Olson’s Observations

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The Credit Crisis: What’s with the stock market?

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As a lot of you know, the stock market was my first love as far a business goes.  I have followed the market closely ever since I was 13 and I continue to do so today.  In my relatively short time following the market I have seen some interesting things.  The unprecedented growth in the 1990s.  The tech bubble inflating and eventually bursting. And now I am watching the incredible sell off set in motion by the credit crunch.

I honestly thought that we’d see some support in the markets around the Dow’s 9,000 mark but the market continued to fall.  That surprised me a little bit considering the values that are there for the taking right now.  I am sure the value guys, like my former boss at Eaton Vance, Mike Mach, are starting to snag some solid companies are ridiculously depressed prices and they will make a killing on the upside (value hounds are going to work!).

To me the drop from the 9,000 level to the 8,000 level was complete fear.  Irrationality had set in.  Over the weekend I did some thinking about this while riding my bike on the lake front and I figured that over the weekend people would start to wise up and the smart investors would start buying again due to the incredibly cheap stock sitting right in front of them.  Today it looks like things are picking up a little and perhaps the fear, while still there, is becoming more rational (if that makes sense) and greed is picking up again.

Matt McCall put out a post today about his thoughts on the credit crunch and how long it may last.  McCall gave a time frame that I also would have suggested; about 2 - 3 years of tough times followed by 2 - 3 years of modest growth and then we will see things pick up again.

McCall also wrote about the difference between equity driven crashes and credit driven crashes, which I think bears quoting.

In equity driven situations, investors need to feel that prices have gotten low enough and they will come back in (fear turns to greed). In credit driven crashes, the whole system needs to “de-lever” and the process is longer and more complicated. The core issue is that families have too much debt. So, the debt needs to go away to fix the problem. Unfortunately, because of cheap debt, poor oversight and general greed, this debt party has gone on way too long. Consumers are underwater on mortgages and credit cards and the government is approaching the trillion dollar nut. Fortunately, corporations are generally not as bad off though some will get into trouble.

It seems that investors are starting to believe that prices have reached a point where they are too low (let’s hope anyway!) but, as McCall says, credit is a whole other story and that piece will take a while to clean up.

This credit crunch is a wake up call for all of us.  Americans have alarmingly high debt compared to the rest of the world.  They also have alarmingly low savings rates.  Combine the two and you have a recipe for disaster, a disaster that we’re currently in the midst of.

However, there is a positive side to all of this.  Perhaps Americans will begin to borrow less and save more.  This would be great for the country in the long run.  Also, as far as startups go, times will be lean for the next 3 - 6 years but in year 7 the best and most lean companies will be left standing and they will reap big rewards for their responsible business building efforts.  In essence we will have separated the wheat from the chaff, which will make our economy much stronger going forward.

I am looking forward to McCall’s follow up post on how VCs and portfolio companies can survive the next 5 - 7 years. It should be a good read.  In the meantime I would suggest reading his latest post in full.  It’ll be well worth the five minutes you’ll spend on it.

Written by Eric Olson

October 13th, 2008 at 9:59 am