Despite knowing that it is notoriously hard to invest during a bubble, even if you diagnose one correctly, the wait for it to burst can be unendurable.
Recently, there has been a large focus on the high levels of valuations, with many commentaries published discussing the evident bubbles, superbubbles and boom-bust as well as boom-bust-rebound cycles. It is noticeable that bubbles or so-called 2-sigma events, defined by two standard deviations from the mean, have almost always broken back. Even though this holds true, a handful of these bubbles went even further to develop into superbubbles, which are 3-sigma or greater events.
According to Jeremy Grantham, Co-founder of the Grantham, Mayo & van Otterloo partnership, today, the US equity market is in the fourth superbubble of the last hundred years. Previous superbubbles we have seen had a series of distinct features that are rare individually, but even more so when seen collectively. Unfortunately, it seems the checklist of these features for the current superbubble is complete again, which is worsened by the top-up caused by several other asset classes showing signs of also being in bubbles. Hence, we are awaiting a wild ride in a rollercoaster that can be launched at any time, even if no one wants to hear a bear case right now.
Lofty valuations
The shares of technology companies, which have reshaped the global economy in the past years, trade at very lofty valuations. Relatively young companies have reached eye-watering valuation levels, and online retail traders have driven the price of some stocks to the moon and back again. The storytelling around disruptions, the fear of missing out, low interest rate environments and uncorrelated risk adjusted returns have encouraged all segments of investors everywhere to put more money in public, and even more so, in private markets with the goal to harvest liquidity premiums and diversification benefits.
Despite knowing that it is notoriously hard to invest during a bubble, even if you diagnose one correctly, the wait for it to burst can be unendurable. Investors want to protect their assets from a crash, but they also want to protect them from the loss of purchasing power when inflation is higher than interest rates. Hence, it is more than worth trying to understand more about such events and subsequently how to survive them well. To make it complicated, sometimes so-called bubbles stem from a real change in the fundamentals, which is why a bust is followed then by a strong rebound, rather than evaporating as it were never there before. At the end, it always boils down to the nature of the bubble and how it is defined. Is speculation and irrationality the essence of it, are prices just well above fair value or is there a tectonic shift in the economics of an underlying market triggered by newly applied technologies or research?
Robert J. Shiller, Economist, Academic and Author at Yale University, who was forthright about the dotcom and housing bubbles, has also been hedging his assets selectively recently, as he believes that markets are quite expensive, but at the same time stating that a lot of stock prices generally are reasonably valued. How come? The difference is whether the comparison is made with historic prices or with the relative yield available in fixed income, he states.
Deal sizes have spiked
Focusing on venture capital, it seems like the industry is overheated, as investors and experts would say. Whether this is true or not depends on your point of view, and of course, how well your portfolio is performing. Nevertheless, in recent months, deal sizes have spiked, and dry powder seems to be available at an unlimited scale. Investors compete to be first in line to get into hot deals. In addition, there are hyper-fast follow-on rounds and more non-traditional market players are backing early-stage startups than ever before. There seems to be a death spiral at work: Capital is flooding into the venture capital market because of high risk adjusted returns, that leads to investors opening their wallet even more and driving up prices and investing in companies that shouldn’t receive monies at all, leading to a dangerous misallocation of capital.
However, nowadays, startups seem to grow faster and generate higher revenues than ever before, backing the rationale of a so-called new normal with high valuations. Even if valuations would decline, as negative sentiment in other markets would also have an adverse effect on the VC market, growth rates and revenue scale shouldn’t follow with the same pace. In other words, multiples might be questionable for some start-ups, but given a solid product that adds value to customers, revenues are here to stay, as are the growth rates. With fat wallets chasing top deals, competition becomes fierce, and the quality of due diligence is declining. What was seen as irrational a couple of years ago is much more rational nowadays.
At Serpentine Ventures, we strongly believe in a structured and rigorous due diligence process combined with operational excellence that will pay out and generate decent performance for our investors in the long run. That means to pay attention to details and often stay at the sidelines when competitors move fast, or to stop justifying outcomes and be able to say no to a deal based on given facts, even if the opportunity looks groundbreaking. Serpentine’s deep operational focus combined with its thorough due diligence process will make sure, we not only will survive wild rides on the roller coaster in the future, but even benefit from market turmoil and meet the expectations of our investors, in line with our purpose: We enable growth by facilitating investments in passionate people and bold ideas. May the wild ride become true.
