Unappetizing Risk/Reward Setup

A common theme coming from yours truly in client review meetings (and herein, as you’ve noticed) is that while I can’t tell when the next meaningful downturn will hit, in my humble view it’ll be another doozy (that’s a technical term for really bad one) when it does.

Per Julien Brigden’s latest commentary, private equity is way over its skis — and that’s ultimately problematic:

“…we have had an unprecedentedly long cycle with extremely easy monetary conditions and (unlike past cycles) existing lenders have mixed incentives to continue providing finance and to participate in debt restructurings.”

“Shifts in conditions are very likely to result in equity for new deals drying up, which would jeopardize the ability of the sector to keep the flow of capital going. Even a small deterioration in conditions is likely to eliminate the flow of capital to these businesses.

The next recession is likely to catalyze a nasty feedback loop, where poorly performing highly leveraged companies struggle to roll over debt funding and maintain their operations. Would anyone really be surprised if a $3.5 trillion wave of private equity engendered a little collateral damage?”

Clients, this all is just me reiterating why we’re no longer completely correlated to a robust, sustainable bull market in stocks. Not that this longest bull market ever won’t sustain itself (with a lot of help from the Fed) for a good while longer, it’s just that in my view prices have strayed substantially ahead of the fundamentals, which makes the risk/reward setup at this juncture very unappetizing. Then, when we finally get there (to the next recession) — yes, guaranteed, expansions and bull markets never last forever — I suspect it’ll be nauseating…


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