Now that's good news. . .Isn't it?

Some extremely encouraging news just came across my Reuters wire this morning:

Revised GDP figures show less severe first-quarter contraction

Now that sounds like some pretty good news to me. Especially when paired with the increase in durable goods orders and uptick in existing home sales in April. However, like in the movies, “All is not good my friend”. I've been listening to this Anthony Robbins 5 Steps to Positive Thinking audio book so will try to spin the positive the best I can. The article goes on to reveal the truth of the matter:

Business investment declined at a record rate during the quarter. Investments in housing fell at the fastest pace in 29 years. Domestic demand fell at the fastest rate in 29 years. Exports fell at the fastest pace in 38 years. . .Economists surveyed by MarketWatch were forecasting that the revision would be to a negative 5.5%. They expect the economy to contract 2% this quarter and grow 1.5% next. . .The big story for the first quarter was in the business sector, where firms halted new investments, and shed workers and inventories at a dizzying pace to bring down production and stockpiles to match the lower demand from U.S. and foreign markets. The massive pullback reaped benefits for the owners. Corporate profits from current production rose 3.4%, or $42.6 billion, compared with the fourth quarter when they fell by $250 billion, or 16.5%.

It's a short article, so I don't want to quote the whole thing. However, let's take a closer look to see what this number really means to the economy as a whole and alternative investments specifically.

Firstly, I'll be the first to cheer a downward revision to a less severe contraction. (Say that three times fast.) That is indeed good news. I'll overlook the fact that the revision is in fact less positive than economist had expected. I generally take their estimates and what they say with a grain of salt and my blood pressure has increased significantly of late. I will also leave alone the idea of an 'expected revision'. Perhaps they should wait until these numbers are confirmed in the future since they impact consumer confidence and economic sentiment so significantly. Still, at the end of the day, -5.7% is a really huge number. This is what it is even with all the stimulus that's being pumped through the system.

More important for us to look at is the 'big story' in the business sector the article highlights. This is really what will impact private equity portfolio companies significantly and even certain hedge fund strategies in the following quarters. So businesses "halted new investments, and shed workers and inventories" to get in line with the new demand curve. It doesn't take an MBA, not that it really matters anyway, to see that none of those activities involved growth. Where is the growth going to come from? Companies can’t continue to increase profits by cutting and pulling back from investments. At some point there will be nothing left to cut and no innovation to sell. If companies are realigning their inventories and workforces to for decreased demand over the long-term what does that mean for company valuations in the short term? At some point there may have to be a more significant fallout in the private equity world. Firms will not be able to hide behind the 'j curve' forever. These firms are really hoping the fundamentals of our economy improve before they have to look for exits. They are getting a lot of help from the numbers and the continued rise in Consumer Sentiment. The only problem is the sentiment seems to be rising because things do not seem to be getting worse and consumers have become (begrudgingly) content with the state of affairs. They're still scared and definitely not spending and investing like they used to. As a true ContracapitalistTM knows, there are always opportunities, and these days opportunities abound for those looking in the right direction.

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Does it all matter?

I've recently been speaking with some of my colleagues in private equity who believe the market's recent vicissitudes have no effect on their firms and underlying portfolio companies. Not only does the state of the market affect all of us on a macroeconomic level, and vice versa, more important in times like these is how it affects us on a psychological level. When the market trades through key levels it can benefit private equity firms on the upside by providing increases liquidity and possibility for exits, and therefore increase investor interest and confidence, subsequently leading to increased access to capital. Of course on the downside it has the complete opposite effect. Remember when the industry entered crisis mode last fall when the markets were in a free fall? While the private equity structure is built as a long term investment, unfortunately investors do not (or cannot) respect that dynamic all the time. Some investors were forced to sell while other were just plain spooked. This is all to say the range-bound market action over the last few days does have an impact on investors. Most don't like 'uncertainty' and private equity is an investment vehicle that cannot necessarily take advantage of short-term corrections through trading, short selling, and arbitrage. Investors will want to know which direction the economy is heading in and whether it will continue. This will let them know what businesses may benefit and where to invest. Until then the alternative investments space will be ruled by nimble and flexible hedge fund strategies that require low leverage and have deep liquidity pools.

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Above the Canopy

The markets have been good to those investors that held tight over the past few months. Unfortunately most will still be sitting on significant losses and I prefer to think we're still looking for a way out of the woods versus in the clearing already. While primarily still in cash in terms of equity related positions, we continue to look at private opportunities in the alternatives space, especially over seas. What this (dare I say 'bear market bounce') has done is stabilize the alternative investments industry for the time being.  The rate of outflows has slowed and funds will super star teams continue to secure commitments.  While some investors in private equity and other illiquid assets may take this as an opportunity to look for an available exit under more forgiving terms, the value of these assets probably hasn't changed significantly due to the rally.  The bids that are out there in the secondary market remain significantly discounted and capital is still hard to come by for many smaller firms.  Who has benefit from this 'bounce' have been many of the hedge fund strategies.  Looking at the Credit Suisse Tremont Indices Convertibles are up over 12% YTD.  Other strategies showing low single digit percentage returns include Emerging Markets, Risk Arbitrage, Fixed Income Arbitrage, and Multi Strat funds.  For investors this will be a game for the nimble and risk seeking.  There are opportunities and risks as always.  Those willing to go against an intermediate trend in the short term will likely benefit from continued secular shifts that develop over the longer term.

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Welcome

After years of trading and investing and consulting on the markets both formally and informally, I've decided to chronicle my views on the current macro and micro economic conditions in this forum.  I plan to keep the technical jargon light and focus on 'big picture' issues with a specific tilt towards the world of Alternative Investments.  I plan to not only rely on my MBA coursework in Finance from The Wharton School and CAIA (Chartered Alternative Investments Analyst) studies, but also yield to my experience trading and managing assets both independently and at some of the largest firms on the Street (or at least what used to be some of the largest).

This first post will be a little more anecdotal, as the markets of late have been experiencing the traditional bear market rallies that have begun to become routine for the market veteran and the retail investor alike, yet still somehow impacts the short , intermediate, and long-term investment decisions equally. With the Dow off some +7% and both the NASDAQ and S&P off closer to 9% today, there is no doubt in my mind that many investors saw the same thing I did this Black Friday.  A lack of buyers.  

It's a tradition of my family members to rise early on the Black Friday AM and head out to gather the best deals.  If  fact, I'm usually done with all of my shopping by 12 noon and am leisurely shopping the secondary and tertiary deals after a quick lunch refueling.  Not the case this year.  After a wonderful Thanksgiving where we discussed the normal current affairs and personal matters, we also discussed what would be 'different' during Christmas this year.  This year instead of many gifts, one of the ideas was one large gift per couple.  The idea of making gifts was even batted around, as well as forgoing gifts for the adults altogether.  So, when later that night I perused the Black Friday ads and saw little that was compelling I was sure that this would be a Grinch stolen Christmas.  

One of my daily tasks is the electronically window shop sites like woot.com, dealcatcher.com, dealnews.com, and dodtracker.com.  Therefore, I knew many of the deals weren't great and that the savvy shopper would play the waiting game.  Finding it hard to break with tradition, I did rise at 7AM to head over to see if Staples had any of the Lightscribe recordable CD deals left. I took my time and hoped for the best.  I pulled into the parking lot to question if the store was even open.  Not a car in the lot, save for the employee cars customarily parked on the side. I walked the store as one of two lone shoppers.  Walked right up to the register and purchase 2 of the items (even though they were one per customer).  The looks on the faces of the workers and managers was more than that of worry.  I knew this was going to be a Black Friday and Christmas season like no other.

What's the really happening here?  With the markets see-sawing and announcements of bankruptcies and layoffs nearly every day, cash is king.  How will this affect the wonderful world of alternative investments is yet to be determined.  A couple of possible scenarios come to mind. That private equity j-curve will likely turn into something more like the Big Dipper.  These firms are in the unfortunate position of having credit tightened and investors either unable or unwilling to make their capital calls.  Any exits for the existing portfolio of holdings are all but closed. Investments will likely be held past 5 or 7 years because of the previous high valuations and purchase prices.  We've all come to realize that the consumer rules this economy and with the consumers now. . .not consuming. . .even what were relatively healthy businesses are starting to deteriorate and be revalued.  The problem is even worse on the hedge fund side where everything moves faster. Add to their list of problems redemptions, margin calls, and valuation implosion.  A vicious cycle hard to counter once begun.

So what's the silver lining?  Valuations have in fact come down to levels not seen since the late 90's in some cases and companies are hopefully beginning to look at their businesses more critically.  This will help the system in the long run.  The fact that we're beginning to acknowledge the fact that we've been in a recession for at least a year now will also help, as will ushering in a new cabinet of leaders committed repositioning the country's priorities appropriately.  As far as the markets, I continue to sit in cash (what little is left) for real time opportunities and make no predictions on market bottoms.  I previously thought we'd be comfortable in the low 7000's, but we'll just have to wait and see. The biggest positive is that I look forward to spending the Holidays with loved ones who this year will undoubtedly look to sharing time as the most valued present of all.