The Market Plunge

Yesterday the stock market dropped almost 1,000 points intraday before rebounding late in the day. Does this matter to the world of entrepreneurship and startups? Yes and No.

I’m no expert in the stock market but I read a bunch of experts blogs. I liked this from Steve Place:

High Frequency Trading broke, then saved the market

This will probably be the most controversial thing I’ll say. Quant firms have been keeping the market in a fairly low volatility state as they seek mean reversion and arbitrage strategies. By doing this they provide liquidity in the market for institutional players and funds. Their risk models are based on statistical distributions, behavioral finance, and other voodoo. When these models go out of wack, they can exacerbate the situation– that did occur in 2008 when liquidity dropped out of the system.

However, I feel that program trading (eventually) provided the liquidity for the snapback of this rally. If it weren’t for quants betting on extreme mean reversion, we would have held a much deeper selloff comparable to 1987. What evidence do I have of this? The sheer snapback of the price in such a short amount of time. It certainly wasn’t fundamental traders who all of a sudden found “value” in the market with a trailing P/E. The only sort of quick analysis that provides that kind of price action are done by non-humans at quantitative firms, and they saved the market from something much, much worse.

What Steve is saying is that computer driven trading drove the plunge and then drove the rebound. It was not human trading stocks that caused the price action. It was machines that had been programmed by humans.

There’s a lot of talk about machine to machine interaction coming into our lives. Yesterday afternoon at 2:45pm, we saw what that looks like. For the people who make their living trading in these markets, it was a sick feeling in their stomaches. For the rest of us, I don’t think this is too much of a big deal.

However, there are some big issues in the capital markets right now. From the bottom last April to the top a few weeks ago, the S&P 500 was up about 70% in a year. It was close to getting back to its pre meltdown high. Maybe the markets came back to far too fast. Its not like we are past all of our problems.

Money is cheap, too cheap. You can’t get a yield anywhere. As my friend Howard points out, junk bonds trade at 8%. Money is going to get more expensive soon. And that will not be good for the stock markets.

And then there’s the coming regulation of banks and brokers, which will likely put pressure on the stock markets. 

So what does matter to the world of entrepreneurs and startups is that stock markets may not have much more room to go up. I’ve been thinking that we are in for a long period of low public equity returns. I have no idea when that will happen but the macro environment just doesn’t look that great to me.

That doesn’t mean that you can’t make money with your startup and it doesn’t mean that you can’t make money in venture capital. The returns in startup land come mostly from taking nothing and turning it into something. If you take hard work, sweat equity, and a few million bucks of startup capital and turn that into a business producing $5mm a year of cash flow, then that is value creation of the old fashioned kind and it will work in any market environment.

But it also means to me that we should not be banking our business on the IPO exit. The public markets are a fickle thing. And it looks like machines are running that show now. I’m more optimistic about institutions turning to the private markets where capital is still traded by humans. I believe the secondary market where institutional private capital comes into the cap tables of startups and provides liquidity to founders, angels, and early stage investors is the next big thing for liquidity in the startup business and I am pleased to see that market continue to develop nicely.

So I don’t think the “crash of 2:45pm” as our friends from StockTwits are calling it matters much to those of us working in the world of startups, but it may be indicative of things to come (as markets tend to be) and it is worth figuring that part out.