Economic Data Watch and Market Outlook
US equity markets seemed to shrug off the surge in hiring reported on Friday. Nonfarm payrolls jumped 336,000 versus an expected 170,000. The S&P 500 jumped 1.18% Friday and closed up 52 basis points for the week. The news raised the probability that the Fed would raise rates again and higher for longer continued to be in the market’s view (see graphic below). Developed and emerging equity markets declined on the week as noted by the MSCI EAFE and MSCI Emerging Markets benchmarks, down 1.85% and 1.61% respectively.
The Bloomberg Aggregate Bond benchmark fell 1.17% for the week as price pressure continues on longer dated bonds. The ten-year settled at 4.804% and the 30 year at 4.974% as of Friday’s close. Bond markets are closed on Monday, October 9th for Columbus Day/Indigenous Peoples’ Day.
Despite the positive job growth, there is evidence that rates are starting to have an impact related to delinquencies. We intend to pay close attention to these results as they represent a change relative to surveys of bank loan officers in July.
The US trade deficit decreased to $58.3 billion in August, its lowest point since 2020, largely due to a reduction in American demand for foreign goods and an increase in international goods shipments. Imports dropped by 0.7% as a result of weaker domestic demand for consumer goods and capital equipment, while exports rose by 1.6%, although this may be temporary due to a stronger dollar making US goods more expensive for overseas customers. This data will influence economists’ projections for the third quarter’s gross domestic product (GDP), with the Federal Reserve Bank of Atlanta’s GDPNow forecast estimating trade could increase growth by nearly one percentage point. In terms of inflation, the merchandise trade deficit fell to $83.9 billion, the lowest since March.
Rivian Automotive Inc. announced its plan to issue $1.5 billion in convertible debt, leading to an 11% drop in its shares, marking the biggest intraday drop since March 7. The company also reported a decrease in its total cash and short-term investments from $10.2 billion in the second quarter to $9.1 billion at the end of the third quarter. Despite analysts’ estimates, Rivian expects its third-quarter revenue to be between $1.29 billion and $1.33 billion. The issuance of bonds, potentially diluting current shareholders’ interests, follows Rivian’s decision to retain its full-year guidance for producing 52,000 battery-electric vehicles in 2022.
The growth of the electric vehicle market is a notable point of stress between the UAW and the big three auto manufacturers. While no deal has been agreed upon yet, there seemed to be some progress on Friday according to UAW leader, Shawn Fain. Fain said the union agreed not to roll out additional work stoppages as GM made a key concession related to the role workers would have as the industry shifts to electric vehicles. GM agreed that workers at future EV battery plants will fall under the UAW agreements.
Equities
Equities were mixed this week following an averted government shut down and the release of employment data. The S&P 500 ended the week gaining 0.52%, the Dow Jones Industrial Average fell (-0.2%), and the Nasdaq gained 1.8%. Large caps outperformed small caps as the Russell 1000 Index was up slightly on the week posting a gain of 0.4% while the Russell 2000 Index fell (-2.2%). Growth outperformed value in both small cap and large cap indices as the Russell 1000 Growth Index posted a 2.1% gain while the Russell 1000 Value Index fell (-1.5%) and the Russell 2000 Growth Index fell
(-1.8%) versus the Russell 2000 Value Index falling (-2.6%). Trading was generally subdued as investors awaited the release of the nonfarm payrolls report Friday. Following the aversion of a government shutdown equities started trading positive on Monday but as yields pushed higher major indices were impacted. Big cap tech names rallied mid-week following the ADP Employment Report which came in higher than expected which caused the Nasdaq to jump 1.4% led by Tesla and Alphabet. Following the initial release of the jobs report from the department of labor equities were negative but rebounded to close the day positive. Positive sectors during the week were technology, communication services, and healthcare while energy was the weakest sector followed by rate sensitive consumer staples, utilities, and real estate.
International equities were negative with developed markets slightly trailing emerging as the MSCI EAFE Index, which tracks 21 developed markets, excluding the US and Canada, fell (-1.9%) and the MSCI Emerging Markets Index fell (-1.6%). In Asia, Chinese and Japanese markets were negative as the Hang Seng HSI Index fell (-1.9%) and the Nikkei 225 Index fell (-2.7%). Japanese equities were impacted by higher bond yields and some negative economic data around consumer spending and sentiment. Chinese property sector remains a concern but showed a slight improvement in September and the PMI reading for September returned to expansionary which is positive for Chinese equity markets. The Euro STOXX 600 Index fell (-1.2%) as bond yields surged as concerns over a higher for longer remain. Italy’s FTSE MIB fell
(-1.5%), Germany’s DAX Index dropped (-1.0%), France’s CAC 40 Index declined (-1.1%) and the UK’s FTSE 100 Index lost
(-1.5%). German industrial orders were a positive for the market, but exports fell. UK economic data suggested house prices increased as construction weakened. This drop in European equities follows a lower PMI reading out of the region and putting them in a state of contraction.
Sources: Bloomberg, Schwab, Morningstar, WSJ
Fixed Income
US Treasuries jumped significantly this week in response to the stronger than expected US jobs report, and investors are now looking ahead to next weeks’ CPI and PPI prints which will provide more clarity on the strength of the US economy. Yields on the longer dated end of the curve saw a significant uptick this week while the increase was more muted for shorter term bonds. The 2-year Treasury yield rose 5 bps throughout the week to close at 5.08% hitting its highest level since 2007, meanwhile the 10-year Treasury yield rose 19 bps to close at 4.78%, and the 30-year Treasury yield rose 22 bps to close at 4.95%. All major bond indices fell over a percent, with the Bloomberg US Aggregate Bond Index falling -1.17%, the Bloomberg US Corporate High Yield Index falling -1.21%, and the Bloomberg US MBS Index falling -1.22%.
Corporate America is still taking on debt, and showing no signs of stopping, having added $570B of debt to their balance sheets over the last 18 months. For example, CVS which has a credit rating of BBB, borrowed $11B this year to acquire two companies as well as boost spending. Jerome Powell was quoted last week saying “One of our goals is to influence spending and investment decisions” and “That will only be the case if people understand what we are saying and what it means for their own finances.” Although this statement was more targeted towards individuals, the messaging from the Fed has been relatively the same. The goal is to slow down the economy, while avoiding a major recession, and in order to do so corporate America may need to slow down.
A potential issue for US credit markets is starting to form as the 30-year Treasury yield is nearing levels not seen in decades. The current correlation between government bond yields and credit spreads on junk rated debt has moved into positive territory, which in turn has caused risk premiums on corporate credit to move higher to track benchmark rates. This could create issues for the Fed which has been hard set on tackling inflation while also maintaining a stable financial environment. The increase in risk premiums could cause further outflows from the asset class which has already seen outflows of $7.3B for the week ending October 4th.
Hedge Funds
The average global hedge fund (HF) posted losses of ~60 bps vs. the MSCI World -1.4% WTD through Thursday. Americas-based funds moved in lock-step with the S&P 500, both down 67 bps, whereas Americas-based long/short (L/S) equity fared slightly worse this past week, down 1.2%. Europe-based funds outperformed their regional counterparts, posting losses of only 50 bps vs. the Euro STOXX 600 -2%. Asia-based L/S funds were down 1%, which compares to the MSCI Asia Pacific Index down 2%.
HFs were sellers of global equities as benchmark indices tracked lower. All major regions tilted towards being net sold, except Europe, though North American equities accounted for most the flow. Within NA, multi-strategy/macro funds and quants drove most of the selling this past week via short additions. The flow from US L/S funds was quiet as they sold longs and covered shorts in a relatively small but similar amount. As such, US L/S net leverage was relatively flat WoW at 45%. The selling of NA was broad-based across most sectors. The most notable trend having emerged this past week was HFs flipping to selling consumer staples. Staples had been persistently bought since mid-August, with this recent break in trend due to HFs trimming longs and adding shorts in personal care products. The consumer staples selling this past week registered as the largest 1-week stretch of selling in >18 months. Outside of staples, much of what was sold took place across cyclical-related sectors including materials, industrials, and energy. Within materials, the bulk of the selling was seen in chemicals and metals & mining. Chemicals has consistently been net sold since May, but metals & mining only recently became an area of selling as these names had been consistently net bought in the prior ~1 month. The selling of energy (integrated oil & gas) coincides with the sector underperforming this past week. TMT-related industries were also net sold as HFs trimmed longs in interactive media and entertainment and added shorts in software. Notably, consumer discretionary was flat as HFs adding longs in autos and hotels, restaurants & leisure but were offset by short addition in specialty retail names.
Across other regions, Europe was the only net bought region for the week with managers overweight Europe compared to the MSCI ACWI. HFs were sellers of Asia ex-Japan, albeit on light volumes (AxJ volumes were 2nd lightest since 2020). The net selling of the region was a ~50/50 mix of long sells and short adds and was mostly concentrated in China (ADRs). Japan equites were also sold this past week. At the sector level, staples and materials accounted for most of the selling.
CTA/trend followers have transitioned from net long equities for most of the last 6 months to net short currently. October ETF volumes have risen sharply along with higher volatility, hitting YTD intraday highs at 43% of the tape. There is demand in Korea/India/broad EM ex-China.
Private Equity
The private equity industry is experiencing a wave of consolidation driven by several factors, including a challenging economic environment and the maturation of the industry. Notable mergers and acquisitions have recently taken place, illustrating this trend. CVC Capital Partners acquired infrastructure-focused manager DIF Capital Partners, while Bridgepoint purchased Energy Capital Partners, an infrastructure specialist, for approximately $1.05 billion, both deals happening within a day of each other. Even larger firms are becoming targets for acquisition. TPG acquired real estate and private credit heavyweight Angelo Gordon for $2.7 billion, and Sweden’s EQT purchased Baring Private Equity Asia, marking one of the most significant mergers in the Asia-Pacific region.
The consolidation of fund managers has long been a characteristic of the industry, but there’s an expectation that such mergers will accelerate. These deals offer advantages to both parties: acquirers gain access to new markets and expertise, while the acquired firms gain access to a larger platform and a broader investor base. Limited partners (LPs) benefit from having their investments managed by a new entity that is better equipped to pursue new investments on their behalf. However, consolidation has its drawbacks. While it may reduce the complexity of the market, fewer players can lead to reduced competition, potentially exposing LPs to higher fees and less diversification.
The maturing market, with a small group of investors dominating fundraising, has contributed to this consolidation trend. Mega-funds with over $5 billion in commitments have been a significant focus in the past decade, attracting a substantial share of capital. Funds over $1 billion represent nearly 79% of all capital raised. Managers overseeing these funds have become increasingly acquisitive, with record merger activity in terms of deal value occurring last year. This trend has continued in 2023.
Economic and political factors are expected to further drive consolidation. Higher interest rates, a challenging fundraising environment, and regulatory burdens are prompting larger managers to acquire struggling peers, gaining access to new talent, expertise, investment verticals, geographies, and investors. However, there are potential downsides, such as culture clashes during integration, reduced market competition, potentially leading to higher fees and less choice for LPs, and the risk of stifling innovation.
In the long run, regulators may also become concerned about the proliferation of mega-managers, potentially leading to regulatory actions similar to those seen in the tech industry. Industry leaders, including the CEO of Partners Group and EQT’s CEO, anticipate further consolidation, potentially reducing the industry to as few as 100 platforms in the coming years. These developments mark a significant transformation in the private equity landscape, with both opportunities and challenges for the industry and its stakeholders.
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
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.