This week fear of missing out seems to have flipped to fear of losing money.
Pretty much all equity markets and individual shares are down today. Bitcoin has fallen 17% since its peak value on the 5th October. This morning, I can see only 11 FTSE 100 companies up in value and all from the worst performing sectors of recent months. Gold looks like the only green spot in a sea of red.
Unusually, it was quite well telegraphed and when we held our webinar last week more than 50% of those attending thought an equity market correction was imminent. Contributing factors appear to be:
- A bubble in AI related stocks.
- Private credit market defaults with the collapse of First Brands and Tricolor in the US.
- Trade tensions resurfacing between the US and China.
Most importantly though is the strong run up in all prices since the Liberation Day sell off in early April, it has just been too far too fast, and many investors will be taking profits and taking risk out of their portfolios.
What we can’t see yet is whether this is yet another ‘buy the dip’ opportunity or a bigger correction in the making.
Our regular contributor, Stephen O’ Sullivan, writes on the clash between the US and China with a keen eye on global security issues. You can read the article here. I can recommend the MI5 history exhibition at the National Archives in Kew. It’s a small but fascinating collection of archived MI5 material and Ursula and I got a guided tour last night by the curator who really brought it all to life. Much has changed over the last 100 years except perhaps the paranoia, prevalent in 1909 when MI5 was set up and clearly present today, highlighted by both Stephen in his piece and Sir Ken McCallum head of the MI5 on the front page of the FT today.
Focusing on 1 and 2 above, I suspect there is clearly more to come in relation to both issues. A quick conversation last night with an old college friend and now US citizen highlighted both.
In the oil and gas sector, in which he operates, leveraged operators are having a tough time as the oil price, down 10% year to date, languishes below $70 a barrel. Over leveraged businesses break their covenants and bankers have to take tough decisions between accepting debt write downs or foreclosing and becoming oil operators themselves. As Jamie Dimon said this week about JP Morgan’s $170m hit from Tricolor, “when you see one cockroach, there is probably more.”
A good friend of my old college mate is Bill Zartler who is a serial Texan entrepreneur and great sailor. When Bill visited London around 20 years ago, he was sent to me to go for a drink and talk sailing and business, we had not met previously and Bill was on his own. For those who were clients of my old firm they will remember its offices were above the Barrow Boy and Banker on London Bridge and several hours later and quite a lot of Guiness later (which Bill thought was fabulous!) we emerged from said pub after a completely engaging conversation. We have met a couple of times since and it always involves copious amounts of alcohol and great conversation.
20 years on and Bill has clearly spotted the AI infrastructure spend as he founded and positioned Solaris Energy Infrastructure Inc (SEI listed on the NYSE) to provide energy solutions to US data centres. SEI shares are up almost 300% in a year and are now trading on a price earnings ratio (PE) of 90X earnings! I read Bill’s last quarterly report this morning and the business is flying, revenues and profits are up c 20% year on year and I am sure the order book is full. But to support a valuation at a PE of 90X when such a business would normally value around 20X earnings, Bill must more than quadruple profits. At 20% compound growth that would take 8 years. As Nick Gait said and as we discussed it this morning, markets are already valuing a decade’s worth of perfect growth from AI infra structure spending today. It feels frothy to say the least.
SEI is off 5% in pre-market trading and please note this is not advice to buy SEI shares at today’s price.
Beware Private Markets
SEI is a small cap listed US company so the price of the shares is trading daily and will adjust rapidly if sentiment or the business performance changes.
Since the turn of the century, it is the private assets markets which have been growing far more rapidly than the publicly traded investment markets. These investments are held in locked in funds and don’t trade daily. They are much less liquid and managers who run the funds and who get paid as a percentage of the fund value are often reluctant to recognise price corrections until they get fully crystalized. The locked in nature of private investments can be a good thing, investments often need time to mature and private bankers and fund managers who have access to these funds often use the exclusivity of them as a selling point; “not everyone can access these opportunities”.
According to the Political Economy Research Institute’s (PERI) working paper of May 2024 ‘The Growth of Private Financial Markets’: Over the past decade, “private” financial markets, which face little oversight by regulators, have grown to the point where they dominate financial activity. Private funds have approximately tripled in size in the last decade to $26 trillion in gross assets (compared to the $23 trillion in the U.S. commercial banking industry). Private markets raise more in equity than public markets: in 2021, new stock issuances resulted in $434.7 billion, while private markets raised $1.73 trillion in committed funds that same year–almost four times as much.
However, the lack of liquidity and lack of regulation as highlighted above makes this a dangerous place to invest and when it goes wrong it typically goes horribly wrong.
Two headlines caught my eye in the FT today:
“KKR forgoes dividends as Euro 22bn Italian bet goes awry”
Good luck with that! KKR are a leading private equity investor and the business going awry is FiberCop an Italian telecoms business, created for private equity investors from Italia Telecom and now losing customers.
And
“Bubble feared as AI Valuations near $1tn”
In this piece the FT highlights that whilst Venture Capital firms (VCs) invested $10.5bn into internet startups in the 2000 just before the bubble burst, in 2021 VCs invested $135bn according to Pitchbook and look set to invest over $200bn in 2025.
Mercifully for us most of these investments are private. Much of the investment is into non-profit making startups so there is no price earnings ratio to consider, just hopes and dreams! There will be massive write downs. However, the FT also highlights the risk that some of the very big startups like Open AI are now distorting valuations in public markets as they commit to spending funds (in some cases which they don’t yet have) with publicly listed companies.
We have zero private investment exposure in our portfolios and are very happy for that. As we have discussed before we are positioned to avoid too much backlash from an AI bubble burst, although we will not be immune to short term volatility.
