I recently listened to the latest quarterly update podcast, “What’s Exciting in the Market Right Now?” by Miller Value Funds. I am a big fan of Bill Miller & always make it a point to deeply reflect on what he says.

In this pod, Bill cited an insightful quote by the late Sir John Templeton, the legendary founder of Templeton Funds:

Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria.

Sir John Templeton

A. Templeton’s framework

Bill then goes on to apply this Templeton’s framework to explain market cycles over the last 15 years as follows:

• During this period, the first point of maximum pessimism was in March 2009, which then birthed a new bull market. The next point of max pessimism was March 2020, which gave rise to another bull market.
• Dec 2020 was the point of optimism, post which the market fell ~38% but then rallied again. Ultimately, the point of euphoria was reached in Nov 2021, which saw the peak of popularity for innovation bulls like Cathie Wood of Ark Invest. At this time, interest rates were at rock bottom while valuations of unprofitable growth companies were sky-high.
• The most recent point of max pessimism was in the Fall of 2022. Since then, overlaying market performance on top of Templeton’s framework, it’s safe to say that the next bull market has already started. Markets are up ~20% since this last point of max pessimism and therefore, this new bull run appears to have reached the “grow on skepticism” phase in July 2023.

Bill then goes on to say something super insightful (man, the amount of wisdom in this 10 min monologue!). Paraphrasing a bit here:

Microstrategists try to use their view of the economy to determine where the market is going. And that’s exactly backwards.

The economy doesn’t predict the market. The market predicts the economy.

The market comprises of real people with real money at risk, and the totality of them is how the market acts.

Bill Miller

Just think about the 2nd para in the above quote. It’s an amazing thought! Intuitively, we all tend to think of the market as an analytical engine when in fact, it’s actually a prediction engine. It’s a complex system where hundreds of millions of people are looking at all the info they have, making a prediction of where the economy is likely to be headed & placing bets with real money based on this prediction.

But I digress! Coming back to Templeton’s framework, as I was digesting it in the context of public markets, I ran a thought experiment on whether it applies to the venture market as well. This is how the exercise went.

B. Applying Templeton’s framework to venture

It’s important to mention upfront that private markets differ from public markets in a few important ways, which manifest in specific behavioral characteristics:

1/ They are illiquid ➡ price discovery happens gradually & therefore, lags public markets at least by a few months if not years, due to system inertia.

2/ They have fewer (very small retail participation) but more sophisticated participants ➡ both upward & downward resets have relatively less internal momentum & are, therefore, more gradual.

3/ They have high information asymmetry ➡ takes time to gather, analyze & react to information. Given higher imperfections, probabilities & confidence intervals are assigned to conclusions more conservatively.

4/ There is negligible automated trading & auto-pilot inflows ➡ information is analyzed & acted on by real humans in a slower, more deliberate way.

Essentially, private markets are slower, more concentrated & more deliberate with longer feedback loops than public markets. Therefore, while public markets can be analyzed daily, weekly, or monthly, I believe a safe unit of time to analyze the cyclicality of private markets is a year.

To start applying Templeton’s framework to the US venture market, I looked at data for total venture capital $$ invested in the US every year since the dot-com bubble. Here’s how the data looks:

Here are some insights I gathered from this data:

1/ During the dot-com bubble, 1997 and 1998 look like the years when the venture bull run entered the “grow-on-skepticism” phase. It then hit the “mature-on-optimism” phase in 1999, achieving the “point-of-euphoria” in 2000.

As per the Templeton framework, the point of euphoria is when the bull market typically starts its journey toward death. This is exactly what happened to the dot-com bull run between 2001 and 2003, hitting the point of maximum pessimism in 2003. Interestingly, going back to the earlier point of a lag between public and private markets, this 2003 point of max pessimism for US venture was a year behind the same for public markets (they bottomed in Oct 2002 when the S&P500 hit a 5 and a 1/2 year low).

2/ Moving forward, the US venture market again followed Templeton’s argument of “bull markets are born in pessimism”. The seeds of its next bull run were sowed in 2003, subsequently entering grow-on-skepticism during 2004 and 2005. This bull run entered mature-on-optimism in 2006 and 2007, growing 25%+ y-o-y.

But before it could hit a real point of euphoria, the housing crisis happened in 2008. The US venture market hit the point of max pessimism in 2009, and similar to the dot-com run, lagged the public markets by a year (their point of max pessimism was in Sep 2008).

3/ With the tailwinds of the Fed’s zero interest rate policy post the ’08 crash, the US venture market saw a secular bull run between 2010 and 2021. Barring a few corrections and a brief Covid hiatus, this was an almost uninterrupted, decade-long, dream bull run.

Fueled by massive liquidity injection by the Fed to counter potential Covid-driven economic distress, on top of astonishingly low levels of interest rates, the US venture market hit the point of euphoria in 2021. As I wrote in my post “Making Hay During Market Peaks“, this was the year of “Crypto shitcoins, ape NFTs, meme stocks, IPOs of unbaked tech companies, and real estate boom in as far as Denver & Raleigh”.

C. Where are we now in the current venture cycle?

Consistent with Templeton’s framework, the recent decade-long venture bull run started its downward spiral from the point of euphoria in 2021 and subsequently hit a point of max pessimism in 2022 (~30% y-o-y decline in VC $$ invested).

But this framework also tells us that the seeds of the next venture bull run were also sown simultaneously at this point of max pessimism in 2022.

As we stand today, I get the feeling that the US venture market is close to entering the Day 0 of the grow-on-skepticism phase of its next bull run (I wrote about how the excesses of 2021 are now winding down in my post “Cheetah in the Rainforest: 2021 Vintage of Venture“).

Per Bill Miller, public markets have already entered the grow-on-skepticism phase decisively, showing ~10% gains in H1 2023, and are likely to continue on this trend in H2. Assuming a ~1-year lag between public & private markets like in previous cycles, my expectation is that the next venture market bull run will decisively enter the grow-on-skepticism phase in 2024.

C. Closing thoughts

As a disciple of Charlie Munger, while I don’t believe in macro forecasts (especially by economists & equity research analysts), I am also a disciple of Howard Marks and therefore, a strong believer in the importance of studying market cycles across asset classes. Where we are in a cycle should be one of the important inputs for deliberation on an optimal investment stance, including what mix of offense & defense to aim for.

Hence, my fascination with Templeton’s framework, and how well it works as a tool for studying cyclicality in both public & private markets.

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