It’s All About Assets

I think people have this idea in their minds about what wealth inequality means. I have come to believe that they think, what it means, is that these super rich people have bank accounts stuffed with cash. That these people have millions and billions just floating around for quick and easy spending. While yes, it’s very possible that is true for some, for the majority of wealthy people, it is a different form of wealth. It’s paper wealth.

Wealthy people tend to be investors and shareholders. It’s where most of their wealth comes from – the perceived value of the shares they own in something. If you could somehow view the world through a lens where asset holdings could *not* be counted, wealth inequality would be subdued. The richest have a lot of shares in things, the poorest have no shares in anything.

Of course, this post is not making any crazy statement about assets, whether they are good or bad. More-so, this post is meant to highlight that financial markets have been the outsized wealth creator for the last 10+ years. And the issue at hand, the proverbial elephant in the room, is that the stock market has enjoyed preferential treatment from Government organizations while others who have no exposure or access to markets, quite frankly, have received none.

Our Fed Officials Should Visit The Bronx More

The Federal Reserve is a lovely entity that saved us from the abysses in 2009. And I have championed them for many years reading books from Geithner and Mishkin to Bernanke and Volcker. However, in my time studying them and watching their rescue missions, I have been unable to ignore their advantageous treatment of certain demographics. They have backstopped the exotic world of finance over, and over, and over. They have been there each step of the way for more than a decade. Yo bro, you need liquidity? We got you. What’s up dog, you need some low margin to buy stocks? Rate cuts coming.

I often joke the Federal Reserve should take their asses to the Bronx and spend a day at PS 178. They should learn what these kids come from and how their families generally have no liquidity whatsoever. After that they should get an Amtrak, not an Acela, and go to North Philly. I write this because I think it’s very possible our Federal Reserve officials have spent too much time roaming in Wall Street circles. Private dinners, meetings, and exclusive events in Wall Street and DC towers will close your mind.

Liquidity Demographics

Our current Federal Reserve Chairman, Jerome Powell, was a partner at the private equity firm Carlyle before he was nominated. Ben Bernanke, the Fed Chairman from the Financial Crisis, is now an advisor to the market makers of Citadel. Tim Geithner is currently a President at Warburg Pincus. These former hard-working Government officials in control of who gets liquidity and when sure sound devoted to solving problems on behalf of society…

I often think about what the Federal Reserve actually does for a lower income people who have no access to financial markets and no assets. Maybe they live near a pay-day lender or know a loan shark. People who are day-to-day, cash only, or checking accounts have not once been bailed out or been given any assistance 10+ years into this economic expansion. Actually, to some degree, they have lost. Because their checking accounts and cash under a mattress now earn LESS than they ever did. They don’t keep up with the inflation rate and the Fed keeps cutting rates at every chance they get.

On the other hand, those who hold most of their wealth in financial markets, are supported with each moment of risk. When rates are low, when liquidity is high, when the Fed is always there, the investor class benefits from rising asset prices. But if you have no assets, you don’t benefit at all. That’s the problem – the Federal Reserve’s response to financial markets disproportionately benefits one class of people more than all others. It made sense at one point in time, I don’t believe the same policies make much sense any more.

So How Do You Fix It?

I should be clear, I do not want markets to go down. I have no problem with the assets you hold whether they are stocks, bonds, real estate or anything else. I think it’s great. Free markets, free trade, and free choices are essential to living well and creating great things. But, what I do stand against is unfairness. More importantly, I think you have to fight for the underdog when you can. And the underdog right now is getting destroyed out there.

So how do you make it fair? Our policy makers, especially at the Fed, could benefit from creativity. More outside the box thinking. Perhaps the Fed could start a program that specifically targets community banks in low-income areas. Perhaps the Fed could work with them, give them unique liquidity preferences, and encourage them to get out there with this new fire power and support.

Or maybe they could give a bigger savings rate to those with less than $25k in savings or checking accounts. Maybe these people can, somehow, be given a rate higher than the Fed funds rate so they can actually earn interest higher than the inflation rate. I mean, does anyone realize that poor people who have to hold cash are actually losing money each day? The Fed wants 2% inflation, but checking and savings account rates are less than that. That means if you hold cash, even if you need to because of your circumstances, your cash is melting each day because of an inflation rate greater than your savings rate.

Traditional methods of cutting rates and supporting markets with asset purchases has proven to work, but today, they are exhaustive measures with very little impact on the people who we really need to be helping and an outsized impact on the people who, at the end of the day, don’t really need much more.

That Is All For Now

It’s funny to watch my philosophical beliefs change over time.

Several years ago, I was in complete support of the Fed. I thought they saved markets, and more. Today, my tone has slightly soured.

But in a free market and country, that is a beautiful thing and it’s how change is made. Being critical of something, taking feedback and sharing your thoughts is how people build and create things that solve problems.

I was surprised to read something about Fidelity the other day. It was a fact they decided to leak out to the public. What they said was, based on all the 401k accounts on their platform, they’ve set a new record for millionaires within their customer base.

That’s just Fidelity. And that’s just 401k accounts. There is probably a record number of millionaires in America today, in general.

Yet, it still seems no one is happy. I don’t know why that is or what’s underneath it. I do worry, though, and what I worry about is our growing obsession with markets and the ways it benefits a particularly small demographic.

The other day I was watching our Treasury Secretary, Steven Mnuchin, talk about the Trade War. He was asked a question about the stock market. His response? He smiled and looked at the reporter, “The stock market is always right.”

90% of Americans own 6.8% of all stocks. The other 10% of Americans own the other 93.2% of all stocks. I don’t find that stat encouraging. It’s even less encouraging when you consider our Government officials speak of financial markets as a barometer for everything they do. Each day it is becoming their new god. And their new god represents a small percentage of the actual population.

In a prior era, we spoke about the middle class with admiration and focus. It was all about lifting up the middle classes. That was the secret to America’s success. Education, wage growth, savings, and increased productivity – that’s how the middle class got going. That’s how we went from one stage of wealth to the next.

Today, it seems we’ve moved on from those years. Today, we’ve graduated to the investor class.

While walking Bryant Park with a good friend several months ago, I explained to him my concerns about this scenario: a roaring market with very little participation from the general public. He said to me something along the lines of, “that’s just how it’s going right now and that’s all the people in this administration care about so either get on board or wait for the election.” I appreciated his bluntness.

The market is up roughly 10% since we had that conversation. He was right.

I wrote this post not to be political, but actually to be introspective. As someone who has followed markets all these years, I’ve been fortunate to enjoy the ride. But I also know when something is tilting in a direction that no longer feels “right.” Or more importantly, feels equitable. Even if that means calling myself out.

The simple fact is that a large percentage of the population is missing out on the excess and appreciation of wealth that come with access to financial markets. In other parts of the country, things seem to be going differently. So far this year, it’s been reported that farmers are going bankrupt at a near record. We live in a time where my brokerage account can do more for me than a plot of land, machine equipment, and the production of food can do for those farmers.

Margin matters most right now. In times of stress, people will sing Cash Rules Everything Around Me. Lately, it’s more like Leverage Rules Everything Around Me. I often joke that I can get a margin loan for 3%, but a college loan will take me up near 10% even though it’s essentially protected by default.

If you really think about it, the investing class has probably received more benefits, backing, and support than any other group in America over the last 10 years. The Fed has been there every step of the way. This is not gloom and doom or gold bug or an end the Fed rant. It’s just a post calling it like it is.

One of the more sobering things ever said about the stock market is, “don’t confuse brains with a bull market.”

When markets are rising, money is flowing, and capital is pouring into the lands of finance, it is easy to get carried away. Look over there! That is a genius investor. Or over there! That trader is a millionaire. And that one? That’s the best stock picker alive!

It is literally a challenge to invest your money poorly in a market that is popping off with excitement, with opportunity around every corner, and with never ending stories of growth. The punch bowl is full and money dances best when it’s drunk.

The real skill is found when you can invest successfully and with a sane mind in a market that is flat or declining. When viscous moves are thundering through the market or prices are grinding sideways in a storm-like manner, how do you perform? There are very few who have proven they are capable in these environments. Even the most diversified investors can get exhausted. At a certain point, the relief of having cash begins to exceed the mental capacity to continue onward. Sometimes, hanging in there, dodging swing after swing, is all that matters and it takes great skill to do.

The problem with making money from other people’s money, which is what financial markets are at the end of the day, is that generally someone, at some point, wants their money back. It’s at that time when gains can turn out to be not as real as once thought. I remember when I was suffering my worst draw down ever, the first time my stomach felt uneasy just looking at my portfolio, and a mentor of mine pulled me aside. He said, “You aren’t down as much as you think you are. Because you never actually had that money.”

What he meant was, while yes my paper value looked wonderful in the months before, it was not exactly mine for the taking. I had no right marking my draw down from that high point. I never saw the cash actually deposited. In the famous monologue from Blade Runner, when Roy Batty is grasping on to his last words of reality, he comes to realize how fast what he saw as reality can wash away:

“I’ve seen things you people wouldn’t believe. Attack ships on fire off the shoulder of Orion. I watched C-beams glitter in the dark near the Tannhäuser Gate. All those moments will be lost in time, like tears in rain.”

Blade Runner, Tears in Rain from Roy Batty

All markets eventually get tested and when they do, what you thought you had and saw, in the words of Batty, become lost in time like tears in rain. There is no easy answer or solution or article that explains what it means to go through these periods of time as a full-time investor. The only way is to go through it first hand. When it rains in markets, we learn the most about how good we really are.

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I think a lot of us have noticed this wave of people who keep saying things like, “the world is so much crazier today.” Or slightly different variations of that, but similar in meaning. Like, “politics are the craziest they’ve ever been.” Another one is, “it was so much simpler when I was younger.”

I’ve been thinking about these phrases a lot lately.

The other night I found myself hanging out in upstate New York. I was at a small restaurant, the kind that has four or five tables, not fancy or anything, but very dim lighting. I noticed a picture hanging on the wall. I don’t know why I noticed it, but I did. The picture showed a lady on a beach wrapped in a blanket. She was smiling. It was a black and white photo. Geez, it really did look like simpler times back then. Behind her was a sprawling row of sand dunes and on top of them sat two modest houses, spread out by a few hundred yards.

I could not stop thinking about that – only two houses on that beautiful beach? How? Where? This picture was clearly taken in another time, maybe 50 or 75 years ago. So of course there was an undiscovered beach like that. Not only was there less economic development, less infrastructure, less money invested, but the population was also less than half of what it is now and something like the iPhone was incomprehensible.

What I’m saying is that it really was simpler then and it really is crazier now. But, that makes perfect sense. Imagine giving 4 billion people the most powerful computing device ever invented, one that fits in their pocket, and then sending them off into a free country where almost anything is possible. That is literally what’s going on. The possibilities, good and bad, are endless.

In the 1970s and 1980s, the population in the US was about 205 million. While quite a few people had color TVs, an even smaller number of people had a computer. Most people at these times had phones, but these were rotary phones, those giant phones that attached to a wall. Some young people reading this today will have to research what a rotary phone is. That’s how far we’ve come.

In the 1930s, there were 122 million people living in America. No one had TVs and pretty much no one had a telephone.

Today, in America, there are nearly 330 million people. And everyone has a phone that’s more powerful and dynamic than any consumer electronic device ever built prior to it. As the population grows, as technology gets better, it will only get crazier. With more people and more technology the probabilities of something happening that’s even more outlandish than what happened before naturally increases. So to does the combination of the way they can happen and more importantly the way we hear and learn about it.

I wrote this post not to try to make excuses for some of the worst things that have happened over the last decade, but more-so as a way to understand that it should not be as mysterious or alarming as we make it. The craziness should be expected. Back in the day, Star Trek actually talked about a food device that created fake meat. While watching Beyond Meat go public, this clip stuck out in my mind. Imagine how crazy the world will be if we ever actually find ourselves in spaceships going back and forth between Mars:

I’m not sure if this post will resonate with anyone, but it was something I had to put down in digital ink. Things are getting crazier and maybe rather than fighting that, resenting it, finding excuses for it, it’s actually something we should be ready for and acknowledging that it comes with the territory of outpaced technological and population growth.

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I have only bet against the market once in my 10+ years. I tried to go net short when the Federal Reserve first started reducing their balance sheet. Well, that was two years ago and the market is up about 30% since.

I often joke with the people around me that, “what’s the point of following markets all the time if I don’t ever try to call a top?” Sometimes, as they say, you aren’t taking four balls during this at bat.

While thinking through all of this, I was reminded of something a well-known short seller once said. I’m not exactly advocating his brilliance or highlighting this short seller. I think most of you already know him and his quote is just that good. I haven’t forgotten it all these years. Here’s what Jim Chanos says about being short:

“What I like to point out is that almost everybody that will view this is the beneficiary of a positive reinforcement cycle in their life.

That is they were told to study hard by their parents, go to good schools, get good grades, go to better schools, get a good job, work hard, get promoted, and be paid well. This is the so-called virtuous cycle.

Studies have shown that most rational people, including people that fit the virtuous cycle profile, find that their decision making breaks down in an environment of negative reinforcement. The ultimate example of which would be interrogation, where your ability to withhold information is broken down by various physical or mental techniques.

If you think of Wall Street, it’s a giant positive reinforcement machine. Basically, I come in every morning, flip on my phone and check Bloomberg at 5:00 AM. Of the hundred short ideas that we have in our global fund, I can pretty much predict at any moment that there’s going to be about 20% to 25% each day where there is some sort of commentary, research report, analyst buy recommendation, estimates raised, or CEO on Bloomberg or CNBC. And generally, it’s noise. Generally there’s not much information or content in that, but it’s nonetheless a noise representative of positive reinforcement. It’s why you should be investing in company “A,” “B,” or “C.”

Most people don’t notice this because they’re in the business of going long securities. I like to say, however, that this is the music that plays in the background of the investment world. If you’re a short seller, this music is negative reinforcement. You’re essentially being told that a quarter of your portfolio every morning is wrong and here’s why. For most people, that becomes a difficult environment in which they continue to think clearly about their investments. There’s a constant drum beat of just negative reinforcement saying you’re incorrect, you’re incorrect.”

Jim Chanos
Interview from Opalesque TV

I’m sure if you tried shorting before, you can relate.

It’s a grind, it is hard, but it is a thrilling challenge to take on. You basically are saying you know better than everyone at an exact moment. It’s a little arrogant, actually. You’re betting against the war drum most other people are playing.

It can be both the worst and the best thing you can do. It’s the worst if you actually wage a significant and risky sum of money. It can also be bad if it takes you over as a person. It does not have to become your life. I think we have seen what’s happened to those people, the permabears who spend their career on such a view. You don’t have to go all in like that ever. There are ways to express your opinion while also defining your risk, or how much you’re willing to lose, from the start (but see the meme at the bottom of this post).

I like to hold myself accountable to what I am seeing and doing by making it open. That’s partly what I use my blog for. I let everyone know what I’m up to. Everyone can share their feedback or criticism or trolly mctroll ways with me. In my new podcast, I actually talk about why this is so important. To some degree, it’s also why I am short stocks from mainland China, because, not only of their strange accounting ways, but also the regime they are operated and controlled by. It’s a dictatorship that stands in opposition to the most basic fundamental freedoms like free speech.

On my blog, all the free speech you want is welcome. You can come at me however you like.

Obviously, if the market keeps ripping I will go down with a swing and a miss, but you can catch up on why I am betting against Chinese VIEs in a Trade War and my latest podcast about what it all means.

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Let me start by reminding you of an IPO I have been unable to forget. I will show it to you as a chart, a wonderful chart that goes straight down.

What you see is the great meal delivery company Blue Apron since it went public. The unicorn! The one that would change the way we eat!

I’m not totally sure how it happened, but at one point this idea to deliver meals in a cardboard box using the USPS was a billion dollar company. In 2017, during a strong bull market, Blue Apron went public. If you had bought $200 worth of this then lauded unicorn, you would have about $15 left today. Good enough for a few coffees and two bagels.

So what exactly happened here? How did it go from exciting startup to the depths of today’s Miami Dolphins? While some might say business decisions or leadership or competition, it seems more likely it was just valued really, really wrong in private markets. Oh, and a good PR firm can really make that valuation pop…

The other week, I read a fascinating stat. It went like this: in 1980 there were only 47 venture capitalist firms and combined they had about $3 billion in total capital. Today, there are 600+ venture capital firms and they have $515 billion in total capital.

Venture Capital is incredibly important to the economy. They fund start-up companies and take immense risk. But it’s important to remember the valuations they seek, or the valuations they decide on, are generally done in a fairly closed setting. Seven people sitting in a room can chose to invest in a company at a valuation of $80 billion and kachinga, this company is now worth $80 billion – call the newspapers and reporters.

In the words of South Park:

The fate of WeWork, to some degree, may be shedding some light on these valuations. Just because some private investor decided to give money to a company at one price does not mean that’s what it’s worth to everyone else with the same information. When WeWork was opened up to public markets for its potential IPO where thousands of people could scrutinize, discuss, and dive deep into it, it fell apart. It wasn’t really worth what private investors told everyone it was worth. There are now more VCs and venture money than ever. The hype and dreams of billions naturally only scales with that. I come back to that scene from the movie The Social Network and how that permeated the startup landscape.

Chamath Palihapitiya, a private investor who made his mark as an early employee at Facebook, but also one who is pretty outspoken, not long ago started talking about problems in the private investing world. He’s worried about the ponzi scheme nature of the existing cycle. I don’t agree or disagree, but I find it interesting and here’s what he writes:

“Over the past decade, a subtle and sophisticated game has emerged between VCs, LPs, founders, and employees. Someone has to pay for the outrageous costs of the growth described above. Will it be VCs? Likely not. They get paid to allocate other people’s (LPs) money, and they are smart enough to transfer the risk. For example, VCs habitually invest in one another’s companies during later rounds, bidding up rounds to valuations that allow for generous markups on their funds’ performance. These markups, and the paper returns that they suggest, allow VCs to raise subsequent, larger funds, and to enjoy the management fees that those funds generate.”

It’s almost as if we’ve taken the “rounds” and accepted them as truth without ever actually getting a clear picture ourselves. If a tree falls in the forest did anyone hear it? If a TechCrunch headline says a company is worth billions do we all believe it?

It’s important to remember that what we see today in private investing is fairly new. Public markets, on the other hand, have been around a long time going back to the Buttonwood Tree. But this cycle of private deals and private rounds of investing is entirely on its own. What I mean is I have yet to meet someone who could show me a historical example of anything like the size or scope of private investing and venture capital like we’re seeing today.

*person walks out of boardroom*

“Today we decided this company is worth $7 billion and we’ve invested $100 million. Tell everyone it’s worth $7 billion.”

*everyone proceeds to say company is worth $7 billion*

My friend always jokes that his life is a startup and it’s worth hundreds of millions if he could pitch it to the right people.

When Lyft IPO’d, I noticed a chart showing who invested in the company when and where. I was most surprised to see Fidelity and Carl Icahn on the list. These are companies and people known for their careers in public markets. You don’t see those names in venture capital often and when you do, you have to wonder: is it now so easy to make money in venture capital that Carl Icahn can just prance right in and then flip his money for a cool 10x return?

2019 has so far been the year of giant new IPOs being challenged. Uber, Smile Direct Club, Lyft, and more hit all-time lows shortly after their IPO. Lately, a group of VCs have been calling for direct listings. One of the core arguments is that investment bankers, day traders, and speculative investors are taking advantages of these companies on the long and short side when they go public. I can’t help but think this is a call for help. A call for help signaling the public markets aren’t buying their companies like they thought they would. I wonder how many private investors have been injecting money into these mega companies on the basis that, “public markets will take care of it, don’t worry.”

Public markets are ruthless. Any real investor or grizzled trader will show you that. I hang with them all the time and hear stories that no one should go through with their own money.

Going forward, the question will be if something like WeWork’s IPO collapse is an outlier or actually the norm for a wave of abysmally wrong private market valuations. I even wonder if a wave of write downs are coming. If anyone is safe. Especially those who have been marking up their stock behind closed doors on the idea that the arbitrary price they determined will easily be accepted by everyone else.

Not so fast.

I have long been a proponent of public equity markets. They are over 100 years old. The Government is heavily invested in regulating them and millions of people have access to them. Generations of people have passed through them and handed down their prized holdings. I am beginning to wonder if, perhaps, public markets are actually the smart money and private markets are the “not-so-smart” money. We will find out over the coming months and it’s possible that this wake up call won’t be friendly to the gurus of today’s private investing landscape.

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I’ve been having this thought lately, one that has been debated before, it’s that very few people are actually cash rich today. Most are asset rich.

Like no other point in time, even greater than the DotCom Bubble, investing has permeated every corner of culture. In hindsight, Bitcoin was a phenomenon that introduced millions to speculative markets practically overnight. There are more brokerage accounts open today than in the DotCom Bubble. And it’s growing. I think part of that is because of the ease of investing. The 20-year-old who just got into vaping can download a commission free brokerage app and buy two shares of Tilray in a few minutes. Even the rapper Waka Flacka, not long ago, was sharing an Instagram image of his stock portfolio.

While I think investing can be beneficial across all asset classes, I do wonder what it means to have a society that is entirely focused on being asset rich and not cash rich. Corporations especially. We read daily about how much cash companies like Apple have, but we rarely ever scruntize their liabilities, their debt, or the actual nature of this “cash.” I would wager most cash assets today are actually in short-term vehicles that are marketed as such, “just as good as cash” … *reads fine print at bottom of page* “but not really cash in its true definition.”

Today, the Fed is quietly injecting $30+ billion each night into repo markets. The main cause is because there isn’t enough cash in the short-term to fund the immediate overnight needs of banks and corporations. Even if it is just a one-time fluke, which many tell me it is and that it’s not that out of the ordinary, the fact remains that whatever just happened, beneath the surface, there was a squeeze for cash going on.

Just recently, on one of these cash-squeezed nights, the interest rate on an overnight loan in the repo market, that thing in the corners where very few ever look, went as high as 9%.

A family member of mine once warned me about the perils of being asset rich. How much do you think everything in your room, the one you grew up in, is worth today? I think a couple thousand dollars. I mean I have some great baseball cards in there, some video games that are still worth playing, some clothes, and a few other items. Now, imagine you took all of that stuff to a garage sale and spent a day or two trying to sell it. How much is it worth now? Probably a couple hundred dollars. Maybe less.

That’s the difference between being cash rich and asset rich. And when the signals start to show, heed them wisely on where you should be.

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