Many Variables, Public and Private

There is a big difference between markets falling under stress from a single clear variable vs risk spread across many different narratives. It is worse to have a market focused on a single variable, like rapid rate hikes to cool inflation in ‘22 or the onset of Covid.

Today there are many negative narratives in markets. The reversal of globalization, higher for longer rates, higher mortgage rates without real estate prices correcting, geopolitical tension, deep rapid cuts to government spending, stressed consumer confidence and demographic challenges come to mind. There’s no question that markets have picked up on those risks in the past five weeks. If anything this market stress represents a re-rating of the risk premium. Equity multiples are now lower to accommodate for the risk that there is a very wide range of outcomes for this period of change.

Outside of these dominant narratives, general data shows modestly positive undercurrents. Earnings continue to grow, unemployment is low and inflation is in a tolerable range.

Private markets seem to be in a somewhat better position for a slightly cynical but still important reason. Private markets don’t have to deal with daily volatility. There is some refuge and sanity in the private markets where investors can confidently allocate with an eye on the horizon knowing they don’t even have the option to ‘exit’ the ‘trade’ 30 days later if market prices drop. The reality is that most investors operate like this with an aim to buy and hold over many years. Most will not sell their investments when the market swiftly corrects. This patience through thick and thin is ultimately what leads to compounding returns over many years.

Private market investors gain confidence by knowing the price they are willing to pay versus the underlying fundamentals. This is one of their clear advantages, along with taking a controlling stake where they can control the levers within the business. If the price is right they will move forward, and if not, they wait. When viewed through this lens it should be obvious why panic selloffs can easily be viewed as an opportunity. Most public investors are not thinking about the underlying earnings growth details, but that’s what drives returns over periods longer than 18 months. To highlight this, US small caps have not done as well over the past 5-10 years because their earnings growth has been a fraction of the earnings growth in FANG and tech.

Back to my introductory comment. The variety of the risks currently present in markets makes me less concerned than if there was a single driving factor. We should expect volatility in public markets because there is a lot of change happening all at once. That might mean that valuations stay lower for a period which, again, should generally be viewed as an opportunity.