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Vruz sent me a copy of this CIBC research report called "Heading For The Exit Lane." I read it this morning and I've been thinking about it for most of today. So I uploaded it to Scribd and reblogged my favorite line in the report on my tumblog. But that didn't get the report out of my head.

This oil thing sure has legs. Even if we aren't in a "peak oil" situation (and even the Saudis can't agree about that), we've gotten to a price point where consumer behavior is going to change significantly over the next few years. Over the long term, that's a good thing. The world economy is addicted to oil, largely because it's been so cheap for so long. But it's not cheap anymore and given the pace at which the rest of the world is developing these days, it's not going to be cheap ever again. Unless we find another source of energy that is a lot cheaper than oil and I am not aware of any developments that will get us there soon.

This has bigtime ramifications for slowing growth and rising prices (inflation). And these impacts will not be limited to the US economy. They will be felt worldwide. The hypergrowth economies of China, India, Brazil, Russia, and other developing economies may not be impacted as much as the more mature economies like Japan, Europe, and most of all the US. Russia, in particular, stands to benefit greatly from the spike in oil prices.

Slower growth and rising prices (inflation) cannot be good for equities. Rising rates, which is what will have to come, will not be good for any kind of financial assets.

Which, of course, leads me to venture capital. The value of your equity in a startup company is a financial asset. It may not be publicly traded but like all other financial assets it is ultimately worth the present value of future cash flows discounted at an interest rate that takes into account market rates of interest plus a risk premium.

We've been operating in a world where real interest rates have been hovering around zero (at least in the US). And that has propped up the value of equities and venture capital assets have been part of that prop-up.

All we have to do is look at the 70s to see the effect of low growth and high inflation (stagflation). Here is a chart of the Dow Jones Industrial Average during the 1970s.

Yes, that's right, the Dow Jones Industrial Average ended the 1970s right about where it started.

I wasn't in the venture capital business in the 1970s. I was a teenager that decade. I remember Vietnam, Watergate, the oil shocks, the gas lines, Gerald Ford, whip inflation now, Jimmy Carter, the Iran hostage crisis, and Paul Volcker and Ronald Reagan.

The first venture capital firm I worked for, Euclid Partners, was formed in 1971. The two founding partners, Milton and Bliss, raised about $4.5mm in 1971. They didn't raise another fund until 1983. They strugggled mightily during the 1970s with their portfolio and ultimately made it work when the technology market took off in the early 80s. I heard a bunch of stories from them about that time and it was not an easy time to be an entrepreneur or a VC.

Surely the next 10 years won't be identical to the 1970s. A lot has changed, particularly the global economic environment. But it's also clear that the economy we are in (and maybe have been in for the past 18 months) is going to be tougher for owners of financial assets than the past 20 years have been. And I don't think the startup economy and venture capital is immune to this new reality.

So what should we do about it? Well first, we need to be careful with valuations. If financial assets are going to be subject to downward pressure then inflated valuations will not be sustainable. We need to be careful with the amount of money we invest and burn. Companies that are capital efficient and cash flow positive will fare better in this environment. And we need to be prepared to wait a long time for liquidity.

It's ironic that the title of the CIBC report is "Heading For The Exit Lane" because I think the exit lane will take longer to find and possibly be less rewarding in the coming years.

A Final Thought: This may mostly be good news for cleantech investors. As oil gets more expensive, cleantech and alt energy technologies can become commercially viable more quickly. But it takes a lot of money, biotech-like capital investments, to get most cleantech investments to profitability. So if the capital markets are going to be more difficult, it's not all good news for cleantech. And the web clearly has a role to play in all of this too. More on that later.

Mike Arrington calls Yahoo!'s decision to partner with Google and finally walk from Microsoft a "Massive Destruction Of Shareholder Value, Employee Morale and Internet Balance Of Power" I don't agree with that view and have stated my opinion about this deal on this blog since the day Microsoft started it's hostile attempt to buy Yahoo! [YHOO]

Here's my comment to Mike's post:

Mike add me to that list of Jerry, Sue, and Tim [O'Reilly]

I’ve been rooting for this outcome since Microsoft first started their effort to acquire Yahoo! It’s worth noting that at today’s closing price, Yahoo! stock is trading about where it was a year ago and above where it was at the start of the year.

The Microsoft hostile move backfired on Microsoft and pushed Yahoo! closer to Google. Yahoo! finally woke up and did what they should have done years ago, cede search monetization to Google who simply does it better and will always do this era of search better than anyone else.

Now Yahoo! will do what it needs to do. Clean house, get lean, get out of businesses it shouldn’t be in. Focus on what it’s good at. And start making money and growing again.

They may need new leadership to do that. But selling this asset to Microsoft just because they had the wrong leadership and probably still have the wrong leadership is a mistake.

Imagine what the right CEO could do with Yahoo!

I went to an event yesterday that featured a number of people active in the hedge fund industry and the financial markets. Here is the series of twitters I sent during that event.

  Headed to the semi annual meeting of a hedge fund of funds. Expect to get some insights and will twitter them

  Observation: great hedge fund managers have come out of goldman, tiger, and michael price's firm

  Has the financial system crisis run its course? Most likely yes if banks and the fed keep doing what they are doing

  Has housing in the US bottomed? Maybe not, but the bottom is nearing. Watch for change in expectations, not prices

  What about the US economy? A tale of two cities. Not like past recessions.

  Inflation? Watch out, its here and more is on its way driven by massive global liquidity of capital

  Regional banks: look for a wave of regional bank failures. Fed won't bail them out

  To clarify that string of tweets and what follows: these are opinions I am hearing at a hedge fund event

Systemic risk is largely gone from the markets but economy risk remains. Market knows how to price the latter but not the former

  @tweetipFH oil (and food) prices are creating big problems in parts of the economy

Hedge fund manager singing the praises of aapl. He's right of course. But his framework is based on the world as it exists right now

  Had to leave the hedge fund event. I hope you enjoyed the twitters

I put up a poll on this blog yesterday and a number of other blogs picked it up or linked to it. The net result was about 1,800 responses as of 6am eastern this morning. You can track the responses (and the number of them) at this poll result page.

The wisdom of the crowd is the closing price today will be $22. I took the percent of vote at each price level and then multiplied them out to get that expected value. Here's the distribution of votes:

The look of this chart tells me that I should have let people vote for some lower prices and that $16 vote was chosen by a number of people who would have voted for lower prices. That would have brought down the expected price, but not by much.

So if my poll is correct, YHOO will be down almost 25% today and I suspect the biggest drop will be in the morning. That's $8bn of market cap lost.

As most of you know, I think Yahoo! made the right choice by walking away from Microsoft's bid. I think it was a wakeup call and they can and will deal with much of what ails them.

Yahoo! had about $2bn of EBITDA in 2007 before you add stock based comp charges. At $32bn ($22/share), Yahoo! will trade at 16x EBITDA and that's not including the impact of their cash, their Yahoo! Japan stake, and their Alibaba stake which together add up to $14bn of value or $10/share. If you back that out, Yahoo!'s a bargain at $22/share.

So if it gets there today, I'll be buying some. I still think it ends the day at $26/share, which was my vote that kicked off the poll.

I voted already and voted for $26/share. I think Microsoft has shown how much value Yahoo has and the market will reflect that once it thinks this through.

And please feel free to embed this poll in your blog. It's all one big poll so the more embeds the more votes we'll get.

Reading the ms/yhoo news on my bberry via twitter. I know I'm in the minority but I think yhoo did the right thing. Great outcome

I wrote a short post yesterday wondering what was in store for the financial markets in the wake of the Fed and JP Morgan bailing out Bear Stearns. This is what's been on my mind the past week for the most part. Sure, we've been thinking a lot about what's now possible with all the new platforms that are emerging (iPhone SDK, YouTube, myspace, etc), and there are plenty of interesting things going on in techland and in our portfolio. But we've got a full blown financial panic playing out on Wall Street and doing venture capital from NYC somehow makes us more cognizant of what's going on. We've got friends working at places like Bear, we've got friends working at hedge funds that are trying to stay afloat. It's brutal on wall street right now.

I read the twin articles on the mess on the front page of the NY Times today, but honestly, I am finding way better stuff in the blogs.

Here's Roger Ehrenberg on why Bear is toast and who's likely to end up picking up the pieces. That's good stuff. I am going to surf around the financial blogs this weekend and I'll post again with other interesting views that turn up. Please feel free to leave links on the comments.

I am sure we'll all be hearing about moral hazards and the like in the wake of the Bear Stearns bailout by JP Morgan and the Fed. This is scary stuff. Henry Blodget talks about the claim that Bear is too big to fail in this post on SAI.

My question is who else is too big to fail but would fail without a similar bailout? How many more of these are coming our way?

Ugh

Twitter bots are a lot like IM bots. You send them a message and they send you one back. Except, of course, you can do that through twitter, on any "device" (Facebook, SMS, web, third party client, etc) you want.

My favorite twitter bot so far is the mytrade stock quote bot that launched late last week.

Here's how do do it (you need to be a registered twitter user to do this):

First, go to mytrade's twitter page and follow them.

Then, wait a minute or two for mytrade to follow you back (no need to do anything for that to happen)

Then, send a message via your phone or any other twitter client device that says:

d mytrade AAPL

and get an Apple stock quote back.  Of course you can replace AAPL with anything else you'd like.  And you can separate ticker symbols with a space to get a bunch of quotes, like this

d mytrade AAPL GOOG AMZN

to pick three tech companies I am long right now

I hope you like it as much as I do.

Over the past month, my wife and I had a run in with the auction rate security market. We emerged unscathed but there were a few uncomfortable moments and they taught us a few things about markets that we had sort of understood but not at a gut level. There's nothing quite like a few sleepless nights to teach you lessons you'll keep for the rest of your life.

It all started almost a year ago, when we parked a significant amount of cash in tax free municipal bonds. The cash is intended to be used to fund a purchase we plan to make later this year. We wanted the money to be totally safe, very liquid, and produce income that we didn't need to deal with the hassle of calculating and paying estimated taxes on. So with the advice of some experts on tax free bonds, we purchased three auction rate tax free municipal bonds.

For those who don't know what an auction rate security is, here's a short explanation. If you want a longer one, click on the link in that last sentence and wikipedia will do its magic for you. Auction rates are generally long term bonds (corporate or muni) that have their interest rate reset every week via an auction. This does two things. First, it allows the borrower (the corporation or municipal government) to pay short term rates on a long term security. And that can be very beneficial to the borrower. It also allows the purchaser of the bond to have much higher liquidity because the auction rate security is re-auctioned every week. So every week, you have the opportunity to say that you want out and you get out. At least in theory.

We've owned auction rate munis on and off for almost 10 years so it's not like we were new to this market. But the amount we parked in auction rates last spring was significantly more than we'd had in auction rates in the past. I understood how they worked, but honestly never paid much attention to the specifics.

One specific provision of auction rates that is really important, but I honestly knew very little about until the past couple months, is the penalty rate (or maximum rate). If a bond auction does not generate enough demand at any time in the life of the bond, it's reverts to a long term bond and pays a maximum rate of interest.

Until the recent problems in the fixed income market, brought on by the subprime mess, the auctions of these securities didn't generally fail. There were a ton of buyers in the market and there was plenty of liquidity. But several things happened that have changed the auction rate market, at least temporarily.

First, and most importantly, the issuers of auction rate securities generally get the bonds insured against default in order to improve the credit quality and rating of the bonds. These bond insurers have gotten into trouble in the subprime mess and they are in various stages of financial distress. Without the security blanket of the bond insurer, many of these auction rate municipal bonds look a bit riskier and so the demand for them has gone down.

In addition, there is a general de-risking going on across all of the capital markets with investors opting in favor of really safe investments right now. So that further dampened the demand for the weekly auctions.

Starting late last year, auctions starting failing. And they have continued to fail for most of the first two months of this year. Investors who were sold a "safe and liquid" bond are waking up to find out that they now have a "pretty safe and illiquid" bond. They are also finding that the interest rates they are now getting have gone up.

So when I got a call from the person who manages our bond portfolio about a month ago telling me that "your bonds have not yet failed an auction but you should know that the risk of it happening has gone up", I started paying attention. I did my homework and got a list of the three bonds we owned and drilled down into the details of what they were. I focused on the borrower, the borrower's credit, the rating, the insurer, and most importantly the penalty rate. All of our three bonds were issued by government managed utilities in NYC (like water and sewer). All were AA rated borrowers and AAA rated by virtue of bond insurance. All were insured by insurers who were in the news. But most importantly, all had penalty rates above 12%, with one at 15%.

We thought long and hard about what to do. We went for a week or two where we watched to see if the bonds would pass the auctions. In every case they did. As we noodled it over, we came to realize that the auction rates we held were really solid securities because of the penalty rate. Even though we needed the money to be liquid later this year, there were investors who would love to own the securities at a maximum/penalty rate of 12-15%. So there were investors coming into this market almost hoping for an auction to fail. That provided the necessary liquidity to the auctions of these specific bonds.

But even though the bonds were solid, the rates they were paying had gone from 3% in the fall of 2007 to over 7% in February. That's how messed up the auction rate muni market had gotten. We were getting paid over 7% tax free for bonds that were solid. And the borrower, in our case the local government utilities, just saw their interest expenses go way up.

Ultimately, we decided to bail out of the market and now our cash is sitting in a money market fund paying a fraction of what we were getting in the auction rate market. But we decided that we should not be taking advantage of a messed up market with cash that we have committed to spend later this year. And so, along with a lot of other "safety first" money, we left the auction rate muni market last week.

The most interesting class I took at Wharton where I got my MBA was called "speculative markets" and in that class I learned that markets include different classes of investors. There is the safe money, the hedgers, and the speculators. For example, when a company (like YHOO) get a takeover bid and the stock soars, the safe money generally leaves the stock, takes its gain, and the stock trades into the hands of speculators who are now taking the risk that the deal will in fact go through. They are a different kind of investor who is getting paid to take those kinds of risks.

The same thing has happened to the auction rate security market, at least temporarily. The safe money, at least our safe money and I am sure many others' safe money, is gone from that market. And in its place are speculators who are willing to take the risk of illiquidity and even default (which is very low in the muni market) in return for getting tax free interest rates of 7% to 15% (which are the equivalent of 10-20% taxable).

What was my big takeaway from this whole affair? When risk is appropriately priced, there is a market for something. And in the case of auction rates, the risk is illiquidity and so you must focus on the penalty rates. When they are priced appropriately, the market works. When they are not, the market doesn't work. Thankfully the people who helped us construct our auction rate portfolio understood this. Now we do.