Our Next Event: Opportunity Zone Pitch Day - July 20th
The Late Stage Market Cycle, With Anastasia Amoroso
Many investors and family offices have been frustrated by the 2023 market. As interest rates rise and inflation begins to abate, certain asset classes are nevertheless slow to reprice.
Anastasia Amoroso, managing director and chief investment strategist at iCapital, joins WealthChannel’s Andy Hagans to discuss how investors can succeed in a late stage market cycle.
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- Background on Anastasia’s career, and how she got her start in finance.
- Several reasons why communications is so important in the investment industry.
- Where the economy is in the macroeconomic cycle (and the difference between a late stage market cycle vs. the first leg of a bull market).
- The external catalyst that may help commercial real estate assets to finally complete the process of repricing.
- Where inflation and interest rates are likely to go in the next 12 to 24 months.
- Tips for investors to succeed in a late stage market environment.
- iCapital Market Pulse: De Facto Pause and a New Metric to Watch (iCapital.com)
- iCapital Market Pulse: April Could be Poised for An Optimistic Shift (iCapital.com)
Today’s Guest: Anastasia Amoroso, iCapital
- iCapital – Official Website
- iCapital on LinkedIn
- iCapital on Twitter
- Anastasia Amoroso on LinkedIn
- Anastasia Amoroso on Twitter
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to the show. I’m Andy Hagans. And today we’re here with a big macro update, obviously, a lot of big macroeconomic news of interest to family offices, high-net-worth investors, really anyone in finance. Joining me today is Anastasia Amoroso, Managing Director and Chief Investment Strategist at iCapital. Anastasia, welcome to the show.
Anastasia: Thanks, Andy. Good to be with you.
Andy: And we’re gonna jump into macro, which I can’t wait to do, but first, I’m sure a lot of our viewers have seen you on CNBC, Fox Business, Bloomberg, and, obviously, you’re Chief Investment Strategist at iCapital. You’re obviously a very sharp person, with a strong financial background, but when they hired you at iCapital, were they blunt, like, “Hey, Anastasia, you’re gonna have to be on TV all the time.” Was that the job description?
Anastasia: I mean, yes, I think so. I mean, to be honest, this, obviously, you know, being able to deliver thought leadership in the media has been a part of my job for a long time, and certainly is a part of my job at iCapital. But prior to iCapital, I spent, I guess, eight years at J.P. Morgan, and that’s how I initially got started in the media. And, you know, it’s really interesting, because it’s really a great way to be able to very succinctly tell what is it that you’re actually thinking. What is the punchline? What is the bottom line? Because when you’re put in that spot, in that 60-second segment on television, you have to deliver that right message, very quickly, very succinctly, and at the right time. So, really, I guess, my point is it really makes you do the work, do the research, to really get to the bottom line of what is it the conclusion really is. So, yes, it is a part of my job at iCapital, and I guess it has been for a while.
Andy: As you point out, I think it’s an underappreciated skill, to be succinct. Like, obviously, with the podcast, I work with a lot of communications professionals, you know, representing their clients, scheduling appearances on the show, and communications is hard. I mean, in finance, I feel like it’s something that so many professionals struggle with, whether it’s advisors communicating with clients, or even asset managers, you know, trying to communicate what their unique strategy is. Do you think that’s, like, an underappreciated skill, or do you think people are very well aware of how hard it is?
Anastasia: No, I think it is sort of under appreciated, and, I mean, I guess we’re all aware of just how much noise there is out there, and financial noise, and there’s, you know, a variety of different opinions, and there’s an for this, that and the other. And, you know, really, a job of a financial professional, of a strategist, or a portfolio manager, is to cut through that noise, and make sense out of what is a really, really complex world.
And, you know, I’m sure you would agree that it takes time in the profession, and it takes time to develop an investment process to be able to cut through that noise. And once you have the process, you know, for example, maybe it’s as simple as looking at three things, valuation, positioning, and a catalyst. And once you kind of have this process in place, it makes it that much easier to tune out the noise, and get to the essence of kind of what is the bottom line? What is an investment decision that needs to be? So, I think it’s a skill that’s developed over time, and in the world of media, and Twitter, and ChatGPT and what have you, it’s really still so important to cut through the noise.
Andy: That’s really interesting. And I’m thinking about, I became a self-directed investor about a decade ago, after I sold my business and had a liquidity event. And I never really thought about it that way, but you’re right. Like, that is a skill that you have to develop. Like, sometimes people ask me, “Well, what do you think about this or that?” As if I’m, like, gonna sell some investment because of some news about Twitter or something. And I’m like, “What are you even talking about? Like, that’s not even really on my radar.” Might be something that’s interesting, but it’s not gonna make me panic. So, that’s…
Anastasia: It’s noise.
Andy: Yeah. Exactly. So, obviously, your job, then, intersects with both financial analysis and economics, as well as communications and that aspect. Which part of the job do you enjoy more?
Anastasia: I mean, it’s all in it together, right? And I guess if I were to get a little bit personal, it’s interesting, because I started in college as a journalism major, and I wanted to be in communications, I wanted to be in journalism. And pretty quickly, I realized that you kind of have to have a specialty. You kind of have to have some sort of subject matter expertise before you can go and cover a certain subject. So, then, at that point, I decided that, you know, I really liked politics and policy, and I decided to go become a political science major.
And then, pretty quickly I realized that a lot of politics actually revolves around finance and the economics of it. And so I eventually ended up getting a major in finance, minor in political science, and I guess communications was sort of wrapped up all around it. When you think about, the job of a financial professional today, it’s really integrating all those three things. You know, we focus on the numbers, we focus on what the economy is doing, what the financial markets are doing, but then, there’s this geopolitical event, or then there’s another. So it’s really difficult to disentangle, you know, policy from economics. And so, you know, today, in my role, I’m sure you as well, end up spending a lot of time thinking through how those two things are entwined. And then, you know, if you can’t communicate your conclusions, you know, what are those conclusions worth? So I would say it’s all sort of part of the same process.
Andy: Yeah, absolutely. You know, I was talking with an asset manager the other day who had a background in the hedge fund space, and he was saying, you know, when you work for a hedge fund, it’s not just your ideas. It’s almost like a boiler room or, kind of, you have to have a very thick skin to be able to not only have the idea, have the trade, but communicate it and defend it, you know. Almost like defending a dissertation or something.
Anastasia: It’s building that conviction, right? You have to do the right amount of work, the research, the preparation, to be able to have the conviction. I mean, let’s face it. You’re never gonna be 100% certain in the investment decision that you’re making at that particular moment. You know, you don’t have a guarantee in this profession. But over time, you know, if you’ve done enough work to have the conviction, and then you use that conviction to actually put on a trade, make a certain investment decision, and then you do this consistently, time after time, and gaining a track record actually starts showing that your work is paying off, you know, that in turn is gonna give you more and more conviction. But the point is, you’re right, you do have to have the thick skin. I think the way you get it is to do the work, to do the research.
Andy: Yeah, totally. And, you know, you can’t second-guess yourself. You know, I think about some of the allocation decisions I’ve made as an investor, you know, having really any allocation to bonds the past 10 years. And, you know, I have to say, if I could go back 10 years ago, you know, I understood my logic at the time, which is, you wanna have portfolio ballast. You wanna have dry powder. And so, even though, yeah, stocks outperformed bonds by a huge margin in the past 10 years, I don’t know that I would do anything differently, because I was following a process, and I would defend my thinking and my process. I think that’s just as important, because you’re right. Not every trade is going to go your way. Right?
Anastasia: That’s right. That’s right. And, of course, in 2022, really just about nothing went our way. But having said, there’s obviously been times where bonds have delivered what they’re supposed to deliver for the portfolio.
Andy: And maybe again in my lifetime they will, but who knows? Well, on that note, you know, let’s move into macro a little bit. The first thing I wanted to ask you about was Silicon Valley Bank. Obviously, that, you know, from the macro standpoint, maybe the biggest news so far this year. It sent shockwaves throughout the economy, throughout the financial sector. Do you think that that…has the market calmed down? Has it sort of priced in all that news? Are institutional investors, or are retail investors feeling more calm about the banking system now?
Anastasia: The answer is yes, absolutely. And we can see it in the market action. We can see it, for example, in the fact that the two-year Treasury note has rebounded again, and we’re not pricing in as many rate cuts, you know. So that even tells you there’s some sort of sense of stability returning to the markets. I think the sense of stability is returning for a couple reasons. First of all, this realization that SVB was actually a kind of a standalone issue. And then the second reason is that the regulators managed to return the sense of calm. So, just to unpack that a little bit, first of all, my take on the Silicon Valley Bank is it didn’t have to be this way. And what I mean by that is the collapse of SVB was caused by a classic bank run. I think there’s certain series of events that caused the bank run, but imagine if a scenario where you didn’t have all the deposit outflows, then you wouldn’t have had to crystallize all the losses on those available-for-sale securities or held-to-maturity securities. And perhaps that could have been a bank, as risky as it was, that maybe’d still continue to exist.
So, what happened with SVB was a concentrated depositor base, that was caused, you know, to stampede out of the door. And at the same time, it was a concentration of securities that they held on their balance sheet. That is very unique. You know, if you look at all the other banks out there, the depositor bases are not as concentrated. It’s not just, you know, close to 100% corporate depositors. And if you look at most banks, they don’t hold 58% of their assets in securities. You know, that percentage is closer to 25% or 30%. So, therefore, you know, as rates went up, those bonds had to be marked down. That’s not as pervasive of an issue for everybody else in the banking sector. So, I think that’s one of the realizations that’s causing the market to stabilize here.
But the other one, if I look at the deposit outflows, you know, in the weeks, kind of like, the one or two weeks following SVB, you saw, I mean, well over $100 billion that went out of the small banks, and either went into money markets, or went into the large banks. But if I look at the data last week, we didn’t see, I mean, just about any outflows. In fact, we saw a little bit of inflows into the small banks, into the small regionals. And so, if the deposits stay at the banks where they are, then this whole issue sort of disappears. And by the way, it’s not to say that, you know, I think banks are a great trade or anything like that, and we can unpack some of the issues with net interest margins, but if deposits stay at the banks, and they don’t have to crystallize the losses on their securities portfolios to compensate for those outflows, and the fact that deposits have stabilized, the flows have stabilized, that’s what sort of returned a sense of calm to the markets.
Andy: Understood. And, you know, arguably, their balance sheet, their portfolio was a little bit mismanaged, right? So that’s a local issue, specific to that bank. It doesn’t mean that every regional bank nationwide is on the wrong side of the bond trade, right?
Anastasia: Well, that’s right. And if you look at Signature Bank, the reason why those were the two that, I guess, one succeeded the other, was because it was Signature Bank, you had a similarly concentrated depositor base, and that was the next domino to fall. But you’re right, that’s not the case with all the other banks out there. What I will say, the reason I don’t think regional banks are a great trade right now, and we should catch that falling knife, despite the low valuations, is because all the banks are going to be competing for deposits. And if you look at the online savings rate, for example, it has done a much better job, you know, being closer to what the Fed funds rate actually is, versus what a deposit, or a checking, savings, or whatever account at a regional bank may be.
So, as a result, if you are a regional bank and you’re trying to make sure depositors stay with you, you are likely gonna have to pay up for those deposits. So your deposit beta goes up, your cost of funding goes up, and that squeezes the net interest margin that the bank may have otherwise. So, that issue was not unique to SVB and Signature Bank, although if you look at their net interest margins, there were arguably under the most pressure, but all the net interest margins, for all the banks out there, are somewhat squeezed now. So, I don’t wanna dismiss that. But in terms of, you know, being really standouts, I would say SVB and Signature Bank were.
Andy: Understood. They’re all gonna be feeling the pressure, and, I guess, as a consumer, I don’t mind. I don’t mind if the banks are under a little bit of pressure. You know, we can…
Anastasia: And pay you more on that checking and savings account.
Andy: Yeah. I told a previous guest, you know, I got kicked out of, well, J.P. Morgan Chase private bank, because they wanted me to keep a minimum cash balance in the account, paying whatever, 0.1% or whatever, and I’m like, I’m not doing that.
Anastasia: That was good once upon a time, but not today.
Andy: Exactly. Exactly. So, yes. I don’t wish for anyone to go under, but I’m all for change in the banking sector, and we can see if there are better deals, I guess, ahead for depositors. But another interesting aspect of all this, in the fallout from SVB and the Fed… I’m gonna link to this article in the show notes, and I wanna read from it. You had a recent article on the iCapital Insight section, “De Facto Pause and a New Metric to Watch,” that was talking about how the Fed pressed on, they raised the Fed funds rate to the target range of 4.75%, to 5%, but you would still call that a de facto pause. And just the language in the FOMC statement, in your words, “The new language is vague and in our view an acknowledgment by the Fed of the uncertainty ahead.” So, you see this as all, there’s a de facto pause for interest rates going forward?
Anastasia: I do, and one way to think about it is just look at the yields since a month or so ago. At one point, the two-year Treasury note was trading at a yield of 5%. Well, that collapsed to 3.8% at one point, and now it’s back up above 4%. So, that, right there, sort of tells you that the markets are expecting the Fed to pause and cut rates. And when you think about, you know, what the economy reacts to is, what are the rates in front of us? And the fact that the two-year went from 5% to 4%, that’s already sort of the relief for the economy, so to speak. So, that’s one way to look at it. But the other way, the reason I think about this as a pause, I mean, we have just hiked rates by 500 basis points. So if the Fed did 25 basis points here, and maybe they do another 25 basis points in May, that’s nothing, in the grand scheme of things. Oh, and by the way, they’re also telling us that the terminal rate, you know, according to the Summary of Economic Projections, is 5.1%.
So, I think it is possible that the Fed may try to go another 25 basis points in May, but that, in my view, is going to mark the end of the hiking cycle. And I just wrote another article this morning, you know, talking about the fact that the Fed is likely approaching the end of this hiking cycle, when you assess the credit conditions. So, inflation is one thing, and we get the inflation number on Wednesday. Inflation is starting to cool, so that’s great. But what’s really cooling is the credit cycle. And that is the new metric that the Fed has given us to watch, is what are the banks doing in terms of tightening lending standards? What are they doing in terms of net new lending? And when I looked at some of those charts this morning, it sort of shocks you just how much tighter credit conditions have gotten over the course of the last few months, in the course of the last year. I mean, just some numbers. The rate on a new car loan went from 4.5% to 7.5%. The credit card loan rate is at an all-time high of 20%. It was 15% just a little while ago.
If you look at the small business average rate paid on short-maturity loans, it’s near 8%. So it’s back to March ’22 levels. So, as consumers and small businesses, we’re now facing much, much higher levels of rates, so that’s likely to be deflationary. And then on top of that, you add the regional banking crisis that we just went through. And, you know, Andy, we talked about it, the net interest margins are squeezed, what are you gonna do? If you’re worried about the deposit outflows, what are you gonna do? You’re gonna lend less. You’re gonna lend a smaller percentage of those deposits out. And so, even before this latest episode for regional banks, you already had the banks tightening their lending standards of the commercial and industrial loans, and on CRE loans, almost back to March of 2020 levels. This was before this latest episode in March.
You know, if I look at the spread that the banks are charging, you know, over the cost of funds, that has been widening as well. So, when you look at a set of charts like that… Oh, and by the way, the net new lending on commercial real estate and commercial and industrial loans, that has now declined. That is now in negative territory, because regional banks pulled back. So, when you look at this set of charts, you know, you can’t help but think, “Wow, this is a lot of tightening that is working through the economy right now.” And I think if you are the Fed, you have to look at these same set of charts and sort of sit back and let the credit cycle do its work. They did the first part of this, which is raising rates by 500 basis points, which is the fastest and steepest tightening cycle in history, but now, let those 500 basis points feed through to the economy, and let that slow the economy down through the credit cycle. So, I think that’s the handoff, that’s the next phase, but in my view, the Fed should pause, for real, come May.
Andy: No, I get it. So, there’s a lot of evidence that their actions are working, but it takes 6, 9, 12 months for that to work its way through the system, right? And, you know, I think we’ve seen a lot of leading indicators are disinflationary, right? So we can expect inflation, official inflation, to continue to trend downwards. But my…not exactly a counterpoint. I don’t think this is a rebuttal of anything you said, but family offices, they have a lot of dry powder sitting on the sidelines, and if interest rates come down…and it almost, to me, could be, like, the beginnings of another bull market, but before inflation has actually come down to that target level, it’s like the bull market would start again, you know? So, I think maybe investors of all types have to understand, it’s not really going to get back to the old normal. There’s gonna be some sort of new normal. Would you say that’s accurate?
Anastasia: I think that’s right. I mean, Andy, if you think back, let’s say, four years ago, it seemed like the economy could only stomach 2% rates. And here we are with rates at 5%, and the consumers are still spending, the unemployment rate is still at 3.5%. You know, yes, we had pockets of the tech wreck and the crypto collapse, and, you know, the banking turmoil, but overall, this economy is on solid footing. So that tells me the new normal is that this economy can handle 5% rates. And if you think about why that’s the case, by the way, I mean, just think about the consumer. We’re not all that interest-sensitive. You know, if this was back in 2007, where something like 19% of mortgages were floating-rate, that’s a very different story.
Today, for U.S. consumers, 4% or 5% of mortgages are actually floating-rate. By the way, and the picture is very different in Europe, and you do have a lot more interest rate sensitivity there, but as the U.S. consumers, we’re sort of insulated and shielded from this interest rate shock, by and large. If you think about the S&P 500 companies, something like 11% of their debt outstanding is floating-rate debt. So, yes, there’s pockets of dislocation that are happening because of higher rates, by, by and large, I would say, big chunks of the U.S. economy are insulated from that. So that leads me back to your question, the new normal. I think the new normal is that it’s not just 2.5% terminal rate, but 5% is something that we can stomach.
Andy: Well, this makes me think, I had a guest a couple months ago, and he cornered me for a prediction. And I’m always hesitant to make a prediction, right? But I am wondering…and I’m just really thinking about a lot of these themes that you’ve mentioned. I almost feel like we’re in this space, we might be at the beginning of a bull market, but it’s gonna be, like, a bull market that makes everyone angry. You know? Because there’s so much cash sitting on the sidelines, understandably, that waited out, to, like, 2021, or first couple months of 2022. “We’re not gonna buy commercial real estate at a 4% cap. We’re gonna wait for deals. We’re gonna see, you know, blood in the streets, you know, and it’s just gonna be like 2008, 2009. We’re gonna see a severe dip in valuations, and be able to, you know, make these kind of once-in-a-generation trades, legacy wealth-type trades, and buy assets on the cheap.” And I’m just beginning to think the other shoe is not gonna drop, and maybe inflation doesn’t get down to 2% or 3%, you know, ever again, or maybe for a long time. But that doesn’t mean that there can’t be another bull market, right?
Anastasia: Well, that’s right. And I wanna pick up on a lot of great points that you just made. You know, first of all, I think it is frustrating for a lot of people, you know, that here we are, with Fed funds rate of 5%, and yet this market is not cracking. But what I think this actually tells you is this a classic late-cycle environment. When you think about the business cycle, you’ve got the recession, then you’ve got the kind of the initial bounce back, which is usually led by valuations. Then you’ve got the earnings recovery and earnings growth part of the cycle, that’s, you know, usually meaningful. And then you’ve got the Fed tightening.
And the Fed tightening typically generates some of the worst returns and the most muted returns outside of a recession. But once the tightening cycle is over, everybody sort of breathes a sigh of relief. It’s like, “Oh, we just hiked rates, but the economy’s still okay.” And if you think about that, that’s exactly where we are today. And so, you know, some people call this late-stage, late part of the business cycle as euphoria, because we sort of feel like we’ve escaped the interest rate reality, and maybe we’re okay. So, I don’t want to confuse the start of a new bull market with this sort of late-cycle dynamic. That’s where I think we are today. And look, it may last for some time.
Andy: So, we’re… So, Anastasia, sorry. You don’t think we’d be at the beginning of a bull market leg right now? It’s more, in your words, that late-cycle dynamic?
Anastasia: Not yet. Not yet. I think we need to see more things to break. I think we need to see more of a slowdown in economic activity before we sort of hit that reset. I think for the new cycle to begin, we will have to see some rate cuts from the Fed. You know, we will have to probably, you know, flush out the rest of the risk areas out there, such as commercial real estate, for example, such as the leveraged loan markets. And I think once we’ve done that and the Fed is now ready to cut rates, I think that’s the new beginning of the true bull market. But I very much kind of distinguish that from this late cycle, you know, we-sort-of-managed-to-escape-reality setup we’re in right now.
Andy: Could we just muddle through though? I mean, could it just be, you know, moderate interest rates, moderate inflation, a range-bound stock market, you know? Like, I guess, that’s kind of where I’m at, is, when you mentioned asset prices clearing, or some of this economic junk. It’s like, I live out in the country. It’s like, you know, people just take all their garbage in the back yard and light it on fire, and it’s like, we’re waiting to do that here, in our economy, right? But I’m beginning to wonder, I’m like, I just kind of wonder if we’re just gonna muddle through and, you know, are asset prices really gonna clear? Are they gonna let that happen with commercial real estate? With housing prices? Are we really gonna find that true price discovery? You know, it’s almost that pain that sets up the next leg of the bull market. I’m just concerned that we won’t actually go through that pain.
Anastasia: I think we will in pockets, and we should talk about commercial real estate, we should talk about leveraged loans. But I think your overall muddle-through scenario could make sense. I mean, if you think about inflation, today, or tomorrow it’s expected to come in at 5.5% headline inflation, but it’s also projected to fall to 3.5% by the end of the year, and at some point be in the twos next year.
Anastasia: So, that’s kind of a nice muddle-through type of a scenario.
Andy: I mean, Anastasia, if it hits 2.5%, to me, that’s not even a muddle-through. That’s, the Fed could take a victory lap if they really get it down to 2.5%. I mean, I think a lot of people had almost given up hope that it would be in the twos again.
Anastasia: Yeah. Well, it may be high twos. I think that’s another thing that’s different this time. But what I mean is that for the next few months, we are probably…and the inflation is starting to slowly come down. The Fed is still holding at 5%, you know, so that’s fine for risk assets. I think that’s kind of range-bound to maybe a little bit higher. But once the Fed actually says, “Well, our gap now between the nominal Fed funds rate and the rate of inflation is so wide that we have room to cut rates,” I think that’s what gets us out of the muddle-through, and potentially, you know, to start the bull market. But I think there’s a few things that may still break in the meantime. And, you know, commercial real estate, speaking of commercial real estate, prices have corrected there already. Fifteen percent is sort of the latest estimate from the peak, off, probably a closer to 25% correction.
But, you’ve got over a trillion dollars in commercial loans that are coming due over the course of this year and next, out of the $4.5 trillion of CRE loans outstanding. So, that’s kind of a wall of maturities that has to be refinanced. Some of it is in office, where the vacancy rates are 15% or 16%. So, when you look at that setup, you have to kind of think, “Well, there’s likely to be some pain and some defaults that come out of that.” And, you know, to put the regional bank crisis back into the spotlight here, who’s the biggest lender to commercial real estate? It’s the regional banks. It’s the local banks. The regionals account for 70% of the CRE loans out there. So, if you have a loan that’s coming due, but a bank, a regional bank, that it’s not willing to refinance that loan, you know, what happens, potentially? Is there a default event?
So, that’s the risk that may sort of eventually create the clearing that you were talking about, Andy. But then, I also wanna take the other side of that, and to your point about dry powder. And if the regional banks, right now, account for something like 25% of, you know, new lending to commercial real estate, if they step back, could a family office step in? Could a sovereign wealth fund step in? Could a private credit fund that maybe now wants to go after the real estate vertical step in? And I think the answer to all those questions is yes, they can, but if they’re stepping in to issue a loan, they’re gonna be demanding a higher spread. And, you know, today, that’s maybe 12%, 13%, 14%. And if they’re going to step in and provide equity, they’re gonna require, potentially, a much lower valuation. So, I think this wall of upcoming maturities will likely force some clearing event in commercial real estate.
Andy: I see. So, you’re seeing that same dry powder that I’m seeing when I talk with family offices, but they’re gonna insist, you know, depending on the asset, they’re gonna insist on that 7% cap, you know, rather than the 6% cap…
Andy: …that it might be priced at today. So, in your view, that could be kind of the final leg down, and then maybe at that point, you know, where we are in the cycle, the Fed can finally start to cut rates, and then, now, everybody wants to go shopping again. Like, “Hey, look. Low interest rates. Let’s all go shopping for real estate again,” right?
Anastasia: I like, Andy, how you fast-forward to the good part of the business cycle. This is great.
Andy: Well, that’s not the good… To me, the good part would be if asset prices could fall, and, you know…
Anastasia: That’s right.
Andy: …those of us with dry powder could go shop… I just feel like we’re in this… I remember… I don’t remember if this was two years ago, there was some year with Black Friday. I don’t do the Black Friday stuff, but, you know, I always read the news stories about the shopping, because it’s always kind of the canary in the coal mine or whatever, and consumers were waiting for deals. And then it was like, this was the least amount of discounting ever on Black Friday, because there were, like, supply chain problems, and there just wasn’t enough inventory, so the retailers were like, “Well, why discount? We’re gonna sell all of these TVs. We’re gonna sell all of these video game systems anyway.” So they were like, “No discounts.” I feel like that’s the scenario. A lot of family offices, they’re waiting for Black Friday. You know, they wanna go to Walmart, buy everything for 30% off, but Black Friday may never come, guys.
Anastasia: Yeah. I wrote this article late last year called “Sitting, Waiting, Wishing,” and maybe it was wishing for the Fed to end hiking, maybe it was wishing for the valuations to correct. And I wrote this back in late November, fast-forward to today, and sort of assess the situation, you know, I think we have had a clearing event in technology valuations, for example. If you look at some of the high-flying software, went from, you know, trading at 20 times EV/EBITDA to trading at 5. So, that is kind of back to historic pre-pandemic averages, so that’s a type of a correction there. If you think about crypto, well, you know, a lot of what needed to be flushed out of crypto I think has been, and Bitcoin is back above $30,000 as we speak. When you think about, you know, bond prices, they have risen significantly. When you think about private equity valuations, they have started to correct, but I think there’s likely more to go there.
But again, the fact that there’s $1.2, $1.3 trillion worth of dry powder, I think that limits the extent of the correction that we may have. But we are in the process of a true real estate correction, as I mentioned. Office, retail are down 25% or 21%, so I think that should start to pique investors’ interest. And, you know, back to the “Sitting, Waiting, Wishing,” you know, I don’t think the strategy is to sit and wait and do nothing throughout this, you know, valuation reset. We don’t truly know how long it’s gonna take to play out. Maybe it’s already happened, maybe it’s gonna be happening in the next few quarters, but chances are, if you commit to invest over the coming quarters, we’ll at least pick up some pretty good valuations along the way, even if you don’t call the bottom here, or the bottom there, but I think this spreading out your investment time horizon, as we muddle through, that’s kinda how I would think about that.
Andy: Totally. It’s interesting, some of the points you made with this technology reset, and it feels like venture capital has reset. And so, you know, if you look at commercial real estate, it’s like, “Come on, guys. Get with the program.” You know, “Didn’t you see what happened over here with venture capital?”
Andy: But, you know, some of these commercial real estate owners, sellers, asset managers, they have relatively inexpensive debt right now, and so it really takes that external event. You know, it takes the carrot and the stick. It takes the stick, I suppose, sometimes, to get sellers to see the light, to really understand the true value of the asset in the current market.
Anastasia: Well, that’s a good point, is when we look at sort of the repricing in real estate’s transaction-based. But if there’s been no transactions, or limited transactions, that’s what’s kind of limiting, perhaps, the extent of the valuation reset. But here’s what I would say. I think the prices of real estate have reset for the rise in interest rates. When you look at the performance of the, one of the NCREIF real estate indices, it posted the worst quarterly result, negative, I think, 4%, which was the worst result since the Global Financial Crisis. And when you dig through the attribution of that total return, that was a negative return, most of that was due to the reset higher in the cap rate. So, if you think that we are now at a point where the Fed is actually done hiking rates, maybe there’s not as much of a headwind from interest rates as there has been in the past.
So, that’s sort of the good news for real estate. The other kind of mitigating factor, maybe we don’t have to have this massive, further reset in real estate valuations, is, I mean, if you look at multi-family, for example, yes, new apartment supplies coming online, but the vacancy rates are 3% or 4%. If you look at warehousing, same thing. The vacancy rates are really, really low. So, maybe the fundamentals are healthy enough, unlike they were in some of the venture and profitable tech. Maybe the core real estate fundamentals are healthy enough to where you don’t have to have this significant reset. Again, in office, it’s a little bit different, because there’s a 15% or 16% vacancy rate, and we know that there’s so much square footage available for sublease that we’ve never dealt with before, so that’s a different story.
But you need a trigger, right? You need a trigger event, again, for this clearing to happen. And I think that trigger will happen in two ways. First of all, the loans on commercial real estate…or the rates on commercial real estate loans, some of them are floating rate. And so, that reset from 4.5% to 7.5%. And how long can you continue to finance that when the cap rate, or the income rate, is 4% on the property, right? So, at some point that becomes an upside-down scenario. So that should cause some final clearing in the space, and then, of course, that wall of maturities that we talked about as well.
Andy: And when is that wall? Sorry. When is that wall? Is that this year? Later this year?
Anastasia: It’s coming. It’s coming now. It’s starting now.
Anastasia: If I look at the distribution of maturities, ’23 and ’24, years ’23 and ’24, represent the two largest maturity years. About $500 billion of maturities in each of those years.
Andy: Is there a “risk”? I say risk in quotation marks, for our audio listeners, but is there a “risk” that interest rates will go down by the time that some of these loans mature and get refinanced, that interest rates come down? And that’s kind of what I mean by the bull market that might make everybody a little mad. You know, in that case, you might kind of get away with it scot-free, right?
Anastasia: Yeah. Well, that’s right. If you look at the Fed Fund futures curve, and it’s implying 3.5% rates in, you know, sometime in 2024, then that’s right. Perhaps that $500 billion that needs to be refinanced in 2024, that actually gets refinanced at a lower rate. So, I would say that’s a mitigating factor. The other one, I guess, for those that are expecting a huge GFC type of a reset, is this lending standards are not GFC-type lending standards. And back during the Global Financial Crisis, the loan-to-value ratio on commercial real estate was 70%, maybe higher. So, you know, if equity prices or if CRE prices drop by 30%, you potentially wipe up all that equity, and, you know, here’s your loan. But today, the loan-to-value ratio for a lot of properties are in the 50s, maybe low 60s, you know, but the average is probably closer to 56%. So that tells you that the real estate prices can decline 45%, 50%, you know, before all the equity is wiped out. So, I would say the lenders, the CRE lenders, perhaps, are in much better shape versus what they were during the financial crisis. Having said that, how do you escape 16% vacancy rate in office? I don’t know if you do without a clearing event.
Andy: Yes. And, I mean, if you look at the publicly-traded REITs, you know, office has already kind of…in the publicly-traded world, has had a clearing event, in the sense of those very steep discounts with the publicly-traded REITs. And it’s just kind of interesting, all the family offices that are listening, you have your dry powder ready, but you may never see that 7% cap or that 8% cap on the property you want. It just may never come. That’s what I mean. Maybe “bull market” is the wrong word, but, you know, we just may never see the true Black Friday, like we saw through the Great Financial Crisis. And it’s like, every crisis that you go through… What’s the saying where, in terms of the Fed, but I think also investors do this, we’re always fighting the last battle, because of our memories. We’re always…
Anastasia: That’s right.
Andy: So, we’re always thinking, “What happened in 2008, 2009? Surely, that’s gonna repeat itself in 2023.” And it’s not, right? There’s a different set of circumstances now.
Anastasia: It’s a different set of circumstances for the broad economy. I mean, completely agree. Just thinking through the leverage in the economy, consumers have a lot less leverage, on more disposable income relative to that leverage. You’ve got corporations, you know, yes, there’s some pain points in leveraged loans, but largely, investment-grade corporates, high-yield corporates, those loans have been underwritten at sort of much higher quality. So I just don’t think you have the same set of leverage issues that got us in trouble during the financial crisis, so that’s why, you know, if it’s a recession, if it’s a slowdown in the economy, it doesn’t have to be this catastrophic event, as we saw before, because that’s what drives that catastrophe, is when things have to deleverage, and assets have to be sold.
But I agree with you that, I don’t think that’s the case this time around. For the broad economy. You know, pockets of kind of dislocation certainly occurred, as I mentioned, unprofitable tech, and crypto, and potentially in leveraged loans. I mean, that publicly-traded lev-loan market tripled in size since the crisis. And, you know, if the interest rate coverage ratio was three and a half, four times, for the index today, after 500 basis points of rate hikes, it’s probably closer to one and a half. And, you know, you have a significant portion, probably 30% of the index, that might be, the interest coverage ratio may be one, or even below that. So I think you will have some, you know, some risks of deleveraging there. But, again, that’s a $1.3 trillion market, versus all of the mortgages in the United States.
Andy: Right. So, unfortunately, it may be a garden-variety bear market, or a garden-variety recession, or maybe not even a recession, muddle-through, what have you. Anastasia, I know we’re getting short on time. I love all these insights today, and you actually have given us a lot of predictions already. But I wanna ask, you know, is there anything else that needs to be on the radar for high-net-worth investors, for family offices, you know, as they’re allocating their portfolio, as they’re managing their portfolios in the year ahead? Is there anything else that they need to keep their eye on?
Anastasia: Yeah. I’ll maybe give you kind of one risk that I don’t think we have discussed yet, and then talk about how do you position against all of this. I mean, the one risk that we haven’t discussed is, everybody in the markets, whether it’s the economists or the inflation swaps, they’re looking for inflation to come down towards the end of the year. And, you know, that’s all gonna depend on what the month-over-month changes in inflation actually are. And if the month-over-month changes in inflation continue to be 0.5, 0.6, 0.7, guess what? Around the midpoint of the year, year-over-year inflation numbers may actually start to creep back up.
So there’s still a risk out there that despite everything that we discussed, and reasons that I’m hopeful, there’s still a risk out there that the Fed is not yet done fighting inflation, and maybe they pause at 5%, but if the year-over-year numbers continue to move higher, then we may have to bring that 6% back to the discussion table. So, that’s a risk. That’s not the base case, but that’s something that should be on investors’ radar this year, again, as we kind of turn the calendar to July and August. You know, so, having said that, it is a highly binary environment, it is a highly uncertain environment. And, Andy, I don’t know if you agree, but it’s a really kind of uncomfortable time to be an investor, because you can’t be too bearish, you can’t be too bullish.
Anastasia: So, you know, you’re back into the muddle-through scenario. But I say the luxury that we have today as investors, and something we haven’t had for a long time, is you can get paid while you wait out this volatility, and then use this time period of uncertainty, where valuations are in the process of resetting, to your advantage as well, and be opportunistic. So, as I think about, you know, how to manage through this period, is let’s get some yield in the portfolio. You know, cash pays you 5%. That’s great. But guess what? Private credit yields you 10% or 11% at this point. So, that’s a nice way to get almost a double-digit yield in a portfolio, and maybe not worry about, you know, the day-to-day of the Fed and inflation.
Andy: Anastasia, I’m sorry to interrupt. You just mentioned private credit. Someone asked me the other day, I’ve never been a huge proponent of it, number one opportunity right now? I said, “The risk-reward for private credit has never been better,” and it’s exactly what you said.
Anastasia: That’s right.
Andy: You can get paid to wait. And in my lifetime, I mean, I’m 39, financial repression has basically been the norm for my entire investment career. I’m like, “It’s amazing.” You can have a positive after-tax yield on some sort of income investment. It’s amazing. It blows my mind. It’s finally here.
Anastasia: That’s new. That’s something we haven’t seen before. That’s the new normal, after tax and after inflation. That’s right. And if you don’t think the Fed is done, then that’s yet another way to kind of hedge that risk as well, is because most of the private credit is floating-rate, and the spread that you get paid over and above the floating rate is getting more attractive, because guess what? As the banks retrench from lending, private credit has the opportunity to step in.
But I’m glad we agree on that. And then the other side of it, you know, so, get paid while you wait, and at the same time, if you look at growth, private equity, if you look at buyout, if you look at profitable technology stocks, if you maybe even look to earlier-stage venture, which is not, in my mind, as high of a lofty valuations as late-stage venture, we have seen some of those valuations come down. If you start looking at the opportunistic real estate from a total return perspective, given, again, the 15% pullback in prices, these are all the opportunities that should be on the radar this year. And my point is, probably, don’t pull the trigger, pull in one month, but spread that risk out, but add to that risk throughout the course of the year.
Andy: I love it. I think those are very wise words of wisdom for all investors. If you’re in a muddle-through scenario, you don’t need to bet on a bull, you don’t need to bet on a bear. You can go back to basics. You can look for assets that have attractive valuations, and you can allocate a portfolio to, you know, receive positive after-tax yield. So, it’s never a wrong time to get back to basics. I love that tip, Anastasia. And that being said, and I know we’re running out of time, where can our audience of family offices and high-net-worth investors go to keep up with your insights and your research, because I know you published this on icapital.com. Is that right?
Anastasia: That’s right, icapital.com. You can subscribe to my, most-of-the-time weekly commentary, “Market Pulse,” where we try to discuss some of the most relevant topics in the markets, and also take a deeper dive into alternative investments. So, “Market Pulse,” and just the whole suite of our Insights and Education would be a place to look for frequent updates.
Andy: Absolutely. And I’ll be sure to link to those in our show notes. And for our viewers and listeners, you can also keep up with Anastasia on CNBC, Bloomberg, Fox Business. She’s everywhere. Anastasia, thanks so much for joining the show today.
Anastasia: Thanks so much, Andy. Thanks, everybody.