VC & PE/China’s economic rebound/Other stuff

As people still debate what kind of landing the US economy will have, we have to understand that the economic impact of both a higher interest rate environment and one that will remain so for a while, won’t be some notable event. Instead the economic slowdown I believe will be a continued slow progression of many moving parts of the economy that decelerates at different times (my death by a thousand cuts economic thesis). The end result will most certainly be a recession. We must expand our thoughts past the most interest rate sensitive parts of the economy like housing and autos. We’re certainly keeping a close eye on any household or business that has floating rate debt and/or loans coming due this year that will reprice at a much higher rate than the one on the loan coming due. Yes, we also watch the consumer closely and the contraction being seen in manufacturing. And parts of commercial real estate, like office and for those properties/projects that have debt coming due this year are in trouble. 

But now I’m also focusing closely on the private equity and venture capital business, two that have partied on over the last decade plus, that rely on generous investor flows of money and have seen deals struck at ever generous multiples over the many years. On the VC side, we’re about to experience true creative destruction with VC backed companies as it is gut check time on who will be able to live by getting to cash flow breakeven and/or with the help of more financing and who will die because they can’t and investor inflows stop. And for those that die, that will also mean less demand for computing power, cloud services, software, hiring, etc… That of course is always offset by the birth of new business but if the capital flow environment is no longer free flowing, the financing of new ideas will just be tougher. 

On the private equity side, more equity and lower multiples for bought businesses will likely be the norm. Much of the leveraged loan market is to finance private equity deals. For those who haven’t hedged floating rate debt, more equity for them will be needed. On prospective deals, more scrutiny is upon us. The end result is this huge source of financing for so many things in the economy just won’t be flowing as easily as before. 

Mortgage applications fell 5.7% w/o/w after the 13.3% drop in the week prior. Both purchases and refi’s were down about 5.5% w/o/w and remain sharply lower y/o/y. With the rise in the average 30 yr mortgage rate to 6.71% vs 6.18% just 3 weeks ago, the bottom line is obvious. 

Here’s just a few lines from the Ross Stores CEO in yesterday’s conference call as Ross is a good tell on the lower income consumer. “To sum up, over the past three years, we have faced a wide range of unprecedented challenges from the Covid pandemic, supply chain disruptions as well as ongoing inflationary headwinds. These factors have not only negatively impacted our own business, but also our customers’ household budgets, their discretionary income, and their shopping behaviors. As a result, our shoppers today are seeking even stronger values when visiting our stores.” 

The main macro story this morning is the positive February economic data out of China that resulted in a 5% rally in the H share index in Hong Kong as the reopening gets some legs. The A share Shanghai comp was up 1%. The state sector focused manufacturing and non-manufacturing PMI rose to 56.4 from 52.9 with both rising about 2 pts m/o/m. That’s the best since at least 2017 that I have data on. The private sector Caixin manufacturing PMI rose to 51.6 from 49.2 and that was above the forecast of 50.7. Caixin said “Firms signaled renewed and solid upturns in both production and new orders as operations and customer demand revived. Fresh increases in employment and purchasing activity were also seen, while pressure on supply chains eased and lead times improved to the greatest extent in 8 years.” 

In response, the offshore yuan is up 1.3%, a rather sharp one day move from this currency, copper is higher by 1.3% and iron ore is rising by 2.1%. The Baltic Dry Index, which is basically a proxy on iron ore and steel demand out of China, has almost doubled over the past two weeks, after plunging prior. It is still down sharply off its 2021 peak but now off the mat. 

Manufacturing PMI’s also rose m/o/m in Taiwan, Vietnam, Thailand, Malaysia, and Australia. Japan on the other hand saw softness with its 47.7 print and we saw little change for India and Indonesia, though both are above 50. 

We also saw trade data out of South Korea, the important semi, smartphone and auto manufacturing powerhouse and exports fell 7.5% y/o/y, a bit less than the estimate of down 8.8%. Adjusting for working days, exports dropped 16% y/o/y. Semi exports plunged by 43% y/o/y, offset by a 47% spike in auto exports. 

The Eurozone and UK manufacturing PMI’s were left little changed from the initial prints already seen but we are seeing a rally in both the euro and pound after further tough central bank talk. German Bundesbank head Joachim Nagel wants a faster pace of QT beginning in Q3. BoE head Andrew Bailey said to expect more rate hikes. “If we do too little with interest rates now, we will only have to do more later. The experience of the 1970’s taught us that important lesson.” Eurozone bonds are weaker again but gilt yields are lower while equities are higher across the region. I continue to like certain UK stocks.