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05/30/2011

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TANSTAAFL

If another tech bubble emerges, it won't be for the same reasons as the one that burst 10 years ago. First, the failed dot.coms of the late 1990s gorged themselves on debt financing from Wall Street that they had no hope of repaying, largely because there were few grown-ups on the scene to discipline how the money got spent. Given events of the last three years, easy credit is a lot harder to come by. Second, it would appear the current batch of start-up tech companies, and the investors chasing them, are getting sober advice from folks who remember the lessons of the last tech bubble. None of this is to deny that Microsoft likely is overpaying for Skype.

ElGreco


Case well taken. The fact that a Nobel price economist says that LinkedIn is overvalued should start placing some shorting pressure on the stock – with the first volunteers being those who claim that the corporations are creating bubbles and living at the expense of the people. So go ahead, short LinkedIn and Microsoft.

But let’s assume it is indeed a bubble. So, the market is crying wolf again (or better said is crying “new era again”). But what if this time the wolf does indeed come. That seems to be one overlooked aspect of that often quoted fable. The wolf only rarely comes but come he does. So come on! Go ahead, short the stock! If you get bold enough in your bet, I’ll cover the long position.

Becker : “Still, if Microsoft and Murdock paid inflated prices for Myspace and Skype, it would be no surprise if other investors who have more limited business experience with Internet companies would have inflated expectations about future earnings prospects of these companies.”

…while more ordinary people, like those of us reading the Becker blog, have wised up and are now going to short LinkedIn and Microsoft and make profit from those who take the long position.

But here is a more cool headed prediction:
If this bubble looks exactly like the previous one then it will pop much sooner. People and markets do wise up and that is the beauty and efficiency of self correcting markets. If this bubble does indeed inflate like the previous one, it will be because some new parameter emerges that makes it difficult to tell if this is yet another great bubble or truly the beginning of some new era that will greatly benefit society if resources (investment) are allocated to it. So when and if this new parameter emerges, go ahead and call the bluff – and of course, short the stocks.

So which way is it? Line up and stake your short and long positions.

Oh, I see. I know. We should do away with all that and make a few government committees, staff them with some Nobel laureates and task them to evaluate on an objective basis once and for all what is really going on here. Then we take their recommendations and make them into law so that markets cannot create bubbles.
Well, that just as a stopgap measure, only until purple elephants riding unicorns come and save us from the market daemons and live happily ever after under central planning.

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StatSpotting

The trick is to ask: "is there a case for this company to be around after a decade". if the answer is yes, buy. forget valuations.

Xavier L. Simon aka Xavier

It is hard to improve on the posts by Becker and Posner and the comments by ElGreco so I won’t try. Instead I’ll raise some questions and tell a couple of anecdotes. Yesterday I started an exploration of the role of complexity, ignorance, arrogance and discipline in creating bubbles. That is, the utter complexity of nature and societies, the limits of our understanding, our hubris in believing that we can overcome those limits, and the failure of discipline even among those that do recognize the limits.

Then today I was reading about the role of rational choice versus ideas and norms, as embodied by religions and their secular equivalents, in providing a theory of social mobilization and organization. This raised some questions and reminded me of my stab at bubbles yesterday. Thus, what is the role of intelligence and analytical capacity versus our use of learned norms in our decision making when the former are limited? And, complicating this relationship even further, what is the role of are our instincts? What is the relationship between the components of a triad that includes chance-instincts, intelligence-rational choice, and norms?

Then the thought crossed my mind that the answer to bubbles and how to avoid them lies somewhere in the interaction of the latter three with complexity, ignorance, arrogance, and discipline. That led me to the Microsoft-Skype and Murdock-MySpace cases as possible examples of ignorance, hubris and indiscipline. I say this because of their very close parallel with two almost identical situations I experienced in my early career. At the time I was working for the largest cotton “trading” company in the world. If anything they knew about trading cotton, yet, in the first example, one year they tripped as badly as Microsoft and Murdock might have. And, in the second, a competitor helped create a bubble that hurt us. This is also a tale about the importance of commodity markets.

Although a trading company, we used to make our profits by moving cotton a few steps in the value added chain—buying seed cotton from farmers, separating it from the seed and baling it, and shipping it to spinners. We never took a position based on price expectations. Instead we used the futures markets to lock in our operating margins the moment we bought the seed cotton. Although we were the largest “trader” in the world we didn’t speculate. What we did gave us a sufficient profit; we profited from good execution. Then at one point in the 50s and 60s the US government created a “strategic reserve” which it then sold thus pulling the rug out from under the commodities market for cotton. That made it very difficult for us to lock in our profits so we left the business.

Now, here is the story. It was very strict company policy that we don’t trade on our position. Yet one year in the late 50s the senior management believed there was going to be a significant price move, one that they couldn’t ignore so they traded on the company’s cotton position. And, as I said, who knew cotton better than the biggest “trader” in the world. Well, that year we took a very bad licking. We had broken discipline based on an assumed knowledge that made us arrogant. The complexity of nature and markets taught us just how ignorant and arrogant we really were.

The second anecdote has to do with oil seeds in Mexico, which we had gotten into as a result of the cottonseed produced in our ginning operations. I was the chief oil trader. Unlike in the US, in Mexico you couldn’t pick up the phone and buy or import your crude oil requirements for next week. Thus we used to take fairly long positions when the crops came in. One year our company bought an excess of safflower for our premium salad oil—also the product of forward integration. Soybeans had proven to be in short supply and we were planning to use some safflower for our lower price brands. The objective was to protect our brands from shortages in the months prior to the crop next year.

Then I went to MIT, took a summer course in System Dynamics, worked with a professor to model the Mexican oil market, and discovered what ElGreco refers to in his 05/30/2011 at 05:56 PM post as a new parameter. It turned out that there was most likely too much oil in Mexico, soybean and safflower prices had “bubbled,” there would likely be a lot of soybean oil coming into the market during the year, prices would drop, and we would be caught with too much safflower—in the event that is precisely what happened and we had a bad year. Despite our being the largest oil trader with the most offices in growing regions we had goofed—note that our buying strategy was so important that it was always set in lengthy multi-day workshop-like sessions with our most senior management.

Okay, so now I wanted to sell our position in safflower but our policies don’t allow us to do anything that even remotely smelled like trading on our positions, more so after our company’s earlier fiasco. I spent hours trying to convince our president. In the event he allowed me to sell about 10 percent but only because I convinced him that we had too much oil for that year. Our company had learned its lesson and was not going to break discipline. They were willing to take a loss or forego an opportunity rather than pretend that they really knew better. It is interesting to compare this with AIG and their London unit going rogue when a weak new senior management failed to enforce company norms, discipline and expertise.

In a very apropos footnote, a few years later I learned from the largest meat processor and trader in Mexico, a self-made billionaire, that he had been ignorant and arrogant. One day over lunch, hearing that I had been the largest oil trader years back, he recounted a “huge mistake.” He told me of how being the largest meat commodity trader, and with cattle and pigs eating soybeans, he had felt he knew enough to buy soybeans. He had been the guy who had messed up the market the year we got caught with too few soybeans and too much safflower. In the event he dumped his position and the rest was history. Ignorance, arrogance and lack of discipline. Murdock, Microsoft, does it sound familiar?

NEH

A Social Network Bubble? A good possibility... Perhaps it can be best explained in two words, "Hubris" and "Rubes". An analysis of any of the historical Bubbles normally breakdown into these root causes.

Lest we forget, let's also add Branding, Marketing, the creation of irrational optimism and then the first release of an Initial Public Offering closely followed up by later Public Offerings pushed by the Marketing tool of "Bandwagoning". The "Rube Factor" at work...

Jack

Xavier: Ha! Another tale of markets not working how they are 'sposed to work:

In the last days before Christmas a dozen years ago, I take "the kid", proud to have his own checking account at 11, to a tech store with the letters C***USA in its logo. After picking out "cool stuff" for his pals adding to the princely sum of $85 or so, the young chk out clerk doesn't accept his check. Next? the 20 year old? "manager" sez we'd have to "call corporate credit on one of those phones over there". Looking, they are both being used by guys on perma-hold.

ANY local retailer would have taken the kid's check with his ID and mine. We ended up buying the stuff as Anch at the time was underserved in computer stores, but, I realized these fools knew zip about retailing. Then the more I thought about it, in that time of rapidly falling computer prices, I realized their whole biz model was screwed. Even were they to maintain margins on rapidly depreciating inventory, they'd have to sell a whole lot more units to make up for falling prices.

I checked on the net, and guess it was no secret, their stock was already trending down. Down too far for a good short? Who knows? and there's that shortie problem of having to get the direction and the timing right. Soo, I chickened out.

Within 30 days I saw notice that one of the wealthier outfits in Mexico bought the entire chain at a small premium to current prices. Shorting, I'd have gotten killed! Though I was right on the fundamentals. They didn't survive even after the buyout and I enjoyed taking advantage of their close out sale.

El Greco? Not sure why you're acting like commie "committees" are waiting in the wings to take over WS, as near as I can tell those called "liberals" one hope for, and expect a market a lot more honest than that of the last decade.

Jim

Linkedin IPO was clearly underpriced by the two investment banks used to manage it, by about 50%. The banks probably told their best customers to buy the IPO and then to sell at noon when the price doubled. A great scam enriching a few favorites without an iota of new asset creation. Gee, do you think that there may be a new bubble? And beside all that, when was the last time the greedy learned from the past. In addition, the unforseen consequences of social networking could render it void in a nano second if something really noxious surfaces. Maybe I will just go to a casino to satisfy my unquencable thirst for lucre.

Legal Funding

I think statspotting hit it on the head here. This social networking "fad" is not going anywhere and it looks like to me that people are organizing into social groups for the long haul. Humans like their friends and family for the most part.

I really think this will be the marketing platform of the future. One prediction, with big government, thought-crime, and identity theft on the rise - companies who are not embracing security quick enough will be left behind.

Even the mighty Facebook can be replaced, as the crowdmind will always win. Just look at what happened to Myspace.

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that is trouble for all of us.

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I suggest Batman and Poison Ivy, rather than The Last Ringbearer, where I agree with Daniel that it is dreary.

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Stock Market Today

Really great article! I think Microsoft will recover from the financial burden of skype. I cannot speak to the future of twitter and facebook but I don't think a new tech bubble will happen anytime soon.

CHRISTIAN LOUBOUTIN SALE

Facebook and Twitter have not yet had IPOs, but they are actively traded in secondary markets. In an excellent discussion in its May 14th edition of the boom in tech stocks, The Economist shows that Facebook is valued on this secondary market at over $75 billion, and Twitter at almost $8 billion. These are enormous valuations relative to the sales and profitability of these hugely popular social networking companies.

mujeres

Good food for thought here... Thanks for such an informative article, it's been very useful.

women


Thank you, it's been very useful. I'm truly grateful.

Paul G

When you get a new 'hot' investment category, such as social networking, there is a good chance there will be a bubble. The markets price in improvements in user numbers, revenues and profits but their estimates are contingent on so many assumptions there will be huge winners and huge losers.

I believe the key risks are:
(1) innovation of competitors;
(2) innovation of technology;
(3) regulation / legislation / litigation; and
(4) inter-continental / language / cultural risks.

If I had to pick two key risks they would be (1) these companies business models appear to be based on advertising, for which margins will be reduced massively by competition in the coming years and potentially legislation; and (2) New technology - such as how TVs are used with the internet in the future.

I have written more about this on my website:
http://www.improveyourwebsiteforfree.com/Articles/FutureofInternetGiants.html

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Good stuff. I would like to see more details about this topic. I'm going to keep coming back here.

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Peutch

It might be a bit fast to just compare trading prices and profits in order to suggest that there might be a bubble, especially in the case of Microsoft-Skype.

Microsoft's valuation of Skype might be much higher than the simple operating profit of Skype. Strategic reasons might beef up this valuation. For instance, being able to compete with Google Voice, locking in users Skype users with Microsoft products, penetrating or controlling the smartphone markets, the opportunity cost of letting Skype go to competitors, etc.

james moylan

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SkipAidek

Ich bin endlich, ich tue Abbitte, aber es ist aller kommt nicht heran. Es gibt andere Varianten?

eyeglasses

Skype for $8.5 billion, which is ten times Skype’s sales, and several hundred times its operating income last year.

MBT Sale

Thanks for the cool badgees! When do we find out who the Petties nominees are???

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