I finally read Howard Marks’ memo, Sea Change, and wow!

In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes.  I think we may be in the midst of a third one today.

For those who want a fast overview of investing, markets, interest rates, and inflation, read this now. For those of you who don’t know who Howard is, he’s like the Warren Buffet of distressed securities.

I’m not having you read this because I’m all doom and gloom, but it does provide a zoom out view of how the asset allocators think, and how 💰 is allocated from debt to equity to PE, VC and eventually founders. Read it, reflect on it and build an efficient business. Despite the pessimistic outlook, I continue to believe it’s a great time to start a company because only the most insane 😜 founders will build in this market, and when the world opens up again in 2024 and beyond, these companies will be ready for the next growth cycle.

Here are a few excerpts I highlighted if you want the TL;DR.

Interest rates are the most powerful force for valuations and of course tech valuations

An Incredible Tailwind

What are the factors that gave rise to investors’ success over the last 40 years?  We saw major contributions from (a) the economic growth and preeminence of the U.S.; (b) the incredible performance of our greatest companies; (c) gains in technology, productivity and management techniques; and (d) the benefits of globalization.  However, I’d be surprised if 40 years of declining interest rates didn’t play the greatest role of all.

That’s what I think happened to investors over the last 40 years.  They enjoyed the growth of the economy and the companies they invested in, as well as the resulting increase in the value of their ownership stakes.  But in addition, they were on a moving walkway, carried along by declining interest rates.  The results have been great, but I doubt many people fully understand where they came from.  It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates.  I consider it nearly impossible to overstate the influence of declining rates over the last four decade

And due to zero or low interest rates, investors became risk seekers looking for more yield from you guessed it, VC, tech stocks, crypto and more

The markets’ strength encouraged investors to drop their crisis-inspired risk aversion and return to risk taking much sooner than expected.  It also made FOMO – the fear of missing out – the prevalent emotion among investors.  Buyers were eager to buy, and holders weren’t motivated to sell.

Investors’ revived desire to buy caused the capital markets to reopen, making it cheap and easy for companies to obtain financing.  Lenders’ eagerness to put money to work enabled borrowers to pay low interest rates under less-restrictive documentation that reduced lender protections.

The paltry yields on safe investments drove investors to buy riskier assets.

In a nutshell…

The Future + what victory means

The Future

In my view, the buyers who’ve driven the S&P 500’s recent 10% rally from the October low have been motivated by their beliefs that (a) inflation is easing, (b) the Fed will soon pivot from restrictive policy back toward stimulative, (c) interest rates will return to lower levels, (d) a recession will be averted, or it will be modest and brief, and (e) the economy and markets will return to halcyon days. 

In contrast, here’s what I think:

The underlying causes of today’s inflation will probably abate as relief-swollen savings are spent and as supply catches up with demand.

While some recent inflation readings have been encouraging in this regard, the labor market is still very tight, wages are rising, and the economy is growing strongly.

Globalization is slowing or reversing.  If this trend continues, we will lose its significant deflationary influence.  (Importantly, consumer durables prices declined by 40% over the years 1995-2020, no doubt thanks to less-expensive imports.  I estimate that this took 0.6% per year off the rate of inflation.)

Before declaring victory on inflation, the Fed will need to be convinced not only that inflation has settled near the 2% target, but also that inflationary psychology has been extinguished.  To accomplish this, the Fed will likely want to see a positive real fed funds rate – at present it’s minus 2.2%.

Thus, while the Fed appears likely to slow the pace of its interest rate increases, it’s unlikely to return to stimulative policies any time soon. 

The Fed has to maintain credibility (or regain it after having claimed for too long that inflation was “transitory”).  It can’t appear to be inconstant by becoming stimulative too soon after having turned restrictive.

People who came into the business world after 2008 – or veteran investors with short memories – might think of today’s interest rates as elevated.  But they’re not in the longer sweep of history, meaning there’s no obvious reason why they should be lower.

Prepare for further pain…

Regardless, I think things will generally be less rosy in the years immediately ahead:

A recession in the next 12-18 months appears to be a foregone conclusion among economists and investors. 

That recession is likely to coincide with deterioration of corporate earnings and investor psychology.  

Credit market conditions for new financings seem unlikely to soon become as accommodative as they were in recent years. 

Lastly, there is a forecast I’m confident of: Interest rates aren’t about to decline by another 2,000 basis points from here.

The kicker, the SEA CHANGE

We’ve gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term.  Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets.  Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21.  And importantly, if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.

That’s the sea change I’m talking about.

As always, 🙏🏼 for reading and please share with your friends and colleagues. Also Happy Holidays, Happy 🕎, and Merry 🎄🎁 to those who are celebrating.

Scaling Startups

1. Demystifying PLG from our bold.camp - read on for our 15 Core Principles of PLG along with some slides from our speakers

   

   Ed Sim @edsim

   Nothing like power of a focused community of developer founders: last week we hosted @Boldstartvc camp to demystify PLG + provide frameworks/hacks to go from 0-1. Here lessons learned from experts at cos @snyk @auth0 @BuoyantIO @D2iQ Slides incl.

   

   medium.comDemystifying PLG at bold.camp, our developer first 0–1 boot campAt boldstart, we ❤️ to collaborate with technical founders well before writing their first line of code or making their first hires, le...

   1:25 PM ∙ Dec 22, 2022

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   39Likes7Retweets

2. As you reflect on 2022 and set goals for 2023, I highly encourage checking out this 🧵 from author of Peak Performance + other books - great balance of getting shit done, enjoying journey, and finding balance

   

   Brad Stulberg @BStulberg

   Been thinking a lot about peak performance, genuine excellence, and what really matters for it. Here are 19 habits and principles, all based on years of research, writing, and coaching:

   1:42 PM ∙ Jul 9, 2022

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   2,560Likes496Retweets

3. Speed = runway

   

   Ed Sim @edsim

   ❤️ the early days of startup, ideation, milestones hit, velocity 📈: every new feature, hire is 🤯 As time flies + bigger u get, gravity sets in + u slow down, best cos find way to maintain that day 1 energy on day 365 + beyond. By prioritizing speed, u also prioritize runway

   5:33 PM ∙ Dec 19, 2022

4. Please…No

   

   Gokul Rajaram @gokulr

   Hearing from CPO candidates in the market: many Series B/C companies haven’t yet found PMF despite having raised tens of millions of $. The CEO believes the CPO will help them find PMF. Finding PMF for a company is a a cofounder role (with appropriate equity), not a CPO role!

   5:01 PM ∙ Dec 19, 2022

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   1,841Likes145Retweets

Enterprise Tech

1. Morgan Stanley opines on software stocks in 2023

   

   Eric Jhonsa @EricJhonsa

   Morgan Stanley on secular software trends it's watching going into 2023.

   

   2:41 PM ∙ Dec 22, 2022

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   100Likes16Retweets

2. Must read on Dev Rel/Dev Advocates - many folks only see the external part but forget about what’s important behind the scenes - which is the make users happy part, lots of folks forget about this and don't send technical, customer facing resources to bridge gap from sign up to habit

   

   Nathan Peck @nathankpeck

   I’m about to reach six years as a developer advocate at Amazon Web Services. Two years ago I shared a retrospective look at my first four years as a developer advocate and many people told me that article was helpful for them. Today I have a follow up:

   

   nathanpeck.comWhat I’ve learned from 6 years as a developer advocateI’m about to reach six years as a developer advocate at Amazon Web Services. Two years ago I shared a retrospective look at my first fo...

   1:07 AM ∙ Dec 22, 2022

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   126Likes17Retweets

3. the OSS Security Index from Chenxi Wang (Rain Capital, former Twistlock)

4. ❤️ from Daniel Bryant of Ambassador Labs in Platform Engineering in 2023 (New Stack)

   The focus on developers “shifting left” has diluted developers’ focus and overwhelmed them with cross-functional requirements, including observability, security, and scalability. This has led to bold prophecies about the death of DevOps. After all, if devs drift into the operations-focused world of building platforms for themselves, who needs DevOps?

   The idea is for developers to be able to “shift left” without “drifting right.” This is where we come back to not just developer productivity and experience but also the changing role of DevOps teams as developer platforms become the standard, providing developers with much-needed abstractions and tools to be able to do their jobs.

5. DevOps Digest - Predictions 1-8 - so many 💎 from industry leaders - here’s one on platform engineering.

   We're going to see a wholesale shift from DevOps to platform engineering in 2023. Historically, the terms "DevOps" or "DevSecOps" have tried to include too much in their job function, so we are now seeing developer teams increasingly adopt platforms that streamline tasks such as writing rules and policies, creating pipelines, and writing code. The industry is going to lean heavily into adopting platforms that empower teams to do their best work by not overburdening one group with certain tasks and, instead, operating as a team in a platform. By leveraging a platform engineering approach, developer teams can work smarter, faster and provide more business value with stronger outcomes.
   Nick Durkin
   Field CTO, Harness

6. from my @boldstartvc partner Shomik Ghosh, author of Software Snack Bites

   

   Shomik Ghosh 🇺🇦 @shomikghosh21

   How developers find products to use Notice free trials, word of mouth, and communities the biggest areas by far Why content, dev rel, documentation, Github Auth is 🔑

   

   4:54 AM ∙ Dec 21, 2022

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   21Likes4Retweets

7. I’d get on the waitlist for lex.page - a word processor with AI baked in, more to superpower what you’ve already written vs generating from scratch

   

   Nathan Baschez 📧 @nbashaw

   Introducing Lex! A word processor with artificial intelligence baked in, so you can write faster. 👉 lex.page 👈 (I've been working on this awhile... so glad to finally share it!!)

   

   Nat Eliason @nateliason

   I just tried an AI-powered writing app, and I am so so so hilariously out of a job. It literally gave me goosebumps. I'm not allowed to share it with you yet but I will when I can 👀 Please send me new career ideas.

   3:48 PM ∙ Oct 16, 2022

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   5,038Likes518Retweets

Markets

1. On down rounds and venture debt deals - latest from FT “Silicon Valley start-ups race for debt deals in funding crunch” and read my post from last week on why Snyk’s latest round of funding in a clean equity deal with no special clauses was a huge win for 🦄 founders raising in 2023

   Company founders have entered into debt-focused deals such as bridge loans, structured equity, convertible notes, participating bonds and generous liquidation preferences. These moves are designed to avoid a dreaded “down round” — accepting funding at a far lower valuation than a company had previously secured.