You ever get the feeling you don’t know how much anything costs anymore? You look at a Toyota Camry that costs $45,000, a hamburger that costs $17, or a basic hotel room for $250. And then there are downtown office buildings selling for pennies on the dollar and airline flights seem reasonable.
Yes, we all know about inflation and the money supply expanding by 40%, but it is more than that. For years the Fed kept interest rates at near zero and the stock market, housing and everything else went up in value. But for a very long time, there has been no real value check on vast swaths of our economy. Free money has created great distortions in all markets.
There is very little price discovery.
You can say that housing almost rarely goes down in value. And it is true, that, except with the GFC, housing has averaged about 6% a year for a hundred years.
But it is also true that homeowners listing their house for 60% more than they bought it for in 2022 are not getting their asking price. Many destination towns are seeing dramatic price cuts. These will eventually sell at prices above what the owners paid, and therefore not officially be a drop in prices, but these houses are at the price they or their realtor believed they were worth.
In other words, housing is undergoing a crash in perceived wealth in destination locations.
Don’t get me started on RVs and boats which are seeing prices dive. When money gets tight toys go first, then vacations, second houses, cars, 401k’s, and finally primary houses.
Private Equity
Private Equity (PE) might have the largest gap between perception and reality. PE is a huge sector of our economy, it was worth $12 trillion in 2022. However, it is hidden from most people because it is private and unregulated. Many think the sector is in a bubble.
For those that don’t know, a PE firm seeks to make money in other ways than stocks, bonds, or traditional Wall Street methods.
Twenty years ago private equity firms like Blackstone, Bain Capital, or the Carlyle Group would make mega deals for Hilton Hotels, PetSmart or RJR Nabisco. But more recently those deals are gone. PE is now a crowded space chasing car wash chains and laundromats.
According to Jared Dillion of Money who wrote an excellent research report on PE, “In 1980, there were 24 PE funds. By 2015, this number had increased to approximately 6,600. By 2022, there were 17,000 private equity firms in the United States.
Being a first mover is everything and the heyday of PE is over.
Here’s how it worked. A PE firm traditionally would borrow tons of money to buy up a business or a series of businesses in the same line. They would then fire all the deadwood, close the unprofitable shops, merge the back office, wait a few quarters for the short-term cash flow to improve, and sell them to a middle-market company.
The key was to borrow cheap and sell fast.
Exit strategies also include taking them public through a SPAC or IPO. The average deal size in 2022 was $964 million.
The problem is that there aren’t any SPACs or IPOs. There were over 1000 IPOs in 2021 this year there will be 146. PE firms are having to hold onto the deals for longer. Months are turning into years.
The pension funds and non-profits who were promised 17% annual gains or some such world-beating number have held on for four or five years now and are getting antsy.
There is also the question of value. In the past, PE would pay 5 or 6 times annual earnings for a company. Last year, they were paying 11 or 12 times. And the deals are getting worse.
So PE is paying more for deals and waiting longer for an exit. Also, remember what used to work at almost zero interest rates doesn’t work at 6.5%. Many people believe that there will be a reckoning. At some point, those investors who cut and run first will be hit with the least losses.
With the Boomers in full retirement mode, pension funds will need their money.
It could be that the PE bubble deflates rather than pops. Or it could be a recession causing a rush for the exits.
That would be the black swan that creates economic chaos and It will be a hard sell to get the public to bail out the likes of Bain Capital.
All the best,
Christian DeHaemer
Outsiderclub.com
Top 10 PE Firms: https://www.forbes.com/advisor/investing/best-private-equity-firms/
Understanding PE: https://www.investopedia.com/articles/financial-careers/09/private-equity.asp
Know Nukes: https://www.outsiderclub.com/the-nuclear-bull-market-is-here/
