Published on November 10th, 2023
I. Primary - Acknowledgement of Geopolitical Chaos, Loss of Life & Hurt to the Collective Human Heart:
In the Mark & Kimberly world there can be no ‘business analysis’ without acknowledging the primary human chaos /impact that is shaking the world right now and touching us all at some viscerally human level. That is our primary acknowledgement. So, we’ll jump into the economics below, but please note our affiliate has provided a scenario analysis on the current crisis in the Middle East gripping the world. Please access this (20 minute) podcast through the link below:
II. Secondary - Economic / Business Update The Big Picture: The overarching questions, since last month, given the world order and so many mixed signals in the economy, are when do we hit terminal velocity in terms of yield pressure – have we peaked, can we still bring in the soft landing and can we balkanize the impact of the geopolitical fall out?
1. Bond Yields are Unrelenting and This is Where We Must Start:
US 10-Year Yield Hits 5% - The move is the first move above that level since 2007
The inflation zombie is relentless, and consistent with last month’s newsletter we expect to be living in a higher-for-longer scenario with a soft landing still possible. (1) With the US 10- Year Yield punching through 5%, coupled with high mortgage rates, the Fed didn’t need to tighten during the Federal Open Market Committee (FOMC) in November, keeping rates steady but still at a 22 year high. The system is ‘self-tightening,’ through market forces, sparing the Fed a tough decision in November but leaving options open for the December meeting.
We need to take a moment and revisit why we are focused on bond yields:
US Treasuries, known as the ‘risk-free rate’, are considered in parallel to other investments. The point is the ‘equity risk premium’ – defined as the difference between the yield of the S&P 500 index and the 10-year treasury measures the tradeoff i.e., risk/attractiveness between stocks and other assets. With ‘safe’ yields this high, alternative asset classes (stocks) may not be worth the additional risk. No one knows where the trigger or inflection point is, but analysts sounded the alarm when the 5% 10-yr yield threshold was crossed.
2. High Rates and High Debt Burden – An Unholy Alliance! On the heels of the August Fitch rate reduction for US debt, the $33.5 Trillion debt burden is stoking investor concern and a real ‘perception problem’ concerning America’s fiscal certainty. This vicious cycle, as noted above, runs-up US bond yields and generates some serious knock off effects which: i) maintain upward pressure on long term interest rates; ii) threatens growth-centric investment initiatives; and iii) increases the risk of future employment pressures. This creates a phalanx of threats to our soft-landing scenario and is amplified by the crowding-out effect driven by the increased government borrowing costs; consider that in the eleven months ending in August, US government debt interest coverage was $808 Billion, an increase of $130 Billion from the same point in 2022. (2)
Compounding the size of the debt burden is the task of maintaining a supply/demand balance, given that US positions are highly concentrated on the two biggest debt holders - China (3) and Japan. Fiscal Balance as of % of GDP
Source: US Forecast to Run Persistently Large Budget Deficits CBO Projection. (4)
3. And How Are Our Global Partners Feeling? There is increased optimism in North America and India, however sentiments are turning negative in Europe. China is facing some real pressures with cross-border trade decreasing 8.2% in August and 13.5% in July, export growth declining 8.8% in August and 14.3% in July, and imports decreasing 7.3% in August and 12.3% in July. (5) % of Survey Respondents – Economy Will Improve Over Next Six Months
III. Plotting Our Course…. Let’s Consider the Headwinds
Both monetary policy and fiscal policy, as macroeconomic tools, (6) must be coordinated to effectively manage and stimulate the economy. There is a misalignment, which creates a conundrum and limits our room to maneuver in tight waters.
Commercial real estate is getting hammered and forced to secure valuations at a premium to the risk-free rate. This increases the loan to value metric and forces the revisitation of loan covenants. Most analysts are keeping an eye on the shifting work dynamics that could portend an office space implosion.
The refinance cliff could be a time bomb with the US junk Bond market facing a $41 billion bond-avalanche maturing in 2024 and $113 Billion in 2025. (7)
As noted at the outset, increasing geopolitical risks are a major overhang. (See Podcast Link Section I).
Deglobalization and energy transition continue to drive inflation.
October capped the third monthly decline in the S&P 500—the longest run since the Pandemic shock in early 2020.
Concurrently, the US dollar has faced decreasing demand over the last two months. (8)
IV. Let’s Look at the Tailwinds
1. The Jobs Report released November 3rd was welcome news reflecting a lower-than-expected increase in nonfarm payrolls (150,000) as well as a downward revision of approximately 100,000 jobs as reported in September. With an unemployment rate nudging north, now to 3.9%, the labor market may be finding some ballast and entering a closer to normal steady state. The obvious inference is that there may be less pressure to increase rates at the December FOMC. (9)
2. The Consumer is saving the day: The economy expanded at the fasted rate in two years with retail sales continuing to grow (0.7% increase in September) which represents the straight month-to-month increase in six months. Strong consumer spending maintained the economy’s velocity – (more so than the forecasters estimated) into Q4, helping breathe life into the Inflation Zombie. (10) For example, the ongoing retail sales strength increased analysts’ predictions of a December rate hike to 40% from 25%, (11) although given the November Jobs Report (above) signaling a trend to stability, these bets will likely be recast. Monthly US Retail Sales Month to Month Delta (2023)
3. The labor market is supporting the economy and fueling the market. (12) Further, the consumer’s psyche and desire to maintain a certain lifestyle, drives the spending of savings and use of credit. The recent settlement of the UAW labor strife could help introduce some planning predictability, and hopefully offset the implied inflationary stimulus (see union wage gains charted below). Unions in 2023 Secure Highest Raises in Decades – Average first-year raises across hundreds of union contracts
But there are some stress signs and questions regarding sustainability:
The most recent study, completed every five years, was released in September, and revealed that US households saved approximately $1.1 Trillion less over the last six years than previously estimated - average of 8.3% of disposable income rather than the assumed 9.4%. (13)
Savings built during the Covid stimulation initiative are now eroded by normal spending patterns in a heighted inflationary environment. Consumer Savings Rate – Billions $
The Consumer Is a Mixed Bag – But Stress Is Starting to Show
If anyone remembers Freddie Mercury and David Bowie’s classic duet ‘Under Pressure’ – (Link below in footnotes/check it out) (14) - it sure comes to mind with the deal funnel right now. Given the lack of rate certainty, the Q3 drag was significant in terms of bringing deal value down to a decade low – with a 20% decrease in M&A spending from Q2 to Q3. (15)
BUT, the number of deals is down only 2.5% so deal velocity is still pushing through, but the deals are obviously smaller.
Relevant M&A Deal Take-Aways:
Debt is more expensive and harder to access. So, no surprise that interest coverage ratios (16) have dramatically increased. Debt as a portion of the finance stack (debt-to-enterprise value ratio) decreased from 50.8% (2022) to 43.9% in Q3.
Value/Revenue metric remains relatively stable over the last year with a 1.5x (2022) to 1.6x (2023) shift. (17)
Given the flat public multiples and heretofore limited IPO access, although we hope to see that change – (see below), more late-stage VC backed companies are receptive to being acquired - another potential M&A driver.
The VC ecosystem was thrilled with the IPOs of Klaviyo and Instacart representing some long-awaited liquidity and setting the stage for an estimated 75 IPO offerings in 2024, with some strong names, like Stripe, Chime and Reddit on the dance card. Having started with this optimistic expectation, it must be objectively balanced given the political environment domestically anchored with a partisan infused election cycle, a geopolitical stir fry, (as acknowledged at the outset of this newsletter), still unknown/unqualified business drivers like generative AI – (as discussed in our last newsletter), and the fact that the third quarter of 2023 weighed in with close to the lowest VC deal value in six years and deal count in three years.
Given the tensions cited above, VC investors are being very discerning reflecting a Q3 capital-demand-to-supply ratio of 2.2x for venture growth stage companies; as reported by Pitchbook, this metric is the highest they’ve recorded. (18) Many companies are electing to pursue bridge financings to avoid settling on a down round and betting that by extending their respective runways they will ultimately be able take advantage of an ecosystem that by any measure remains extremely well capitalized and a series of government programs – Inflation Reduction Act and CHIPS, that will (hopefully) propel liquidity and support future enhanced valuations.
Things are ‘Skinny’ on the Healthcare Front:
A new class of medicines (GLP-1s, with an active ingredient semaglutide) is sculpting the medical weight loss market, expected to reach $100 Billion by 2030. (19) GLP-1 suppresses the appetite and slows the pace of food through the digestive tract. So, now you have Novo Nordis pushing its brand - ‘Wegovy’ and Lilly marketing tirzepatide, branded as ‘Mounjaro’. These two will likely form a duopoly, estimated by Goldman to ultimately control roughly 80% of the weight loss market, and given recent approval for diabetes, they may engulf the collateral targets of the diabetes, heart attack and stroke market segments as well.
V. Call to Action
Key take-aways reflected by the trends noted above as we enter Q4 2023 are:
Interest rates possibly plateauing through 2024, but we have a December FOMC window – (December 12/13) and in this volatile environment there still remains a wide range of bets.
The November 3rd Jobs Report was positive insofar as job growth was less than expected and accompanied by a significant downward September revision. This may ease rate pressure BUT it is only one data point.
The deal ecosystem remains well capitalized, but investors are discerning.
Private and public valuation multiples remain compressed.
Inflation is not dead, but hopefully less ‘zombie-like’ and uncontrollable.
Consumer resilience is saving the day, but the question is now one of spending-sustainability.
A soft landing is less clear but still possible, again with the optimistic input from the November 3 Jobs Report.
Adult supervision is needed in terms of managing the debt burden and reducing partisan gridlock.
We’ve served up a mixed dish with this month’s report in terms of trends, headwinds and yes, some positive tailwinds. It may be counter-intuitive but it is exactly during times like these that you must stay engaged, objectively review your strategy / plan of action / options and work only with a seasoned Investment Banking team. We’ve managed through these cycles before. Experience counts and we are well positioned to support you. Call with any questions and look for our next update.
(1) Bureau of Labor Statistics. Economists forecast a reduction in ‘rent inflation’, although core consumer price index in September (i.e., excludes food and energy) increased 0.3% in September.
(2) Bloomberg 10-23.
(3) China: People’s bank of China moving to rapidly loosen monetary policy. Underwhelming post Covid reopening …needs to shore up the yuan…How: cut liquidity and foreign exchange requirements for domestic banks and reduce holdings of Treasurys.
(4) Congress and Budget Office/Office of Management & Budget as sourced from Bloomberg Oct 18, 2023.
(5) McKinsey Global Economics Intelligence report Sept 2023.
(6) Monetary policy addresses interest rates and the supply of money in circulation - managed by a central bank. Fiscal policy addresses taxation and government spending - determined by government legislation.
(7) Economist Sept 15 Interview with Mohamed El-Erian.
(8) Morgan Stanley Report 10-31-23.
(9) Bloomberg Morning Brief 11-3-23.
(10) Bloomberg 10-25-23.
(11) Yahoo Finance Oct 17, 2023.
(12) Bloomberg 10-31-23.
(13) Bloomberg Sept 28, 2023.
(15) PitchBook Summary 10-31-23.
(16) Metric used to determine debt pay off potential – (Earnings divided by interest payments during duration).
(17) PitchBook Summary 10-31-23.
(18) PitchBook November 1, 2023.
(19) Goldman Saches study as reported by Bloomberg 10-17-23.
*** The content is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional(s) before entering into any M&A transaction. ***
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Mark offers over twenty years of experience managing all facets of investment banking (M&A, VC/PE and IPOs) as well as company operations; additionally he offers the ability to orchestrate resources and manage the process/personalities required to close complex transactions. Licenses: Series 7, 24 and 63. Mark has an M.B.A. from Harvard Business School and a B.A from The Royal Military College of Canada / Navy ROTC.
Mark Mansfield, Principal MM@GlobalCapitalMarkets.com
Direct: (949) 400-3760
Ms. Valentine-Poska has 30 years of experience in investment banking & financial services and is registered with the Financial Industry Regulatory Authority (“FINRA”). In 2023, she was recognized nationally by Opus Connect as “Top 25 Women in M&A”. Ms. Valentine-Poska has an M.B.A. from Harvard Business School and a B.S. from University of Southern California, where she graduated summa cum laude and as the Valedictorian.
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