Drinking from the Firehose #138: 🔝 Index bubble. 🔝


Bubbles are a frequent topic of conversation in Silicon Valley. The discussion usually focuses on individual companies whose last round price seems to be inflated relative to fundamental value (e.g. WeWork), or whole sectors that seem to be trading at inflated multiples relative to recent comps history (e.g. recent bottoms-up SaaS IPO's).

A true bubble is one where the perception of value departs from reality, and that perception is reinforced by a herd mentality. At its worst, bubble logic says an asset's value will go up because of its upward momentum at present. When profit taking occurs, the chain of events inevitably produces a downwards spiral of value destruction.

Tech valuations, while aggressive in some instances, do not seem bubbly to me today. WeWork is a singular example. Its last private valuation is a function of a particular investor's motivations. That investor reportedly has a deal structure such that the "headline price" doesn't represent its true pricing of WeWork's equity. Bottoms-up SaaS as a sector appears to have eye-popping valuations compared historical SaaS multiples (e.g. ZM at 32x NTM revs, SHOP at 23x NTM revs). Yet, the efficacy of the bottoms-up business model is enabling the growth of companies in markets that were previously inaccessible and massive.

Michael Burry, on the other hand, sees a bubble in plain sight. In his opinion, it's everywhere and nobody sees it.

Burry was famously played by Christian Bale in The Big Short and previously ran Scion Asset Management, the firm that made a killing by shorting the real estate market before the last U.S. recession. He compares the CDO crisis back then to the state of passive index funds today.

Index funds? What could be more banal? If they just track the market, shouldn't they reliably go up over long periods of time? How can that be controversial?

For Burry, the bubble isn't in the market itself, but in the mechanisms firms like Vanguard have built to track it. In his own words:

"Passive investing has removed price discovery from the equity markets. The simple theses and the models that get people into sectors, factors, indexes, or ETFs and mutual funds mimicking those strategies -- these do not require the security-level analysis that is required for true price discovery.

This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis in that price-setting in that market was not done by fundamental security-level analysis, but by massive capital flows based on Nobel-approved models of risk that proved to be untrue.”

Index funds are projected to account for half of the entire U.S. investment management business by 2024, up from 29% today. The notion that the nearly universal enthusiasm for these funds is founded upon shaky ground is fascinating to me. I encourage folks to read more below on Burry's justification and let me know if you have a strong argument against his views.


The Big Short’s Michael Burry Explains Why Index Funds Are Like Subprime CDOs

This structured asset play is the same story again and again -- so easy to sell, such a self-fulfilling prophecy as the technical machinery kicks in. All those money managers market lower fees for indexed, passive products, but they are not fools -- they make up for it in scale. Potentially making it worse will be the impossibility of unwinding the derivatives and naked buy/sell strategies used to help so many of these funds pseudo-match flows and prices each and every day. This fundamental concept is the same one that resulted in the market meltdowns in 2008. However, I just don’t know what the timeline will be. Like most bubbles, the longer it goes on, the worse the crash will be.



Stop and Go.

Amazon Go is a shopping experience so smooth it feels like stealing. The tech that enables Go is serious business, however, and testing it at scale has proven expensive for Amazon. According to The Information, costs of the Go initiative are growing from $224M in 2018 to $474M in 2020. Next year, the projections call for 156 stores, which would imply $3M+ in spend per store. That's significantly more than a traditional store format like 7-Eleven. Unless Go stores can generate multiples on standard convenience store rev/sq ft comps, they need to be significantly more profitable than standard stores to make the economics work.


Spin the black circle.

For the first time since 1986, vinyl is about to sell more units per year than CDs. Nostalgia's a helluva drug.


Can you hear me now?

AI-generated impersonation attacks are just getting started. A software program parroting the voice of a German executive managed to convince a subordinate to wire money to a (fake) Hungarian supplier on short notice.

The power of such technology at scale is frightening. Imagine A/B testing the script and simultaneously targeting multiple employees with signatory capabilities. When computers are making the phone calls, fraud can scale and transform rapidly.


Be kind. Rewind.

Reversing the biological clock is typically the stuff of science fiction, but a recent study in Nature demonstrated a reversal in the epigentic clock. Patients took a combination treatment of growth hormone and anti-diabetic drugs. While the sample is small (only 9 patients), the effect is sizable and unexpected. It even persisted 6 months after the study concluded.


Triple neck madness (video).

One of my favorite YouTube rabbit holes is acoustic covers of heavy metal songs. Remove all the distortion and growling and you get a better sense for the interaction between melody in rhythm.

I recently stumbled upon this video of an Italian guitarist named Luca Stricagnoli, who specializes in altered guitars with multiple fretboards. Here he covers several Iron Maiden songs with a triple neck monstrosity.