How Private Markets Are Impacting Public Markets

I believe that active management has a place in everyone’s portfolio. With that said many people might do reasonably well over time if each month they simply dollar cost average in a simple portfolio that consist of an U.S. equity index like the S & P 500, a few international  ETFs that cover both developed and emerging markets and some muni bonds. This approach has helped consistent savers to average about 6-7% per year over the past 30-40 years.  Can we expect this approach to continue to work in the future? No one could know for sure. Past data is all we have. Any speculation about the future is just that – speculation.

There is a good reason to opine that the 6-7% average annual return that a diversified portfolio has returned over the past will significantly diminish in the future. The cause – private markets have changed substantially. In “The Next Apple”, we wrote that investors need to adjust their expectations about new IPOs:

Nike, Microsoft Amazon and similar companies went public relatively early in their growth cycles. As a result, public investors had the opportunity to participate in 95 to 99% of their overall price appreciation. Founders, early employees and VCs took all the risk. Most of the reward was left for grabbing – anyone could’ve bought those stocks on the secondary markets.

As the Federal Reserve prints more money and interest rates remain low, an increasing percentage of capital is flowing into risky asset classes like venture capital and “angel investing.” This capital has chased up valuations in the pipeline preceding IPOs, making the IPOs feel more like the end of the journey, not the beginning. Thus, investors must adjust their expectations and understand the new metrics in the context of the speed at which companies are being created, growing staff and revenue, and expanding globally.

It has become harder to get small companies to market. The venture capital industry is playing the role that the public market used to play for micro-cap IPOs. As a result, nearly all of the market value of public technology companies is accruing while they are still private.

The IPO market has changed tremendously over the past few decades. It used to be that companies went public because they needed cash to expand. In 2015, high-growth companies can raise all the money they need in private markets.

Look at the data below, and tell me if you notice a trend: Total VC money ever raised by select companies:

Microsoft: 1MM

Apple: 3.6MM

Intel: 2.5MM

Cisco Systems: 2.5MM

Google: 25MM

Webvan: 441MM

Facebook: 2,426MM

Uber: 4,000MM

The growth that is supposed to come from young public companies isn’t likely to come. Nowadays, many of the companies with a great growth story are staying private longer and going public as much more mature companies. As a result they leave a lot less meat on the bone for public investors. This trend is likely to accelerate.

Yes, recent IPOs continue to be amazing short-term trading vehicles. Due to their small float and supply/demand imbalances in the first 6-12 months after they go public, many new issues could appreciate substantially. By the time they are fit to join any of the major indexes, many of them are likely to have bloated valuations and slowing growth numbers.

This means that simply buy and hold an index isn’t likely to work as well as in the past. The only way to have a shot at achieving good returns in public markets today and in the future is active management, which includes timing market exposure, swing trading, position trading, trend following, proper risk management.

Just my biased opinion.

Carl Icahn’s Favorite Setup


Frank Zorrilla has an interesting piece on Carl Icahn’s position trade in Netflix:

Carl Ichan showed the world how he made over $2.1 billion dollars on a $321 million dollar investment.   Carl bought $NFLX in late 2012 when the stock was in a downtrend, near its 52 week low, he sold it today as it traded at all time highs.  Buying stocks near lows and in downtrends goes against what every trading book and trading guru advises you to do.  Carl made over 1000% doing the exact opposite.

While it is absolutely true that there are various ways to extract money from the market, you have to take into account the little details to gain a better understanding of Icahn’s approach:

First of all, the mere size of Icahn’s portfolio simply limits his options. It is hard to put $300 million to work in a stock that has just broken out to new all-time highs. You almost need the liquidity that corrections and forced liquidations bring in order to build a large position at favorable price.

Carl Icahn sold half  of his position in Netflix in October 2013, when it was trading at $315 or 55% below its current level. His gain at the time – over 400% in 14 months – Netflix was trading near $58 in late 2012, when he started to accumulate it. Icahn went from owning 9.4% of Netflix to 4.5%. Here’s what he tweeted at the time: “Sold block of NFLX today. Wish to thank Reed Hastings, Ted Sarandos, NFLX team, and last but not least Kevin Spacey,”.

At that time, Netflix reported record quarterly results and it gapped to new all-time highs. Carl used the liquidity that a new all-time high provided and sold some of his shares at a favorable price. Remember, when you have a large position, it makes a lot of sense to take partial profits on strength. Also, one of the ways to stay longer with a trend is to take partial profits along the way. No one knows how long a trend will continue or how far it will get, but it is a lot easier to continue to ride a trend by taking partial profits along the way, especially when you trade with a size. Here’s Carl on the subject:

“As a hardened veteran of seven bear markets I have learned that when you are lucky and/or smart enough to have made a total return of 457 percent in only 14 months it is time to take some of the chips off the table.”

Basically, one of the major reasons Icahn sold was because his Netflix position became too big as a % of his portfolio.

For the record, his son Brett Icahn did not agree with the early sale and at the time said that Netflix continues to be significantly undervalued. Nathan Vardi has the details on the story:

Brett Icahn and Schechter wanted to hold onto all of their Netflix shares and not cut back on the position, but Icahn overruled them. Instead, in an unusual arrangement Icahn agreed to increase the Sargon funds under management if Netlix’s stock kept rising so that the Sargon portfolio would capture those Netflix gains. Icahn committed that the sold Netflix shares would be deemed to remain in the Sargon portfolio on a notional basis for the purposes of calculating the market value of the portfolio and be reflected in the performance fee of Brett Icahn and Schechter.

Using Overbought Signals

Many traders use RSI to measure overbought and oversold conditions. The textbook says that a reading above 70 is typically considered overbought, a reading below 30 is considered oversold. Different traders use RSI in a different manner.  Some sell a long position that has been in a long-term downtrend when it becomes overbought on shorter time frame. Some buy stocks in a long-term uptrend when they become oversold on a shorter time frame. Some only buy when a stock suddenly becomes overbought – usually after a high-volume gap, and then sell when it stops being overbought.

Here’s Greg Harmon’s take on the subject:

Perhaps there is a better way to understand and interpret the overbought condition. It may be easier if you let go of the label all together, since it is randomly selected anyway. What if instead you looked at just two things to determine if a stock is for you or not. First, is the RSI rising, falling or flat. If it is rising or flat then the momentum is increasing or holding by definition. This is not a time to avoid a stock.

Second, is the price confirming or diverging with what you see in the RSI? Price and its direction is always more important that any indicator. That is because price is all that matters to your transaction when you buy or sell. I do not like to buy stocks when they are falling. That is my rule and it is not for everyone, nor the only way to make money.

In “The Next Apple”,  I wrote about using weekly RSI above 80 as a means for partial profit taking:

The technical term “overbought” basically means acceleration in buying to levels that might not be sustainable for too long. What could possibly be wrong about an overwhelming number of buyers? It might be an indication that there is no one left to buy. Some institutions need the liquidity that new highs provide in order to exit a big position.

Using a weekly RSI above 80 is a good rule of thumb, but it is not perfect. There are stocks that remain overbought for a very long time and go up 100% – 200% after hitting that level. It is rare, but it happens. In 2013, Tesla Motors went from $ 55 to $ 200 while its weekly RSI stayed above 80. The hottest stocks of each year often don’t care about overbought conditions.

Under overbought conditions, you need to look at everything in context. Those conditions could resolve through time consolidation or through a price pullback:

– Is it a fresh breakout from a humongous base? Have earnings just accelerated? In this case, an overbought condition is likely to be the beginning of a powerful new trend, not the end.

–  Is the stock already up more than 800% in the past three years? Do most analysts have a buy rating on the stock? Is the institutional ownership above 90%? Are the CEO and the company featured on the first page of magazines, newspapers, websites? In this case, a severely overbought condition is a good reason for partial profit-taking.