“Forward, the Light Brigade!”
Was there a man dismayed?
Not though the soldier knew
Someone had blundered”
The Charge of the Light Brigade
“We are late in the cycle.”
Lord only knows how many times I’ve heard that phrase used in the past few years. People were using it as far back as 2012 in the (mistaken) belief that this cycle would be truncated, and the world economy would slip back into recession.
Morphic has consistently held the view, for many years, that the cycle could carry on longer than many expected. Indeed, it has carried on longer than even we dared to believe, which has cost us this year. But there are some signs that guide one to where we are, be that quantitative or qualitative, and these are starting to show a lot more amber than green.
Firstly, the quantitative. There is a saying that “debt markets lead you into recession and equity markets lead you out”. It is now well-publicised that parts of the US yield curve inverted in the last 12 months. The curve has been a good (though not perfect) predictor of future economic activity. An inversion doesn’t mean the end, rather that it’s late stage.
Then there are credit markets. Spreads often widen before equities fall, and we have seen triple-C spreads widen this year. Investment-grade spreads also remain higher than 2018, despite equities being higher – another amber signal.
But for me, the most interesting signs this year are qualitative. Markets are inherently human (for now) and so behaviour through a cycle tends to be consistent, even if the actors change. It is this changing of actors that sees behaviour repeat as per Jim Grant’s great quote, “progress is cumulative in science and engineering, but cyclical in finance”.
Particularly of note in 2019 is the increased “fraying” of the technology narrative that has driven this long great bull market.
Consider the increasing public market rejection of private market valuations; 2019 has seen a rush of IPOs from private equity (PE) and venture capital (VC). The nature of PE and VC investing is these assets have to be sold, either via IPO or trade sale. In prior years, IPOs such as Facebook and Alibaba soared.
Yet this year Uber is trading well below its float price and the failed WeWork float has all the hallmarks of a future Harvard Business School case study. Pets.com anyone?
If we look at our market, Australians have rejected the Latitude float (for the second time) and now PropertyGuru has been pulled as well to go with Retail Zoo and MPC Kinetic.
We also observe the increasingly “skewed” response of tech stocks in Australia to bad news. In the last few weeks, both Wisetech and iSignthis shares have been suspended from trading, for different reasons. Both were market darlings in the local tech space and may yet recover, but note the way they fell more swiftly than before. This increased two-way price action, is late cycle stuff.
Then there is the “death of style X”. In the late 1990s you couldn’t give away BHP shares, such was the disdain for commodities. In 2002, Gordon Brown famously sold the UK’s gold reserves for $US275 an ounce, marking the low in the gold price. In 2006, the story was “the end of large cap US investing”, with everyone chasing Asian growth. Today, it’s “the end of value investing”.
Lastly there is the increased funding to private markets and VC who are already having a hard time getting away those old deals. Whilst this is not a comment on the merits of allocating to these strategies, there has historically been a pro-cyclical allocation pattern from pension funds, with 2007 seeing a peak of $US762 billion in buyouts, with the lows of $101 billion in … 2009. Yes, the very year that one should have been allocating to the surplus of cheap assets around the world, allocators shied away.
Instead there is a now a rush to allocate in 2019.
So, is it the very end? Sorry to disappoint, but probably not yet. It usually gets really, really silly at the end. This is more like 1998. I haven’t had an Uber driver say he’s started a VC business as a side-hustle and with interest rates this low, it’s hard for businesses to default.
Then again WeWork is setting new standards as a place where money goes to die for no good reason.
This article was written by Morphic’s joint-CIO Chad Slater in a column for the AFR and you can find a pdf version here.
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