First, if you were in any way hurt by the events surrounding FTX, I send you my condolences and sympathy… these moments hurt real people.

In my book $100M Careers, I argue that there are moments in your career where it makes sense to stop, pause and look around.

This week is one of those moments.

**FTX is like EnronLehmanMadoff**

Enron for the accounting fraud and opacity. Lehman for the length of financial tendrils and extent of unintended consequences to its bankruptcy. Madoff for controlling both custody and accounting so performance can be created out of thin air.

Why you should pause and reflect

These events only happen (thankfully) once a decade
You can learn more from extremes (in anything) than from the status quo
The shockwaves and dislocations create opportunities (mispriced assets and careers)

2001

After Enron (and WorldCom), even though stock prices were low, they went lower, and because this followed the Dotcom bust, investors left the stock market in droves (driving the market to a June 2003 low, 18 months after Enron declared bankruptcy). Investors who left the stock market moved over to real estate, driving a stronger real estate bull market (2002-2007) than we’d seen previously.

2008

After Lehman, real estate prices tanked, and stocks were already cheap by Sept 2008 when Lehman declared bankruptcy, but stocks went down further hitting a double bottom 3 weeks after Lehman, then the second bottom March 2009. This created opportunities in both real estate and stocks.

After Madoff, clients insisted in separation of custody and performance. This meant using professional custodians (not sending money to money managers), and giving trading permission to money managers (but not asset custody). FTX ran both custody and accounting internally.

Career opportunities are made by entering before a boom cycle and grabbing ownership when prices are low.

Here’s what I’ll cover:

Could we have seen it coming? (and would that have changed anything)
Why does it keep happening? (especially in recessions)
Where do we go from here? (I give you a curated list of my bear market guides)

1. Could we see it coming? Did we? Being early vs late…

Even if you see it coming, it’s a huge career risk to call it too early.

September 1996 (no company websites exist). I’m a newly minted energy analyst. I hear Enron is worth investing in.
“Hi, I’ve heard great things, can you send me your annual report?” (normal answer is yes)
“Which one?” (not normal)
“How many do you have…?” (annual report mean companies create ONE each year)
“Five.”
.
?
.
“Send them all!”
I rebuild and link all 5 cash flow statements. Each entity owned 20% of the other. And…
They don’t reconcile. This is a publicly traded company, with Arthur Anderson as their auditor. These are audited (reconciled) financial statements. Cash ALWAYS reconciles. You count the cash going in and the cash going out. Simple.
“Here’s the thing…” Never a good start to a black-and-white accounting question.
“The books don’t reconcile, but everyone knows it. The two analysts who put sell ratings on Enron because they were suspicious lost their jobs (and careers) as the stock kept going up, and they are no longer in investing.”
He continued:
“Enron has an analyst meeting every year in Aspen. They fly us up there for a long weekend of skiing, give us next year's numbers, and always beat them.”
My reply? Moving on...
I was fortunate. Being on the buyside, I wasn’t required to have an opinion on Enron.
Unearthing the scam 4 years early could have ended my career. Early is just as bad as late. Unless you have the luxury of choosing avoidance. This is the career risk Jeremy Grantham famously writes about.

Often we see something is off, but there’s too much individual career risk to do anything about it. Some see it and call it (especially if it's their job - short sellers and reporters). Some see it and avoid it. Others fall for the FOMO and play until the music stops.

This week, the music stopped. FTX was left without a chair.

What is FTX? (and why you should care even if you don’t “do” crypto)

FTX was the second largest centralized crypto exchange. Binance is #1. FTX was bigger than Coinbase.
FTX’s fallout may be bigger than Enron.
FTX had 134 affiliates spread across the globe and its liabilities may be as high as $50 billion. Enron had liabilities of $23 billion.
FTX was valued at $32B (generating $50B in liabilities in months), and its 30 year old founder was worth $24B, the fastest-made fortune of that size in history.

VCs invested and lost over $2 billion in FTX:

That’s the crypto world coming into the real world. VCs invest for foundations, teachers’ retirement accounts and individuals. This experience will decrease VC’s risk appetite (at least for a few years).

What were the signs?

There were plenty of red flags. Let’s take a look at 5 red flags out of ONE article from September 22, 2022, less than 2 months ago. The author follows Sam Bankman-Fried (called SBF), founder and CEO of FTX around for a week. A few red flags:

1. SBF “doesn’t need the money” but would allow investors to come in as he could spend on branding (FTX arena, charity, investing in other startups)...

I once worked for (pardoned) felon Mike Milken. He was freshly out of jail…”camp” for “securities violations” . He was battling prostate cancer and started the Milken Institute as a think tank to make progress on cancer and other large issues.

While Milken’s institute has done a great job connecting people globally to solve the world’s toughest problems, it was created to change the narrative from felon/criminal to benefactor.

Why would SBF (not a felon at the time) need VC money to do the same?

2. SBF did have “some losses” in Alameda (a related hedge fund) due to counterparty risk.

Losses from counterparty risk is a nice way of saying Alameda was executing trades and the people on the other end just took the money, or went under, or got hacked.

Alameda had a “risk neutral” strategy which some mistook for zero risk. Risk neutral means 50% chance of $100 equals $50. But it doesn’t. Because if you receive the other 50% chance of $100, ie $0, a few times in a row, you can go bust before you get the chance to flip the coin enough to hit $100 at least 50% of the time.

I’m not sure any strategy was followed as it’s looking like the books were entirely made up (like Madoff). SBF had a back door into the accounting software and cash and could move money and numbers whenever he wanted without alerting auditors. And when they "rescued" BlockFi, the first thing they tried to get were client assets moved over to FTX. Ponzi classic.

3. VCs' investment decisions sounded rushed and SBF gave out exactly ZERO board seats, so he could do whatever he wanted with the money, and there were no controls.

Most hot deals are rushed. Demand exceeds supply for talented founders going after massive ideas, so investors act quickly. One offset to this is spending time ahead of deals getting to know a founder.

“I walked over, thinking, Oh, s**t, that was really good,” remembers Arora (FTX's head of product). “And it turns out that that (SBF) was playing League of Legends through the entire (Sequoia) meeting.”

Hubris. Playing a video game while answering questions where a VC was going to invest hundreds of millions of retirement, company and individuals’ money.

4. FTT - It’s like Monopoly Money. Print as much as you want. Then grab keys for other tokens and print those too.

Binance created the BNB token you could use as currency on their exchange to trade for a 50% discount on trading fees. It worked well. So well that people made profits holding BNB, betting if the exchange grew then demand for a token that allows you to trade would go up. It did.

So other exchanges copied the model and created their own native tokens.

FTT was FTX’s native token. Binance had previously invested in FTX and owned a fair bit of FTT ($500M before the collapse). And Alameda with it’s “counterparty risk” was using FTT as collateral for borrowing other tokens to execute trades.

Hedge funds borrow to go short and to lever up. In a stock brokerage, you put up cash as collateral for these loans. Alameda was using FTX’s printed money FTT as collateral for its borrowings. And, if that wasn’t enough (it wasn’t), it turns out they had keys to another token and were printing that to the tune of $2B on their balance sheet even though the market cap was in the hundreds of millions. They were masquerading as a central bank.

5. Rescuing firms.. SBF is “the next JP Morgan.”

Remember that old nursery rhyme: I know an old lady who swallowed a fly?

She swallowed a fly… She swallowed a spider… To catch the fly .. She swallowed the bird...To catch the spider…

As crypto crashed along with other risk assets this spring, SBF kept buying failing companies… Celsius, BlockFi, Voyager… 134 affiliates. Leverage and risk don’t get added. They get multiplied, or worse … squared or cubed. Each entity SBF bought “quickly” likely didn’t know their full risk picture as it changes daily as risk correlations vary… not to mention margin accounts with 1000 to 1 leverage in some firms.

Turns out they were buying them to get their hands on customer deposits to keep the Ponzi going. Thus FTX built a war chest of … “up to” $50B in liabilities. A mere five days prior, they thought the liabilities were around $8B.

These 5 red flags, came out of one article on FTX from 2 months ago.

In April 2022, SBF explained to Bloomberg's Matt Levine how DeFi Yield Farming (which he was doing through Alameda) worked like a perfect Ponzi Scheme.

SBF starts with (my paraphrasing): Imagine you had a box.

People put money in the box. The box doesn’t do anything, but there’s the hope it will. It gets value from that hope and from the fact people are putting money in it. Then the money earns yield in the form of other tokens created for the box.

The FTX story keeps unraveling real time and is beyond the scope of this blog.

FTX announced bankruptcy Friday, November 11, 2022.
Saturday $600M of funds were hacked from FTX allegedly by SBF
SBF had a custom coded software “back door” into FTX where he could take money and rewrite books without auditors knowing.
He’d used this back door to funnel $10B of funds into Alameda
The Twitter-sphere is asking if other exchanges are sound (many are not). In the wake of FTX, many exchanges promised to show reserves, but appear to be shuffling the same reserves among different unrelated exchanges, showing a snapshot of reserves before sending the funds on…

2. Why do these scandals keep happening?

In my time as a Semiconductor analyst, I saw multiple cycles.

Chip cycles are like high-speed economic cycles:

Chips are in demand as we build more computers and phones
A new computer or phone comes out, increasing demand beyond the number of chips being made.
Not wanting to miss their own sales of phones, Apple, Samsung, etc., call their chip suppliers and order double what they need, and get a bit less, but still more than what they need. Thus their sales are safe.
Chip makers create new factories. Supply comes online. Next comes the inventory glut.
Factories take partial vacations and lay off workers as Apple, Samsung, etc work through the accumulated inventory.

And the same question every cycle: What will you do to avoid double ordering next time?

Management gives a nice long answer on tracking the business better.

The real answer: they’ll do exactly nothing. Why?

Because Apple or Samsung not double ordering would mean Apple or Samsung might get caught short and miss their own forecasts.
And not selling to Apple or Samsung in that moment would mean losing share to competitors.
It’s the same movie in economic cycles.

Bill Gurley, the billionaire partner at Benchmark VC, has mentioned that unless VCs invest through the whole cycle, including right up into the high valuations, they will not earn outsized returns after fees. When the “supply” of hot deals like FTX is tight, natural FOMO takes over, as the best teams can have an outsized impact on a VCs overall returns.

Economic boom times hide Ponzi schemes like Madoff, Enron, WorldCom, and FTX.

They can hide under the natural “double ordering” or excess demand. Then, when things slow down, the tide goes out, the slower economy differentiates the frauds from the real deals.

The real deals have real demand. They may need to tighten their belts, but they can make it through because they have a business, customers, and profits.

The frauds stay exposed when the tide goes out.

So, we will see these in our past, present and future.

If these frauds are part of the journey, how can we stay safe?

3. Where do we go from here?

For all the pain they cause, challenges, like bear markets, are our greatest teachers.

“You’ll be glad you came, and thrilled to leave.” - My Papua New Guinea Guide
In 2008, as markets careened south and JP Morgan “rescued” Bear Stearns from near death, I went on a round the world trip.
For Papua New Guinea we had a choice of destination: Sepic River (relaxing, cultural), Western Highlands (bird watching, hiking), and Southern Highlands (birds and danger).
Guess which I picked?
I picked the Southern Highlands, which had the most violent, war-loving, eye-for-an-eye culture. This was the place where Michael Rockefeller was abducted and never found again.
I wanted my money’s worth, so I wanted them to take me somewhere I could never go alone. I also wanted to come out alive, so I picked a guide with ZERO bedside manner who’d guided people through Papua New Ginea twice a year for 30 years.
Did we need her services?
Yes.
The homestead we were supposed to visit was burned down by their neighbor. It all started with one neighbor stealing the other neighbor’s pig. Retribution was stealing the other’s wife. Retribution for that was burning the other’s house down. She arranged another visit, and brought enough wood to rebuild a bridge we needed to cross (people stole wood off bridges to use in their houses).
And leaving?
Our plane was hijacked and didn’t arrive to pick us up. Our guide calmly opened her duffel bag, got the appropriate stewardess uniform, put it on, boarded a commercial airline and instructed 25 passengers to deplane and give her their boarding passes. She then handed us those boarding passes, told us to hide our IDs, and we boarded and took off. She partially hijacked a plane to get us home without the pilots knowing.
We were glad we came, and thrilled to leave.

When traveling the road less traveled, i.e. dangerous countries or bear markets, pick the right guides.

Optimizing for bull markets is imagining a bright future, buying on dips, and riding your winners. Your best guides will have an optimistic, expansive mindset.

Optimizing for bear markets is about navigating dead cats, false charges, and falling knives while hoping to have cash near the bottom. Bull market optimists will fall for every false charge (bear market rally), chase dead cats, and catch falling knives. They’ll end with damaged, bloodied portfolios.

For most, navigating a bear is about surviving to be in the best shape for the next bull. Your best guides will be pragmatic, data-driven, and cautious.

You’ll be glad you came and learned, but even happier to leave the bear.

When bulls lose confidence, they sell, sell, sell, until the value investors are willing to buy. Thus leaving the value players running the show.

My favorite bear market guides are focused on economic and market signposts, value-oriented, and prolific in sharing their thoughts.

Here are my top 3 (plus two bonus guides):

Danielle Di Martino Booth

Danielle is a previous member of the Dallas Fed. She is bright, insightful and prolific on Twitter (free info), and has a daily email I highly recommend ($59/month) that gives pointed insights into the latest economic data.

Her interview on Powell’s performance at the Fed November meeting shows how Powell has changed his tone. Danielle has been right that Powell will not pivot as soon as people think/hope.

I read Danielle’s work to stay up to date on macro events which matter far more during bear markets. For instance, if rates go up more, this hurts all sorts of companies, which then trade together. This is why we all become macro analysts during bear markets.

I’m not a professional macro analyst, so Danielle’s work helps guide me.

John Hussman

Known (unfairly) as a Perma Bear, John Hussman has 2 PhDs. He launched and ran a fund management company where he paid fairly but gave all “excess” profits to charity. His work looks at a century of data before offering opinions, thus avoiding “overfitting” to the wrong time period.

Because we had such a long bull market, it’s tempting to go back 5 or 10 years to test data, but the last time we had inflation was the 1970s… Hussman solves for this by looking at 100 years of data (and imputing it with the discipline of a PhD when it doesn’t exist).

You can subscribe to his monthly email and also look back at his archives. It’s all free.

Bear markets don’t go one direction (down). It was through John’s work in 2008 that I learned that bear markets contain some of the most aggressive rallies (up 30-40% in a matter of months within a longer term downtrend).

Hussman’s Market Comments are well researched and long. You can take your time and learn a ton. When I am more time constrained, I flip through his piece looking for his proprietary measure of market health: internals.

When they are “uniform” that is bullish near-term. When they are not, look out. He doesn’t share the model, but he does share how market internals are faring in each and every monthly report.

Here’s a snippet from Hussman’s October Market Comment so you can see what I look to find in each comment.

Jesse Felder - Quick Weekly Value Guide to Markets

Fall of 2021, when tech stocks were starting their swoon and investors were buying them on dips, hoping for the next leg up, Jesse was focused in the energy space. He wrote two pieces saying to buy. Since then, energy stocks have risen 60% while growth tech stocks declined 70%.

Here’s Jesse’s latest blog, sharing why value investing will come back into vogue during this downturn (as it does in every downturn). Jesse is active on Twitter, and I am a subscriber to his free newsletter (fast to read yet captures the main issues).

Bonus: Jeremy Grantham, BMO - Bubbles and Career Risk

Jeremy is the OG (Original Gangster) of value investors. He keeps trying to retire, but stays prolific. Starting over a decade ago, he began studying bubbles. How they happen. How to spot them. How to trade them.

Recently, he called the top in this market in late 2021. Useful for individual traders for sure. And did he take his firm to mostly cash (they are long only, ie don’t go short)? Nope. Why?

Even the most senior, respected market and bubble expert worried he would lose clients and risk his firm’s health by betting against the market and holding cash. That’s career risk. Just like putting a sell on Enron 4 years too early. The asymmetric risk of being wrong is so much higher than the reward of being right.

I use Jeremy’s work to understand bubbles and where we are in the cycle.

Bonus: Ben Hunt - Narrative

Ben Hunt focuses on debunking narratives in markets and in the world. He has free content and paid content. He did an excellent takedown on SBF and FTX in May 2022, months before the collapse.

With all of us on social media more and more, Ben provides a chance to step back. He shows us the man behind the curtain and splashes cold water on FOMO regularly.

I use Ben’s writing to stay clear-headed.

But, you ask, who is my TOP guide?

Me!

And your TOP guide should be YOU.

Before you push back and say you don’t know enough…

YOU are the one who is removed from the market. You can use your common sense. Go for a walk and ask yourself if any of this makes sense.

Could you explain what SBF was doing to a 5 year old?

Listening to his interviews, the answer was no (for me).
Now the answer is yes: he was stealing.

When you can’t understand something and explain it, there’s likely a problem with the thing you can't understand, not with you.

YOU are your best bear market guide.

And then supplement with my guides or those you like.

I’m not recommending you shift your investing style.

I’m suggesting the best guides through bear market hazards are cautious, tire-kicking value investors. The beauty of the information-abundant internet is you can use these experts as your own guides through this time.

When we finally hit capitulation (we’ll be closer after the FTX fallout), be sure to pause and look around for mispriced assets.

Where can you invest your time and/or money that is beaten down?

Then when the bull run starts, remember that momentum and growth tend to rule that phase. Unless value is your own style, this might be an occasion where you don’t come home with the same person you went to the dance with.

If you wish, you can follow all the investing experts I follow on Twitter without the hassle of looking them up. Simply follow my list: https://twitter.com/i/lists/1273472015798681601