Economic Data Watch and Market Outlook
Global equity markets continued to rise for the week. The MSCI World index was up 62 basis points while the S&P 500 jumped 1.35% for the week. The S&P had been on an eight-day run which ended Thursday after Jerome Powell threw cold water on markets by leaving the door open for another possible rate hike, stating “We are not confident that we have achieved such a stance” related to the Fed’s 2% inflation target.
As Congress continues to debate raising the debt ceiling, on Friday, Moody’s lowered its outlook on the United States from stable to negative, citing rising deficits and political polarization. Even with lowering its outlook, Moody’s kept their Aaa rating and remains the last of the three major ratings agencies with a top rating for the US. Rising rates and inflation contributed to increased borrowing costs and cost of living increases in Social Security were among the biggest contributors.
Last week saw a significant drop in the average 30-year mortgage rate, the largest decline in over a year, leading to a substantial increase in home purchase applications according to the Mortgage Bankers Association. Although this decline offers some relief, mortgage rates are still high, deterring current homeowners from moving and maintaining pressure on housing supply and prices. Amidst these developments, the Federal Reserve’s steady interest rates and the downward trend of the 10-year Treasury yield have spurred some optimism in the real estate market, as evidenced by a rise in both purchasing and refinancing applications.
As work from home continues to evolve, businesses have less demand for office space. As a result, vacancies are up and asset prices are starting to drop in several major cities. As a result, interest continues to grow to convert that space into residential housing. At the end of October, the Biden Administration, introduced a $25 billion below market loan program supported by multiple agencies to “supercharge” the conversion of vacant office space to livable space.
Automakers have started to slow investment into EV factories amid weakening demand and increased costs. The new UAW contracts have also added some strain on the market as other auto firms outside the UAW have now increased employee salaries to keep up with the wage increase. Tesla has traditionally only offered online sales of its cars through its own website. As a possible sign that sales are slowing, it has started to offer NEW cars through other sites such as Cars.com.
Equities
The S&P 500 saw its longest win streak, spanning 8-days, since 2021. Mega cap stocks are now outperforming small caps by the largest margin since the dot com bubble (large-caps are also outperforming small-caps) while growth stocks were a winner over value during the week. Markets took a turn Thursday and Treasury yields pushed slightly higher after the 30-year bond auction showed weaker demand than sales of 3- and 10-year Notes over the past week. Major indices continued to decline following Fed Chair Powell’s IMF panel as his comments reiterated what he said at his post FOMC press conference on November 1. The Dow Jones Industrial Average did not see as big of declines Thursday as other US indices as Disney’s stock price rose following its better-than-expected earnings report. Disney streaming subscription growth topped earnings expectations and the company plans to accelerate cost cutting. Friday the S&P retraced the losses rising over 1.5%.
Internationally, emerging markets outperformed developed markets as China’s GDP growth for 2023/2024 was increased by the IMF which lifted local markets. In Europe, stocks finished lower Friday as the EURO Stoxx 600 Index finished the day down roughly (-1%) bouncing off a low following a positive start on Wall Street. Ahead of Friday, the index gained 4.2% over the past two weeks so the strong rise could be attributed to some profit-taking heading into the weekend. London’s FTSE 100 was the worst performing index in Europe, falling 1.3% Friday after a disappointing update from Diageo, the drinks giant, and declines in the mining and homebuilding sectors. Markets fell across Paris and Frankfurt as well Friday, each falling (-0.8%) and (-1%) respectively, as markets in Spain and Italy outperformed the rest of Europe.
Fixed Income
Treasury yields were mixed this week with the 2-year treasury yield rising 21 bps, the 10-year Treasury yield rising 4 bps, and the 30-year Treasury yield falling 4 bps. Meanwhile major bond indices fell, with the Bloomberg US Aggregate Bond Index falling -0.29%, the Bloomberg US Corporate High Yield Index falling -0.30%, and the Bloomberg US MBS Index falling -0.55%.
According to a chart from the Financial Times, the post Covid drawdown in nominal and real bond returns are worse than the late 1970’s and early 1980’s. Today’s global bond bear market stands out for the pace of the drawdown across Treasuries while the drawdown in the 70’s and 80’s stands out for the duration of the drawdown, which took over a decade to recover purchasing power on some Treasuries.
Financial Times, Liz Ann Sonders, Bloomberg
Recent volatility has created significant discounts in closed-end funds. Closed-end funds invest in cash-generating assets such as junk debt, muni bonds, or even dividend paying stocks. They are intended to provide regular income but lately with yields screaming higher investors have seen these funds take a hit. Currently muni bond closed-end funds are trading at an average 13.6% below their asset value as of the end of October. This is the largest price disparity in over 15 years, and well above the historical average of 4%, according to Mattise Capital. As of the end of October, the discount stands at 8.94% across asset classes.
On Thursday, Industrial & Commercial Bank of China Ltd.’s US unit was hit with a cyber attack which made clearing large amounts of US Treasury trades impossible. This forced ICBC to send required settlement details to affected parties by messenger carrying a USB stick. The perpetrators go by the name Lockbit, a cybercrime gang with ties to Russia that has attacked Boeing, Ion Trading, and the UK’s Royal Mail in the past. US Treasury trades that were executed on Wednesday and Repo financing trades executed on Thursday were successfully cleared according to the ICBC.
Hedge Funds as of Thursday, November 9th
Hedge Fund (HF) performance this week was relatively challenging as the average global HF ended down -16 bps (vs. MSCI World -3 bps), while the average US long/short L/S equity fund fell more than the S&P 500 (SPX) losing -44 bps (vs. SPX -22 bps). EU-based funds similarly underperformed their respective benchmark, capturing ~30% of the upside, gaining +27 bps (vs. Euro STOXX 600 +84 bps). Asia-based funds, on the other hand, were down -6 bps against the MSCI Asia up 38 bps. HFs are off to a rough relative start to November. The average global HF is up just under 1% (vs. MSCI World +4.1%), the average US L/S equity fund is up +1.9% (vs. SPX +3.7%), the average EU-based fund is up +76 bps (vs. Euro STOXX 600 +3.3%), and the average Asia-based HF is up +1.8% (vs. MSCI Asia +4.4%). Systematic long/short funds are now outperforming the market.
HFs were sellers of global equities this week, with the bulk of the activity taking place in North America (NA) in what was the 9th largest week of short additions in the region YTD. Notably, Europe was the only region to be net bought in material amounts, followed by Japan to a lesser extent, while flows in Asia ex-Japan (AxJ) were flat as funds trimmed gross from both sides of the book in nearly equivalent amounts. In NA, volumes this week were far lighter than the elevated levels last week, and US L/S net leverage only fell 1% on the week to 47% – a much smaller move relative to last week’s historical +8.5% shift. Driving directional tilts lower, HFs added shorts across consumer discretionary, led by specialty retail, autos and hotels, restaurants & leisure. HFs were also sellers of communications services via interactive media, as well as financials via banks (mostly large-cap diversified banks). On the other hand, HFs were smaller buyers of ETFs, as well as consumer staples via food products. European equities were the only region to be net bought in notable amounts this week, as HFs ultimately trimmed gross exposure with a skew towards short covering. Financials and consumer discretionary were the most net bought sectors as both made up the bulk of what was covered on the short side. HFs covered shorts in most sectors except for energy and industrials which were the only sectors to be net sold via a mix of selling longs and adding shorts in integrated oil & gas, as well as short additions in building products. In Japan, HFs were smaller net buyers of the region driven largely by financials (banks), communications services and industrials, while sellers of consumer discretionary. AxJ flows were muted this week as HFs trimmed longs and covered shorts in equivalent amounts. However, this week was the largest week of short covers in the region YTD. China led the buying (the 2nd time in the last 15 weeks), while Australia, South Korea and India were net sold. Korea made up majority of notional flow across the entire region, though was quieter in net terms as HFs trimmed gross from both sides of the book. At the sector level, industrials/materials and tech were the most net sold and saw the largest notional flows.
Private Equity
The global M&A market faced significant challenges in Q3, resulting in a decade-low deal value, influenced by extended interest rate uncertainty, limited access to debt for some buyers, the Federal Reserve’s rate increase, a temporary government shutdown threat, and geopolitical turmoil in the Middle East. The unanticipated factors have dampened expectations for an M&A recovery, with experts citing the need for a catalyst to reignite deal activity. Despite a 20% reduction in M&A spending from Q2 to Q3, the number of deals has only decreased by approximately 2.5% in 2023.
Financial sponsors, including VC and PE firms, faced difficulties accessing debt from financial institutions, while corporate buyers utilized cash from operations and corporate bonds to finance M&A. This shift has led to sponsors holding a smaller share of the M&A market compared to corporate buyers. The median debt-to-enterprise value ratio dropped from 50.8% in 2022 to 43.9% through Q3, the lowest figure since at least 2005, reflecting decreased reliance on debt in leveraged buyouts due to higher interest rates.
The median enterprise value/revenue figure remained relatively stable at 1.6x in 2023, with variations across industries. The energy sector experienced the strongest valuation growth, driven by higher commodity prices and confidence in robust crude oil prices. Conversely, the financial services industry, particularly banks facing high funding costs and challenges following the collapse of Silicon Valley Bank, saw a decline in valuation multiples over the past year. Insurers, resembling asset managers, struggled with losses in fixed-income markets that prominently featured in their holdings.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Michael McNamara, Analyst
Sam Morris, Analyst
Josh Friedberg, Fall Associate
Data Source: Apollo, Barron’s, Bloomberg, BBC, Charles Schwab, CNBC, the Daily Shot HFR (returns have a two-day lag), Goldman Sachs, Jim Bianco Research, J.P. Morgan, Market Watch, Morningstar, Morgan Stanley. Pitchbook, Standard & Poor’s and the Wall Street Journal.