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Goldman Warns ‘Dollar Dominance On A Downtrend’

Goldman Warns ‘Dollar Dominance On A Downtrend’

As we have noted numerous times in the past (since 2014), nothing lasts forever…

And…

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Goldman Warns 'Dollar Dominance On A Downtrend'

As we have noted numerous times in the past (since 2014), nothing lasts forever...

And while he falls short of the apocalyptic views of The World Bank's former chief economist:

"The dominance of the greenback is the root cause of global financial and economic crises," Justin Yifu Lin told Bruegel, a Brussels-based policy-research think tank.

"The solution to this is to replace the national currency with a global currency."

...and Zoltan Poszar's recent warnings of the backlash against US weaponization of the dollar against Russia, noting that

"...wars tend to turn into major junctures for global currencies, and with Russia losing access to its foreign currency reserves, a message has been sent to all countries that they can’t count on these money stashes to actually be theirs in the event of tension... it may make less and less sense for global reserve managers to hold dollars for safety, as they could be taken away right when they’re most needed."

...and Dylan Grice's fears over the end of dollar hegemony...

Goldman Sachs' Zach Pandl argues that the Dollar’s role as the dominant international currency will likely continue to decline over the coming years, reinforcing his view that the Dollar will weaken over the medium term.

Within a country’s borders, the typical money medium used by households and firms is largely dictated by government rules and regulations. At an international level, by contrast, currency users have a choice. For over six decades, the US Dollar has been the world’s dominant international currency, reflecting both the convenience of using the US currency and a lack of suitable alternatives. But the Dollar’s international role is now under pressure on both fronts. US foreign policy choices may discourage heavy reliance on the Dollar in some cases, while policy changes by other governments, as well as technological innovation, may help facilitate diversification away from it. The Dollar’s share of global foreign exchange reserves peaked at around 85% in the 1970s and fell to below 60% last year, a downward trend we expect to continue over the coming years as other nations pivot toward other fiat currencies and, potentially, alternative money mediums.

US foreign policy doing the Dollar no favors

Pressures on the Dollar’s dominant international role partly stem from US foreign policy choices, in particular, the US’ aggressive use of extraterritorial financial sanctions. Given that all transactions in Dollars eventually pass through the US financial system, preventing US banks and their subsidiaries from transacting with a sanctioned entity effectively shuts that entity out of the global financial system. For example, an EU business could be prevented from trading with Iran, even if it’s legal under domestic EU law, because its bank could run afoul of US sanctions. For this reason, the EU Commission has said that US sanctions and trade disputes with other countries represent a threat to the EU’s economic and monetary sovereignty. Overuse of sanctions by the US could discourage other countries from transacting in the Dollar in the first place, a risk that US officials are well aware of. Former Treasury Secretary Jacob Lew said in 2016 that the US “must be conscious of the risk that overuse of sanctions could undermine our leadership position within the global economy, and the effectiveness of our sanctions themselves… if they excessively interfere with the flow of funds worldwide, financial transactions may begin to move outside of the United States entirely—which could threaten the central role of the US financial system globally.” Similarly, former US Secretary of State Henry Kissinger said in 2014: “I do have a number of problems with the sanctions [on Russia for its annexation of Crimea]. When we talk about a global economy and then use sanctions within the global economy, then the temptation will be that big countries thinking of their future will try to protect themselves against potential dangers, and as they do, they will create a mercantilist global economy."

Will the recent imposition of sanctions on Russia’s central bank over the war in Ukraine be the straw that breaks the camel’s back? Countries hold foreign exchange reserves as a store of value to use in times of crisis. But when the Russian government recently needed its reserves to stabilize the country’s financial system, they were immobilized by Western sanctions. As a result, other nations may worry that the value of their Dollar-denominated financial assets is only as solid as their relationship with the US at the time, which may motivate sovereign investors to search for alternative assets, including a more diversified mix of foreign currency holdings.

Dollar facing stiffer competition

Competition for the Dollar has also gotten stiffer, especially from China, which has taken significant steps to modernize and open up its financial system, leading to a wave of fixed income portfolio inflows in recent years. Since 2016, mutual fund and ETF holdings of Chinese bonds have increased sixfold and official reserve allocations to the Yuan have increased almost fourfold.

We expect both of these trends to continue over the coming years, due to likely increases in China’s weight in major benchmark indices, as well as the Yuan’s relatively high nominal and real yields, its relatively cheap valuation, and China’s increasing strategic importance. The Bank of Israel, for instance, cited related considerations when explaining the ramp-up of its Yuan-denominated reserve assets this year. And China’s efforts to develop the first major central bank digital currency (CBDC) may also help facilitate international use of the Yuan, perhaps first by Chinese tourists abroad and partner countries in the Belt and Road Initiative.

Separately, recent institutional upgrades to the EU—as well as the prospect of positive cash yields—could help the Euro compete with the Dollar in international currency choice over time. While the Euro functions as an international currency today, primarily in trade with its regional neighbors, it has fallen well short of the project’s initial aspirations, and is generally thought to be “punching below its weight”, for several reasons.

  • First, the Euro area has lower macroeconomic stability than other highly-developed economies, due in large part to an incomplete fiscal union and therefore more persistent internal imbalances.

  • Second, the Euro area lacks a large supply of the type of high-quality government bonds sought by sovereign investors.

  • And third, Europe lacks the geopolitical reach of the US, in part because foreign affairs and defense policy are still conducted at the member state level. While the European Union has a coordinator for regional foreign policy, and arguably some aspects of “soft power”, it lacks the type of global military arrangements that help underpin Dollar dominance.

However, Europe tends to take steps forward in times of crisis, and the policy responses to recent disruptions are likely building a better foundation for the single currency for the future. While not billed as an effort to speed up Euro internationalization, the EU Recovery Fund/NGEU project— Europe’s response to the Covid pandemic—helps address the Euro’s structural weaknesses, and may therefore have positive implications for the currency’s global use over time. The program addresses macroeconomic instability through intraregional transfers—in effect, a step toward fiscal federalism— and also creates a new supply of highly-rated government bonds, which should be attractive to sovereigns and other international investors. Russia’s invasion of Ukraine presents new challenges for the EU and Euro area, and may damage economic growth over the short term, but could be positive for the Euro over the long term if it results in an increase in defense spending and more “hard power” for the region.

Lastly, while cryptocurrencies are still in their infancy today, the technology could eventually be applied to certain types of international payments, possibly displacing the Dollar. The Western conflict with Russia, for example, demonstrates the key challenge that cryptocurrency networks like Bitcoin aim to solve: the need for parties who may not know or trust each other to transact value. Gold often served this role as an alternative international money medium to fiat currency in the past. Before Bitcoin, there was no digital equivalent to gold, because digital payments required a centralized intermediary. While there is no guarantee that Bitcoin will serve this purpose in the future, its foundational blockchain technology demonstrates that a scarce digital medium can be created through cryptographic algorithms and the careful use of economic incentives, and some market participants may prefer this type of digital medium to traditional fiat currencies for certain types of international payments.

Declining dominance, eventually a declining Dollar

In recent days and weeks, the Dollar has continued to appreciate as markets have discounted even more monetary tightening by the Fed, and, over the near term, the outlook for rate hikes in the US relative to other economies will likely remain the primary driver of Dollar exchange rates. But over a medium-term horizon, the balance of risk around the Dollar is skewed significantly to the downside, in our view, due to the currency’s high valuation (more than 10% overvalued on our standard models) and three potential structural changes in global capital flows:

(i) fixed income flows back to the Euro area as the ECB exits negative rates,

(ii) outflows from US equities on any sustained underperformance, and

(iii) de-Dollarization efforts by official institutions designed to reduce exposure to Dollar-centric payment networks.

The Dollar maintains its role as the world’s leading international currency for many reasons - with reinforcing complementarities or “network effects” a key factor - so this structure will not change overnight. But the shifting tactical and structural trends reinforce our conviction in a weaker Dollar over the medium term.

Tyler Durden Tue, 05/03/2022 - 21:25

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Off Campus Texas A&M Housing With “Resort Style” Rooftop Pool Defaults On Debt Payment

Off Campus Texas A&M Housing With "Resort Style" Rooftop Pool Defaults On Debt Payment

Who could have possibly thought, amidst all this…

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Off Campus Texas A&M Housing With "Resort Style" Rooftop Pool Defaults On Debt Payment

Who could have possibly thought, amidst all this euphoria, that luxury college housing complexes for students might not be the best idea in the world?

It's looking like for one complex - with, of course, a "resort style" rooftop pool (which everybody knows is integral to ones studies) - near the Texas A&M University campus is starting to find out this harsh reality. 

The 3,400-bed student housing complex, called Park West, is going to default on its July debt payment according to Moody’s Investors Service, who downgraded the company's bonds deeper into junk territory this week.

The property, which provides off-campus housing for students, is located in College Station, Texas, Bloomberg reported in a mid-week wrap up. It has reportedly been struggling since even before the pandemic, thanks to the building's higher rents.

Moody's commented: “The project’s financial distress is directly linked to prolonged weakness within its College Station, Texas student housing submarket which has been an ongoing problem since Park West opened for fall 2017.”

$15.3 million is due in principal and interest, but the complex will only pay $8.5 million. The company that sold the bonds, NCCD-College Station Properties LLC, still has about $342 million in bonds outstanding, Bloomberg reported. 

The vice president and director of operations for the company confirmed that the company would default but offered up no other color. 

For a look at the complex's posh amenities, you can review its website here. 

Tyler Durden Fri, 07/01/2022 - 21:55

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“Worst Start Since 1788”: A Closer Look At The Catastrophic First Half Performance

"Worst Start Since 1788": A Closer Look At The Catastrophic First Half Performance

As discussed yesterday…

Worst first half for stocks…

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"Worst Start Since 1788": A Closer Look At The Catastrophic First Half Performance

As discussed yesterday...

... and again this morning, when Rabobank's Michael Every said that "if you bought stocks in H1, you lost; if bonds, you lost; if commodities, you were doing great until recently; if crypto you lost; if the US dollar, you were fine" but lost purchasing power to inflation, the first six months of the year were terrible.

Just how terrible? To quantify the destruction, we go to the latest chart of the day from DB's Jim Reid who writes that "the good news is that H1 is now over. The bad news is that the outlook for H2 is not looking good."

To demonstrate just how bad H1 was, Reid shares three charts.  They show that:

1) Deutsche Bank's US 10yr Treasury proxy index did indeed see the worst H1 since 1788 in spite of a sizeable late June rally, and...

2) the S&P 500 saw the worst H1 total return since 1962 after a rally last week just pulled it back from being the worst since 1932.

Here, BofA has outdone DB, and notes that in real timers, the S&P500's performance was the worst since 1872!

As Reid further notes, "I’ve found through my career that these type of charts are always the most demanded as investors want to put their performance in context." Which is why he also added a the third chart which is an abridged version of one published by DB's Henry Allen in a report fully reviewing H1, June and Q2 (more below, and also available to professional subs in the usual place).

As Reid concludes, "if you like horror stories its an alternative to Stranger Things which returns to our global screens today. Obviously if you run a commodity fund you may think differently!"

Stepping back from this narrow take, we look at the full performance review for June and Q2 conducted by Reid's colleague, Henry Allen, which finds that "it's hard to overstate just how bad markets have performed over recent months, with the returns in Q2 very much following in Q1’s footsteps... a range of asset classes saw significant losses, including equities, credit and sovereign bonds, whilst the US dollar and some commodities like oil were among the few exceptions. In fact, in total return terms we’ve just seen the biggest H1 decline for the S&P 500 in 60 years, and in June alone just 2 of the 38 non-currency assets in our sample were in positive territory, which is the same as what we saw during the initial market chaos from the pandemic in March 2020."

On a YTD basis as well, just 4 of 38 tracked assets are in positive territory, which as it stands is even lower than the 7 assets that managed to score a positive return in 2008.

The main reason for these broad-based declines is the fact that recession and stagflation risks have ramped up significantly over Q2. This has been for several reasons, but first among them is the fact that inflation has proven far more persistent than the consensus expected once again, requiring a more aggressive pace of rate hikes from central banks than investors were expecting at the start of the quarter. For instance, the rate priced in by Fed funds futures for the December 2022 meeting has risen from 2.40% at the end of Q1 to 3.38% at the end of Q2. A similar pattern has been seen from other central banks, and the effects are beginning to show up in the real economy too, with US mortgage rates reaching a post-2008 high. The good news is that as of today, the market is now pricing in not just rate hikes to peak in Q4, but about 14bps of rate cuts in Q1.

in any case, the big worry from investors’ point of view is that the cumulative effect of these rate hikes will be enough to knock the economy into recession, and on that front we’ve seen multiple signs pointing to slower growth recently in both the US and Europe. For instance, the flash Euro Area composite PMI for June came in at a 16-month low of 51.9, whilst its US counterpart fell to a 5-month low of 51.2. Other recessionary indicators like the yield curve are also showing concerning signs, with the 2s10s Treasury curve still hovering just outside inversion territory at the end of the quarter, at just +5.1bps. The energy shock is adding to these growth concerns, and that’s persisted over Q2 as the war in Ukraine has continued. Brent crude oil prices built on their sizeable gains from Q1, with a further +6.4% rise in Q2 that left them at $115/bbl. Meanwhile, European natural gas is up by +14.8% to €145 per megawatt-hour. However, fears of a global recession have knocked industrial metals prices significantly, and the London Metal Exchange Index has just seen its first quarterly fall since the initial wave of the pandemic in Q1 2020, and its -25.0% decline is the largest since the turmoil of the GFC in Q4 2008.

That decline in risk appetite has knocked a range of other assets too:

  • The S&P 500 slumped -16.1% over Q2, meaning its quarterly performance was the second worst since the GFC turmoil of Q4 2008.
  • Sovereign bonds built on their losses from Q1,
  • Euro sovereigns (-7.4%) saw their worst quarterly performance of the 21st century so far as the ECB announced their plan to start hiking rates from July to deal with high inflation.
  • Cryptocurrencies shared in the losses too, with Bitcoin’s (59.0%) decline over Q2 marking its worst quarterly performance in over a decade

Which assets saw the biggest gains in Q2?

  • Energy Commodities: The continued war in Ukraine put further upward pressure on energy prices, with Brent crude (+6.4%) and WTI (+5.5%) oil both advancing over the quarter. The rise was particularly noticeable for European natural gas, with futures up by +14.8% as the continent faces up to the risk of a potential gas cut-off from Russia.
  • US Dollar: The dollar was the best-performing of the G10 currencies in Q2 as it dawned on investors that the Fed would hike more aggressively than they expected, and the YTD gains for the dollar index now stand at +9.4%.

Which assets saw the biggest losses in Q2?

  • Equities: Growing fears about a recession led to significant equity losses in Q2, with the S&P 500 (-16.1%) seeing its second-worst quarterly performance since the GFC turmoil of Q4 2008. That pattern was seen across the world, with Europe’s STOXX 600 down -9.1%, Japan’s Nikkei down -5.0%, and the MSCI EM index down -11.4%.
  • Credit: For a second consecutive quarter, every credit index we follow across USD, EUR and GBP moved lower. EUR and USD HY saw some of the worst losses, with declines of -10.7% and -9.9% respectively.
  • Sovereign Bonds: As with credit, sovereign bonds lost ground on both sides of the Atlantic, and the decline in European sovereigns (-7.4%) was the worst so far in the 21st century. Treasuries also lost further ground, and their -4.1% decline over Q2 brings their YTD losses to -9.4%.
  • Non-energy commodities: Whilst energy saw further gains over Q2, other commodities saw some major declines. Industrial metals were a significant underperformer, with the London Metal Exchange Index (-25.0%) seeing its largest quarterly decline since the GFC turmoil of 2008. Precious metals lost ground too, with declines for both gold (-6.7%) and silver (-18.2%). And a number of agricultural commodities also fell back, including wheat (-13.6%).
  • Japanese Yen: The Japanese Yen weakened against the US Dollar by -10.3% over Q2, which also marked its 6th consecutive quarterly decline against the dollar. By the close at the end of the quarter, that left the Yen trading at 136 per dollar, which is around its weakest level since 1998. That came as the Bank of Japan has become the outlier among the major advanced economy central banks in not hiking rates with even the Swiss National Bank hiking in June for the first time in 15 years.
  • Cryptocurrencies: The broader risk-off tone has been bad news for cryptocurrencies, and Bitcoin’s -59.0% decline over Q2 is its worst quarterly performance in over a decade. Other cryptocurrencies have lost significant ground as well, including Litecoin (-59.2%) and XRP (-61.2%).

June Review

Looking specifically at June rather than Q2 as a whole, the picture looks even worse in some ways since just 2 of the 38 non-currency assets are in positive territory for the month, which is the same number as in March 2020 when global markets reacted to the initial wave of the pandemic. The two positive assets are the Shanghai Comp (+7.5%) and the Hang Seng (+3.0%), which have been supported by improving economic data as Covid restrictions have been eased. Otherwise however, it’s been negative across the board, and even commodities have struggled after their strong start to the year, with Brent crude (-6.5%) and WTI (7.8%) posting their first monthly declines so far this year as concerns about a recession have mounted. The main catalyst for this was the much stronger-than-expected US CPI print for June, which triggered another selloff as it dawned on investors that the Fed would be forced to hike rates even more aggressively to rein in inflation, which they followed through on at their meeting when they hiked by 75bps for the first time since 1994.

Finally, without further ado, here are the charts showing total returns for the month of June...

... for Q2...

... and for YTD.

Tyler Durden Fri, 07/01/2022 - 15:00

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Risk Capital and Markets: A Temporary Retreat or Long Term Pull Back?

As inflation has taken center stage, markets have gone into retreat globally, and across asset classes. In 2022, as bond rates have risen, stock prices…

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As inflation has taken center stage, markets have gone into retreat globally, and across asset classes. In 2022, as bond rates have risen, stock prices have fallen, and crypto has imploded, even true believers are questioning what the bottom for markets might be, and when we will get there. While it is easy to call the market movement in 2022 a correction and to argue that it is overdue, it is facile, and it fails to address the question of why it is happening now, and whether the correction is overdone or has more to go. In this post, I will argue that almost everything that we are observing in markets, across asset classes, can be explained by a pull back on risk capital, and that understanding the magnitude of the pull back, and putting in historical perspective, is key to gauging what is coming next.

Risk Capital: What is it?

To put risk capital in perspective, it is best to start with a definition of risk that is comprehensive and all-inclusive, and that is to think of risk as a combination of danger (downside) and opportunity (upside) and to consider how investments vary in terms of exposure to both. In every asset class, there is a range of investment choices, with some being safer (or even guaranteed) and others being riskier.

Risk capital is the portion of capital that is invested in the riskiest segments of each market and safety capital is that portion that finds its way to the safest segments in each market

While risk and safety capital approach the market from opposite ends in the risk spectrum, one (safety capital) being driven by fear and the other (risk capital), by greed, they need to not only co-exist, but be in balance, for the market to be healthy. When to two are not in balance, these imbalances can have profound and often unhealthy effects not just of markets, but also on the overall economy. At the extremes, when risk capital is absent and everyone seeks safety, the economy and markets will atrophy, as businesses and investors will stay away from risky ventures, and when risk capital is too easy and accessible, risky asset prices will soar, and the economy will see too much growth in its riskiest segments, often at the expense of more stable (and still necessary) businesses.

Risk Capital's Ebbs and Flows

It is a common misconception that the risk-takers supply risk capital (risk takers) and that the investors who invest for safety draw from different investor pools, and that these pools remain unchanged over time. While investor risk aversion clearly does play a role in whether investors are drawn to invest in risk or safety capital, it obscures two realities:

  1. Variation within an investor's portfolio: Many investors, including even the most risk averse, may and often do  set aside a portion of their portfolios for riskier investments, drawn by the higher expected returns on those investments. For some investors, this set aside will be the portion that they can afford to lose, without affecting their life styles in any material way. For others, it can be the portion of their capital with the longest time horizon (pension fund savings or 401Ks, if you are a young investor, for example), where they believe that any losses on risk capital can be made up over time. For still others, it is that segment of their portfolios that they treat las long shot gambles, hoping for a disproportionately large payoff, if they are lucky. The amount that is put into the risk capital portion will vary with investor risk aversion, with more risk averse investors putting less or even nothing into the riskiest assets, and less risk averse investors putting in more.
  2. Variation across time: The amount that investors are willing to put into risk capital, or conversely redirect to safety capital, will change over time, with several factors playing a role in determining whether risk capital will be plentiful or scarce. The first is market momentum, since more money will be put into the riskiest asset classes, when markets are rising, because investors who benefit from these rising markets will have more capital that they are willing to risk. The second is the the health and stability of the economy, since investors with secure jobs and rising paychecks are more willing to take risks. 

There are two macro factors that will come into play, and both are in play in markets today. The first is the return that can be earned on guaranteed investments, i.e., US treasury bills and bonds, for instance, if you are a investor in US dollar, since it is a measure of what someone who takes no or very low risk can expect to earn. When treasury rates are low or close to zero, refusing to take risk will result in returns that are very low or close to zero as well, thus inducing investors to expose themselves to more risk than they would have taken in higher interest rate regimes. The second is inflation, which reduces the nominal return you make on all your investments, and the effects of rising inflation on risk capital are complex. As expected inflation rises, you are likely to see higher interest rates, and as we noted above, that may induce investors to cut back on risk taking and focus on earning enough to cover the ravages of inflation. As uncertainty about inflation rises, you will see reallocation of investment across asset classes, with real assets gaining when unexpected inflation is positive (actual inflation is higher than expected), and financial assets benefiting when unexpected inflation is negative (actual inflation is less than expected).

And Consequences

    If you are wondering why you should care about risk capital's ebbs and flows, it is because you will feel its effects in almost everything you do in investing and business. 

  1. Risk Premiums: The risk premiums that you observe in every risky asset market are a function of how much risk capital there is in play, with risk premiums going up when risk capital becomes scarcer and down, when risk capital is more plentiful. In the bond and loan market, access to risk capital will determine default spreads on bonds, with lower rated bonds feeling the pain more intensely when risk capital is withdrawn or moves to the side lines. Not only will default spreads widen more for lower-rated bonds, but there will be less bond issuances by riskier companies. In the equity market, the equity risk premium is the price of risk, and its movements will track shifts in risk capital, increasing as risk capital becomes scarcer. 
  2. Price and Value Gaps: As those of you who read this blog know well, I draw a contrast between value and price, with the former driven by fundamentals (cash flows, growth and risk) and the latter by mood, momentum and liquidity. The value and price processes can yield different numbers for the same company, and the two numbers can diverge for long periods, with convergence not guaranteed but likely over long periods.

    I argue that investors play the value game, buying investments when the price is less than the value and hoping for convergence, and that traders play the pricing game, buying and selling on market momentum, rather than fundamentals. At the risk of generalizing, safety capital, with its focus on earnings and cash flows now, is more likely to focus on fundamentals, and play the investor game, whereas risk capital, drawn by the need to make high returns quickly, is more likely to play the trading game. Thus, when risk capital is plentiful, you are more likely to see the pricing game overwhelm the value game, with prices often rising well above value, and more so for the riskiest segments of every asset class. A pull back in risk capital is often the catalyst for corrections, where price not only converges back on value, but often overshoots in the other direction (creating under valuations). It behooves both investors and traders to therefore track movements in risk capital, since it is will determine when long term bets on value will pay off for the former, and the timing of entry into and exit from markets for the latter.
  3. Corporate Life Cycle: The ebbs and flows of risk capital have consequences for all businesses, but the effects will vary widely across companies, depending on where they are in the life cycle. Using another one of my favorite structures, the corporate life cycle, you can see the consequences of expanding and shrinking risk capital, through the lens of free cash flows (and how they vary across the life cycle).

    Early in the corporate life cycle, young companies have negative free cash flows, driven by losses on operations and investments for future growth, making them dependent on risk capital for survival and growth. As companies mature, their cash flows first become self sustaining first, as operating cash flows cover investments, and then turn large and positive, making them not only less dependent on risk capital for survival but also more valued in an environment where safety capital is dominant. Put simply, as risk capital becomes scarcer, young companies, especially those that are money-losing and with negative cash flows, will see bigger pricing markdowns and more failures than more mature companies.

Risk Capital: Historical Perspective

How do you track the availability and access to risk capital over time? There are three proxies that I will  use, and while each has its limitations, read together, they can provide a fuller measure of the ebbs and flows of risk capital. The first is funds invested by venture capitalists, with a breakdown further into types, from pre-seed and seed financing to very young companies to capital provided to more young companies with more established business models, as a prelude to exit (acquisition or IPO). The second is the trend line in initial public offerings (number and value raised), since companies are more likely to go public and be able to raise more capital in issue proceeds, when risk capital is plentiful. The third is original bond issuances by the riskiest companies (below investment grade and high yield), since these issuances are more likely to have a friendly reception when risk capital is easily available than when it is not.

Let’s start with venture capital, the typical source of capital for start ups and young companies for decades in the United States, and more recently, in the rest of the world. In the graph below, I trace out total venture capital raised, by year, between 1995 and 2021, in the US: 

Source: NVCA Yearbooks
The dot-com boom in the 1990s created a surge in venture capital raised and invested, with venture capital raised peaking at more than $100 billion in 2000, before collapsing as the that bubble burst. The 2008 banking and market crisis caused a drop of almost 50% in 2009, and it took the market almost five years to return to pre-crisis levels.   In the just-concluded decade, from 2011 to 2020,  the amount raised and invested by venture capitalists has soared, and almost doubled again in 2021, from 2020 levels, with venture capital raised in 2021 reaching an all-time high of $131 billion, surpassing the 2000 dot-com boom levels, albeit in nominal terms. Along the way, exits from past venture capital investments, either in IPOs or in M&A, have become more lucrative for the most successful companies, with 43 exits that exceeded a billion (the unicorn status) in 2021. 

If success in venture capital comes from exiting investments at a higher pricing, initial public offerings represent the most lucrative route, and tracking the number of initial public offerings over time provides a window on the ebbs and flows of risk capital, over long periods. Using data made public by Jay Ritter on IPOs, I track the number of IPO and dollar proceeds from offerings in the graph below from 1980 to 2021:
Source: Jay Ritter
As you can see, IPOs go through hot periods (when issuances surge) and cold ones (when there are relatively few listed), with much of the last decade representing hot periods and 2000/01 and 2008/09 representing periods when there were hardly any offerings. While the number of IPOs in 2021 is still below the peak dot-com years, the proceeds from IPOs has surged to an all-time high during the year.

    In the final graph, I look at corporate bond offerings, broken down into investment grade and high yield, by year, from 1996 to 2021:

Source: SIFMA

Here again, you see a familiar pattern, with the percentage of high-yield bond issuances tracking the availability of risk capital. As with IPOs, you see big dips in 2000-01and 2008-09, reflecting market corrections and crises, and a period of easy access to risk capital in the last decade. Again, the percentage of corporate bond issuances hit an all-time high in 2021, representing more than a quarter of all bond issuances. In sum, all three proxies for risk capital show the same patterns over time, pulling back and surging during the same time periods, and with all three proxies, it is clear that 2021 was a boom year.

An Update

The last two and a half years may not represent much time on a historical scale, but the period has packed in enough surprises to make it feel like we have aged a decade. We started 2020 with a pandemic that altered our personal, work and financial lives, and in 2022, at least in North America and Europe, we have seen inflation reach levels that we have not seen for decades. Looking at the 30 months through the lens of risk capital can help us understand not only the journey that markets have gone through to get where they are today, but also perhaps decipher where they may go next. In the graph below, I look at venture capital, IPOs and high yield bond issuances over the last two and a half years:


The first thing to note is that there was a pullback on all three measures in the first quarter of 2020, as COVID put economies into deep freeze and rolled markets. The big story, related to COVID, is that risk capital not only did not stay on the side lines for long but came surging back to levels that exceeded pre-COVID numbers, with all three measures hitting all-time highs in 2021. In a post in late 2020, I argued that it was the resilience of risk capital that explained why markets recovered so quickly that year, even as the global economy struggled, that year, and pointed to three explanatory factors. The first was the perception that the COVID shut-down was temporary, and that economies would come back quickly, once the immediate threat from the virus passed. The second was the decline in interest rates across the globe, with rates in developed market currencies (US $, Euro, Japanese Yen etc.) moving towards zero, increasing the costs of staying on the sidelines.  The third was a change in investor composition, with a shift from institutional to individual investor market leadership, and increased globalization.

    The first half of 2022 has been a trying period for markets, and as inflation has risen, it is having an effect on the availability of and access to risk capital. There has been a pullback in all three proxies for risk capital, albeit smaller in venture capital, than in IPOs and in high-yield bond issuances in the first few months of 2022. That pullback has had its consequences, with equity risk premiums rising around the world. In the graph below, I have updated the equity risk premium for the S&P 500 through the start of July 2022:

Spreadsheet for implied ERP

The chart reveals how unsettling this year has been for equity investors, in the United States. Not only has the implied ERP surged to 6.43% on June 23, 2022, from 4.24% on January 1, 2022, but stocks are now being priced to earn 9.45% annually, up from the 5.75% at the start of the year. (The jump in ERP may be over stated, since the forward earnings estimates for the index, from analysts, does not seem to be showing any upcoming pain from an expected recession. )

As inflation and recession fears have mounted, equity markets are down significantly around the world, but the drop in pricing has been greatest in the riskiest segments of the market. In the table below, I look at the price change in the first six months of 2022 for global stocks, broken down by quintiles, into net profit margin and revenue growth classes:
Source for raw data: S&P Cap IQ

Note that high growth, negative earnings companies have fared much worse, in general, during the 2022 downturn, than more mature, money-making companies.  The fear factor that is tilting the balance back to safety capital from risk capital has also had clear consequences in the speculative collectibles space, with cryptos bearing the brunt of the punishment. Finally, there are markdowns coming to private company holdings, both in the hands of venture capitalists, and public market investors (including mutual funds that have been drawn into this space and public companies like Softbank).

    The big question that we all face, as we look towards the second half of the year, is whether the pullback in risk capital is temporary, as it was in 2020, or whether it is more long term, as it was after the dot-com bust in 2000 and the market crisis in 2008. If it is the former, there is hope of not just a recovery, but a strong rebound in risky asset prices, and if it is the latter, stocks may stabilize, but the riskiest assets will see depressed prices for much longer. I don't have a crystal ball or any special macro forecasting abilities, but if I had to guess, it would be that it is the latter. Unlike a virus, where a vaccine may provide at least the semblance of a quick cure (real or imagined), inflation, once unleashed, has no quick fix. Moreover, now that inflation has reared its head, neither central banks nor governments can provide the boosts that they were able to in 2020 and may even have to take actions that make things worse, rather than better, for risk capital. Finally, at the risk of sounding callous, I do think that a return of fear and a longer term pullback in risk capital is healthy for markets and the economy, since risk capital providers, spoiled by a decade or more of easy returns, have become lazy and sloppy in their pricing and trading decisions, and have, in the process, skewed capital allocation in the economy. If a long-term slowdown is in the cards, it is almost certain that the investment strategies that delivered high returns in the last decade will no longer work in this new environment, and that old lessons, dismissed as outdated just a few years go, may need to be relearned. 

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