have a scramble for liquidity.
It’s not a coincidence that we are seeing a scramble for liquidity across the global financial system. Rather, it’s the typical turning point in a natural boom-bust process — the capital cycle.
During a boom, excess liquidity leads people to over-invest. In particular, we invest liquidity to build ‘structure’ (for a walkthrough of what I mean by structure, see the article below).
Some of the structure we build is helpful and leads to economic growth. Some of this structure isn’t helpful and needs to be unwound.
We delegate this authority (to determine what is and what is not helpful) to the market. Thing about the market, is it’s just a bunch of humans running around making all the mistakes behavioral economists write books about. And so every now and then we need a bit of a scramble for liquidity to get people to slow down, break out the pencils and start doing the tough work of figuring out if this structure is or is not valuable.
We know that usually the excesses of the boom are proportional to the a pain of the bust. Problem is, when we see a turn in the capital cycle, we don’t yet know how bad the excesses in the boom were, and hence, we don’t know how much pain is to come.
One way to figure it out is just for everyone to try to withdraw liquidity from capital markets at the same time.
This usually clears the table of a lot of bad structure, but also ends up blowing up a lot of totally reasonable businesses which are based on helpful structure, but also liquidity.
Things are Moving Faster
What’s interesting, and perhaps unsurprising in retrospect, is the speed at which this transition is occurring today. LinkedIn’s valuation getting cut in half isn’t surprising per se, but that it happened in a day is.
In reading the media or in talking to professional investors, we hear a lot of opinions about what’s causing this volatility but without much actual information. “Must be high frequency traders” or “must be oil sovereign wealth funds liquidating their positions” etc.
While we don’t know exactly who’s doing all the selling, what we see is a an ever-more interconnected global financial system with a lot more ability and willingness to process information.
Meaning that for the first time, a Hebei steel mill going bust pulls liquidity from your SF-based Software-As-A-Service (SaaS) startup.
Time itself is accelerating.
Call it singularity, call it evolution.