The Eye of the Storm
Hello friends, my name is Jack Raines. I will be writing on Alpha’s platform once a week. I
also write a newsletter, Young Money, where I cover all things investing, finance, and careers. You can check it out here. Hope you guys enjoy today’s piece!
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The Eye of the Storm
Hurricanes are destructive forces of nature. With wind speeds of 150+ MPH, a CAT-5 hurricane can destroy cities with ease. In 2005, Hurricane Katrina caused $125B in damages in just eight days.
If your city is located in the path of a hurricane, you will notice that wind speeds increase and the rain grows heavier as the storm approaches. These 20 MPH gusts accelerate to 50 MPH, then 100. Scattered showers become concentrated thunderstorms. Soon, these storms grow strong enough to flip cars, destroy houses, and flood cities.
The irony of hurricanes is that in the dead center of these waves of destruction lies a 30-mile-wide circle of tranquility. No clouds, no wind, no rain.
The eye of the storm is the most peaceful part of the hurricane. The eye of the storm is also the most dangerous part of the hurricane. As the storm marches onward, its eye continues to move. As soon as the eye drifts away from your location, you are subject to the most vicious elements of the storm.
But from the center of the eye, everything seems normal. You have 15 miles of peace in any direction. The sun is out, there isn't a cloud in the sky, and everything feels so normal.
And yet, this period of maximum peace is precisely when you are exposed to maximum risk. If you find yourself in the eye of the storm, it is critical to batten down the hatches and prepare for the danger ahead before it hits. But how do you prepare for the worst-case scenario if you don't understand the dangers around you?
Ladies and gentlemen, we have spent the last 18 months in the eye of the storm. In June 2022, the walls of hurricane are bearing down on us, and many weren't prepared.
After a brief pandemic-induced slowdown in the economy and financial markets, we rebounded seemingly overnight. Stocks climbed to all-time highs. Home prices went parabolic. Alternative asset classes such as cryptocurrencies and NFTs exploded in popularity. Startups raised funding at higher and higher valuations. Every hot tech company went on hiring sprees. Every employee got a pay raise.
Every chart of every possible economic and financial variable pointed in one direction: up and to the right.
And a near-euphoric case of FOMO enveloped anyone with exposure to any asset class. Why wouldn't it? For 18 months, you could seemingly buy anything and generate fantastic returns.
The eye of the storm was a utopia where everyone got a job, everyone got a raise, and everyone's investments were printing money. What got ignored in the eye of the storm was the Pandora's box of risk factors just waiting to burst open.
Sure, we had hints. There were always hints.
Interest rates were at historic lows, surely they wouldn't stay there forever
Trillions of dollars, through quantitative easing and stimulus packages, flooded global economies and markets
Investors throwing money at near-defunct video game retailers and movie theater chains were getting rich
Unprofitable tech companies were going public, one after another, at 11-figure valuations
"Companies" with no functional products used PowerPoints that showed $0 to $10B five-year revenue projections to raise billions through SPACs
"Projects," which had more in common with the half-baked late-night conversations you would hear in fraternity house living rooms at 4 AM than actual businesses, were able to raise millions through cryptocurrency token offerings
The wind was picking up, and we could see some light showers in the distance. But few people understood just how risky the current environment was. How could they? Anyone under the age of 35 has never seen a true "recession" in their post-college adult life. The only downturn that we have seen, March 2020, was hardly a blip on the chart a few months later.
Every dip was a buying opportunity. The price of every asset would keep going up. Everything was fine. Until it wasn't.
Risk Happens Fast
"How did you go bankrupt?" Bill asked."
Two ways," Mike said. "Gradually, then suddenly."
- Ernest Hemingway's The Sun Also Rises
Like bankruptcy, risk happens gradually, then suddenly.
Transitory inflation gave way to 8% YoY CPI prints. Rumors of potential Fed rate hikes quickly became reality as Jerome Powell and company wanted to control our inflationary spiral.
Tech companies extrapolated short-term labor and consumer trends, and tech investors extrapolated short-term revenue and earnings numbers. Believing the momentum would continue, companies over-hired new employees and overpaid for new acquisitions. Companies worth 50x revenue buying smaller companies for 50x revenue worked, until it didn't.
Investors saw 100% YoY revenue growth, and they paid a premium for these high-growth companies under the assumption that this hyper-growth would continue. Venture capitalists bid late-stage private companies higher and higher, because for a decade, investing in growth was a winning formula.
New investors threw more and more money at more and more speculative investments as they sought to generate alpha in new ways. Cryptocurrencies 10x'd, and speculators paid millions for pictures of JPEGs.
Stories and ideas, not fundamentals, were in control.
But the eye of the storm kept moving, the clouds grew more ominous, and things began to break.
The stock prices of every recent tech IPO dropped by 70%+ as growth slowed, expectations and interest rates increased, and suddenly no one was willing to pay 40x revenue for a stock.
Fast, a one-click checkout company that had raised $120M+ in funding, went bust after only generating $600k in revenue last year.
"Stablecoins," namely Terra, became quite unstable, destroying billions of dollars in value as a result.
Over-levered cryptocurrency exchanges such as Celsius paused withdrawals and locked up funds as they faced liquidity crises.
Remote workers who refused to go to the office found that they no longer had an office to go to.
Job offers were rescinded and waves of layoffs hit former high-flying companies after two years of over-hiring and over-spending when money was cheap.
In just a few months, we have gone from peak euphoria to peak fear. All-time highs to face-ripping declines. Overpaid and underworked to underpaid and unemployed.
Risk happens fast.
Risk is highest when it feels lowest. When all assets have been climbing up and to the right for months, and companies are freely spending millions (and billions), and employees are paid a ton of money for not a ton of work, it feels like the good times will roll forever.
But nothing lasts forever.
The problem is, we have a tendency to overemphasize our current experiences, while we discount history. Two years is just enough time to normalize recent events, no matter how extreme they may be.
Two years of euphoria leads to an expectation of more euphoria. And when euphoria becomes the new normal, a regression to the mean is painful and unexpected. Investing isn't supposed to be easy. High cash burn isn't supposed to be sustainable. Lines don't go up forever.
But the eye of the storm is a seductive place, and two years is a long time to spend in the eye of the storm. After two years, it's easy to forget that the storm even exists.
Those who are lulled to sleep by the false peace of the eye are hit the hardest once the storm moves.
We are beginning to see who was prepared for the storm, and who forgot that the storm existed.
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