2023 Review, Private Markets, Nuclear

2023 Review

Rates are notoriously tricky to predict. With that said, rates across the board are solidly trending down. The US inflation rate has also trended lower since its peak in May 2022. The most significant and slowest portion of the inflation rate (Consumer Price Index) is shelter (rent), which shows signs of a sustained drop. The Zillow Rent Index shows that rent inflation is 3.3% vs the official CPI metrics of 6.5%. Redfin’s most recent rental data shows deflation. The Fed does not set policy on the Zillow Rent Index, but based on the real-time nature of Zillow’s data, we can expect CPI to drop further with high confidence. Falling inflation rates are a prerequisite for rate cuts. The futures market is currently predicting a 90% chance that the Fed will cut rates four times by December 2024. That’s reasonable, given the downward trend in inflation and the 10-year treasury.

2023 was a harsh year for the current banking system, venture capital and San Francisco real estate. The trend against our current banking system and in favor of private credit is a topic I have covered many times this year that I don’t expect to end anytime soon. As for venture capital, approximately 3200 venture-backed startups shut down in 2023, representing at least $27.2 billion in capital raised. Despite the washout in venture capital, there are examples of VC companies that have done well. The fintech APEX is one example of a pre-IPO company that exceeded its targets and is now looking at an IPO, and I’m sure there are many others behind it. San Francisco is the first major city in the US to see a downturn in their real estate values for this cycle. SF real estate metrics don’t look that bad in the aggregate, but when you spot-check Zillow listings, it’s easy to find significant price reductions. One article estimates that one in eight real estate investors in SF are now selling at a loss.

We picked an image of salmon swimming upstream for this week’s article because it exemplifies how nature can successfully adapt and fight against challenging environments. The strongest companies find ways to swim where they want to go regardless of the direction of the economic waters. We have remained biased towards US technology for many years now and that extensive cohort continues to surprise to the upside. For example, while the S&P 500 is up 20% YTD, the US Tech heavy Nasdaq is up 50%. There is very little performance elsewhere in the world. Non-US and non-tech markets have barely produced any performance in 2023. There is positive room for growth among companies that have found a way to maintain positive earnings and free cash flow growth. Those companies continue to reveal themselves and have been rewarded accordingly to date.

Private Market’s Primary Concerns

Switching to private markets, Apollo recently published a survey of the concerns of each private market investor for their given sector focus. The results are about what you would expect, but it’s always helpful to frame the context, even if it is obvious to both knowledgeable and less knowledgeable readers. The question is, “What are the main challenges to returns in the next 12 months?”

• Private Equity is concerned about exit and entry multiples and interest rates. Private equity firms can’t deploy or return capital unless they agree on an attractive price for both sides of the transaction. In the meantime, higher interest rates are eating away at profits and reducing valuations. A drop in interest rates would relieve the pressure on PE firms to roll debt at higher rates.
• Venture Capital is concerned with exit opportunities. There is a massive IPO backlog, and attractive public comps are needed to re-open the IPO door. Public comps have improved. If the fundamentals are there, the IPOs could start as soon as Q1 2024.
• Private Debt is mainly concerned with inflation. Inflation eats away at the return potential. When the upside is capped, inflation counts.
• Hedge funds are concerned with market volatility. That’s nothing new. This has always been true and will always be true.
• Real estate investors are primarily concerned with rates.
• Infrastructure and natural resource investors are concerned with rates and regulation. Infrastructure and resource investments operate over long periods where future cash flows are worth dramatically less when rates are higher.

More Nuclear

Nuclear was a popular investment theme this year among niche hedge funds. The general thesis has focused on expanding capacity and underinvestment in the supply of nuclear fuel. There’s also the further realization from the public that nuclear is a phenomenal energy resource once you get over the instinctual fear. There is a pro-nuclear line from the recent Oliver Stone documentary Nuclear Now, “not all that is scary is dangerous and not all that is dangerous is scary.” I have no opinion to impart here other than a comment that the math behind nuclear power is orders of magnitude more efficient than any other fuel source, which is why Microsoft has started actively looking to power its AI models with nuclear.

At the recent global energy and environment conference COP28, twenty developed nations declared they would increase nuclear energy capacity by as much as three times by 2050. That’s not a trustworthy statement, but it’s a step in the right direction.