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Friends,

I started paying the 6-year-old interest on his piggy bank. I figure it will be a neat way to get him to engage with numbers while teaching him about money in the process. Computing percentages is above his pay grade so instead, we created an interest schedule. For example, on Saturdays, he'll report his savings and if he has between $0 and $200 he'll receive $.50 interest. If he has between $200 and $400 he'll receive $1.00, and so forth.

If you produce evidence that you a) share 50% of my genes and b) are not my sister then you too can open a Moontower Savings Account.

The fact that you are drooling at the implied APR tells us so much about financial environment we live in today. Let's explore.

Your money has nowhere to go

Interest rates are historically low, basically in line or even less than the low inflation rates we are experiencing. In other words, keeping your money in savings accounts means the value of your savings is slowly eroding. This is by design as global monetary policy is meant to encourage you to invest in risky assets or spend your cash. Whether or not the policy is justified, it has certainly affected markets.

Interest rates are low, meaning bond prices are high. Annuities are historically expensive. Real estate is expensive. Stocks are expensive. We are awash in liquidity and attractive investment opportunities are scarce. Another way to say investments are expensive is to say that implied forward returns are much lower. People are willing to pay a lot today for a dollar of cash flow in the future. In reference to the purchasing power of your savings, I regretfully say "your money has nowhere to hide". 

Now what?

Buying assets near all-time high valuations feels like chasing a ball into the middle of a busy street. How do you take the other side of the trade? If the market is supplying infinite cash for investment today, ask yourself: "What is the market begging me to do?"

A sensible thing to do is refinance and you should, but this feels like you're taking an inch when a mile is on the offer. Another option is to take a low-interest rate loan. But what do you do with the money? Buy an expensive house? That's like staging an intervention only to find yourself getting drunk with the person you are trying to help. 

How hustlers respond to loose capital conditions
  • Entrepreneurs
While investors are crying over the lack of attractive investments at reasonable valuations, entrepreneurs focus on the opportunity. The investors are the customers. Investments are the product. So give them what they want. "You need to put a billion dollars to work and the SP500 ain't doing it for you? Here invest in my scooter company."
  • Funds
In the reach for yield, investors want access to riskier bets to have a chance at more meaningful returns. While traditional stocks and bonds have a mature fund industry bridging the gap between capital and companies, hordes of angel syndicates and venture funds have set up shop to raise money for these start-ups. But the funds who were smart enough to recognize this demand also recognize a market truism -- the amount of capital that goes into a sector is inversely correlated with its future returns. The funds are like drug dealers who need to assure their clientele that the drugs (the supply of start-ups) are safe to smoke. So what story do they tell? (I have noticed the VC world is especially obsessed with comedian's craft, improv, the ability to write, present, influence, convince, sell, promote. This is worthy of its own discussion as a microcosm of what is feeling like an increasingly postmodern world to me. Sorry to be a tease, but that's a story for another time.)

To understand the pitch is to understand that the story's most important feature isn't its feasibility, it's the scalability. Fake meat. Scooters. Office rental space. Ride-sharing. All of these stories are low margin, low probability of success but...they address humanity's biggest needs. Food, transportation, occupancy. They have the capacity to absorb oceans of capital. If you need to raise $1mm, nobody cares. Need a billion, just call Softbank. In the equation for expected value, EV = P(X) * X, all eyes are on the magnitude of the payoff, X. The probability is more of an impression than something to inspect with a microscope. 

This isn't irrational. Venture funds need to hit massive home runs on their winners to make up for the many losers since they are investing when companies are very young and extremely speculative. But if we jam more money into venture, they aren't going to be able to generate the returns by marginal increases in their ability to choose better investments. Instead, the size of the home runs will be the largest factor in the fund's returns. Play venture capitalist for a moment -- would you rather improve your hit rate from 10% to 20%, or maintain a 10% hit rate and increase your payoff from x to 10x?

While the mood in the traditional finance labor markets is besieged by automation and disintermediation, there are growing segments such as fintech and crypto. These are areas where one can find opportunity and a tailwind to reap the benefit of loose capital. 

The peace dividend of overvaluation

For investors, these bidding wars will lead to buyer's remorse. Their loss will be many others' gain. Entrepreneurs will be paid in opportunity. Matchmakers in fees. But guess who else? Consumers.

You get the ability to hail a ride from your phone and the sum of the world's knowledge at your fingertips. The fiber optic bubble of the late 1990s wiped out investors but successfully laid the undersea cable that billions of 0s and 1s travel across every second. In fact, the consumer surplus resulting from the overinvestment may be the biggest bounty of all. 

Simply:

overvalued companies —> low cost of capital —> funding for crazy ideas

If you wanted a shortcut for identifying the most speculative themes in markets you can browse the highest-valued ideas on Motif, take note of what themed ETFs are coming to market, or check out platforms for angel and pre-IPO investments (see under Private Investing).

Communism has been described as a system where the intentions are good and the outcomes bad. Well, capitalism is the demonstration of greed leading to good outcomes. The investors, without intention, subsidize innovation and by extension humanity. 

Opportunities lie in the inversions

It's useful to remember that the flipside of overvaluation is a low cost of capital. By funding speculative companies aggressively, the market is signaling a desire for big payoffs and big dreams. Entrepreneurs and funds organize around this incentive to provide the market what it wants.

Instead of crying about the Fed, lack of fiscal discipline, the lack of reasonable investment opportunities, remember that overvaluation cannot exist independently of a low cost of capital. It's your job to find it then use it for what it begs for...enterprise and creativity.

 

Some parenthetical stuff: 

(The mental inversion of "overvalued" to "low cost of capital" is adaptive because it mentally re-orients you from thinking "How do I short this?" to "How do I use this?". Shorting companies requires borrowing shares to sell them. This doesn't create a new supply of shares but changes how they are distributed to cause downward pressure on a stock. It is supply that is eventually required to be repurchased. Permanent supply can only be created by secondary issues or by capitalizing more companies and competitors. Here's my explanation of the brutal math of shorting.

Note that a symmetric inversion is to re-cast "undervalued" stock as companies' with low implied forward rates of invested capital...traditional so-called "value traps" come to mind. Thanks to Eric for introducing me to the concept of "implied forward ROIC".)

 

 



Climb Higher

In a matter of weeks, WeWork went from being a $50b unicorn to being mentioned in the same breath as the "b" word. I won't rehash the We saga, but a recent interview with Scott Galloway who has been spitting acid on them for 2 years is one of the best things I've read this year. His colorful metaphors and ruthless candor need to be enjoyed in their full glory. Enjoy

As I mentioned above, overvaluation has a peace dividend, but that doesn't mean it was correctly allocated capital. Some say if you hit every pitch you swing at, you are probably taking a suboptimal level of risk. That's a smart observation. But investors in We look like they took a smart idea too far. When a pitcher notices a batter is willing to swing too far out of the strike zone, he'll try to get away with less honest pitches. Here's Matt Levine on We founder Adam Neumman:  

If you want, you can imagine him as a diabolical genius who explicitly set out to short the unicorn bubble and then walked away barefoot with a jaunty whistle and $700 million of SoftBank’s money, but that does not strike me as necessary or accurate. My model doesn’t require you to think that your startup is dumb! You don’t need to worry about Neumann’s personal beliefs and motivations at all, really. You can just think of him as a product of the invisible hand of the market. A lot of money was pouring into startups, there was a lot of demand, and the demand called forth supply, and the people who supplied the supply got rich; it is elemental and straightforward and has very little to do with questions like “is this a good business model?”

 


Last Call
  • Keeping the TI-82 calculator relevant in classrooms for so long required some gangsta business practices. Find out more.
  • A lot of weird stuff happens when people get struck by lightning. A super fascinating look at the aftermath and science here.
  • The Four Week MBA is a repository of many business case studies and models. Lots of things to learn, all free. 
  • A quote I liked in context by a respected teacher in our life. "My parents taught us to be able to eat with paupers and kings"
  • Ben Thompson admits ways in which he misunderstood Uber's business, contrasts Softbank's game theory from a typical VC fund, and births the phrase: neither and new.  See the latestThompson's tech missives are like mini chess classes.

 

 


From my actual life 

Yinh and I celebrated our official 10th-anniversary on Wednesday in a fitting way. Stuffing our face with italian food at A Mano's, ice cream at Salt & Straw, and seeing Greta Van Fleet perform their 70's style rock set at Bill Graham Auditorium. Sure they sound a bit too much like Zeppelin, but the kid has pipes. We've seen them 3x in the past year. We estimated that we have seen 60 concerts in the past decade. We'll spend the next decade instilling our boys with the love of live music. 

This weekend we had the honor of zipping down to LA for a night with a group of friends to see Brenda and Kit who were babymooning from across the pond. Besides the joy of breaking bread and catching up, a big highlight included getting to check out the Magic Castle in Hollywood. It's a 100-year-old chateau which has been dedicated to the art of magic since the 60's. The shows and brunch were outstanding and the building is as magical as the acts, especially in its Halloweened out decor.

If you can, try Jet Suite. These are charter planes that seat 30 people. No security. Roll up to a small airport and wheels up. The best part...you don't need to be a billionaire. A one-way ticket was $130. Check out their site for routes. Jet Suite is just a left coast thing but if such an airline exists elsewhere please share.

Finally, this is week #30 of Moontower. 165 people receive this letter and 100 people at least open it every week. This is a special, smart group of readers so I'm proud of that. I am grateful and really want to live up to the privilege of your attention. The readership has more than tripled since I started and that's because of your referrals. New readers feed back too and a virtuous circle of content and ideas takes shape. Please continue being forward about feedback. Some of the most engaged readers have been on the younger side of their careers or even in HS and I find that to be especially cool. As always if you think there is somebody who would like the letter pass it on.


From Yinh using the plane to punk influencer's staging practices:



 
Suggestions? Feedback?
Want to learn more about a topic? 

Don't hold back, let me know.

Thanks for reading and have an awesome week! 
Sincerely, Kris 
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