Speculation and Investment

INET-CIGI Conference: Toronto, April 11, 2104William H. Janeway

Warburg PincusUniversity of Cambridge/Princeton University

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Objects of Speculation

“Investors have speculated in commodity exports, commodity imports, agricultural land at home and abroad, urban building sites, railroads, new banks, discount houses, stocks, bonds (both foreign and domestic), glamour stocks, conglomerates, condominiums, shopping centers and office buildings.” (Kindleberger and Aliber, Manias, Panics and Crashes: A History of Financial Crises, 6th edn. (New York: Palgrave Macmillan, 2011) p. 15)

Bubbles: A Typology

Locus of Speculation

Non-Productivity Enhancing

Productivity Enhancing

Object of Speculation

2005-2008

1998-2000

Banking System

Capital Markets

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Profiles of Two BubblesNew York: 1929 and 1999

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Keynes’ Bridge

“The daily revaluations of the Stock Exchange . . . inevitably exert a decisive influence on the rate of current investment. For there is no sense in building a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; while there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectation of the professional entrepreneur.” (Keynes, General Theory, p. 151)

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Tobin’s Q and Technological Innovation

“The average q ratio for existing capital stocks may be a serious understatement of q for new capital goods of quite different nature. This occurs spectacularly when the new have rendered the old obsolete. The Schumpeterian phenomenon may occur within a single firm, but it is more likely to characterize whole industries or economies during periods of rapid innovation. It is at least conceivable to observe investment booms during periods when observed average q ratios are low and even declining.” (Tobin and Brainard, p. 243)

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US VC Returns Relative to IPO Market

Exit conditions < 2 19% 9%Exit conditions = 2-3 33% 24% Exit conditions > 3 106% 76%

Mean Median

Source, McKenzie and Janeway, “Venture Capital Funds and the Public Equity Market”

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Harris, Jenkinson and Kaplan:Actual and Estimated PMEs

Harris, Jenkinson and Kaplan, Figure 2, Panel B

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US VC Fund-raising 1980-2011

# of Funds $B raised $B managed 1980 52 2.0 2.1 1985 118 3.7 11.4 1990 86 3.2 22.1 1995 165 9.5 32.4 2000 649 105.0 182.2 2005 234 30.8 234.4 2010 173 13.2 164.7 2013 185 16.7 n/aSource: National Venture Capital Association

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Crossing Keynes’ Bridge:Financial Valuation and Real Investment

“By conveying a positive signal about profitability, higher aggregate investment . . . increases asset prices, which in turn raises the incentives to invest. This two-way feedback between real and financial activity makes economic decisions sensitive to higher-order expectations and amplifies the impact of noise on equilibrium outcomes. As a result, economic agents may behave as if they were engaged in a Keynesian “beauty contest” and the economy may exhibit fluctuations that may appear in the eyes of an external observer as if they were the product of “irrational exuberance.” (M. Angelotos, Lorenzoni. G. and Pavan, A., “Beauty Contests and Irrational Exuberance: a Neoclassical Approach”; emphasis in original)

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Financial Valuation and Technological Change

“The effects analyzed in this paper are likely to be stronger during periods of intense technological or institutional change, when the information about the profitability of new investment opportunities is likely to be highly dispersed. At some level, this seems consistent with the recent experiences surrounding the internet revolution or the explosion of investment opportunities in emerging economies.” (Angelotos, Lorenzoni and Pavan, p. 32)

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Amazon

“Amazon’s IPO, on May 15, 1997…raised $54 million.…(p. 59)“…In those highly carbonated years, from 1998 to early 2000, it raised

a breathtaking $2.2 billion in thee separate bond offerings….(p, 69)“While other dot-coms merged or perished, Amazon survived through

a combination of conviction, improvisation and luck. Early in 2000…Amazon sold $672 million in convertible bonds to overseas investors….The deal was completed just a month before the crash of the stock market, after which it became exceedingly difficult for any company to raise money. Without that cushion, Amazon would almost certainly have faced the prospect of insolvency over the course of the next year.” (p. 101)

B. Stone, The Everything Store: Jeff Bezos and the Age of Amazon

Where Are We Now: Hot Web Start-ups

Where Are We Now: the IPO Market

VENTURE-BACKED IPO EXIT ACTIVITY MAINTAINS MOMENTUM WITH BEST QUARTER FOR NEW LISTINGS SINCE 2000; LED BY LIFE SCIENCES COMPANIES, FOURTH CONSECUTIVE QUARTER FOR 20+ OFFERINGS

Average M&A Deal Size at Highest Level Since 2004 New York, New York, April 2, 2014 – Thirty-six venture-backed initial public offerings (IPOs) raised $3.3 billion during the first quarter of 2014, a 50 percent increase, by number of new listings, compared to the previous quarter, according to the Exit Poll report by Thomson Reuters and the National Venture Capital Association (NVCA). This quarter, which marks the fourth consecutive quarter to see 20 or more venture-backed IPOs, is the strongest three-month period for new listings since the third quarter of 2000.

A Tale OF Two Mini-Bubbles

BioTech Internet

Where are We Now: S&P Price/Earnings Ratio 1881-2014

Source: Wikipedia, “Price-earnings ratio”