So, here we are. The US economy is slowing and Congress is fighting over cutting government spending. Punditry abounds, as our economy is held hostage by dogma. I wish I could say I am surprised, but I am not. In January in my Outlook 2011 I wrote this:
“Whether you love tea parties, fiscal restraint, government spending or libertarianism, there is now someone in Congress ready to espouse your viewpoint free of nuance or complexity. We have entered a political age where purity of expressed belief is more important than acknowledging alternative ideas, and name calling and point making is more important than governing. The problem is that the challenges facing the US economy are not simple, nor is it likely that any single viewpoint’s pure response will solve the problems for we face. For example, it’s very seductive to espouse that the government deficit must be shrunk immediately. It’s another thing completely to formulate a plan for doing that without cutting defense spending, Medicare and other entitlements – unless, of course, you raise taxes. And, as any economist can tell you, if you take money out of the economy, whether it is through less government spending or higher taxes, it will likely depress economic growth. Would you want to slow growth now? Really? How much? 1%? 2%? 10%? When? Now? Next year? You get my point – there is nothing pure about the answer.
Sometime this spring the US government will need to increase its debt ceiling and agree to an operating budget. If it does not, lots of interesting and problematic things could happen – government could stop operating, the financial markets could get roiled by a fear of “US becoming Greece,” and retirees could stop receiving social security checks, among many equally awful possibilities. Of course, this is not a new issue – for example, the debt ceiling has been raised many times. What is different now is that you have a Congress that is looking for purity as it grapples with a big issue – what is government for, and how much should we all pay as citizens for the government we get? We all have opinions on this question to be sure, but so many things, from Social Security to regulation of food safety fall out of these decisions.
My concern is that in its desire to pursue purity of viewpoint will deadlock Congress. Some would say “well, that’s good, if they are fighting they can’t mess anything else up.” That does have a certain simplistic charm, but the issue is that over the next year and beyond Congress is going to have to affirmatively act to allow the US government to continue to function and the US economy to continue to grow. Will they do so? My guess is that eventually they will, but only after various pure viewpoints are expressed and a general Congressional food fight occurs. What does that mean in simple English? My best prediction is that Congress will not increase in the debt ceiling and provide an operating budget for government until after it has roiled the economy in some way. Where things get murky is how long they will fail to act to increase the debt ceiling and approve the budget and what spending and entitlement changes may result from the resulting crisis. I am not alone in believing that a politically manufactured US debt crisis will dramatically and adversely affect the capital markets – both the cost and availability of capital. Moreover, a resolution of the debt crisis that mandates immediate and large cuts in the Federal budget will shrink consumption and lower economic growth.
What does this mean? For individuals and corporations it means that if you are planning on obtaining capital for business expansion I would do it in the first quarter, or plan on waiting until the third or fourth quarter of this year. For stock market investors, expect volatility or even a flash crash in late February or March. Congress could surprise me, of course, and they could differentiate between rhetoric and governing, as it often does, but somehow this electoral cycle felt different to me. I hope I’m wrong.”
Other than not counting on the Treasury being able to find some pennies in the sofa to extend the deadline, I think things have parsed out the way I expected.
In May I wrote the following to my Limited Partners:
“There are two large trends affecting technology investing in the United States in the near term. The first is resurgence in investor interest and company creation activity around social media and mobile technologies. This is reflected on the high end by growing valuations of social media companies such as Facebook, Twitter and LinkedIn, as well as a renewed interest in early stage investing, particularly in Silicon Valley and New York. Venture capital and Angel investment in early stage social media and mobile companies, as well as M&A activity in these sectors have continued to accelerate in comparison to levels prevailing in 2010.
These trends are being accentuated by the accumulation of hot money into the sector – capital looking for immediate return. As was the case in the late 1990s, when software investing is particularly favored, there are opportunities to grow and sell companies on an accelerated path.
Juxtaposed against this narrow sectorial trend, is the overall status of the US economy. In the near term the US economy will most likely continue its slow growth, hindered by politicians and commodity prices. The fiscal deadlock in the US Congress and the coming fight over the US Government’s ability to borrow and finance its operations is already affecting international confidence in the US Dollar and investor sentiment. Unfortunately, as confidence in the US economy falters, prices of alternative investments, particularly commodities, are driven upward. As I have noted in many other forums, the presence of large pools of “hot money” that is agnostic on where it invests and in what type of investments it makes has a profound effect on market trends – it increases volatility and velocity. Economic trends are amplified and accentuated, as markets that were not previously interconnected affect each other in unpredictable ways. Macro investment strategies have become more and more a function of traders making investments on directional changes in market behavior, regardless of underlying economic fundamentals. Market data suggests that this behavior is currently driving commodity prices, the stock market and perhaps privately held social media stocks.
[My] overall viewpoint is that as a long term investor it is important to anticipate trends, and appreciate that early stage investing exists in the larger context. And, more importantly, that venture investment should not confuse short term trading behavior for long term investment opportunities. Certainly, macro-economic conditions and market trends matter when evaluating opportunities in the near term in particular, particularly where they provide immediate opportunities. However, long term investment in technology requires a reflection of longer term technology and economic trends. These trends remain favorable.
Accordingly, the following factors will shape the economy and near term opportunities:
- Congress is unlikely to agree to increase the US Government’s borrowing capacity (the “Debt Ceiling”) in a timely manner (i.e., before it adversely affects the US credit markets and the stock market). Although some observers do not believe that this is possible and attribute current political discussions as posturing, I believe that there is true deadlock in Congress. This political situation is compounded by a general ignorance among the US population of what the Debt Ceiling is, how the US federal budget is composed, and what cuts would be necessary to achieve a balanced federal budget. As recent conversations about Medicare show, the US population really doesn’t connect the dots between federal debt management and entitlements. At the risk of offending some – the level of political nonsense surrounding the Debt Ceiling issue is exceptional.
- Commodities will continue to attract hot money, and this will drive values. There will be considerable volatility, particularly as the Debt Ceiling deadlock continues. This is because at a time of uncertainty, investors, particularly hedge funds and similar, will look for investments that are a hedge against deterioration of the US credit markets and economic outlook. As my Grandfather used to say, “money has to go somewhere.”
- When the deadlock relating to the Debt Ceiling is resolved, the most likely outcome of the Debt Ceiling crisis will be changes in government spending and some tax increases. Both will have the effect of restraining US domestic demand.
- Technology investing, particularly in emerging software and mobile will remain a target of hot money. For the same reasons that investors are allocating to commodities, they are allocating to technology investing. Technology is a sector that traditionally transcends near term economic dislocation under most circumstances (other than when it is the cause of the dislocation as in the popping of the 1990s Internet Bubble).
The net of all of these factors will most likely be a slow growing economy with low interest rates and manageable inflation. It will not be without its drama, however and depending upon how quickly Congress acts, the adverse effects on the US economy could be very significant.”
I point out these posts not to demonstrate any particular prescience, but for a number of more important reasons.
Firstly, the current “debt crisis” is a manufactured event, being created for political gain. I think that is one of the few things that most agree on – where it breaks down is “who is at fault.” For what it is worth, I am rapidly reaching the point of not caring who is at fault. Although, resolving this is clearly above my pay grade. However, because it is a manufactured event the markets have to this point been almost incredulous – and trading as if it will be resolved promptly. I think that they under estimate the dysfunction in Congress.
Because it is a manufactured event, once it is resolved the markets will likely return to some sort of normality (or at least the normality I describe above). However, as I describe above, this normality will be a continued bifurcated economy with opportunities for some and continued pain for others.
Second, the issue here is not a government default. There is sufficient money coming into the Treasury to finance continued debt service. The issue is the immediate effect of having to finance a budget deficit through operating cash flow. This will mean an immediate removal from the economy of a significant amount of government spending. A back of the envelope estimation of this magnitude is that around 1/15 of the total US GDP will just be removed overnight. To put this in perspective, the Great Recession had an overall GDP shrinkage of around half this. The US will not default, but if this crisis goes on for any period of time it will harm the overall economy. I am sorry, but that’s just the way it is. The economy is a large machine – when you take away gas, it goes slower. Depending upon one’s political persuasion that may be OK –we should “take our medicine” – but get ready for another recession, possibly a bad one, if the situation is not resolved before the government starts missing payments to citizens and contractors.
Third, anyone involved in technology investing and company creation should be ready for some dislocation. Angel investors will be affected by this crisis, even if it is largely psychological. Markets will be roiled, and technology stocks will be affected. In the longer term, there remains a HUGE opportunity for technology company creation in the US. Entrepreneurs should focus on bootstrap and revenue acquisition strategies this quarter.
Overall, I remain extremely optimistic about the US economy. Because of its relative position in the international economy (something that I will explain in a subsequent post), the US has the potential to significantly out perform Europe, China and Brazil over the next ten years. But, first we have to go through some political nonsense.
So, fasten your safety belts and see you on the other side.