Google too is showing that expenses-be-damned attitude prevalent in parts of Silicon Valley. Afterhours on Thursday, it reported that revenues grew 20% to $16.5 billion. But its operating expenses soared 28% to $12.8 billion. Operating income declined 1%. And net income dropped 5.3% to $2.8 billion. Expenses do matter.
But the nearly unlimited open wallets of Google, Facebook, and other mastodons in this neck of the woods sustain the startup bubble with its crazy valuations and reckless cash burn rates. A corporate buyout is one way of how startup investors exchange these crazy valuations for other people’s real money. But corporations get notoriously stingy and unwilling to blow cash or shares out the door when the ground under their foundations is shaking. IPOs are the other way of converting crazy valuations into other people’s real money. And they too need a booming stock market.
So the ground has been shaking a little the past few days. And the market top has been identified down to the very minute. Bank of America Merrill Lynch handed down the sacred words with divine certainty: “roughly 8 minutes” after the launch of the Alibaba IPO, when the S&P 500 index hit 2019. And that was it. Since that fateful September 19, “US and global stocks have fallen 10%, and cyclical sectors such as energy, materials, and industrials have been decimated.”
But optimism of the IPO and startup hype-machine, though dented, must soldier on.
“IPO investors are going to be there” even if “volatility is uncomfortable,” explained Andy Kearns, co-head of global technology investment banking at Morgan Stanley. He was speaking at the “Bloomberg Next Big Thing Summit: East.” The fact that these next-big-thing shindigs are popping up like mushrooms shows how everyone has been trying to monetize that momentum gravy train while they still can.
“At the margin there may be price dynamics that we need to work through,” he added, with an eye on the stocks that have gotten demolished. But for the rest, full steam ahead: “People are looking at the long-term opportunity in big markets, markets that are being disrupted or being enabled by brand new technology.”
It’s hard to squeeze more buzzwords of the current IPO bubble into a single sentence.
He did see somewhat of a problem. Hedge funds and others are lusting after the instant paper returns that occur when a startup goes through another round of funding during which its valuations may multiply based on a decision made behind closed doors and not subject to the finicky markets. So “there’s a much greater pool of capital being allocated to the private opportunity,” Kerns said. “That could be a sign of a bubble – more capital moving into a higher-risk sector.” And so mega-startups go parabolic [read… Last Time It Was This Crazy, the Stock Market Crashed].
It’s not about the fundamentals of the business – as is obvious from app-maker Snapchat that is just now trying to figure out how to get some kind of revenues though it already has a $10-billion valuation. “So much of this market is driven by psychology and momentum,” Kerns said. And that “works really painfully on the way down.”
Ah yes, “the way down.”
That’s where the startup and IPO bubble has become entangled in the end of QE. For the last couple of years, these ever crazier valuations of startups and the flood of IPOs have been declared immune to the vagaries of the Fed. Their ascent into the stratosphere hasn’t been caused by QE and ZRIP, the theory went. Silicon Valley was far from the money-printers. The valuations were based on globally “disruptive” technologies – such as texting or photo-sharing apps – and would continue to bloom without QE and ZIRP. But with markets heading south and with corporate America keeping a leery eye on their shrinking stock prices, how the heck could these crazy valuations be converted into other people’s real money?
And when that problem becomes apparent, when investors realize that they cannot get out at these crazy valuations, they lose their appetite for these paper profits, and the money dries up, and startups that are so good at burning cash are going to run out of cash to burn. A booming no-questions-asked stock market powered by QE and ZIRP is what they all need.
But here is what happened the last two times QE ended, as Bob Janjuah, Nomura’s global head of tactical asset allocation, pointed out:
I want to remind readers of a message that may be buried in the past: When QE1 ended, the S&P 500 fell just under 20% in a roughly three-month period before the QE2 recovery. When the QE2 ended, the S&P 500 fell about 20% in a three-month period before the next Fed-inspired bounce (aided by the ECB). QE3 is ending this month….
And look what happened to the markets. Volatility returned. Downward, that is. Dip-buying, which worked so wonderfully during QE3, has been punished viciously.
“I think markets are now collectively having to consider what I think is the reality,” Janjuah wrote.
But just when some profusely sweating souls on Wall Street thought that the bottom was falling out, a savior appears. St. Louis Fed President James Bullard got on Bloomberg TV and pressed the red panic button. Wall Street had been clamoring for it. Markets cannot be allowed to go down more than a couple of percentage points, the theory goes. And dip-buying must be instantly rewarded. Bullard handed them what they wanted. Or they thought he did. That was enough.
Using declining inflation expectations as a pretext, he proposed to delay the end of QE. The Fed should continue buying $15 billion in securities a month. It wouldn’t be much, and Bullard doesn’t get to vote on the FOMC, and he’s considered a hawk and still wants the first rate hike in Q1, and it was just an interview. But nevertheless it instantly turned around the markets. The spoiled brats on Wall Street were ecstatic to imagine that the Fed might continue to deliver the goodies they’ve become addicted to, and without which life no longer seems possible. To allow markets to return to some sort of old normal – forget it.
Bullard bailed out Wall Street by jawboning, at least for the day. But for investors to continue pouring perfectly good cash at startups that are just burning it, they must have a magnificent exit in view. But that only exists in a booming no-questions-asked stock market. And that market psychology and momentum has been hit hard.
Theories abound why the oil price collapse is suddenly happening, after years of deceptive calm. But there are consequences in the US. Read… Toxic Mix Blows up: Oil Price Collapse & Junk Bond Insanity