Notes and Takeaways from Craft Ventures: Operating During a Downturn
When I watched it: June 2022
Why I watched it: I’ve been looking for a simple explanation of the current macroeconomic situation and how it impacts investors and entrepreneurs. The first 20 minutes of this talk is exactly that.
Go here for the talk, review the slides here, or scroll down for my notes.
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My notes
About David Sacks
David Sacks is an internet technology entrepreneur and investor. He co-founded Craft Ventures, a venture capital firm, and he is a co-host of the All-In Podcast. Previously, David was the founding COO of PayPal and founder and CEO of Yammer.
About Jeff Fluhr
Jeff Fluhr is a co-founder and partner at Craft Ventures. Previously, he co-founded StubHub and served as its CEO until it was acquired by eBay.
What’s happening in the market?
The Federal Reserve System (Fed) is the central banking system of the United States of America. The way the Fed controls inflation is via interest rates. One way to drive down inflation is to hike interest rates. So when inflation increases, we (and the market) should expect the Fed to react by increasing interest rates.
One way to measure inflation is via the Consumer Price Index (CPI). In a nutshell, the CPI is a measure of the average change over time in the prices paid by consumers for certain goods and services.
As you can see from the below chart, the CPI and the Fed rate have remained mostly in sync since the 1950s. But in 2020, they started to diverge. (Due to recession concerns during the pandemic, the Fed kept interest rates close to zero percent despite inflation concerns.)
Inflation has now spiked to 40-year highs. It has been roughly two percent for many years. Now in 2022, it’s up above eight percent. Since the Fed waited way too long to respond and now the CPI and interest rates are out of sync, we can expect the Fed to start hiking interest rates to regain control. (Jerome Powell, Chairman of the Fed, has indicated the Fed will raise rates to fight inflation even if it hurts the economy and leads to a recession.)
Long-term interest rates have already increased to more normal levels in anticipation of rate hikes by the Fed, but they could go even higher.
Stocks generally move in the opposite direction of interest rates.
Stocks get hurt by increased interest rates and growth stocks get hit the hardest. This has to do with the time value of money. Growth companies invest money today in exchange for the value of future earnings. When interest rates rise, the present value of those future earnings gets discounted to a lower number.
Here are some examples of public growth company stock prices that got hit hard in May 2022:
Private venture markets follow the public markets.
Private venture investors take their cues from the public market because that’s their liquidity source when exiting. When public company valuations go down, private market valuations go down too. This trickles down each stage of investment (Series C, B, A, etc.). Uncertainty also causes people to freeze until they get clarity. The combination of lower valuations and this wait-and-see approach causes the pace of private to grind to a halt.
We’ve been here before.
The Dot.com Crash
For example, we went through the Dot.com Crash of 2000-2002. This lasted two-and-a-half to three years and led to mass layoffs and bankruptcies. The Dot.com Crash was driven by excessive speculation of internet companies which was driven by an abundance of venture capital available from the late-1990s bull market.
The Great Recession
Another example is the Great Recession of 2008-2009. It lasted for over a year and a half and cratered the whole economy. The Great Recession was driven by an asset bubble in the real estate market driven by aggressive lending.
The Post-Covid Recession of 2022-2023?
The current crisis is likely the beginning of another recession of at least one-and-a-half to two years. Inflated valuations that were driven by a decade of low-interest rates are now facing a correction due to inflation and rising interest rates.
Random anecdotes
It takes a much bigger percentage increase after a percentage loss to get back to where you were.