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The Cobblestone Advisor October 2023

Public v. Private Markets

First, he identifies four major tailwinds to recent performance:

  1. Rates went from high to low.
  2. Monetary policy printed massive amounts of money.
  3. Economies borrowed against future demand via fiscal stimulus and borrowing.
  4. Globalization improved efficiencies.

“It does not surprise me with those four tailwinds that risk assets (equities growth, real estate, things like that) did really well. But I ask myself, are any of those four things true today?”

“Looking backward is not likely to be a good indication of what needs to be done going forward for investing success.”

“In 2008, we came very close to an absolute debacle in our financial system. And the rules of how our financial markets work were fundamentally rewritten. We, not just Apollo, but all of us, we just didn’t notice, because right after we changed the rules we printed $8 trillion and everything went up and to the right. Well now that we are no longer doing that, now that rates are up, now that there are headwinds, we are starting to notice some of these changes.”

  1. Change #1: Less Public Market Liquidity
    1. By some estimates, dealer capital (which facilitates trading) is roughly 10% today what it was in 2008, yet markets are 3x their size.
    2. Liquidity might exist on the way up, but not the way down, contributing to greater volatility.
  2. Change #2: De-Banking
    1. Dodd-Frank constrained banks. The failures of SVB, First Republic, and Credit Suisse will spur more regulation and further this de-banking.
    2. As banks retreat, other providers of liquidity and capital will fill the void. This includes alternatives such as private credit.
  3. Change #3: Indexation and Correlation
    1. “80% of the volume traded today is the S&P 500, 60% of our markets are ETFs.”
    2. “10 stocks make up nearly 35% of the S&P 500 and these 10 stocks are responsible for 100% of year-to-date returns. These 10 stocks have traded between 52x and 44x P/E over the last few weeks. Not many of you come in every day looking to buy 50 P/E stocks. Yet we feel really comfortable with a massive portion of our country’s retirement system assets and fiduciary assets in 50 P/E stocks.”

“We had this perception historically that public was safe and private was risky. I ask, is that even the right framework to think about how market structure is today?”

As Marc points out, public markets are losing some of their ‘edge’ over private markets.

Going forward, alternatives will play a larger role, not just in client portfolios, but in the entire economy. As this develops, many financial firms will rush to exploit this opportunity- most of them will make (dumb) mistakes.

The best positioned firms are those like Cobblestone, who spent the last decade laying the groundwork and building up institutional knowledge.

China Check-In: What’s Going On?

Housing is the most significant issue facing the world’s second biggest economy.

The difference now is that the government has started taking steps to address the issue.

So far, China’s policy changes have been incremental in nature- a far-cry from the full-throttle “bazooka” caliber stimulus many have called for.

So far, China’s measures include:

  • Cutting interest rates and providing liquidity to help developers complete stalled housing projects.
  • Pressuring banks to lower rates and extend credit to developers.
  • Trying to support economic growth through other avenues like infrastructure spending.

Is this enough? No. 

Is this just the beginning of a larger policy response? Perhaps.

Bulls say:

+ This is just the start of stimulus. When China wants something done, it gets done.

+ Government stimulus programs have worked before.

+ Stocks only go up.

Bears say:

– This is not the 08/09 housing crisis- it’s actually much worse.

– China’s housing issues are structure, not cyclical.

– You can stabilize housing but China’s population is not growing. Housing will NOT be a driver of economic growth going forward.

– You can save the developers and finish the apartments but the “animal spirits” of the Chinese property market are gone (see: Japan in 1992).

Some Key Problems:

  • The extent of China’s housing crisis is difficult to grasp. China’s property sector is notoriously opaque with liabilities running through companies, banks, shadow banks, and local governments.
  • Dysfunctional Funding Model. Chinese developers fund their activity by pre-selling unfinished apartments. Unfinished apartment towers represent buyers’ hard-earned savings. It’s not surprising that consumer sentiment, particularly towards property purchases, is extremely low.
    • Is China’s pre-sale funding model sustainable? Probably not. In other countries, buyers have protections like escrow accounts and installment accounts to protect against what’s happening in China.
  • China can’t grow into its excess housing. China’s population is shrinking. There is no immigration to offset this.

Government stimulus is one heck of a tool, but it can’t fix every problem. China has some very severe imbalances at the root of its housing crisis- it isn’t clear to me how government policy can easily address these.

I remain highly skeptical that China’s economy can return to the high-single-digit GDP growth it once enjoyed.