Global Financial Crisis 2.0? Part 7

Chapter 7: The big question: how can we as investors profit from the coming credit turmoil…AND the inevitable recession?

Because it IS coming. This is what I’ve been driving at for the last 18+ months: The market factors we saw leading up to the Global Financial Crisis may not repeat, but they will rhyme.

What do I mean?

I mean that, during every run-up, huge swaths of investors always seem to find some way to overextend themselves.

They always think this time is going to be different (we’ve been hearing a lot of that vis a vis the housing market). Or that they’re smarter than investors past.

Their actions always seem to reflect this weirdly contradictory mentality that they have to “get while the gettin’s good”, but also that the run-up will last forever.

I don’t think there’s any clearer evidence than the widespread balance sheet turmoil we’re seeing now, and the resulting pullback in the credit markets.   

Bottom line: no matter how much smarter or more “responsible” we think we are, or how many regulations we put it in place, greed always finds a way. 

And greed in any form eventually leads to fear down the road. And fear means opportunity. 

What opportunities am I referring to?

Some in tech, for sure. Many of the less prudent early stage (Seed - Series B) tech investors could be in trouble.

Why?

Runway. Runway is a term in startup investing that refers to the amount of time a startup company can survive at its current monthly “cash burn” rate.

And we’re seeing a Pareto Distribution with respect to runway: 80% of startups are at risk of failure this year, with less than 12 months of cash left on their balance sheets. (Nearly all of the companies in our ACCESS Venture Fund portfolios have more, FYI).

And most if not all of the leverage in this asset class sits with the Venture Capital world. VCs, if you recall, are one of the “asset managers” I talked about in my previous article.

So the big question is: How many VCs have these short runways baked into their current marks?

Not many, I suspect. And they’re going to have to; they’ll need to mark their portfolios materially lower later this year, which may come as a surprise to their LPs. 

And if VCs do indeed mark their positions lower, they’ll need to generate DPI (Distribution to Paid-In Capital) for their investors. DPI is the ratio of money that a Fund distributes to its Limited Partners (passive investors) relative to their capital contributions.

In order to generate DPI and keep their investors happy, VCs need liquidity. They’ll never be  able to raise a subsequent fund if they don’t.

And to get that liquidity, they may have to take drastic measures. They may need to sell a portion of the winners in their portfolio by selling shares on the secondary market. Smells like opportunity to me!

Seriously, these could be prime opportunity targets if you’re looking to buy secondary shares in startups. One of the funds within our ACCESS™ Venture Fund II portfolio does exactly that.

Beyond the VCs themselves, countless early employees at Pre-IPO companies waited too long to get liquidity. They will now be forced to look for buyers/liquidity providers at the worst possible time.

At the end of the day, I don’t think this is an isolated event. Rather, I think it’s the beginning of a 6-18 month period of unmet liquidity/capital needs.

After all, not only was SVB itself a general liquidity provider to VC's / private tech companies, but there are crossover investors, family offices etc. who are like us — largely “pencils down” on deploying capital in private markets for the remainder of 2023. These capital sources are gone for the time being.

Again, opportunity.

There will be opportunities in real estate too

Because it’s not just the insurance costs I mentioned earlier; ALL the costs of owning property have been going up.

Flat revenue with increasing expenses is going to squeeze margins considerably.

The decrease in operating income further increases the difficulty in reaching profitability…

…and in turn also hits the property’s valuation (valuation = net operating income / market cap rate).

When valuations get hit, overleveraged properties become distressed. And that’s where we can swoop in. At the right time.

Heck, the commercial real estate sector is already seeing issues in the credit markets. Valuations have dropped, so borrowers on big apartment and office projects can’t refinance the short-term debt they took out back in 2020 and 2021 when rates were low. Loan defaults are already starting to climb.

Some recent examples:

This will likely have a trickle-down effect for borrowers on smaller projects. In my opinion, a multi-year commercial real estate downturn is just getting started, and will likely be exacerbated by tighter credit policies.

I remember a Nobel Laureate professor of mine once simplifying markets and behavioral economics for me

He said, “when it comes to…

How people expect things to be (expectations)... and

How things are supposed to be (theory)... and

How things truly are (reality)...

…when all 3 begin to radically differ, that cognitive dissonance makes people feel uneasy.”

And here’s the thing: feelings shape behaviors. Feelings create self-fulfilling prophecies.

That’s why it is VITAL that you and I manage how we feel about this market…using FACTS

In my case, using RESEARCH. Like you’ve seen here. Like the last 21 years I’ve been doing this.

Because if you think about it, how we feel about something is a really a function of 3 things:

1. What we believe to be true about it;
2. How we interpret its meaning; and
3. What we’re willing to DO about it.

And here’s the kicker…all 3 of those things are ENTIRELY within YOUR control.

Seriously, the buck stops with YOU

It’s on YOU to cut through the media and government B.S., and find the right sources for real, honest facts about this market.

It’s on YOU to interpret and analyze the data like a mad scientist, and figure out what the heck it actually MEANS.  What it signals, what it points to, what it calls for.

And it’s on YOU to take that analysis, find the opportunity it reveals, and create a plan to capitalize HUGE.

And then execute - when and where - like there’s no tomorrow.

At the end of the day…

Everyone thinks it’s about THE economy. And it’s NOT. It’s about YOUR economy.

I honestly don’t care what happens in THE economy. In fact, the worse, the better, for me. Because I spend invest a LOT of money AND time to understand what’s coming at every point in the market cycle. I have strategies and blueprints for each. Then I execute. Simple.

So ask yourself, and really answer honestly:

What are doing RIGHT NOW to make the most of the current moment…

…and set yourself up for the opportunity of a LIFETIME down the road?

I know what I’m doing. Perhaps we can do it together.

If you’re an accredited investor, and you’d like to do something with me, my Family Office, and my ACCESS Insiders™, let’s find a time to talk.