The PitchBook Economy

One of the marked trends of the past year has been innovation in financial markets – which with the benefit of experience I can say is usually an entertaining and ultimately dangerous phenomenon. We have seen and explosion of activity in the options market, unconventional financial structures like SPAC’s (Special Purpose Acquisition Companies) become conventional weapons of acquisition and the crypto currency/coin market has blossomed, partly on the back of impressive technology platforms such as FTX.

Two further points are worth noting. One is that as ever, innovation and speculation go hand in hand – a chart of the price of Tesla and the price of bitcoin following the same parabolic upwards path (they only go up) shows how the options market, technological innovation and animal spirits are all umbilically linked. Second, promisingly for the broader economy, waves of innovation often start in the financial markets and spread out towards other sectors.

Much of this financial innovation has been cast as the ‘democratisation of finance’, giving people access to low-cost trading platforms and multiple types of assets (and leverage). When all is said and done it will more likely be remembered as the ‘democratization of risk’ – the distribution of risk from large institutions and hedge funds to retail investors (note that in the last year inflows into US equity funds exceed the total of the previous 19 years).

While much of the financial media fixates of the ‘democratisation of finance’ and the meme stocks that define it, there is another, almost opposite trend taking place at the other end of markets – the deepening of private capital investments.

This is defined by a quest by higher end asset managers, large family offices, well connected financial investors for access to non-quoted (e.g. venture capital, pre IPO stakes) investments in companies that are at the heart of technology driven sectors. To a certain degree, not least in its sociology and anthropology, the contrast between the search for private investments and the hurly burly of retail trading reflects growing social divisions.

It might also be exemplified by differences in the tools of the trade. To a large extent the rise in equity markets over the past twenty years, and all of the wealth that has been created around them, is exemplified by the Bloomberg terminal, which provides data on nearly all quoted markets and thousands of companies. It is hard to get exact figures for the usage of Bloomberg terminals but what I can glean is that it has plateaued at around 330,000 in recent years.

In the private capital world the tools of choice are ‘rolodex’s’ in the modern sense that private capital operators rely largely on trusted networks, and Pitchbook – an information service that provides otherwise hard to get detail on private companies (such as funding rounds, identity of shareholders, financial profiles). The idea it seems, is that Pitchbook saves the effort that would be incurred by junior analysts in venture and corporate finance teams.

The ‘Pitchbook’ economy has sprung from several factors. One is an explosion in entrepreneurship. For instance, George W Bush is reputed to have said ‘the French don’t have a word for entrepreneurship’ but even in France the venture and startup culture is very healthy, fueled by a rising number of business schools, incubator platforms like Station F, supportive state bodies like the BPI and government support (inEurope the value of venture activity is seven times what it was in 2014). The same is true in other European countries and individual American states like Texas.

A second change is the role that technology has played in permitting companies to grow faster (and fail faster too it must be said). I was struck by a line in Azeem Azar’s excellent ‘Exponential Age’ where he remarks that when he started writing the book, TikTok was little used, and when he finished some twenty months later it was the most downloaded app’.

In the Pitchbook economy, capital moves very quickly towards companies that are perceived to be able to win in the sense of establishing a market foothold. Commensurate with this, competition between venture capital firms, banks and new investors (Tiger Global is increasingly spoken of) is heating up. Against this backdrop investors talk of the growing number of unicorns (startups worth a billion dollars) and decacorns (startups worth ten billion dollars of which there are 30 globally – almost the same as the total for the three previous years).

At this relatively early stage in the emergence of what I call the Pitchbook economy the rising private investment sector has several implications. One is a change in the way people work and regard employment. It seems to me that any younger people are willing to try the entrepreneurship/growth company route than be seduced by the security of large corporations. There is now a cachet associated with entrepreneurship, and for the moment a sense that the payoffs can be significant. Labour and pension structures have yet to adjust.

A second is that the digitization and the ‘greening’ of our economy will accelerate – I find it hard not to think of private growth companies in Europe that are not involved to some degree in either trend.

We will also likely see rapid consolidation across sectors. The neobank market in Europe is in my view becoming congested and some operators will simply not make any money (N26 has wisely pulled out of the US market) and in the mobility sector BOLT is now becoming the dominant player.

As a final comment, the one factor that unites the private capital and public markets is financial liquidity. The bloating of stock market valuations is matched by the very demanding valuations of private companies. In that respect, the ‘Pitchbook’ economy will only prove itself once we go through a monetary tightening cycle, and we get a sense of who the survivors are.

Have a great week ahead,

Mike

While the rest of you were struggling under grey skies and rain, I spent the end of last week under the blue skies and fresh Atlantic breeze of Porto, Portugal. Now, before I lose half my audience through jealousy, I can say that I was working at a corporate event on the topic of the uncertain future for globalization.

With supply chains in chaos and the key trade relationship between the US and China still in a delicate state, the future of globalization is something that bears heavily on corporations as they emerge into the post covid recovery.

While many of the people I met felt that the image of a deflated globe (see the logo above, and cover of ‘The Leveling’) was too pessimistic a representation of the state of the world economy, my current roadmap is that we are on a path away from the globalization of the period 1990-2020 (fall of communism to the fall of Hong Kong), and towards a new multi polar form of world order, that has largely yet to be constructed.

To give this phase or path a name, I propose ‘Interregnum’, an English term to denote a pause between periods of government (notably used between the end of the reign of Charles I and the ascension of Charles II to the throne between 1649/60 – highly relevant to the Levellers by the way).   

Today, the Interregnum is the mid stage of a paradigm shift (see Thomas Kuhn’s Structure of Scientific Revolutions) and is characterized by noise, uncertainty, and multiple contests between the ‘old’ and the ‘new’ (finance is a good example with the emergence of ‘DeFi’ or decentralized finance).

In the Interregnum, new leaders have yet to emerge (think of the USA, Russia and China) and the firm ‘rules of the game’ of the new world order have not yet been fixed (there is no binding agreement on the rules of engagement of cyberwarfare for example).

That’s not an optimistic sounding diagnosis, though a realistic one, and one that should also challenge the view that everything is well in our world.

What is also confusing is that in the context of globalization (an intertwined, interconnected and interdependent world where nations are willing to sacrifice some sovereignty for better trade relations), there are several emerging trends that could be taken as representing a return to globalization, but in fact do not do so.

One of these is the upturn in the business cycle, which has had a huge helping hand from government spending and developed world central banks. Indeed, one interesting snippet from the earnings calls of large US banks is that households are cash rich and this should fuel consumer spending into the second half of next year. In contrast, I suspect that China is now close to a recession.

More broadly, my point is that a rise in economic activity is not the same thing as a resumption of globalization. Globalization is a very specific pattern of activity and while many of the drivers of globalization such as the flow of people and ideas are in abeyance, other, distinct patterns are emerging.

In general, globalization and the business cycle (see the NBER page on business cycles) have a very odd relationship. Prior to the beginning of this wave of globalization the world enjoyed a regular rhythm of short business cycles. In contrast, the period of globalization has been marked by the two longest periods of expansion in modern economic history (1991-2001, 2009-2020), punctuated by the dot.com bubble and the global financial crisis.

A partial explanation for this is that the positive effects of globalization – China exporting deflation, emerging economies growing up, greater global consumption and the international disintermediation of financial risks have all helped to dampen and sustain business cycle expansion phases.

Another positive trend that bears watching is the acceleration of the digital economy, which from an investment point of view is exciting and disruptive. There is a temptation to say that the advent of the digital economy portends the revival of globalization but my sense is that the effects of digitization will be largely confined to industry verticals and nation states.

Consider the point someone made to me of the hundreds of thousands of Indian ‘tele-doctors’ – they will disrupt the Indian rather than say the UK health system. Consider also the vast amounts of data that will be created by the application of 5G and then 6G to our cars – the use and storage of much of this will be local (at least in Europe) than global.

However, the idea that technology is transforming the nature of economic activity is a very important one, and one that gives clues as to what will replace globalization. For corporations, globalization meant that they could optimize their activities through an interconnected network of activity – a factory in Mexico, fed by research and development in Zurich from a head office in Berlin, inspired by marketing specialists in Barcelona and sold to consumers in North America.

The effective end of cheap labour, the rise of protectionism as a political issue and advances in robotics most likely mean that the trend of ‘going abroad’ is slowing. What is more interesting is what is happening to consumers and workers – to a large extent they are ‘coming home’ – feeling freer that they can, even at the margin, work from the city of their choice and consume more services online (from legal advice to trying on clothes virtually).

I am not sure what the long term effects of this can be but I suspect that in Europe at least people flows will be better distributed around second and third cities (Bordeaux, Porto, Munich, Malmo for example) and that there will be greater attention to local political issues (one sub trend I have picked up on is the growth in applications that seek to make participation in local democracy easier and more innovative – see Polyteia, Citizen Lab, Civocracy and Fluicity for example).

That’s probably a hopeful way to end this chapter of the debate on the future of globalization, or ‘what’s next?’

Have a great week ahead,

Mike 

To the north and east of Paris lie two of the great medieval cities of France, Amiens and Reims, both possessed of spellbinding cathedrals that have played a central role in the history, and especially, the monarchy of France. The cathedral of Reims sticks in my mind because the marathon/semi-marathon of Reims starts directly in front of it and the early morning view through the stained-glass windows is as inspiring as any sporting setting.

The cathedral at Amiens – where the skull of St John the Baptist was reportedly brought – stays with me for a different reason. Amongst its many tombs and graves it has a tablet to the memory of Raymond Asquith whose life story is an impressive, near caricature of the elite of his generation – he was a distinguished scholar (Balliol and All Souls), part of the London intellectual scene and notably the eldest son of prime minister Herbert Asquith.

At the age of 38, Raymond Asquith, father of three children, led a charge at the battle of Flers de Courcelette (September 1916) and was shot in the chest. He reportedly lit a cigarette, so as to distract the attention of his men from his injuries but died later.

At a time when Europe has commemorated Armistice Day, Raymond Asquith’s particular story is a reminder of several factors – the intertwining of French and British history over the past one thousand years, the fact that elites were once very close to wars and their consequences and in the case of the First World War, how the tactics of war proved disastrous.

Today, elites are far away from the ‘front’ in many respects, France and Britain are still locked in a close, troubled relationship, and the tactics of war have changed greatly.

For some, the dreadful end to the first period of globalization (Great War) echoes to the end of the second period of globalization in the sense that geopolitical tension in general and a Great Power rivalry (US-China) looms large in the newsflow. Anyone who has read in detail the build-up of the German and British navies in the early 20^th century will worry that America and China are following a similarly dangerous path – China has more ships than America, America has better sailors, generally better equipment though China it seems has more tricks up its sleeve (hyper sonic anti-ship missiles).

What is more interesting and worthwhile (than predicting a naval battle in the South China Sea) is the way in which the idea of war is changing. In previous notes I have referred to the Russian (Gen Gerasimov) doctrine of total war, which is a view of conflict that covers many strategies such as cyber, border testing, propaganda, and covert attacks, for example. This approach is very much in display across Eastern Europe – the encouragement of discord in Bosnia, the hollowing out of Hungarian politics and in particular the harnessing of Belarus as a form of geopolitical attack dog against the EU.

An excellent steer as to the tactics of ‘total war’ is David Kilcullen’s ‘The Dragons and Snakes’ where he examines the new, unconventional forms of conflict pursued by the likes of Russia and China. One striking example Kilcullen describes is Russia’s efforts to drive immigrants and asylum seekers through the border with Norway, the aim being to test Norway’s reaction, its border security and to generally aggravate NATO (by the way, recently, the cables of a Norwegian undersea surveillance system have mysteriously been cut). To a large degree this tactic is being repeated in Belarus. The suspicion that most of the immigrants have been flown into Belarus suggests that sadly for the immigrants, this is a manufactured crisis that targets the EU’s sensitivity to the migrant issue.

The build-up of Russian troops in Belarus and in Ukraine is also threatening, though in my rather amateur view does not portend an outright conflict but rather represents Russia’s aggressive way of delineating the limits of its tolerance for NATO. It is hard to see what gain an outright military conflict might bring for Russia.  If a full conflict in Ukraine is triggered, by instinct is that the USA in particular will surprise to the upside in terms of the vigour of its response.

In the past five years Russia has extended its military footprint around the world – notably in the Middle East and lately through African countries like the Central African Republic where the activities of Russian mercenaries have had ugly consequences. What remains to be seen is whether foreign policy adventures can, in the eyes of the Russian people, substitute for sluggish economic growth and a horribly mismanaged response to COVID.

What is also critical is the response of NATO and the EU. The situation around Belarus is complicated by many factors – consider that Poland recently bought drones from Turkey, though Turkish Airlines has flown some of the migrants to Belarus, and also that Turkey – a NATO member – imports lethal, sophisticated arms from Russia, whilst also facing off against it in multiple theatres. Consider also the position of smaller Baltic states like Lithuania and Estonia who foreign and security policies has been becoming more vocal and sophisticated, and who will expect the full diplomatic support of larger countries like France.

A savvy approach would be to try to reduce migrant flights into Belarus and in my view to double up on sanctions on the Lukashenko regime and to more robustly support Belarus’ pro-democracy movement. The USA will not be displeased either if this spat lead’s Germany and the EU to reconsider their energy ties to Russia. As for Russia itself, this latest move, sadly and unnecessarily in my view, deepens the divide between it and Europe, and is yet another cleavage in an increasingly fractured post-globalization world order.

Have a great week ahead,

Mike 

Christmas is approaching and in Britain and Ireland at least, that means that pantomime season is upon us. Pantomime is a form of theatre or musical, usually based around fables and children’s stories and involves a healthy dose of slapstick comedy. A key feature is audience participation, where a protagonist on stage engages in a mock argument with one saying “Oh, yes it is!” and “Oh, no it isn’t.

While I am not, unfortunately, an aficionado of the pantomime, it oddly enough has me thinking about central banking.

More and more, facts, trends and signals pop up that seem to contradict the logic of current monetary policy in the developed world to the effect that many investors and economists are proclaiming ‘oh, yes it is’ with respect to higher inflation, extended asset prices and inappropriate monetary policy, whilst central bankers hold to the ‘oh, no its not’ chorus.

What is new, is that markets are now beginning to chip in.

In recent weeks the yield on short-term debt (i.e. 2 year bond yields) in the key economies of Canada, Australia and Britain have spiked dramatically higher, signalling the view that central banks are entering into new terrain in terms of adjusting to a world of higher, noisy inflation.

That has stopped some central bankers like Christine Lagarde from continuing to harp ‘oh, no it isn’t’ as she did at a press conference last week, though credit risk of some periphery countries (notably Italy) is starting to rise (relative to Germany).

Overall, there is a generalised rise in bond market volatility (especially in instruments that try to price inflation expectations), which other asset classes do not yet seem to have picked up on.

It is also worth making the point that assets that are not in thrall to central banks (EM equities and many commodities) are behaving quite differently to those that are (i.e. Nasdaq). I do think that as the economic cycle becomes ever more noisy, that the idea of ‘pantomime monetary policy’ (PMP), where there is growing discord between central banks and markets, is here to stay.

There are several factors at work – activity levels are very high (the ISM Services index just hit a 25 year high), asset prices (real estate, equities, credit and crypto) are at highs, the end of globalization and scarring of economies and labour markets by the coronavirus are creating a complex set of inflationary pressures, whilst the strain that underinvestment (link to an excellent thread by the CEO of Freeport) and shifts in trade are placing on supply chains is complicating this. Add to this the risk that China could well be in a recession, and the outlook is very muddy.

For the time being, the risk to politics and profits is from higher prices. If I were a pantomime villain, or simply a populist politician, inflation would be my best friend. We wrote about this a few months ago (A Face in the Crowd), warning that rising prices (which contrary to government statements in countries like the UK and US, are not being outstripped by wage growth) will soon become a contentious public issue. The populist panto villain knows that in the short run a government or a central bank can do little about inflation (especially if it is only caused by extraneous issues). As if to illustrate this, last week Andrew Bailey the Governor of the Bank of England declared that he was ‘very sorry’ that the cost of living was rising so quickly, but, against expectations, declined to raise interest rates.

In this context, the panto villain can rabbit on about the ‘price of things’ or ‘the pound/euro in your pocket’ (i.e. the price of milk is up 26% over the last year in the USA) and gain an easy audience.

He or she also knows that a government or central bank that tries to do anything meaningful to bring down prices will be equally unpopular. So, my prediction is that in 2022 political battles and some elections will be swayed by the issue of inflation (something that many have never experienced by the way).

The second implication of PMP, is that without the ‘fairy godmother’ of enlightened fiscal policy, overly generous monetary policy will run wild and produce even greater socio-political imbalances.

The great lesson of the collapse of globalization is that it produces ongoing imbalances (indebtedness, climate damage and financial flows) that need to be energetically buttressed. Most of the highly globalized countries in the world (small, advanced economies) do not by and large have a problem with inequality because they use their tax systems to channel the benefits of globalization. The UK and US did not do so, and that is perhaps why we have had the twin shocks of Brexit and Trump.

Following from this, few governments have sought to channel and capture the effects of excessively easy monetary policy through asset charges or taxes or measures that would redistribute the benefits of higher asset prices (the primary effect of quantitative easing) across societies. As a result, and consistent with the above prediction, housing affordability will become a pan-national, lead political issue.

So, dear audience…

Is inflation back to haunt us? ‘Oh yes it is!’

Will central banks step in, especially to curb asset price inflation? ‘Oh no they won’t!’

Is the world a stable place? ‘Oh no its not!’

Will it all end badly? ‘Oh yes it will!’