Jerry Bowerman
There are too many headlines and articles about bubbles, market crashes, negative interest rates and venture-backed unicorns. Why write one more? Because I believe there is a much more pragmatic way to evaluate what you are reading from all the “experts.”
Experts armed with mountains of data and statistical analysis predict the stock market is going to crash, while at the same time foresee it soaring to new highs. If you’re not trained in finance and economics, how do you make sense of it all?
My degree is in finance and economics, and I can decipher all the expert articles. But I have found it’s easier to predict the future by paying close attention to what is happening to me, my family and my friends.
Back in the early to mid-1990s when I was No. 2 at Sierra Online, I engaged Piper Jaffray multiple times. One of the benefits of a good, personal relationship with an investment bank is they let you buy “friends and family” shares in an IPO. Prior to a company going public, the investment bank sells most of the stock to mutual funds, pension funds, family offices, etc., but they hold back a small amount for friends.
1998 and 1999 were crazy years for going public. About 450 companies went public in 1999. It was common for a stock to jump 30-50 percent on its first day of trading, and wasn’t unheard of for a stock to double on its first day of trading.
The day before a company was to go public, Piper would call and ask if I would like to buy friends and family shares. The deal was always the same: 1,000 shares at the IPO price set by the investment bank and I had about an hour to make up my mind. It was common back then for an IPO stock to be priced around $15, pop $5 to $7 on its first day, then maybe go up a bit the second day. For $15,000 invested, I would get $20,000-$22,000 back in two to three days tops. It was a nice perq while it lasted.
In late June 1999, Piper called and asked if I wanted 1,000 shares of Internet.com at $14.00 per share. I asked, “How does Internet.com actually make money?” The reply, “Who the fuck cares? With a name like that it’s going to pop at least 50 percent tomorrow. Are you in or out?” I decided to pass — and close my account at Piper. I didn’t know how long it would take, but the IPO party was coming to an end. If no one was actually even looking at the financials and expected a 50 percent return in one day, a crash couldn’t be far off.
I called the person that managed my money at Smith Barney and told them to sell all common and preferred stocks and either stay in cash or tax-free municipal bonds. She told me I was over-reacting and the market was fine, but still processed my order. The market crashed in March 2001 and wiped out a ton of wealth for people holding stocks in their investment account. My account barely budged.
Fast-forward to late 2007. One of my close relatives called to tell me she was buying a home. She struggled with being consistently employed and was on and off State assistance, so I asked about her loan application. She told me a friend at a bank I never heard of took care of all that for her. I asked where the bank was located and was told over a Pizza Hut in a rundown office. That got my spidey senses tingling and I started reading about collateralized debt obligations and credit default swaps. They were complex securities, but one thing was clear: Housing prices had to always rise for them to earn the return they promised.
A few months later, in the spring of 2008, I flew to San Francisco for a meeting at Lucasfilm. On the ride from the airport, the cab driver took a call that obviously was about a deal he was excited to close. After the call I asked about the deal; he told me he was flipping his third house. It was about a 45-minute cab ride from the airport to the Presidio and he was more than happy to go into all the details of house flipping with no money down and a “huge” upside.
At the point my unemployed relative and this cab driver could both buy houses worth hundreds of thousands of dollars with no money down and no income history to prove they could repay it, I knew the housing market would have its day of reckoning.
After my meeting at Lucasfilm I called my portfolio manager at Citigroup (they had bought Smith Barney) and told them a real estate market crash was coming and to dump anything in my portfolio with exposure to real estate. He went on to lecture me for a good 10 minutes about how irrational I was being and that just this week he had invested his entire retirement in Citigroup stock. That was the final straw (a diversified portfolio is Investment 101).
I told him to sell everything, close the account and wire me the funds. On April 5, 2009, Citigroup’s stock fell to an all-time low of $0.97 per share — from an all-time high of $57 (as adjusted for splits) in December 2006. The S&P 500 fell 53 percent from its peak of 1,549 on September 30, 2007 to 735 on February 1, 2009. It took four years for the market to recover. Many people in the U.S. lost their homes and most of their savings.
As 2015 was coming to an end, my son was working on his Personal Management Merit Badge for Boy Scouts of America. One of the requirements is “Discuss your understanding of what happens when you put money into a savings account.” I asked him to grab his latest bank statement from the filing cabinet in my office and explain it to me. He has saved $1,029 from birthday money and odd jobs over the years and is a natural saver (unlike his brother, who likes to spend his money).
He noticed his interest for the entire year was a paltry 12 cents, a 0.01 percent annual percentage yield. I told him several European countries have negative interest rates: You pay the bank to store your money. The expression on his face was priceless. Even a teenager with limited understanding of money and investing wasn’t going to pay a bank to store his $1,000 in savings.
And yet, there is an entire generation retiring right now who believed if they saved a retirement nest egg of a few hundred thousand dollars, the interest they earned (along with their Social Security) would fund their retirement. For example, $500,000 in savings at a 5 percent savings rate yields $25,000 per year in interest, or just over $2,000 a month. That same savings at 0.01 percent interest earns $50 per year in interest, or about $4 per month. That won’t even buy a latte at Starbucks, let alone pay for groceries or gas.
So what happens? People (and professional investors at mutual funds, hedge funds, venture capital funds, retirement funds, pension funds, life insurance companies) go looking for higher returns by taking on risk. They buy riskier and riskier assets to earn the return they need. But this strategy only works when the markets are rising. What will happen when interest rates start to rise and markets peak? People will move their savings to less risky assets and the price of risky assets (such as a startup unicorn) will fall.
On December 16, 2015 the Federal Reserve of the United States raised interest rates for the first time since 2006. Granted, it was only a 0.25 percent increase, but it is an increase and the beginning of a new trend. The S&P 500 peaked at 2,131 on May 21, 2015. It’s been more than seven months and the market refuses to go higher. The stock market has peaked and interest rates are rising. We know what happens next. It may be a gentle decline over many months or years, or a sudden crash, but the value of risky assets is going down.
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