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Market notes from up above

If the economy were a single business, it would now be a restart, with aspects of a startup, in the post-pandemic world. This is a new form, with new behaviors and results that can be unpredictable. It is different from a recovery, which is a continuation but with an improved trajectory. The following commentary is an atmospheric review of conditions in this context.

Both sides now

The economy is a multi-sided market. Many have tried to build such a platform, and a few have succeeded. To build and scale, and then support a multi-sided market, each of its core components — the sides, the underlying mechanism, the environment that makes the commerce happen — have to come together just so.

The large and complex multi-sided market that is the economy has been purposefully broken in order to be saved, because the health of sides is critical for economic survival. As we begin to note resulting devastation when this multi-sided market stalls, the impetus to unbreak the ties has grown.

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Axios April 6, 2020 — What top CEOs fear

But to optimally reconnect, the timing and the mood, the protocols, the flows, and most of all, the knowledge of each side that others will be present, attentive and engaged, all these things are much as in a chemical reaction that requires perfect elements and measures to yield the desired results.

It isn’t enough for the store to open up its doors. The shelves have to be stocked, the shopping carts and checkout must be functioning, the staff must be in place and ready to assist, and lest we overlook the most important thing, the customers have to be interested. For different stores of different types with different products and locations, the multi-sided chemical reaction will yield different results.

The economy, which is the aggregate of all the stores, will have a different profile… Initially, and possibly ongoing.

What makes the outcome particularly difficult to predict — even more than the success of a new marketplace that might be launched as a startup operation — is that in the broader economic sense the staff and customers are one and the same. Supply and demand, in other words, are not just interlinked, but in this case conjoined.

When the marketplace is relaunched, both sides must be willing and able, and the activity combined has to be fluid, as it was before, for this startup operation to scale and function properly. It’s venture risk, venture reward, but in this case we’re all investors, customers, and operators, at once.

Behavioral recovery

The economic inflection coming up will be at the time of re-opening. It seems to be assumed that when the doors to business start to swing again, there will be a shape — V, U, or L (each letter more or less depicting the growth curve after the hiatus) — dependent on timing and, perhaps, some differences between sectors. This is overly simplistic.

First off, as a multi-sided market, the customers have to show, as mentioned and the established systems have to work. But that isn’t enough.

To forecast marketplace behavior with some level of correctness, its unit economics have to be somewhat accurately measured. While this is to a large extent dependent on aforementioned factors, the difficulty lies in ways these factors interact and push or pull each other. There is some reflexivity involved, with causes and effects that can be circular, compounded by the challenge of a multitude of levels — behavioral, technical, financial — each with its own set of causes and effects, intertwined.

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Axios April 16, 2020 — The coronavirus chain reaction

When an economy, like a marketplace, is mature, these variants and value drivers are reasonably stable and clarified with data. There is a history to look to, and it’s likely that over time the possibilities have settled in a narrow band of sorts, which maybe even narrowed with the length of time and richness of the data. When a marketplace is in its early stages, though, when there is no data or when this is limited in time as well as depth, the bands are wide and forecasts at best unreliable.

Had the hiatus been short-lived, a case could have been made, and was, that the restart could take place almost as though nothing changed. But the timing of the restart now seems not to be so short, and furthermore it is unknown… Or possibly it only feels mysterious while in wait and isolation. How it feels and how it is, however, aren’t unrelated pieces in a calculus where growth is ultimately a function of engagement, which is ultimately pushed or held in check by individual and collective psychology.

Thirdly, thus, there is the biggest and most unpredictable aspect of anticipating the economic bounce: behavior. The economic restart and its shape is veiled in this infinite enigma.

The guidance of the networks

When there is a disturbance to one part of the network flow, the change is often felt throughout the mesh, with unknown consequences. The magnitude and nature of the disturbance, the density and quality of links, direct or indirect transmissions between nodes and clusters that may be differently conditioned and responsive, the causes and effects that may be circular or reflexive, these and other puzzles can form a butterfly effect, which is essentially a network observation.

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As a large multisided marketplace, the economy and its drivers are mirrored in the large complex network that is financial markets. The large disturbance of the epidemic, itself a network entity with network patterns and complexities, is having a large and complex effect on both the economy and markets. This happens when networks intertwine.

The final outcome (but who’s to say precisely when that is and what defines it) — when the smoke has cleared (which is perhaps a never-ending process) — is therefore unpredictable not only in the aggregate, but individually and for different businesses and sectors. On the individual level, the following section depicts one way to measure what this means.

The asset’s optionality

Enterprise value is made up of two elements: the asset and the optionality. The asset is the business everybody knows, and which defines the enterprise in present form, the base. Optionality is the future possibilities, unknown and possibly unknowable.

At the inception of a business, the ratio of optionality-to-asset is very high, maybe infinite, and this diminishes as the business grows, matures, and takes a shape. Optionality doesn’t altogether vanish, unless the business does… even the staid electric utility may one day become an electric vehicle manufacturer, or vice versa, which may lead to a payment platform and eventually a bank… which all started with the lightbulb.

In the current economic context, the general asset value should be shrinking as the underlying business slows (or, in many cases, ceases) and the discount factor reflects the growing risk. In theory, the option value — the unknown behind the door — should be growing with the growing volatility.

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WSJ April 14, 2020 — KKR Warns of Damage

There may be hints at how such theory might manifest itself in practice. In a sense, the public earnings and guidance reports are a comment on the asset, while the market’s settled value multiple contribute an opinion about its optionality.

The combination of these two elements will be different in different cases, and results are always more interpretive than formulaic, but when we look for hints of sense in an economic network pattern that is shaken and chaotic, the market network’s reflexive narrative may offer up some guidance. As with startups in general, we may look to venture capital for clues.

The venture filter

The reflexive dynamic between public and private markets in this coming period of the unknown will make for interesting analysis. Private markets have always looked to the public for hints of receptivity and valuation metrics up ahead, as these things may drive liquidity of the initially illiquid long-hold investment. Public markets, in turn, look to the private for hints at coming innovation and disruptive forces that shape consumption and behavioral trends. In essence, each of the two influences and rounds out the other’s perspective.

In the case of institutional (partnership) funds, which make up the majority of money flows on both sides, there is yet a third body in the mix, the limited partner (LP), who stands behind the private and the public simultaneously, as a matter of portfolio diversification. It isn’t unusual for performance on one side to affect LP allocation to the other, but we all know that when three bodies are involved the combined trajectory is unpredictable. It’s math.

And the uncertainty has only just begun… Because the three described bodies collectively make up the markets unit that is itself one of three in the more universal context. Together with the other two — the economy and, for lack of a better term, let’s say society, which is the base of general behavior and mood — the combined effect of the interconnectedness is unpredictable to an elevated degree. Even as each of the spheres impacts the others.

It’s a complicated network mesh, as previously contemplated here, where the uncertainty is escalated further still as all the different bodies look to one another for answers no one really has. Financially, if value is made up of an asset and its option value, this moment suggests a time of great optionality.

As we all watch and wait and look for some direction, the investment leadership, when it arrives, will likely come from the body best equipped to operate in a high uncertainty environment and best trained to evaluate long-term illiquid option value.

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Pitchbook download — April 13, 2020

The circular and reflexive influences are all the same, but the filter will have qualifications that recommend it… generally speaking and individual cases aside.

Now the wider lens

Decade, century, or millennium markers are contrived milestones in history, which — unaffiliated with the solar orbits and powers of ten in the number system — isn’t so neatly structured. When we think of decades in the recent past, we assign qualities to each, shaped by events and culture of the period, as though there had been a migration at the precise time, from one room to another, each with a different decor and set of furnishings.

Who’s to say but maybe this is how it works. The influences and trajectories are complicated, and the possibility of ten-year subdivisions is still one among many. Nevertheless, this category set feels artificial in a natural continuum, even with characteristics that we associate with each.

A different way to look back, which maybe combines aspects of the structured and unstructured, is to isolate the discrete items in the mix and mark these as approximations. It’s an imprecise and subjective exercise, but no more so really than the ball that drops in the last ten seconds of the year that passes.

So, for instance, let’s say that in the market context — which reflects economics and shapes people’s lives, directly or indirectly — the ’80s ended with the Black Monday crash of 1987…

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And then let’s say that the following decade ended with the dot-com bubble burst and 9–11 in short order…

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The Great Recession happened a few years after that, not precisely ten, but approximately enough…

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And now, some twelve years later, this…

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The milestones, markers, and events depicted in these charts are approximate, as stated, and the causes and effects are complex, as we’ve seen. Had I picked a chart from, say, the middle of each decade, the picture would have told a different story.

In this particular story, though, there seems to be a pattern. Each ten-year period, loosely speaking, concludes with a big shock. We take time to recover, and each successive shock, in ways, seems worse than the one before… not quantitatively necessarily, in the strict market value sense, but in terms of impact, depth, and breadth.

Again, the explanations and the different angles are nuanced, and the timeframes are rough estimates to meet some artificial bounds halfway. But the pattern that is seen, as it were from far away in space and without the detail, glares.

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Axios April 16, 2020

For decades now, on certain levels, we’ve been playing catch-up and digging out of holes that each seems harder to climb. By this time the lesson should be learned, and we may want to plan ahead and build up energy for the next time.

The key, as always, only more so now, is in re-adaptation. The decades have taught us the importance of this skill that can be learned like any other.

We must see to it (or at least try) that our position and its value to the market network are secure. Any startup entrepreneur knows this.


The preceding were originally published separately in my daily journal of snippets about markets, other networks, technology, finance, books, and assorted other subjects.


A sort of related companion piece:

Finance notes from underground

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Investment, finance, strategy, execution in the networked tech economy.

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