Investment Climate: The Importance of Brexit

What a crazy few weeks in world markets!  The second quarter was shaping up to be a decent rebound from the sloppy start in January,  but the markets made an abrupt about-face and sold off dramatically in the wake of the vote in Great Britain to leave the European Union. The “Brexit” vote was a surprise to most speculators/traders who had taken the consensus bet that it would never actually prevail.  The consternation and teeth gnashing emanating from the “elites” in both Europe and the U.S. was so pervasive and fierce you would think the world as we know it was truly ending!  In our view, it was another case of “here we go again.”  

How many more tales of impending doom, which simply don’t come about, do we need to hear before the sober world of investors takes hold?  Somewhat surprisingly, the market may finally be tiring of these pundits of pessimism since, as of this writing, barely three weeks after the June 23^rd Brexit vote, the stock market averages have powered to new highs, ignoring the sirens of the elite class.  

On the day of the Brexit vote results, we posted on our blog (entitled “Don’t Fear Brexit”) that we believed the vote was a significant positive step toward rebuking the decades-long degradation of Western Europe at the hands of “democratic Socialism.”  A system that has resulted in perpetual sub-par growth throughout the European continent.  

It was our stated belief in 1989, when the talk of a “United States of Europe” was taking hold and the stage was being set for the European Union’s formation, that it would be extraordinarily difficult to achieve monetary and economic union without political union.  Essentially, without a U.S.-style constitution the project was destined to have major problems.  While we certainly argued for the benefits of a common currency amongst nations so closely tied geographically and economically, it was that stubborn political and even cultural difference amongst these same countries that we thought would be at least problematic and potentially fatal to the union.  If those political issues were not eventually dealt with (sooner rather than later) at some point a break would ensue.  The beginnings of that break appear to be underway.  

The lack of a truly “democratic” political structure, and, in fact, what turned into the equivalent of “taxation without representation” via the bureaucratic, unelected European Parliament in Brussels finally reached a breaking point as the British people decided they were tiring of having mandates forced upon them by people they had no say in putting into power.  Worse, these same bureaucrats advocated a level of socialistic control over the Europe that has resulted in the weak economic growth, to which we previously described, and a series of financial train wrecks such as the Greece mess, which we have discussed at length in past commentaries.

To reiterate, it is our view that the events in Europe are a very positive step in beginning the healing process from decades of mismanagement in Europe.  However, we would strongly emphasize that this in no way means that we are taking an “anti-globalist” view in our positive reaction to these events.  It does not mean we favor trade protectionism in any form.  We thoroughly endorse the free flow of trade amongst nations and would agree that a positive byproduct of the European Union has been the role it has played in keeping peace on the European continent for the longest time in world history.  So it is imperative that one not misread our support of Brexit and a retooling of the order in Europe as support for those forces that would throw up tariffs and other protectionist obstacles in the way of economic progress, or use misplaced nationalism to allow for the rise of bad actors the likes of which caused two world wars in Europe. 

However, as was our view in 1989, a U.S. of Europe, along with a constitution and bill of rights, is not going to happen across the European continent any time soon.  Probably never.  That being the case, in order for truly free enterprise to flourish, it is crucial that those forces propagating the exercise of freedom, in all forms, be allowed to flourish.  If those forces emanate from places like a sovereign Great Britain, a country with a recent history of promoting free enterprise, then that is a step in the right direction.  Perhaps it is enough to stem the tide and swing the pendulum back towards policies that are less intrusive on businesses and citizens alike, and promote economic growth through low taxes and easy access to capital markets across the globe.  Maybe it will encourage a similar movement in the U.S of America, which is growing like Europe of the last five decades (weakly) under the weight of ever more regulation and taxation; a topic we have harped on in these commentaries for years.  For while great companies can still succeed in spite of these intrusions, they would flourish all the more in an environment more favorable to business formation.

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Don't Fear Brexit

In 1989, as we were hearing about the benefits of the "United States of Europe", we can clearly recall our skepticism over the noble idea of creating a common currency throughout Europe without a clear political union to go along with it.  Was it reasonable in an area so geographically tied together to have a common currency to allow business to transact their trade across the many borders in a more effective way?  Absolutely!  Yet it seemed impossible to us to think that the myriad cultural differences throughout that same geographic region would allow for that necessary political cohesiveness.  Essentially, our thoughts were that without a U.S.-style constitution, it seemed improbable, at best, that the experiment would succeed.

Yesterday, voters in the United Kingdom dealt a devastating blow to the experiment of a "United States of Europe" with their vote to leave the European Union.  The "elite" of Europe, and throughout the world, including America, warned of cataclysmic ramifications if the vote to leave were to win.  We believed all along that was ridiculous and continue to believe so in the wake of the approval by the British people to leave the Union.  Not only do we think that it is ridiculous to think that Brexit would be cataclysmic, we believe the historic vote is a step in the right direction towards exposing the failure of socialism in Europe and throughout the world!

Whatever negative reaction happens in the markets today or over the course of coming weeks and month, related to fear over this movement, we believe it will be short-lived.  We stand ready to take advantage of any weaknesses to add to our holdings in great, innovative companies run by the solid entrepreneuers who make our capitalist system so vibrant.

Stay tuned for more updates on this amazing turn of events.

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Higher Interest Rates....Please!

We have written about this issue for so long now it is hard for us to imagine it is still necessary to do so; however, we feel compelled to reiterate how important we think it is for the US Federal Reserve to continue the nascent increase in interest rates it began late in 2015.  Obviously, the era of "Zero Interest Rates" (ZIRP) has ended, but the ramifications still endure as long as the Fed continues to hesitate in getting on with pushing their target for the Federal Funds Rate up.

We now live in a world where Central Banks in Europe and Japan actually think a "Negative Interest Rate Policy" (NIRP) is a good thing, so in "relative" terms, the US Fed is thought of as "tight"!  This is all crazy!!  These extended years of ZIRP and now NIRP are causes of slower economic growth, not "stimulative" policies that are helping the world economy.

Last week we had the pleasure of meeting with our distinguished Board of Advisors member, VC partner and best-selling author George Gilder in the Silicon Valley and this topic was at the forefront. George's view (which is well spelled out in his latest book, The Scandal of Money) is that these policies fail because they are actually valuing time far too low, thereby creating a lack of urgency or incentive to innovate.  The old adage "time is money" really gets turned on its head in a world which values time as worth zero -- or less than zero, in the case of NIRP!

This is not going unnoticed any longer as both German and Japanese bankers are realizing that the NIRP world is creating uncertainty for their their customers and, as a result, hurting them.  The following excerpt from a Wall St. Journal article regarding Japanese banks underscores the problem:

MUFG President Nobuyuki Hirano in April became the first top Japanese banking executive to publicly criticize the BOJ's negative-rate policy, saying it had actually caused households and businesses to rein in spending by creating a sense of uncertainty about the future. "For the banking industry, the consequences, at least in the short term, are clearly negative," Mr. Hirano said in a speech in Tokyo.

The Germans are protesting these policies as well, as this Reuters article on the topic points out:

. . . some banks complain that a dim global economic outlook means there is weak demand for loans on the terms they require, and they have little option but to hoard cash.

The "hoarding" of cash is not a good thing! This is all part of the argument that Gilder is making when he says:

Since time is the scarcest of all scarce resources, the fact that the market values it at zero creates an environment where there is no sense of urgency to create or innovate.

Our last two posts have emphasized the fact that we are suffering from a lack of IPOs coming to market.  This all fits together in the sense that the ZIRP and NIRP world has at least served to exacerbate that phenomenon if not been a primary culprit in this predicament.

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Follow-up on the IPO conveyor belt disconnect

We certainly don't agree with Mark Cuban on everything, but we give him credit for continuing to hammer on a subject of great importance to the economy at large: the lack of IPOs.

We wrote a post last week entitled "Disconnect in the IPO conveyor belt" discussing some of the ramifications of this problem, ramifications which extend far beyond the somewhat rarified and (to many investors) unfamiliar world of start-ups and venture funding -- ramifications which impact employment, prices, innovation, and the quality of all kinds of goods and services used in business and in daily life.

This morning, Mark Cuban was on CNBC again talking about this subject, and made the point that the dysfunctional IPO landscape also has a negative impact on equity markets in general.

Specifically, he said (beginning at about 00:45 seconds in the above-linked clip):

If we have a problem, it's not that there's frothy valuations for tech companies in the public markets: it's that there's no tech companies that have high growth rates, that are in a position to get frothy valuations -- that's the problem. I mean, if you look at, you know . . . tell me who the high-growth-rate companies are today that have under a hundred billion dollar market caps -- Netflix? You know, how many of them are  there? And that's the real problem in this market. And what's happening is, you've got -- because companies are refusing to go public -- it's just, you know, if you want to talk about the Valley, the whole ethos is now: "Don't go public." It's crushing our stock market.

This is a huge issue, for all of the reasons we discussed in the earlier post (here's that link again) and in our post from 2013 on this same subject, as well as the reasons discussed in Mark Cuban's blog post from February on this topic, and the even more in-depth discussion in the excellent article from Julie Segal from 2010 which we linked in the previous post as well.

Despite what Mark Cuban appears to be saying at the very beginning of the clip above, we don't actually agree that the solution is to "write down to zero" any investment in a private company that is not yet profitable -- one reason start-up companies raise venture capital is because they are not yet profitable, despite having a new or innovative idea which could be profitable in the future.

For that matter, many innovative public companies may not yet be profitable, but this does not mean that investors should "write their stock down to zero." We actually do believe that there are innovative and worthwhile companies for investors to analyze whose market capitalizations are well below $100 billion (some of which may not yet be profitable), but we definitely agree with Mark Cuban that there are a lot fewer of them than there might be if the funding and IPO landscape were not as dysfunctional as it has been for the past fifteen years.

Of course, there are many other contributing factors to this present environment, including the increasingly convoluted regulatory landscape and the additional costs which have been added to the burden of being public in the past fifteen years (or more -- the process has been going on for quite some time).

We commend Mark Cuban for his efforts to bring this situation to the attention of a wider audience.



At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Netflix (NFLX). For the record, the market cap of Netflix at time of publication was approximately $38 billion.

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Disconnect in the IPO conveyor belt

image: Wikimedia commons (link).

Entrepreneur and investor Mark Cuban was on CNBC's "Squawk on the Street" this morning discussing what he sees as a "disconnect" in the progression from company formation ("start-ups") to growth and access to the capital markets through public listing. In a response to a question about the lackluster economic growth in recent years, he replied:

There's a disconnect right now because so few companies are going public. That gives an incentive for any S&P company, any major public corporation, to just wait and see rather than investing -- making capital investment in their own company, the things that make them competitively strong -- just waiting to make an acquisition. 

And so if you are not investing in yourself -- look, there's hundreds of billions of dollars being invested in start-ups of all kinds, whether it's retail start-ups, technology start-ups, biotech start-ups -- and so, rather than big companies having to invest in their own R&D, they just sit back and wait because now the culture of start-ups is you don't go public: you look for an exit. [based on the unofficial transcript posted by CNBC here].

In other words, he notes that very few start-ups are trying to make it all the way to public viability as a new competitor on the scene, and instead their founders and investors are just looking for "an exit" by selling to a large company. One effect of this situation, he points out, is that the big companies can outsource the research and development that they would normally undertake, and just watch for interesting or innovative start-up companies, and buy the ones that look promising -- absorbing their technology.

Mark Cuban casts this situation as a negative development -- and we agree with him.

We would argue that the reason so many entrepreneurs have a culture of (in Mark Cuban's words) "You don't go public: you look for an exit" is not that they wouldn't want to go public and compete as an independent entity, but because the path to doing so has become much more constricted over the past twenty years, for a variety of reasons, leading to an unhealthy situation which has ramifications far beyond the world of venture investing and which ties in to the health of the economy at large. 

The "conveyor belt" connecting innovative ideas with access to capital that entrepreneurs require in order to grow and compete on their own in the economy is broken, to the point that many companies which could become viable players never even get funded, and those who do end up getting bought by big, existing companies. It is a problem that signals unhealthy developments involving the capital market landscape, although it may manifest itself more noticeably in the world of start-ups.

It is a topic that many experienced investors in the venture capital landscape have been writing about for the past few years. Mark Cuban published a more detailed discussion of some of the issues he expressed in today's interview in a blog post he wrote this past February, entitled "The Pre-cognitive Anti-trust Violation: How the decimation of the IPO market has hurt the economy and worse." 

The title may at first seem a little whimsical, but it actually conveys an extremely important idea, albeit in a somewhat obscure metaphor that takes a little thinking in order to unpack. 

It appears to be a reference to the "pre-cogs" in the famous movie Minority Report, which depicts a dystopian future in which three psychic beings known as "pre-cogs" are able to see crimes before they happen, and then law enforcement officers can go take down the criminals before they even carry out the future crime (a situation which is obviously ripe for horrific abuse, as the movie dramatizes quite effectively, and as the brilliant author Philip K. Dick was trying to warn society when he wrote the story upon which the movie was later based).

Mark Cuban implies that unhealthy constriction in the pathway to public viability is enabling established competitors to do a kind of "pre-crime" take-down of their future competitors, before the competitor even has an opportunity to get out into the world and become a competitor. Thus, it is a situation in which competition is killed off in much the same way that the anti-trust advocates of a hundred years ago were worried about, but in an even more sinister way -- before the competition even happens (hence the reference to the "pre-cogs" of Minority Report fame).

The negative effects of such a situation are obvious: less opportunity and incentive for companies to innovate;  less opportunity for investors to invest in small public companies before their real growth kicks in; less capital available for entrepreneurs to create a viable business; less ability for employees to benefit financially from the added work and risk they take by working at a startup; and ultimately fewer jobs, fewer opportunities, and less innovation for the economy at large.

And those are just the more obvious negative effects of the problem that Mark Cuban is describing!

We ourselves also wrote about this phenomenon back in May of 2013, in a post entitled "Crossing the chasm to IPO becomes even more difficult."

Perhaps the deepest and most thorough analysis of the historical causes of this phenomenon could be an article written by veteran investment journalist Julie Segal, published in 2010 in Institutional Investor entitled "Death of the IPO." Even more wide-ranging consequences that she traces back to this problem include a reduction in the volume, availability, and ultimately quality of equity research. 

The most telling of the ramifications she points to is the widening divide between "Main Street" and "Wall Street," as the connecting link between the two is narrowed, constricted, or obstructed completely.

This is a very serious subject, and one we commend Mark Cuban and others for discussing candidly. The solutions to the problem are not easy or obvious -- as Julie Segal points out in her article, some of the contributing factors go back to decisions made decades earlier. But it is one that we believe investors should think about and understand.

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