Dave Canal's blog

“History Doesn’t Repeat Itself, But It Often Rhymes” –Mark Twain

The current unicorn IPO market is reminiscent of the psychology used in the Trojan War.  Today the hidden “soldiers” are venture capitalists, investment bankers and corporate employees.  According to mythology, the “gift” to the Trojans was an 80’ wooden horse that seemingly marked the end of a ten year war.  We are now ten years into a bull market.  A market that has not been believed, nor participated in, by individual investors.  However, they are now being offered “gifts” of unicorn IPOs.  These companies are immense in size and … unprofitable.   

With deference to Stephen King and his horror novel “Misery,” it seemed the only appropriate name for my scrapbook.  The “book” started 10 years ago when a famous hedge fund manager massively underperformed the S&P 500.  Then it happened again with a well-known mutual fund manager.  I sensed there was more to come.  Over two, three, five years, the list grew rapidly.  As time went by, active underperformance became a “gift” to passive investment firms.  One that kept on giving.

When I was quite young, my father and I would go into Boston on Saturday afternoons to see my grandmother.  She lived in a brownstone in the south-end across from the Greek Cathedral.  As we settled in, she would give me a dollar and ask me to “go down to ‘Sam’s” and get a pound of hamburger for dinner.  Sam was the butcher at the end of the street.  Every time I walked in the store an overhead bell on the door would ring and I would become instantly mesmerized by all the sawdust on the floor and the smell of meat.

Most of us think of the stock market as a monolithic entity.  I don’t.  I believe it has an internal structure of three categories each based on the size and history of the companies.   Or sometimes, it’s just the nature of the business.   Each segment has its own investment advocates.  

For all the presumed sophistication of Wall Street investment banking firms, I have yet to see a mention of a simple financial law.  The law states the faster a company grows, the harder it is to maintain the same percentage of growth.  We now have dozens of “unicorn” companies (billion dollar valuations) ready to go public.   Many are 10 billion or more in size. Some have been in existence for 10 years or more and most (80%) have not made money.   They’re following the Amazon model.    “Build it and they will come.” Gaining market share is not the same as gaining profitability.

You might think I’m referring to Bill Gates, but the story goes back much further in time.  The father of 20^th century technology, undoubtedly, was General Georges Doriot.   He was born in France in 1899.   Twenty-one years later, he came to the United States as a young immigrant to attend the Harvard Business School.   Four years later, he was the Assistant Dean of the school.  Yes, he was that bright. 

If you created a computer system that could send signals close to the speed of light, would it make you a successful investor?   You might respond, “What does the speed of light have to do with investing?  That’s astrophysics.”  You would be correct; it has nothing to do with investing.   So why have astrophysicists made most of the money in the investment business for the past 10 years?  It’s not because of their investment acumen.  They’re using knowledge few others have … to legally steal money because of a tenuous legal distinction. 

In a speech before the House of Commons, Winston Churchill paraphrased a phrase first said by Harvard professor George Santayana.   Churchill’s statement that, “Those who fail to learn from history are condemned to repeat it” became instantly famous because of its undeniable truth.  This is especially so in the investment business given its historical cyclical boom and bust periods.  Nonetheless people still like to think, “This time is different.”

The recent pullback in the stock market has caused much angst in the media.  The strength of the economy is questioned daily.  It’s reminiscent of the investment chatter after the October “crash” of 1987.   The “coming recession” that never happened.   In my opinion, both periods were impacted more by the structure of the market rather than the economy.   In 1987 it was the buildup, and subsequent unwinding, of portfolio insurance.   In 2018 it’s been the buildup of passive investing and the start of its unwinding.  Both were intended to reduce risk.   Neither did.