The private equity industry -- excluding VC, which represents a small fraction of total capital raised -- relies extensively on debt (LBOs, debt-financed infrastructure deals, debt-financed real estate deals, etc.), i.e., borrowing to juice returns. It's not a coincidence that the industry was born in the 1980's, when interest rates in the US began declining, after the Fed had increased them to combat high inflation in the 1970's. Ever since, for four decades now, interest rates have only declined and declined, in fits and starts, making life easier and easier for borrowers of all kinds:
Many private equity deals that arguably were economically viable when the 10-year treasury's annual yield was ~0.6%, less than a year ago, may not be viable now that the 10-year treasury's annual yield is ~3%, and are likely to suffer financial distress if interest rates rise further -- say, 10-year treasury yields of ~5%, ~6%, or more. If that sounds high, keep in mind that the last time the Fed had to deal with high inflation, in the 1970's, the 10-year treasury yield rose to a peak of ~16%!
Over the same past four decades, valuation multiples have only risen and risen, in fits and starts, making life easier and easier for those who make money by buying businesses, holding them for a while, and selling them down the road. For example, here's the ratio of US stock market capitalization to the size of the US economy (GDP):
The rise in valuation multiples over the past four decades makes sense, given that the net present value of any business is inversely proportional to the discount rate used to value its future profits, and discount rates are equal to prevailing long-term treasury rates plus a premium. If interest rates continue to rise, valuation multiples are bound to decline too.
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EDITS: Changed language in response to comments below so it better reflects what I meant to write in the first place.
Most LBOs aren’t really that interest rate sensitive, let’s say you buy a company for $100m dollars 12x EBITDA, and 15x unlevered free cash flow ($7m), you would have put $50m of non amort. debt in the business @ 3%, so had a $1.5m interest payment. Lets say that doubles to $3m, earnings would have to be cut in half to not be able to service debt…
[EDIT: the data in this paragraph is WRONG! See comment below.] 12x EBITDA? Unlikely. According to the article, the average valuation multiple for US deals to take firms private is 19.3x EBITDA.
A 3% rate for a leveraged entity? Unlikely. Current high-yield spreads are in the neighborhood of 500-600bp, on top of treasury rates.
So, you'd need 60% more debt (19.3/12) to keep the same capital structure [EDIT: this last sentence is WRONG! The amount of debt needed would be the same, because the correct EV/EBITDA multiple is 12.3x. See comment below.], and the debt would be 2-3x more expensive, leaving much less margin for a downside scenario, say, in the event of a prolonged recession, rising rates, and/or declining valuation multiples. If all three of those things happen at the same time, things could get... ugly.
LBOs haven’t been the defining structure of PE for a while now, though leverage is still a key ingredient. The massive growth of the “PE industry” over the last decade has really been on the credit side (which does include equity plays, e.g., in real assets and distressed debt that leads to equity positions) despite the low interest rate environment.
Do you happen to know if “private credit” (I don’t know if that is the actual correct term) is a big part of PE’s investments? I stumbled upon mentions of it more and more during the last 2 years (I’d say) and it kind of gave me some “this can’t be structurally right”-vibes. Or maybe that is just a very small market, comparatively speaking, and I’m talking bs, hence my question.
> The private equity industry -- excluding VC, which represents a tiny share of total capital raised -- relies extensively on leveraged buyouts (LBOs), i.e., borrowing to juice returns.
Thanks. Yes. I changed "tiny share" to "small fraction," and noted that the industry is much more than LBOs. Note that many other kinds of PE deals -- e.g., infrastructure, real estate, distressed secondary investments -- are done with lots of leverage too.
Regulatory and tax changes in the 1980s created private equity. Declining interest rates juiced it, as has computerization, but the fundamental change was Reagan's policy of financial deregulation and reducing capital gains and marginal rates so that entrepreneurs had more money to invest.
What specific regulatory changes occurred in the 1980s that created PE? KKR, a pioneer of the industry, was started in the '70s and they did a landmark $380 million deal in 1979, which is billions in today's money.
The first LBO was of Orkin Pest Control in 1964 and there were about a half dozen other LBOs in the 60's.
what does this mean if your company is acquired and run by a private equity? will the rising fed rate mean that they are looking to cut out the highest salaries? am I better off not takin a higher salary because that might paint a red target on myself?
Sorry but ain't no way 10 year is going to 5-6%... I'd wager it's very likely peaked at 3.5% and it won't break that again (for this cycle).
Valuation multiples are (relatively) crushed, and I don't think we'll see much more of a multiple compression. What we will see, in both private and public markets, is when businesses adjust their earnings forecasts for the (very likely) impending recession. If you look at Wall Street numbers companies are still forecasting growth pretty every quarter through 2023. Now, that doesn't seem very likely to me.
The deal is, the public markets will overreact as always and sell off harder, but private equity will stay more fairly valued because of it's inherent lack of liquidity (two wrongs make a right).
Oh, I very much hope you're proven right. I mean, almost no one wants higher interest rates -- except the Fed, whose priority is curtailing inflation. I'm not sure anyone can predict rates accurately. Consider that just over a year ago, almost everyone was talking about rates going negative, and look at what actually happened!
I agree on the 10-year. We might get Fed Funds above 5%, but the market won't expect that to continue for 10 years. (Mathematically, the 10-year yield should equal the expected average Fed Funds rate over the next ten years).
I disagree that valuations have been crushed. You qualified that with a "relatively". We're lower than at the peak of the bubble of course but Shiller PE is still 30, higher than any time other than the dot-com bubble and the current bubble.
Private equity firms will choose not to write down the value of their assets, but the actual transactable prices will probably drop further than public stocks.
Very true, but 2020-2021 was unique in that a lot of young, first-time investors were introduced to the stock market via the popularity of Robinhood and meme stocks.
The entire stock market may only be down 20%, but the investors who piled into hot tech stocks like Peloton and Zoom went from thinking the stock market was easy money to thinking that the stock market is a great way to lose most of your money. Even Robinhood went from a trendy young person trading platform to a perceived villain in the span of a couple years.
The stock market that you see as a seasoned passive investor is completely different than the boom and bust meme stock market that many young people were introduced to recently. I don’t know what the long term effects will be on those who were burned in the exuberance and ensuing crash.
When rates go up, bonds become more useful as an investment.
When the 1-year US Treasury was yielding 0.2% earlier this year, it was a bad idea to buy 1Y treasuries (and most other treasuries). Today, the 1Y is 2.87%, and suddenly a whole slew of investors just won't want to invest into shady high-risk companies anymore (Hey look, US Treasuries are yielding good values again. Lets buy those instead).
The people who did buy 0.2% 1Y treasuries earlier this year (or worse, 10Y or 30Y treasuries) have lost a lot of value due to these higher interest rates.
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Case in point: the 1Y US Bond is literally a better rate than my 15Y mortgage. It makes more sense to buy 1Y bonds than for me to pay off my mortgage right now (ignoring tax issues of course)
Equity and debt. In 2000, 2008 and Covid, bonds all heavily rallied while stocks were selling off. That's the reason the 60/40 stocks/bonds portfolio is the cornerstone of modern portfolio management. Historically one tends to hedge the other, cushioning pain on the way down.
2022 is unique in that both stocks and bonds have simultaneously nosedived in a synchronized a fall. We've had worse equity selloffs. We've had worse treasury selloffs. But together, this year has been historically unprecedented bad performance for the 60/40 portfolio.
You think we've reached bottom? Given the various global economic shocks we've already experienced and are likely to experience later this year, a long, relatively slow bear market decline is more likely than one giant drop.
Keep in mind Russia is only starting to cut off Western Europe (which is only starting to cut off itself), so oil and gas prices still have lots of room to go up if Putin doesn't relent (which he won't). Also we've yet to price in impacts to food from the global fertilizer shortage.
And those are just the obvious 1st order effects in the pipeline. The last time wheat prices went through the roof in North Africa it kicked off the Arab Spring and subsequent Syrian Civil War as side effects. There's going to be all sorts of fun coming out of this year, and I imagine a lot of stocks reliant on global supply chains are going to be ground down by hit after hit after hit.
That's not even touching on domestic demand destruction and interest rates.
In my experience we’ve hit bottom when everyone agrees we haven’t yet hit bottom. Which seems to be around now. In other words everyone who was going to sell has already sold. Unless more surprise bad news comes out.
i expect a secular change as rates increase and all sorts of things that worked in a declining interest rate environment stop working, coupled with increasing global trade issues
There are short term effects and long term effects. The short term effect is basically a lot of uncertainty, supply chain issues, and the market re-adjusting to not being able to depend on Russian energy exports. Chaos in other words. Putin's ability to induce more chaos is however declining. Except for going nuclear and starting WW III, he's basically played most of the cards he had. And given how his army performs in the Ukraine, that seems ill advised.
The long term effect is enormous investments in energy and defense spending. E.g. Germany just announced enormous public spending on both. That's after decades of not doing much public spending at all. Other countries are likewise accelerating investments on both fronts. That is a lot of money that is flowing into the economy in the next years. And also a classical recipe for boosting economic growth. We're only a few months into this crisis and it has already unlocked hundreds of billions of funding in Germany alone. Normally, spending that big is going to have an impact on economies. There are companies that will benefit from this. And there are effects on employment, etc.
Investors of course are a mixed bag of headless chickens, snake oil sellers, amateurs and the occasional level headed person with a bit longer view on things. I'd offer advice, but I don't qualify as anything more than an absolute amateur. But the one thing I know is that the short term behavior of stock markets is perplexing and irrational. I wouldn't read too much into it other than that "there's a thing going on and it's impacting the stock market". I would not expect anything less given the thing that is going on. What matters is what happens when that thing is in the past.
IMHO, this situation is a blessing in disguise. It got world + dog moving a lot more aggressively on cutting their dependence on fossil fuels. I think that's a good thing. Going cold turkey on Russian gas is going to suck for a lot of countries short term but the current situation simply leaves no other choice. High prices are a great incentive for moving quickly. The good news is that there are companies itching to step in the void with solutions and they now have the full attention of investors and governments with very deep pockets.
Keep in mind that at 10% inflation in the US, 20% inflation worldwide, nominal earnings will probably be increasing in most companies. And eventually the stock market will build the money devaluation into the prices (i.e. nominal stock prices will go up)
So while the market might only be down 25% which isn't the biggest drop ever, 10-20% inflation on top that makes the actual drop larger. It also might mean the bottom in closer than it would normally be.
> Keep in mind Russia is only starting to cut off Western Europe (which is only starting to cut off itself), so oil and gas prices still have lots of room to go up if Putin doesn't relent (which he won't).
> Also we've yet to price in impacts to food from the global fertilizer shortage.
The US at least can protect itself from rising prices by prohibiting oil and food exports and thus increase domestic supply - they are a net exporter for both. The European Union however is completely dependent on either Russia or the OPEC oil sheiks, we will be hit real hard (but that shouldn't bother US stocks all too much).
> The last time wheat prices went through the roof in North Africa it kicked off the Arab Spring and subsequent Syrian Civil War as side effects.
That one will be the real interesting part, but again, it's mostly us Europeans who will feel the impact the most - the US can simply send off a bunch of soldiers to the Mexican border and continue treating people fleeing from utter poverty even worse than us Europeans manage to do. The US doesn't care all too much about Africa, Arabia and most of Asia except China and Russia any more, no matter what goes down there they won't involve themselves.
The problem for us Europeans is that our leaders are ineffective and the crises are accumulating:
- the UK government is outright collapsing at the moment and its society fracturing up, not to mention the economic consequences of Brexit or the potential split-offs of Scotland and Northern Ireland. I don't even want to speculate when they will have a stable-ish government with sane policies again.
- France is headed for difficult times, similar to Obama's last six years Macron will have to live without a parliamentary majority
- The Dutch government is still unstable and it's highly unlikely Rutte will survive his term
- Germany... well, Olaf Scholz is no leader, doesn't want to be a leader and frankly he should resign. The coalition itself is beginning to tear apart, particularly because of the financially extremist FDP.
- Europe still doesn't have any sort of common concept on how to deal with immigrants and refugees, partially because Viktor Orban and the Polish PiS keep blocking anything that would require them to house their fair share of migrants or even pay in solidarity. Meanwhile at the borders, horrible crimes against humanity are reported regularly (beatings and illegal pushbacks at the Poland-Belarus border, refugees being extorted by Greek border police to aid in illegal pushbacks at the Turkish sea border, refugees dying at the Spain-Maroccan border in Melilla, people drowning at sea because aid ships are regularly seized by Italian police, ...). The Turkish dictator Erdogan keeps using refugees or the threat of sending them as a political way of extortion.
- Germany has long undermined any sort of independency from Russian gas and oil, and now we're doing dirty deals with Qatar instead of forcefully modernizing industry and housing or doing anything to meaningfully conserve energy.
- Prices in the EU are exploding: rent, energy, food. And our politicians don't have the will or the financial power to assist those in poverty.
Europe is getting fucked hard, the US may escape that same fate if Biden and especially his Democrat Senators get their shit together.
We'll see, but those events were dramatically different. I don't think anyone can easily predict what is going to happen right now by looking at those two events.
It’s clear to anyone who looks at a stock chart from 2020-2022 the entire economy was artificially pumped and we’re living through the dump.
I don’t really know what else people expect voting for gerontocrats who have made their names on leveraged buyouts, insider trader, gaming the courts after their businesses commit fraud and the like. Neither “side” of the political spectrum is innocent of such things, including the voters.
Elder Americans are straight up grifters, free loaders with no ability to accept the rest of the world is not a post-WW2 crater. They were able to win big easy, they are the gold star for nothing generation, due to the rest of the world having been obliterated shortly before their birth.
Electing Romneys, Feinsteins, and the rest is lunacy. They have no idea how to do productive work as the world rebuilt itself without them; they all huddled in offices learning how to design models decoupled from reality, convincing themselves of their genius and work ethic as their families expropriated earnings from workers; because of course they’re owed a cut for producing nothing. It just makes perfect sense.
I'm struggling to find something useful in this comment. I'll just pick one point.
> Elder Americans are straight up grifters, free loaders with no ability to accept the rest of the world is not a post-WW2 crater
Compare against younger Americans who are straight up grifters, free-loaders making up crypto coins and NFTs and other garbage that wastes precious natural resources for their scammy activities?
In case my point isn't clear, you're attributing to some class of people an attitude that equally applies to all other classes of people, but in a way that somehow implies it's special to that one.
I guess the one useful tidbit I can get from your comment is... well... it's already a tired cliché, albeit true: neither American political party is the friend of the little people. And although those parties are dominated by Feinsteins and McConnells, there are still Bernie Sanders and Rand Pauls.
So... what do we do about that? Other than discriminate against some class of people that's your personal outgroup?
Maybe work at a local level to elevate more Sanders and Pauls?
Private Equity is an arbitrage on bloated companies. Typical cycle is innovative startup -> efficient corporation -> beauracratic corporation. PE firms buy the companies late in the cycle and then cut the fat. Commonly also seen in activist investors. This is a needed function that will never go away.
It's a bit of a romanticized view. Like a junk yard mechanic opining on the circle of life.
Some PE firms definitely resurrect companies. But a lot are junk yards for companies: they buy to divest & accelerate lifetime profits to today, knowing they'll just dispose the husk at the end. Others are monopoly plays: "roll ups" of local/regional players until there's just one option left and they can raise prices. Still others are growth plays: they're willing/able to take bigger risks, for bigger rewards. And others exist too.
Notably, all would likely describe themselves as arbitrage on bloated/mismanaged companies.
A lot of people view companies as fundamental and bankruptcy as bad because companies are the biggest "things" you can point to in the economy. But the economy itself doesn't think in those terms (it doesn't really think in any terms, not being alive). The fundamental assets in the economy are land, labor, capital, and information, and a firm is just a way to organize those factors of production to do something useful. Over time the optimal way to do things often shifts so that whole companies become obsolete, but the incentive of everyone involved in a company is to make sure the company keeps existing.
The role of a P/E firm or corporate raider is to buy the company, strip all the assets off, sell them to other companies that will use them more efficiently, lay off all the employees, and force them to get other jobs. Which sounds utterly cruel if you think of the company itself as a thing whose existence you want to preserve, but if you think of the company as an organization of convenience which should be dismantled and reconfigured when economic & technological conditions change, you are just paving the way for other companies to flourish.
There's another type of PE out there beyond what you've described which is, the owner of a moderately sized privately owned firm (doing somewhere between 10-100 mil revenue a year) wants to retire and sell it off, and PE firms are the only ones who can afford to buy it for the 100mil+ price tag it warrants.
Typically they cut a bunch of expensive overhead, like employees, which juices the books to make it look much more profitable, then sell to someone else left holding the bag of a dead shell of a company. Cut long term viability for short term gains.
I think it’s fair to assume both exist. The (small) company I work for sold to PE in 2019. They basically dumped a bunch of money in to help us scale up quickly. It hasn’t all been great, but revenue continues to grow and we have (many) more employees than before from top to bottom. I expect they’ll probably try and move on soon to realize their gains, but the next buyer definitely won’t be receiving a “dead shell” unless they somehow fail to retain the employees during the transition.
Sometimes squeezing the last drops of juice out of a doomed lemon is the economically most efficient thing to do. The purpose of a company is to serve the interests of its shareholders (within the bounds of law), not to survive indefinitely. We all know cases of companies that squandered value in vain attempts to stay alive, when they just could have slowly put themselves out of business and returned the last years of profits to their shareholders. Kodak, I'm looking at you.
One view does not exclude the other. Predators have a role in ecosystems, culling the weak and the sick from the herd. PEs are corporate predators, preying on bloated orgs, killing them, returning whatever value still held (trademarks, patents) back to the "environment".
But of course that "pure market" viewpoint doesn't take into account the social costs and individual pains these operations entail.
I've seen both. A place I worked once got bought by PE, and they cut development costs for a product which was becoming less and less relevant anyways. There's a variety of opinions about that.
You look at Toys R Us, and a few other major retailers, it is as you say.
If this were commonly true, who are the dumbasses buying companies from private equity funds, and why would they continue to buy them? And, whether your statement is true or not, why should I (or anyone else) feel bad for anyone who would buy back a company that has been gutted and has no future? This is business, people are supposed to be professional and to differentiate opportunity from disaster.
Lastly, "Cutting long term viability for short term gains." actually sounds somewhat noble. Why should a company exist for 50 years when all of its usefulness (i.e. profit) can be extracted in 5? Let everyone move on to something else productive. If you owned an oil well you could exhaust in 5 years, you'd do it, not sip at it for the next 50.
> Typically they cut a bunch of expensive overhead, like employees, which juices the books to make it look much more profitable, then sell to someone else left holding the bag of a dead shell of a company. Cut long term viability for short term gains.
This really only exists in large cap deals. Most middle market deals are actually about long term viability...mainly because they have to sell to other PEs or strategics that will underwrite the long term viability during diligence when they go to buy. Large cap on the other hand will typically try to IPO it where the public investor might be left holding the bag (or creditors, or employees).
The goal of PE firms is to exit their investments. Do you think PE is a long running greater fool scam, where there’s always a foolish buyer available.
Or, do you think sometimes the buyers are not getting a dead shell?
Wild that what's obvious to ransom HN commenters hasn't been noticed by the guys buying the dead shells of companies. You'd think that it would be important to them.
Or maybe that's anecdotal and not necessarily the brought trend.
Theoretically, yes; in practice most private equity is no better at management than the people they are replacing. Often times they miss the fat and cut the bone instead.
It's hard to actually see what provides company value and what is actually expendable. Remember that the whole idea behind free markets is that you can't perfectly know and precalculate every input and output of an economy; you want a distributed set of economic actors making decisions for themselves. And large businesses are not immune to this - they operate not like tribes, but like little mini-economies unto themselves. If we actually could "cut the fat", command economies would have worked and America would have collapsed instead of the Soviet Union.
People take over organizations and loot them for personal gain. It's the simplest business model imaginable.
In fairness that's not the only PE model. The other model is to buy up competing businesses, engage in anti-competitive practices, and extract monopoly rents from a sector.
In my view, someone from the uk, they generally buy companies and strip as much money as they can out of the company by selling bits off or they buy it and load it up with debt and then take as much money as they can out.
If by fall you mean from its all time highs, sure, but theres still so much money allocated that needs to be spent:
After 10 years of steady growth, dry powder set yet another record in 2021, rising to $3.4 trillion globally, with approximately $1 trillion of that sitting in buyout funds and getting older (see Figures 8 and 9).[0]
There was an all time high of 490 buyout funds closed in 2021. What is very likely is that many of these new funds (I see a lot of them...the 8-man shops that came from MDs at places like KKR, Carlyle, Apollo, etc.) will just fizzle out.
Like everything else, it's just gettting corrected.
Speaking as someone who came from PE, agree that higher rate environment means both better investment alternatives and also more expensive capital for LBOs. That said, the firms with fresh capital can make a ton of money buying into this environment. Zendesk being a great first example. Not a huge amount of debt required to do these types of deals. Liquidity going to hide under the figurative rock of fixed income means values get dragged down, which creates an incredible buying opportunity for all these PE funds. Look 5-7 years out, I'd guess 2022 and 2023 vintage funds will be some of the best in history.
Readit News
https://fred.stlouisfed.org/graph/?g=RveY
Many private equity deals that arguably were economically viable when the 10-year treasury's annual yield was ~0.6%, less than a year ago, may not be viable now that the 10-year treasury's annual yield is ~3%, and are likely to suffer financial distress if interest rates rise further -- say, 10-year treasury yields of ~5%, ~6%, or more. If that sounds high, keep in mind that the last time the Fed had to deal with high inflation, in the 1970's, the 10-year treasury yield rose to a peak of ~16%!
Over the same past four decades, valuation multiples have only risen and risen, in fits and starts, making life easier and easier for those who make money by buying businesses, holding them for a while, and selling them down the road. For example, here's the ratio of US stock market capitalization to the size of the US economy (GDP):
https://fred.stlouisfed.org/series/DDDM01USA156NWDB
The rise in valuation multiples over the past four decades makes sense, given that the net present value of any business is inversely proportional to the discount rate used to value its future profits, and discount rates are equal to prevailing long-term treasury rates plus a premium. If interest rates continue to rise, valuation multiples are bound to decline too.
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EDITS: Changed language in response to comments below so it better reflects what I meant to write in the first place.
A 3% rate for a leveraged entity? Unlikely. Current high-yield spreads are in the neighborhood of 500-600bp, on top of treasury rates.
So, you'd need 60% more debt (19.3/12) to keep the same capital structure [EDIT: this last sentence is WRONG! The amount of debt needed would be the same, because the correct EV/EBITDA multiple is 12.3x. See comment below.], and the debt would be 2-3x more expensive, leaving much less margin for a downside scenario, say, in the event of a prolonged recession, rising rates, and/or declining valuation multiples. If all three of those things happen at the same time, things could get... ugly.
In 2021, buyout was ~30% PE funds raised, VC was ~10%, growth was ~10%. “Tiny” is not true anymore. https://www.bain.com/insights/private-equity-market-in-2021-...
The first LBO was of Orkin Pest Control in 1964 and there were about a half dozen other LBOs in the 60's.
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Valuation multiples are (relatively) crushed, and I don't think we'll see much more of a multiple compression. What we will see, in both private and public markets, is when businesses adjust their earnings forecasts for the (very likely) impending recession. If you look at Wall Street numbers companies are still forecasting growth pretty every quarter through 2023. Now, that doesn't seem very likely to me.
The deal is, the public markets will overreact as always and sell off harder, but private equity will stay more fairly valued because of it's inherent lack of liquidity (two wrongs make a right).
People like to say this because of how negative the consequences would be, but that is not a reason why it won't happen.
FWIW, given that it would only affect the US Gov't's new issuances, it's not impossible for them to let it happen.
I disagree that valuations have been crushed. You qualified that with a "relatively". We're lower than at the peak of the bubble of course but Shiller PE is still 30, higher than any time other than the dot-com bubble and the current bubble.
Private equity firms will choose not to write down the value of their assets, but the actual transactable prices will probably drop further than public stocks.
A generation is 30 years.
The stock market is roughly 20% off its highs.
It went down 25% at the start of covid, just two years ago.
In 2008 it went down 57%
In 2000 it went down 42%
The stock market is doing alright. Some investors are getting destroyed. And some new investors are receiving a very useful, very painful lesson.
(Full disclosure: I’m mainly a buy and hold index investor)
Still waiting for the first month of negative employment numbers.
That is when things are likely to start getting interesting. Right now we're still in the warm-up act.
Zoom is still 80% higher than it was at the start of 2020.
The entire stock market may only be down 20%, but the investors who piled into hot tech stocks like Peloton and Zoom went from thinking the stock market was easy money to thinking that the stock market is a great way to lose most of your money. Even Robinhood went from a trendy young person trading platform to a perceived villain in the span of a couple years.
The stock market that you see as a seasoned passive investor is completely different than the boom and bust meme stock market that many young people were introduced to recently. I don’t know what the long term effects will be on those who were burned in the exuberance and ensuing crash.
I have the feeling that we are not done yet ...
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And other debt instruments price off of these. Not sure the economic fallout has been fully felt yet.
To compare to other periods, gov debt instruments increased in value during 2000, 2008 and 2020.
When rates go up, bonds become more useful as an investment.
When the 1-year US Treasury was yielding 0.2% earlier this year, it was a bad idea to buy 1Y treasuries (and most other treasuries). Today, the 1Y is 2.87%, and suddenly a whole slew of investors just won't want to invest into shady high-risk companies anymore (Hey look, US Treasuries are yielding good values again. Lets buy those instead).
The people who did buy 0.2% 1Y treasuries earlier this year (or worse, 10Y or 30Y treasuries) have lost a lot of value due to these higher interest rates.
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Case in point: the 1Y US Bond is literally a better rate than my 15Y mortgage. It makes more sense to buy 1Y bonds than for me to pay off my mortgage right now (ignoring tax issues of course)
2022 is unique in that both stocks and bonds have simultaneously nosedived in a synchronized a fall. We've had worse equity selloffs. We've had worse treasury selloffs. But together, this year has been historically unprecedented bad performance for the 60/40 portfolio.
Keep in mind Russia is only starting to cut off Western Europe (which is only starting to cut off itself), so oil and gas prices still have lots of room to go up if Putin doesn't relent (which he won't). Also we've yet to price in impacts to food from the global fertilizer shortage.
And those are just the obvious 1st order effects in the pipeline. The last time wheat prices went through the roof in North Africa it kicked off the Arab Spring and subsequent Syrian Civil War as side effects. There's going to be all sorts of fun coming out of this year, and I imagine a lot of stocks reliant on global supply chains are going to be ground down by hit after hit after hit.
That's not even touching on domestic demand destruction and interest rates.
i expect a secular change as rates increase and all sorts of things that worked in a declining interest rate environment stop working, coupled with increasing global trade issues
i do not have a crystal ball
The long term effect is enormous investments in energy and defense spending. E.g. Germany just announced enormous public spending on both. That's after decades of not doing much public spending at all. Other countries are likewise accelerating investments on both fronts. That is a lot of money that is flowing into the economy in the next years. And also a classical recipe for boosting economic growth. We're only a few months into this crisis and it has already unlocked hundreds of billions of funding in Germany alone. Normally, spending that big is going to have an impact on economies. There are companies that will benefit from this. And there are effects on employment, etc.
Investors of course are a mixed bag of headless chickens, snake oil sellers, amateurs and the occasional level headed person with a bit longer view on things. I'd offer advice, but I don't qualify as anything more than an absolute amateur. But the one thing I know is that the short term behavior of stock markets is perplexing and irrational. I wouldn't read too much into it other than that "there's a thing going on and it's impacting the stock market". I would not expect anything less given the thing that is going on. What matters is what happens when that thing is in the past.
IMHO, this situation is a blessing in disguise. It got world + dog moving a lot more aggressively on cutting their dependence on fossil fuels. I think that's a good thing. Going cold turkey on Russian gas is going to suck for a lot of countries short term but the current situation simply leaves no other choice. High prices are a great incentive for moving quickly. The good news is that there are companies itching to step in the void with solutions and they now have the full attention of investors and governments with very deep pockets.
So while the market might only be down 25% which isn't the biggest drop ever, 10-20% inflation on top that makes the actual drop larger. It also might mean the bottom in closer than it would normally be.
> Also we've yet to price in impacts to food from the global fertilizer shortage.
The US at least can protect itself from rising prices by prohibiting oil and food exports and thus increase domestic supply - they are a net exporter for both. The European Union however is completely dependent on either Russia or the OPEC oil sheiks, we will be hit real hard (but that shouldn't bother US stocks all too much).
> The last time wheat prices went through the roof in North Africa it kicked off the Arab Spring and subsequent Syrian Civil War as side effects.
That one will be the real interesting part, but again, it's mostly us Europeans who will feel the impact the most - the US can simply send off a bunch of soldiers to the Mexican border and continue treating people fleeing from utter poverty even worse than us Europeans manage to do. The US doesn't care all too much about Africa, Arabia and most of Asia except China and Russia any more, no matter what goes down there they won't involve themselves.
The problem for us Europeans is that our leaders are ineffective and the crises are accumulating:
- the UK government is outright collapsing at the moment and its society fracturing up, not to mention the economic consequences of Brexit or the potential split-offs of Scotland and Northern Ireland. I don't even want to speculate when they will have a stable-ish government with sane policies again.
- France is headed for difficult times, similar to Obama's last six years Macron will have to live without a parliamentary majority
- The Dutch government is still unstable and it's highly unlikely Rutte will survive his term
- Germany... well, Olaf Scholz is no leader, doesn't want to be a leader and frankly he should resign. The coalition itself is beginning to tear apart, particularly because of the financially extremist FDP.
- Europe still doesn't have any sort of common concept on how to deal with immigrants and refugees, partially because Viktor Orban and the Polish PiS keep blocking anything that would require them to house their fair share of migrants or even pay in solidarity. Meanwhile at the borders, horrible crimes against humanity are reported regularly (beatings and illegal pushbacks at the Poland-Belarus border, refugees being extorted by Greek border police to aid in illegal pushbacks at the Turkish sea border, refugees dying at the Spain-Maroccan border in Melilla, people drowning at sea because aid ships are regularly seized by Italian police, ...). The Turkish dictator Erdogan keeps using refugees or the threat of sending them as a political way of extortion.
- Germany has long undermined any sort of independency from Russian gas and oil, and now we're doing dirty deals with Qatar instead of forcefully modernizing industry and housing or doing anything to meaningfully conserve energy.
- Prices in the EU are exploding: rent, energy, food. And our politicians don't have the will or the financial power to assist those in poverty.
Europe is getting fucked hard, the US may escape that same fate if Biden and especially his Democrat Senators get their shit together.
my point is only that there is a lack of perspective on how bad things currently are
https://en.wikipedia.org/wiki/Generation
even by the 20 year definition, all of the events listed fall within that window: the .com crash bottomed in 2002/2003
I don’t really know what else people expect voting for gerontocrats who have made their names on leveraged buyouts, insider trader, gaming the courts after their businesses commit fraud and the like. Neither “side” of the political spectrum is innocent of such things, including the voters.
Elder Americans are straight up grifters, free loaders with no ability to accept the rest of the world is not a post-WW2 crater. They were able to win big easy, they are the gold star for nothing generation, due to the rest of the world having been obliterated shortly before their birth.
Electing Romneys, Feinsteins, and the rest is lunacy. They have no idea how to do productive work as the world rebuilt itself without them; they all huddled in offices learning how to design models decoupled from reality, convincing themselves of their genius and work ethic as their families expropriated earnings from workers; because of course they’re owed a cut for producing nothing. It just makes perfect sense.
> Elder Americans are straight up grifters, free loaders with no ability to accept the rest of the world is not a post-WW2 crater
Compare against younger Americans who are straight up grifters, free-loaders making up crypto coins and NFTs and other garbage that wastes precious natural resources for their scammy activities?
In case my point isn't clear, you're attributing to some class of people an attitude that equally applies to all other classes of people, but in a way that somehow implies it's special to that one.
I guess the one useful tidbit I can get from your comment is... well... it's already a tired cliché, albeit true: neither American political party is the friend of the little people. And although those parties are dominated by Feinsteins and McConnells, there are still Bernie Sanders and Rand Pauls.
So... what do we do about that? Other than discriminate against some class of people that's your personal outgroup?
Maybe work at a local level to elevate more Sanders and Pauls?
Dead Comment
Private Equity is an arbitrage on bloated companies. Typical cycle is innovative startup -> efficient corporation -> beauracratic corporation. PE firms buy the companies late in the cycle and then cut the fat. Commonly also seen in activist investors. This is a needed function that will never go away.
It's a bit of a romanticized view. Like a junk yard mechanic opining on the circle of life.
Some PE firms definitely resurrect companies. But a lot are junk yards for companies: they buy to divest & accelerate lifetime profits to today, knowing they'll just dispose the husk at the end. Others are monopoly plays: "roll ups" of local/regional players until there's just one option left and they can raise prices. Still others are growth plays: they're willing/able to take bigger risks, for bigger rewards. And others exist too.
Notably, all would likely describe themselves as arbitrage on bloated/mismanaged companies.
But that doesn't make it true, really
A lot of people view companies as fundamental and bankruptcy as bad because companies are the biggest "things" you can point to in the economy. But the economy itself doesn't think in those terms (it doesn't really think in any terms, not being alive). The fundamental assets in the economy are land, labor, capital, and information, and a firm is just a way to organize those factors of production to do something useful. Over time the optimal way to do things often shifts so that whole companies become obsolete, but the incentive of everyone involved in a company is to make sure the company keeps existing.
The role of a P/E firm or corporate raider is to buy the company, strip all the assets off, sell them to other companies that will use them more efficiently, lay off all the employees, and force them to get other jobs. Which sounds utterly cruel if you think of the company itself as a thing whose existence you want to preserve, but if you think of the company as an organization of convenience which should be dismantled and reconfigured when economic & technological conditions change, you are just paving the way for other companies to flourish.
Typically they cut a bunch of expensive overhead, like employees, which juices the books to make it look much more profitable, then sell to someone else left holding the bag of a dead shell of a company. Cut long term viability for short term gains.
But of course that "pure market" viewpoint doesn't take into account the social costs and individual pains these operations entail.
You look at Toys R Us, and a few other major retailers, it is as you say.
Lastly, "Cutting long term viability for short term gains." actually sounds somewhat noble. Why should a company exist for 50 years when all of its usefulness (i.e. profit) can be extracted in 5? Let everyone move on to something else productive. If you owned an oil well you could exhaust in 5 years, you'd do it, not sip at it for the next 50.
This really only exists in large cap deals. Most middle market deals are actually about long term viability...mainly because they have to sell to other PEs or strategics that will underwrite the long term viability during diligence when they go to buy. Large cap on the other hand will typically try to IPO it where the public investor might be left holding the bag (or creditors, or employees).
Or, do you think sometimes the buyers are not getting a dead shell?
Or maybe that's anecdotal and not necessarily the brought trend.
It's hard to actually see what provides company value and what is actually expendable. Remember that the whole idea behind free markets is that you can't perfectly know and precalculate every input and output of an economy; you want a distributed set of economic actors making decisions for themselves. And large businesses are not immune to this - they operate not like tribes, but like little mini-economies unto themselves. If we actually could "cut the fat", command economies would have worked and America would have collapsed instead of the Soviet Union.
The best way to describe PE is as a means of exploiting principal/agent issues:
https://en.wikipedia.org/wiki/Principal–agent_problem
People take over organizations and loot them for personal gain. It's the simplest business model imaginable.
In fairness that's not the only PE model. The other model is to buy up competing businesses, engage in anti-competitive practices, and extract monopoly rents from a sector.
After 10 years of steady growth, dry powder set yet another record in 2021, rising to $3.4 trillion globally, with approximately $1 trillion of that sitting in buyout funds and getting older (see Figures 8 and 9).[0]
There was an all time high of 490 buyout funds closed in 2021. What is very likely is that many of these new funds (I see a lot of them...the 8-man shops that came from MDs at places like KKR, Carlyle, Apollo, etc.) will just fizzle out.
Like everything else, it's just gettting corrected.
[0] https://www.bain.com/globalassets/noindex/2022/bain_report_g...
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