From: allin
The current state of the US economy and the Federal Reserve’s policies are major discussion points, particularly concerning interest rates and their impact across markets [00:37:41].
Interest Rate Environment
Interest rates are a key factor influencing investment decisions across both public and private markets [00:09:13].
- Short-Term Rates: Credit Suisse offered a 6.5% yield on a three-month T-bill to private banking customers [00:08:51]. Robinhood also offers 5.2% on accounts [00:26:44]. However, the three-year treasury bill rate was noted at 4.7% [00:26:21].
- Long-Term Investment Thresholds: For long-term investments like startups (typically 10-15 years), a venture investor would need to generate 20% to 25% returns if the three-month money is paying 6.5% or 7% to make the investment worthwhile [00:09:13].
- Market Expectations: One month prior to the discussion, the two-year bond rate was 4.1% versus the Fed funds rate of 4.5%, suggesting the market expected interest rates to fall [00:37:57]. This has since shifted, with the two-year bond rate at approximately 4.9% against a Fed funds rate of 4.5%, indicating market expectation of higher rates for longer and a need for the Fed to continue raising rates [00:38:24].
- Inflation Outlook: Despite expectations at the start of the year for the S&P to retest 3200 and an earnings recession, the equity markets have held up well [00:40:00]. The consensus view suggests inflation is “sticky” and will remain at higher levels (3.5% to 4.5%), leading to expectations of three or four more 25 basis point rate hikes [00:39:30]. This means higher rates and higher inflation are expected to persist longer [00:41:01].
- Uncertainty: The market dislikes uncertainty [00:41:07]. While the market has functioned with 3% inflation and 5.5% rates previously (e.g., during the internet boom 2000-2005), if allocators of capital are unsure whether rates or inflation will double again, everything could shut down, which would be detrimental to the economy [00:41:41].
Impact on Investment Markets
Private Markets & Venture Capital
The cost of capital currently limits the amount of money flowing into new businesses [00:12:20].
- Pressure to Deploy Capital: Venture investors are under pressure to deploy committed capital, as limited partners (LPs) can otherwise earn significant returns (e.g., 6.5%) from short-term T-bills [00:09:48]. This pressure may lead to over-investment in new trends, potentially resulting in poor returns for many companies [00:10:32].
- Time Diversity: A lack of time diversity, where capital is deployed in a very short period, often leads to terrible returns, as seen in past cycles like Web3 and crypto [00:10:46].
- LP Behavior: LPs typically have a 10-year view and expect inflation and rates to come down [00:27:08]. They are not quickly shifting allocations from venture to rate bets [00:27:46]. Instead, they are narrowing their focus to the top 10% of venture firms that demonstrate strong deal flow and selectivity [00:28:10]. Subscale and smaller funds without a track record of distributions (DPI) will find it challenging to raise capital [00:29:01].
- Valuation Adjustments: The second half of 2023 and all of 2024 are expected to see a lot of “medicine being taken” in the form of down rounds and restructurings for companies that received peak valuations in 2021 [00:30:52].
Public Markets & Earnings
- Cash Flow vs. Earnings: There is currently the worst gap in 30 years between reported net income (earnings) and actual cash flows from operations for S&P 500 firms [00:44:10]. This suggests that some reported earnings may be inflated due to accounting tricks [00:43:50].
- Earnings Recession: This discrepancy supports the view that an earnings recession may be at hand, potentially leading to a 15% reset down in S&P 500 valuations [00:44:31].
- Stock-Based Compensation (SBC): SBC has been a significant factor in Silicon Valley, often used to hide expenses and leading to “bloat” in employee numbers [01:10:10]. While intended to align employee incentives in early-stage companies, it has become a major expense for public companies, often adjusted out of reported earnings, leading to substantial dilution for shareholders [01:05:37]. Some companies, like Booking.com, include SBC in all reported metrics, resulting in much lower shareholder dilution compared to others [01:09:01]. There is a call for compensation committees to base bonuses on free cash flow per share to ensure better accountability [01:11:16].
Consumer Economy
- Resilience: The US consumer has remained resilient, with record-low unemployment rates (1% in Utah, 3.5% nationally) and multiple job openings per unemployed person [00:45:21]. Retail and e-commerce sales have continued to perform well [00:47:05].
- Offsetting Factors: While higher interest rates impact consumers through increased mortgage and credit card expenses, these have been offset by lower energy costs and ongoing stimulus, such as cost-of-living adjustments in Social Security [00:46:01].
- Layoffs: Despite widespread layoffs in the tech sector, this has not significantly impacted the broader consumer economy, which remains robust [00:46:39].
Macroeconomic Outlook
While there is uncertainty in the short term, the long-term outlook suggests that the US economy is undergoing a significant shift.
- Higher Rates for Longer: The prevailing view is that rates will be higher than desired and stay there longer than expected [00:42:11].
- Withdrawal Symptoms: The rapid pace of interest rate increases, after a decade of near-zero rates and monetary stimulus, is causing “withdrawal pangs” for parts of the economy addicted to easy money [00:50:51]. This is particularly visible in sectors like real estate, which has seen year-over-year decreases [00:51:30].
- Tech Sector Resilience: The tech ecosystem, having experienced its bubble and crash in 2021-2022, is largely on the other side of its downturn [00:49:14]. New investments are being made intelligently, with a focus on milestone-based funding, product-market fit, and efficient capital deployment [01:17:17]. Innovation continues regardless of the macroeconomic picture [00:50:06].