The Fall and Rise and… Who Knows?!
April 2 marked the famed (infamed??) Liberation Day by President Trump declaring tariffs on nations’ goods near and far. The stock market promptly plummeted. Then, the President said there’d be a 90 day pause on the new tariffs and the market began to recover, and quite quickly.
The market fall was not at all surprising but the quick recovery has been. It seems we’re not out of the woods regarding the tariff tiffs and that certain chain-reaction events have been started which might be hard to fully stop and reverse.
Industrial and commercial orders have been delayed and business decisions suspended due to tariff (and other policy) uncertainty. This will likely appear in company and economic forecasts and results in coming months. If so, the stock market could experience downdrafts, perhaps large ones. As always, this theory could ultimately be proven incorrect (and I hope so!) as short-term market and economic results are very hard to predict.
Interest Rate Increase?
During 2024 and the first half of 2025, many people have expected interest rates to fall. They haven’t. Further, I don’t believe they will fall, or at least not likely much. Alternatively, it’s certainly possible that rates will stay ‘as is’ or even rise due to our giant and growing national debt. To keep investors willing to buy up new Treasury bonds in larger and larger amounts, the price (interest rate) must go up – it’s basic supply and demand. Yes, there are other factors too, (and the government has some ‘tools’ they can use) but be sure to keep in mind the most obvious elements first.
Private Equity – Ivy League Fail
Most Ivy League endowments have had significant dollars in private equity, perhaps partly because, as exclusive private schools, they naturally gravitate toward exclusive private investments.
When you unwrap private equity, is it really worthy of its lofty reputation? In the past, private equity (PE) did often show outsized investment returns. This was likely due to it being a relatively ‘new’ and untapped market with lots of good opportunities.
Further, years of falling interest rates, up until recently, allowed PE investors to use debt (leverage) to their advantage to enhance returns – something they were very comfortable leaning in to. For better and worse (I would argue more for worse), PE investors often buy companies by loading up on debt which allows them to buy bigger companies with relatively fewer dollars out of pocket. As long as the investments grow (which is relatively easy in growing economies) and interest rates stay low (which they had), more leverage and more risk paid off handsomely.
Recently, with interest rates going up and now more and more money chasing new PE deals, the environment has changed and returns have fallen.
To raise new investment dollars, partly since borrowing has become much more expensive and partly because previous investors have dialed back (including the Ivies), some PE firms are now trying to bring their investments to the masses. They’ll argue it’s to make investing in PE more ‘equitable’. Others will argue, including me, it’s more to goose their own profits. If history holds, this ever-wider offering of PE, soon to include certain 40Jk’s, will complete the process of bringing its outsized returns back to Earth. Adding to the fun, one should know that PE’s fees are typically quite high and the investments very, very illiquid (it usually takes years, perhaps a decade or more, to fully get out of the investment, whether it’s doing well or not). This is probably fine for university endowments since they are typically very long-term investors, but for us ‘regular’ investors, a 5-10+ year lock-up is far from ideal and should be considered with eyes very wide open.
Even with higher fees and lower liquidity, what PE invests in is not night and day different from public equity. PE perhaps seems more ‘stable’ because pricing is not often updated where public equities have prices that change minute by minute. But don’t mistake that for private equity actually being more stable. Fewer updates on price are simply that. In fact, Moody’s recently suggested that the ‘opening’ of PE to the common investor might not only create a lot of regulatory issues (to properly inform potential investors, etc..) it could in fact even stress our financial system in general if these new risks – both known and unknown – snowball. Caveat Emptor!
A Private Equity Pattern
PE investment firms have a spotty record when they invest in businesses. They can be overly confident in their skills to improve a business and then leave the entity laden with debt. The fuse is lit for the acquired company’s ultimate destruction.
PE managers consider ROI (return on investment) as well as their ‘investment exit’ (sale of the business) as signals of a successful investment. The fate of the employees at the acquired firm, and the company itself, is often secondary.
When a company is bought by a PE firm the new management says all the right things initially: how much they love their acquired company and how they’ll keep the current management in place as much as possible. However, within a year or two, it often has changed for the worse. With the (presumed) successful original management team now gone, the business starts to suffer. Down the road, the acquired company can find itself being put up for sale by the acquiring company for a fraction of the price originally paid (sometimes, the people who sold the business buy it back for pennies on the dollar). Of course, this scenario is not the rule in PE, but it’s not a small exception either. Failed acquisitions are quite preventable, but lots of capital and over confidence by PE teams can create a compromised mix of investment overreach and risk-taking.
Contrast this approach to that of Warren Buffett, who often buys private companies for cash (the opposite of too much debt and leverage) and then he keeps the current management in place long-term. His take is that if he’s buying a quality business, why would he remove the management that made it successful? Further, Buffett generally meets with the management of the acquired firm only once a year unless the firm is struggling and needs his input. This approach is both simple and effective.
Brian Weisman, CFA, CPA, CFP,CMA
(734) 665-1454
brian@columbiaasset com
Uncertainty On Purpose