Money Stuff: The Stock Market Will Get More Stock

You could tell a story like this:

1. Companies raise money from investors. They use the money to do business things. The business things generate money. If the company is successful, its business will generate enough money to (1) pay for future business things without asking investors for more money and (2) pay back the investors’ initial money with a nice return.
2. There are, at any given time, different companies in different stages of their life cycle. Some companies are raising money from investors to build their business. Other companies are successful, doing their business, and returning money to investors.
3. The successful money-generating companies are generally bigger than the nascent money-raising ones. A scaled profitable tech company returns a lot of money to investors every year; a startup in a garage raises only a little bit of money. Most of the money used to build new businesses is internally generated by companies doing old businesses; success begets success.
4. In a very loose sense, a successful stock market might be one that is shrinking, one that pays out more than it takes in. Over time, as businesses get better and more efficient, they will return more money to investors than they require from investors. The world will get closer and closer to its optimal state, one in which all of the necessary businesses exist and make money, and no money is needed to start new businesses. Investment capital will be superfluous. So people will put their spare cash in risk-free government bonds, or in pure speculative assets like crypto or sports gambling.
5. The previous paragraph approximately describes the world of, like, 2021, when the 10-year Treasury was below 2% and this column covered topics like fractional ownership of nonfungible tokens and GameStop.
6. But the world has changed.
7. Now there is artificial intelligence. In the future, every business will be rebuilt for AI, and new businesses will be created by AI.
8. This requires enormous, simultaneous, foundational, speculative investment. Giant new AI companies need to raise tens of billions of dollars to build AI. Giant old companies need to raise tens of billions of dollars to retool their business for AI. We need tens of billions of dollars to build infrastructure — data centers, power plants — for AI. And everyone is at the same (very early) stage of the AI life cycle; everyone needs money at once.
9. In the future, if this all works out, the AI businesses will generate tons of money to return to investors.
10. In fact, in the maximalist view, the AI businesses will generate, like, all of the money. In the very maximalist view, AI will usher in an abundance society in which human labor is superfluous and we all just live off the proceeds of our (hopefully widely distributed) investments in AI. This will require trillions of dollars of investment now, but it will generate the greatest return on investment in history.
11. In, like, 2060, when the AI buildout is complete, the stock market will reach its optimal state: No more investment will be required, because AI will do all of the necessary businesses and generate plenty of money, which it will use to (1) fund any necessary further investments and (2) pay everyone a nice universal income. Business will generate tons of capital and require no additional capital, and financial history will come to an end.

Of course I am kidding. You don’t have to believe any part of this story, which is obviously speculative and simplistic and naive and optimistic and maximalist about AI and for that matter rather complacent about the set of business opportunities in 2021.

Still this silly story does seem to roughly capture what is going on. We talked two weeks ago about Alphabet Inc.’s gigantic equity raise, which launched shortly before SpaceX’s gigantic equity raise last week. I wrote that perhaps the stock market is entering a new phase, one in which it exists principally to raise money for the AI buildout rather than just to return capital to shareholders of existing giant money-gusher tech companies. And now Bloomberg’s Lu Wang and Carmen Reinicke report on the trend:

For the better part of two decades, a defining feature of the US stock market has been scarcity. Year after year, shares disappeared from public hands, with buybacks by S&P 500 companies alone erasing nearly $12 trillion worth.

Now, investors are about to discover what happens when the supply suddenly comes rushing back.

According to JPMorgan Chase & Co., IPOs, secondary offerings and other share sales are poised to add roughly $1.5 trillion of stock to the US equity market over the next two years, even after accounting for buybacks. If realized, it would mark the strongest period of net equity issuance since at least the late 1990s.

This newfound abundance may reverse one of the market’s most enduring tailwinds and herald the start of a seismic shift across Wall Street: that after years of buying back stock to boost shareholder returns, or staying private altogether, companies are now turning to equity markets to raise capital instead. …

That “equitization” is largely due to the financing demands of the AI boom, which are pushing firms toward raising capital rather than returning it. Net share repurchases by so-called hyperscalers, a catch-all term for big tech companies that provide computing power for AI, fell last year, according to data compiled by Citigroup.

Many companies initially relied on excess cash and debt markets to fund spending on data centers, chips and power infrastructure.

Now, some investors say, those avenues are no longer sufficient.

“We started with profits and free cash flow, then they started raising debt,” said StoneX Financial’s [Vincent] Deluard. “Now it’s everything. It’s the cash flow, it’s the debt and it’s the equity.”

And at the Financial Times, Robert Armstrong writes:

The huge surge in investment the technology has triggered, and the rush to finance it, will alter the landscape in profound ways.

This week’s SpaceX flotation is just the latest sign: we are facing regime change not just in technology but in finance. …

One of the major trends of recent decades has been “de-equitisation” as big companies bought back their own equity and many smaller groups were bought by private equity, using mostly debt.

But now, if the Big Tech companies want to buy back their shares, they will increasingly have to borrow to do it. As a result, a major source of support may have left the whole market.

“When a correction happens — which it will — it is harder for these guys to prop their stock up than it was before, as when Meta bought lots of Meta shares back after its stock crashed [in 2021-2022],” says Robert Buckland, who popularised the concept of de-equitisation as an equity strategist at Citigroup.

Will the rising valuations and prices that characterised the de-equitisation era persist in an era of re-equitisation?

I mean. The answer that theory, or Elon Musk, would give you is: Sure, this is fine. Stock valuations reflect expected long-term future cash flows. If the market thinks that the long-term future cash flows of SpaceX, or Alphabet, or the S&P 500 or whatever, are world-historically enormous, then that will support high valuations. It’s just that we’re in a strange and uncharted transition to get there. 

Also, of course, the market might be wrong. “Public companies generate steady profits, which they return to shareholders,” is a pretty straightforward and predictable source of future cash flows for shareholders. “Public companies sink trillions of dollars into computer chips and nuclear power plants to build superintelligent robots which will usher in a post-scarcity society in which the role of money is uncertain” has more ways to go wrong.

I wrote on Thursday that:

1. The perfect IPO pop is 20%. That is, if a company prices its initial public offering at $135 per share, as SpaceX did on Thursday, it is hoping that the stock will trade up to about $162, a 20% first-day return. This gives buyers in the IPO a nice quick win, rewarding them for taking risk on the IPO, but it is not such a big pop that the company will regret “leaving money on the table” by pricing the IPO too low.
2. SpaceX’s $135 per share price ($1.77 trillion valuation), though arguably chosen arbitrarily by Elon Musk at the start of the IPO roadshow, and though obviously aggressive as a multiple of revenue (100x) or earnings (negative), was nonetheless perfect and would produce a 20% pop.

Pretty much!

SpaceX’s first day on the stock market transformed the startup into one of the world’s most-valuable public companies, handed buyers of the IPO a 19% return and turned its founder Elon Musk into the world’s first trillionaire. …

The shares jumped as much as 31% above their $135 offering price, before closing up 19% at $160.95. That left the company’s market capitalization at $2.2 trillion, meaning it ended its first day on the stock market as the sixth-highest valued public company in the world.

It’s up again today. This was the biggest IPO ever, and traditionally IPOs are a big deal, and you can read about the high-stakes drama behind it. The Financial Times has a story on “How Wall Street pulled off the biggest IPO in history for SpaceX.” (There were custom cronuts.) Business Insider has “a look at the celebrations, scenes, and protests surrounding one of the most anticipated public debuts in market history.” (There were “moon rock macarons.”) “SpaceX, Now Worth $2.1 Trillion, Pulls Off Goldilocks Debut,” reports the Wall Street Journal.

But what I wrote on Thursday is that this is a bit of an anticlimax. In 2026, there is much more integration than there used to be among:

• public markets,
• private markets, and
• betting markets.

Traditionally, when a company goes public, (1) it doesn’t know the right trading price for its stock and (2) it finds out in the IPO. SpaceX’s stock already traded, somewhat, in private markets. And betting markets — prediction markets and pre-IPO perpetual futures markets — traded SpaceX bets in large volumes, allowing for price discovery before the IPO actually priced. On Thursday, I quoted a note from TD Securities market structure analyst Reid Noch saying that “SpaceX PERPs are trading meaningful volumes on Hyperliquid despite the most popular provider offering no true equity exposure,” and “if the market is directionally accurate again, institutional and retail interest in pre-IPO PERPs will likely continue to grow.” Today Noch writes in a follow-up note:

The day before the IPO, SpaceX PERP prices traded for most of the day in the mid-$160s to low-$170s, which is largely where the stock traded Friday. We also heard from major institutions that they were closely following Hyperliquid in the days leading up to the SpaceX IPO to observe this price discovery in real time. That raises an important question: is the tail wagging the dog, or is the dog wagging the tail? …

PERPs mark a new era in private-market price discovery. SpaceX formally priced its IPO at $135, but pre-IPO PERP markets were already implying a materially higher opening price on Nasdaq when its first trade took place Friday morning. That dynamic diverges from the traditional IPO process where price discovery is largely controlled by the issuer, underwriters, and strength of the institutional order book. Future IPO candidates, including OpenAI and Anthropic, may start to use these markets as an additional signal to better gauge where the opening price will be relative to the suggested pricing range of the IPO. The goal may be to ensure investors have potential for short term upside in return for IPO capital without leaving too much money on the table at the expense of the issuer and its shareholders

I have speculated about links between these sorts of gambling markets and the actual market for SpaceX stock; presumably there is some arbitrage available where a pre-IPO SpaceX shareholder can hedge its exposure by selling perps on Hyperliquid. But I am not sure how real, or how necessary, those links are. Simply creating a platform for gambling on the future price of SpaceX might be sufficient to create good price discovery, without any sort of arbitrage between the gambling platform and actual SpaceX stock. [1]  Gamblers are getting pretty good now. Bloomberg’s Chloe Cresswell wrote on Friday:

The World Cup arrives as the boundaries between investing, betting and trading continue to blur. ...

That convergence is part of what strategists at Bank of America describe as the “gamification” of markets. They argue the trend is likely to accelerate as prediction markets, digital assets and retail trading platforms increasingly borrow from one another’s playbooks, making it easier for users to place rapid-fire wagers on everything from soccer matches to economic data releases.

The analysts point to the explosive growth of crypto perpetual futures, a type of derivative contract with no expiration date that has become one of the most heavily traded instruments in digital-asset markets. Annual volumes in those contracts now exceed $90 trillion, according to the bank, underscoring the scale of investor appetite for always-on, highly speculative products.

One aspect of this is that now you can bet on sports in your brokerage account, but another aspect is that institutional investors are tracking gambling markets to figure out how the biggest IPO in history should price.

I think sometimes about the education of a pod shop manager. You can sort of understand how someone might end up running a stock-picking hedge fund, or a credit fund or whatever: Trade some stocks in your personal account as a teen, get a job as a trader or research analyst or investment banker, learn how to analyze companies, get a good feel for which stocks or bonds will go up, start your own fund to buy them. And then if you’re good at that you might get big enough to expand into other areas, hire other portfolio managers, and end up running a big multi-manager multistrategy “pod shop” hedge fund, where your job is not buying stocks that go up but rather hiring and supervising portfolio managers. I once wrote:

You start as an investor and end up as an allocator of capital to investors. There are good reasons for this path. For one thing, the investing job prepares you pretty well for the meta-job. Also, though, the investing job is pretty legible to a young person starting a career. You play the stock market game in high school, and you do well, and you think “ah, I have a knack for this.” You start trading stocks in college, and your stocks go up, and you think “hmm this could be a career,” and it all proceeds logically from there.

Whereas there is not really a direct way into the meta-job. 

That, it turns out, was wrong. In the New Yorker today, Gary Sernovitz profiles Ken Griffin, the founder of Citadel (the multistrategy hedge fund) and Citadel Securities (the market maker). Griffin did in fact start out trading options and convertibles in college, but his epiphany came early, and was of the form “buying stuff that goes up is for chumps and I should find a meta-job”:

He started trading in 1986, and, he told me, made five thousand dollars on one transaction involving Home Shopping Network options. But he said it bothered him that the market maker who bought the options, though his profits were relatively small, had a much higher “quality of earnings”: whereas Griffin was taking risky bets, the market maker was generating a reliable cash flow. Griffin’s frustration led him to try to find a way to achieve higher-quality earnings himself. At the Harvard Business School library, he taught himself derivatives pricing and trading theory, and by 1989 he’d settled on convertible arbitrage as his method of choice—buying a company bond that could be converted to stock while simultaneously shorting the company’s stock. At the time, this strategy was being pursued by only a few banks and about a dozen hedge funds, even though you could do the math with pen and paper.

Griffin called up First Boston, an investment bank, and asked a salesperson how it handled convertible arbitrage. The salesperson, Griffin remembers, said, “We don’t do this with any customers. We do this with the firm’s money.” To Griffin, “that was a light-switch-on moment.”

Customers buy stocks that they think will go up. Banks run businesses that reliably generate returns in excess of the cost of capital. There are a lot of investment firms, including many hedge funds, whose essential activity is finding trades that they think are good and doing them. Citadel and its pod-shop competitors are in a somewhat different business. I write sometimes that the pod shops are the new banks, that they are doing the sorts of business — providing liquidity to the market, capturing durable risk premiums, making markets more efficient — that investment banks did 20 years ago. Or 40 years ago, apparently. Sernovitz:

The goal at Citadel is not to be right all the time; it is to be consistently right most of the time. (The fund’s best portfolio managers beat the market on only about fifty-four per cent of their trades.) As Alec Litowitz, an early Citadel partner, told me, “It’s not about a portfolio, it’s about a business that can re-create great portfolios again and again.”

Arguably the way to do that is to build a general-purpose factory that uses people (portfolio managers) as inputs and turns them into outputs (portfolios). The inputs, in this model, get used up to make the outputs. The inputs are people. “Citadel consumes new traders as voraciously as Starbucks consumes beans,” writes Sernovitz, and:

A former Citadel portfolio manager said of such overhauls, “The next incarnation of what gets built is better than what was there before, and that’s always the case.” The downside: “a highway wreck of human bodies.” Almost every former employee I spoke to had stories about turnover. One had five bosses in five years; another kept a “Book of Souls” listing the fifty colleagues who had left his small trading unit in six years. Yet another moved to Chicago only to see his boss’s boss be immediately fired, and then his boss fired. ... (A Citadel spokesperson said of its firings, “We have deliberately built a high-performance culture.”)

“It was a gift to be there and a gift to leave,” one former employee told Sernovitz, which is perhaps how Citadel feels too.

We talk from time to time around here about my favorite postmodern comedians, the people who design user interfaces for Citigroup Inc.’s internal software. If you work at Citi, you come in every day and open up some proprietary software to do trades and send money and stuff, and that software has a bunch of fields you can fill in and buttons you can press to do things, and some of them are pranks. Like there was allegedly a field in some payments screen that “came pre-populated with 15 zeros, which the person inputting a transaction needed to delete”; if you forgot, apparently typing “$1” in that field would send the customer $1,000,000,000,000,000? Just hilarious Dada-esque comedy.

Citi appears to do this stuff out of genuine commitment to the bit, but pitfalls like this exist at every bank. Every bank has software with fields that you can fill in and buttons you can press, and you are tired and distracted and you might, say, put the dollar amount of your trade in the “shares” field and sell 7,548 times as much stock as you intended to sell. That really could happen anywhere, though in fact it happened at Citi.

More generally, it is the nature of software that any piece of software will contain a button you should not push, just to make life exciting. (For me it is the “Publish” button in this column’s content management system. Have I ever published a half-written draft by accident? No. Do I think about it every day? Yes. Have I jinxed myself by writing this? Of course.) Probably most banks do not give their employees software with a big red button labeled “LIQUIDATE BANK,” which when pressed initiates a liquidation of the bank, though Citi might. (No, I’m kidding, at Citi the liquidation is probably triggered by a small green button labeled “Help.”)

On the other hand, Nubank gives at least some employees a button that initiates at least some aspects of a liquidation of the bank. Not the actual liquidation, but messages to customers informing them of the liquidation, which when you think about it is almost as bad. “Every banker knows that if he sends his customers a push alert saying ‘oops the money is gone,’ in fact his money is gone,” Bagehot almost said. Bloomberg’s Martha Beck and Matheus Piovesana report:

Nu Holdings Ltd. co-founder Cristina Junqueira apologized to Nubank customers who received an app alert telling them the bank had been liquidated, saying it was sent by mistake.

“Really bizarre, but that’s exactly what it was: an operational error,” Junqueira wrote late Friday in response to questions from followers on Instagram. An employee accidentally triggered a protocol designed for situations involving a bank liquidation after submitting an internal request for software changes, she said.

“The messages went to a very small portion of customers, but of course it causes some disruption,” Junqueira said. “We sincerely apologize to everyone who received the information.”

I wrote the other day that banks and brokerages mostly do a pretty good job of not deleting their lists of customer money, but you cannot expect perfection; for a while Fidelity apparently deleted a customer’s entire account and all of the money in it. Nubank did them one better and briefly deleted itself.

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