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As we write today, the surge in energy costs and consumer prices everywhere looks set to drag on through the summer, and investors are evaluating the prospect of a much steeper path for monetary tightening than had been forecast earlier this year.

The convulsions in markets as this paradigm shift is digested have been much discussed. There is little new we can add to the debate. Deglobalization, nearshoring, geopolitical conflict, political dysfunction, ESG backlash, energy insecurity… these are contemporary wrinkles on a longer-run background pattern that’s as old as capitalism: money gets cheap, asset prices rise, people extrapolate recent momentum indefinitely into the future, risk standards get loose, the world suddenly gets more complicated, tighter money flushes out the excess, markets correct. Rinse and repeat.

An exceptional decade

In many respects, it is not today’s market that is abnormal; it was the decade after the last financial crisis that was singularly unusual. Low inflation, abundant central bank liquidity, slow but steady and predictable growth, and very high rates of savings made for near-Goldilocks conditions for risk assets. Volatility reached record lows, punctuated by short bursts and flash crashes. Valuations rose steadily. Today many of us are reconsidering notions that had become deeply ingrained over the long last cycle. Ideas such as “the 60-40 portfolio,” “lower-for-longer,” “low-cost beta,” and “secular growth winners” were once tautologically obvious pieces of investment advice. Now they are very much contested.

For all these years we kidded ourselves that a new reality of moonshots and endlessly bountiful capital was permanent. Free lunches. Win-wins. Bits, not atoms. Decisions like “buying the dip” no longer needed to be weighed carefully or carried any risk. Unemployment could reach record lows with no inflationary payback. Printing money could cure all manner of social ills. Digital transformation could create untold riches overnight—for the lucky workers in Silicon Valley, but also for regular folks, Youtube creators, Reddit stock jockeys, fintech and cryptocurrency early adopters (many of them, to our secret irritation, our friends and neighbors). It was a wonderful period for investors. A time of abundance.

MasaSource: Marketplace.org

Hard choices

Let’s return to basics. The ordinary condition of economic life is scarcity. Tradeoffs are costly. Economics itself is sometimes defined as the science of choice under constraints. As it turns out, investing, like most things involving an uncertain future (buying a house, planning for retirement, applying to college, etc.), is hard.

Inflation is a clear reminder that, despite our many modern conveniences, scarcity still nips at our heels. Like the difficulty procuring a roll of toilet paper in a global pandemic, rising prices are signals that markets equilibrate supply and demand only imperfectly. Sometimes there is more demand than there is actual stuff (or workers) to go around. High prices are capitalism’s alternative to rationing (which we tried in the 1970s and hopefully will be wise enough to avoid this time around.)

Similarly, high interest rates signal that money and capital too can become scarce. Decades of low and falling interest rates meant than capital providers were only too happy to part with their cash. It was easy to get a loan and easier still to open a zero-commission trading account. On the back of central bank helicopter drops—along with high rates of East Asian household and U.S. corporate savings—cash coffers swelled, driving up asset prices and driving down return expectations.


Source: AP, Washington Post.

In a world where liquidity is suddenly dear, corporate cashflow is newly valuable, and many potentially attractive investments are competing for limited capital. This is the historical norm, not the exception. Markets had forgotten.


One other commodity that is suddenly scarce again is time. Higher interest rates don’t just imply higher required returns. They also mean that investors want a greater proportion of their money back sooner. A once arcane idea, “equity duration,” has enjoyed newfound popularity as an explanation for why technology and biotech stocks are being punished. A large proportion of their cashflows—if, in some cases, they ever materialize—are forecast relatively far out into the future. Therefore, when rates rise, these “high duration” assets get sold more aggressively as there is a higher premium on prompt return of capital. In other words, time and patience are scarce. Inflation is justifiably causing investors to become more focused on the short-term. Venture capital, the ultimate bet on a radically better future, is in the crosshairs. Where financial repression once gave rise to the acronym “TINA” (There Is No Alternative), we are experiencing a swerve to “TARA” (There Are Reasonable Alternatives). This shift in mood will cause everyone to become stingier.

Thoughts on private markets

In an upcoming blog post we plan to loosely segue this discussion on scarcity to one of its most interesting investment implications: the prospects for private equity (PE). We wrote in 2019 on the need to approach this asset class with caution, despite our believing strongly in its potential for continued outperformance. These arguments are all the stronger today. Markets’ reorientation from abundance to scarcity gives us a new lens on PE strategies. PE is in the business of avoiding competitive markets, creating scarce business models, and limiting access. “Monopoly is the goal,” venture capital’s dark prophet once proclaimed. Paradoxically, just as interest rates are reminding us that capital is sometimes in short supply, PE is experiencing an exuberant torrent of inflows—much of it coming from retail investors seeking to avoid the turbulence of stocks and bonds. In an environment of scarcity, selective becomes the critical watchword. Not everything goes up. Choice under constraints. As parts of private markets get overcrowded, we will need to be doubly selective in our search for market-beating, uncorrelated returns. Fortunately, much of the money flowing into private markets is relatively inexperienced and undiscriminating, a fact which in and of itself will offer up compelling opportunities for those who know where to look. This is the subject of our next essay.

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