Funding Unprofitable Growth

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We have been reminding everyone that we believe we are unwinding a financial euphoria episode that Charlie Munger called the biggest of his career, “because of the totality of it.” In the process of its unwinding, the sins committed during the euphoria episode will have a price to pay. Many investments got over-capitalized by nearly free money.

“For the near term that’s gone,” he said, adding that another trend coming to an end is a willingness to fund growth at all costs. “You could call it the SoftBank Vision Fund era, where there was just unlimited amounts of capital to fund losses and growth in unprofitable business models, and I think that’s gone.” — G. Raymond Zage III

The current tribulation is closely associated with a myriad of startup companies in everything from tech to clean energy. The Federal Reserve tightened credit by taking short-term rates to 4.75% from nearly zero. In the process, we are now learning that the regional banks most closely associated with new technologies have severe problems and a few have been shut down by the government. The flow of funds to venture capital investments and profit-less growth businesses could possibly come to a halt.

Here is the irony. The on-the-ground real economy is very healthy due to favorable demographics and pent-up demand for goods and services. This is true even while the tech sector, which had been the main driver of the weak economic recovery of 2009-2019, begins to deal with a significant cost of capital in the form of higher interest rates and lower stock prices. Why is the stock market so anxious to buy the dips in their tech stock favorites and treats them as “safe/quality?”

We at Smead Capital Management believe it is because they don’t understand how manias unwind. Let’s go back to the DotCom bubble, which broke in 2000. We remember at that time that there was very little understanding of the food chain that runs from the venture capital world to the stock market and the mainstream economy.

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