I spent Tuesday of this week out of the office and at the NY Athletic Club for the Big Picture Conference, a conference that focused on financial markets, global economy and trading. It was my first year in attendance but have been a regular blog reader of Barry Ritholtz (Big Picture). Of the many topics we covered on Tuesday, I’d like to highlight two in this post as they are timely to the conversation circulating around Web Startups Hitting Cash Crunch and Fred’s perspective from Union Square Ventures. Note, we didn’t really speak about Venture Capital or angel investing at the conference but there are similarities.
In one of the talks, Barry came on stage and discussed investing behavior. It was less of a conversation around around the act of investing, but more about the behavior and perception around how investors think. Of the many topics that Barry discussed, one of them in particular stood out: Herd Behavior. He used a cartoon that I’d not seen before, but it quickly made me understand what he was saying:
As you can see from this cartoon, things can become misinterpreted quickly and then irrational behavior stems. I don’t think our current entrepreneurial/funding environment is misunderstood, but I do think there is a strong sense of herd mentality at the macro-level.
Angel investing is the cool thing to do. For many, it’s actually the right thing to do. If you’re an entrepreneur who has raised money from angel investors and then got lucky with a liquidity event, many of us, myself included, pay it forward by investing in other early stage startups. We don’t do it purely for the “karma” it brings, but we also do it for the potential of the financial returns (early risk, high rewards).
It seems these days that everyone and their uncle are investing in startups. This has pushed the seed stage funding rounds much higher which has changed the venture financing world, maybe temporarily, or maybe structurally. Time will play this out.
Around Advertising Technology, there is certainly a funky behavior going on. We see too many investors without any marketing or advertising knowledge chasing Ad Tech deals. I spoke about this at a conference a few months back and my friend Will has a great post about this that appeared on DigiDayDaily yesterday. The infamous Lumascapes which have made the rounds of every ad tech company and put Luma Partners on the map (beyond Mr. Kawaja’s smarts) have actually created a sense of transparency in which allows non-ad tech investors to suddenly become ad tech investors. Think about that.
One of the talks during the BPC referenced a gentleman by the name of Bob Farrell. Many people in the audience knew exactly who he was, but I had no clue. I quickly Google-d him and it turns out he was the Chief Stock Market analyst at Merrill Lynch & Co from the late 60s thru the early 90s. Apparently, he was highly well regarded. Over his career, he came up with 10 Rules for Investing, which is highly regarded.
As you read through the 10 Rules For Investing, think about them in the context of the recent meme around startups/fundraising/angel investing. His wisdom lives on and makes a lot of sense.
1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.
2. Excesses in one direction will lead to an excess in the opposite direction
Think of the market baseline as attached to a rubber string. Any action too far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.
3. There are no new eras – excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past six years, only to get cut in half.
As the fever builds, a chorus of “this time it’s different” will be heard, even if those exact words are never used. And of course, it – human nature – is never different.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don’t expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction eventually.
5. The public buys the most at the top and the least at the bottom
That’s why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing. Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors Survey.
6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains “make us exuberant; they enhance well-being and promote optimism”, says Santa Clara University finance professor Meir Statman. His studies of investor behavior show that “Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks.”
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
This is why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks.
8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend
I would suggest that as of August 2008, we are on our third reflexive rebound – the January rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July.
We have yet to see the long-drawn-out fundamental portion of the bear market.
9. When all the experts and forecasts agree – something else is going to happen
As Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets
Especially if you are long only or mandated to be fully invested. Those with more flexible charters might squeak out a smile or two here and there.
Sources: The Big Picture, 17 August, 2008 and MarketWatch, June 11, 2008.
Lastly, if you made it this far, we’re hiring. kbs+p Ventures is looking for an Intern to come and join us at our offices. The job description is here. We’re looking for someone who is knowledgeable in advertising/marketing and it’s technological applications. Someone who will roll up their sleeves with administrative work around our financing and portfolio companies but also help us with diligence and strategy. Don’t hesitate to reach out.