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Investors, ‘starved for returns,’ flood private markets



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Many global investors are turning toward Silicon Valley instead of Wall Street in search of returns.

The total invested in private markets hit all-time highs last year and continues to break multi-decade records this year. In the first half of the year, total investments in venture capital hit a 19-year high of $53.3 billion, according to data from Refinitiv published last week. That marked a 21% increase by total dollar amount compared to the first half of 2018.

The steady stream of funding comes alongside a drop in the number of publicly listed companies, rock-bottom global bond yields, and historically weak small-cap performance.

“The incentives for early exposure to rapidly growing, mature companies are still intact,” PitchbBook senior manager Garrett James Black said in the firm’s 2019 “Unicorn Report” published Monday. “With those imperatives in place and current market conditions — despite concern about a supposed imminent recession— looking to persist, unicorns aren’t going away anytime soon.”

Analysts say the trend is largely the result of relatively lower expectations for Wall Street investments such as stocks or bonds. As the trade war between the U.S. and China escalates and economic indicators weaken, investors have fled to safer assets such as Treasurys. The 10-year Treasury note fell below 1.7% Monday.

‘Starved for returns’

Money managers for pensions and endowments are turning to alternative investments — private equity, venture capital or hedge funds – to “keep up with expectations that they set years ago with their stakeholders,” according to McKinsey Partner Bryce Klempner.

“In a world where big institutional investors find themselves starved for returns, it’s not surprising that they have steadily increased allocations to private markets and you’ve seen capital continuing to flow into the asset class,” Klempner told CNBC in a phone interview. “Private equity has, on average, managed to outperform public markets over the last couple of decades.”

Growth in smaller public companies has been significantly slower than their private-market counterparts. PitchBook looked at the valuations of late-stage, Series D funded companies compared to the small-cap benchmark Russell 2000. That index is in correction territory, trading nearly 14% below its 52-week intraday high in August of 2018. The S&P 500 is off by 4% from its high.

Meanwhile, there has also been a contraction in the total number of public companies. Part of that is due to mergers and consolidation, but Klempner said managers — not just investors — tend to prefer private ownership, too. They’re able to operate “outside of the quarterly spotlight or the glare of public markets,” and often take a longer-term view, he said.

“As a consequence, you’ve seen considerable management talent migrate to private equity portfolio companies,” Klempner said.

One factor allowing companies to stay private was a change in legislation. The 2012 JOBS Act raised the limit of private shareholders in a company from 500 to 2,000 – meaning companies can stay private until they reach that limit. And in many ways, companies don’t need to go public: They can raise money with ease from private investors and don’t need the cash injection that comes with an initial public offering.

Foreign buyers

Foreign investors are also looking for early entrance into quickly growing tech companies, which in the case of Uber and WeWork, stayed off of public stock exchanges for a decade. Last year, venture capital deals that included “tourist” investors soared to more than $45 billion over 102 investments. Halfway through 2019, the deal total was at 53.

Another factor fueling the growth in private equity is acceptance and usage of secondary markets for investors to get liquidity. In traditional stock markets, it’s easier to buy and sell your stake with the click of a button or calling your broker. And there are plenty of buyers on the other side.

With private markets, that’s not always the case. Private companies aren’t listed on exchanges, meaning finding a buyer isn’t as seamless since alternative assets are mostly off limits unless you’re a qualified, or accredited investor.

“It’s important to emphasize that multiple companies are now increasingly comfortable buying and selling the securities of large, privately held companies in private transactions at the scale of billions of dollars,” PitchBook’s Black said in the report.

McKinsey’s Klempner called it a snowball effect. As secondary markets get deeper, the extent of the discount investors would need to sell a stake in a privately owned company is much less painful than it was a few years ago.

“For a long time, some investors were relatively wary of private markets because of the perceived illiquidity of those asset classes,” he said.

Despite the shift, Klempner highlighted the sheer size of public markets — $70 trillion, versus roughly $3 trillion to $3.5 in total assets under management for private equity — as a sign that stock markets are here to stay.

Still, some analysts have pointed to potential negative effects in the shift to private markets. There is potential for less liquidity in public markets, causing more volatility, and retail investors may have fewer high-growth opportunities as companies opt out of listing on exchanges.

“It throws a spotlight on the resilience of the liquidity of public markets and even questions the point of a public stock market,” Bernstein senior analyst Inigo Fraser-Jenkins said in a note to clients in May. “Soon, active investing is going to be mainly in private markets.”

Fraser-Jenkins also highlighted the difficulty of the average stock market investor to get exposure to high-growth companies until they list on public exchanges.

“This should be a concern for policymakers, as the public equity market allows for democratized access to investment vehicles in a way that private assets do not,” Bernstein’s Fraser-Jenkins said.

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China says ‘vice ministerial’ officials will be in Washington for trade talks on Wednesday



Chinese officials will be in Washington on Wednesday to hold consultations with the U.S. ahead of high-level trade talks in October.

State-controlled media CCTV reported on Tuesday that the Vice Minister of the Finance Ministry, Liao Min, will be leading the delegation at the vice-ministerial level to discuss trade and economic issues, according to CNBC’s translation.

The meeting comes at the invitation of the U.S., CCTV reported.

The U.S. and China have been engaged in a trade battle for more than a year, with both sides slapping retaliatory tariffs on each other’s goods worth billions of dollars.

Tensions escalated last month when both sides announced increased tariffs on each other’s goods.

In response to earlier duties, China announced on Aug. 23 it would apply new tariffs of between 5% and 10% on $75 billion worth of goods from the United States. President Donald Trump then threatened to increase tariffs on all Chinese products by the end of the year.

Both sides have since made small concessions, with Beijing exempting some U.S. products from additional tariffs.

At the request of Beijing and out of “good will,” the Trump administration also agreed to delay tariff hikes on $250 billion worth of Chinese goods by two weeks — from Oct. 1 to Oct. 15. The People’s Republic of China will be celebrating its 70th Anniversary on October 1.

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Expectations rising that rate cut might not happen



Surging energy prices Monday helped add to sentiment that the Federal Reserve suddenly might not be in such a hurry to cut interest rates.

While markets still see the central bank lowering its benchmark overnight lending rate by a quarter point at this week’s Federal Open Market Committee meeting, the case for continued cuts seemingly has gotten weaker. Traders in the fed funds futures market on Monday were pricing in a 34% chance that the Fed will stay put on rates; the probability was zero a month ago and just 5.4% a week ago, according to the CME.

That came amid some changing economic trends as well as inflation pressures caused by a 14% jump in oil prices. Rising inflation makes the Fed more likely to tighten policy or at least hold the line rather than to cut rates.

“While the push-through of inflation from oil prices to core prices is small, the jump in overall prices, in combination with signs that core inflation is already heating up, may make it more difficult for the Fed to cut rates further,” said Beth Ann Bovino, U.S. chief economist at S&P Global Ratings. “They had a cushion to fall back on with lower inflation — they could cut rates given inflation was low. Has the cushion been removed?”

Stronger economic data recently, featuring increases in consumer and business confidence as well as retail sales, has helped fuel some of the dovish sentiment. Some halting signs of easing tensions in the U.S.-China tariff battle also contributed.

And the firming inflation trend, such as the 2.4% annual rise in consumer prices, plus the likely boost from oil prices, complete a picture where Fed Chairman Jerome Powell at least could reiterate his position that this is a “mid-cycle adjustment” and not part of a longer easing trend.

‘We’re kind of done now’ on rates

“I can’t think of another time recently that the Fed had this much of an about-face within a month or a few weeks of their meeting date,” said Jim Paulsen, chief investment strategist at the Leuthold Group. “I still think they do 25 [basis points], but the case is weak.”

Economic data has been consistently better than expected dating back to early June, boosting the Citi Economic Surprise Index to its highest level since February. Paulsen said the changing state of affairs is going to present a challenge to Powell when he delivers his post-meeting news conferences and has to justify why the Fed is tightening amid an improving economy and stock market indexes near record highs.

“You could make a very cogent argument that ‘we’re kind of done now,'” Paulsen said. “Most of the time a lot of the drama is taken out of this. But I think there might be quite a lot of drama in that press conference.”

Powell has developed a history of saying things the market doesn’t want to hear.

In October 2018 he triggered a selloff when he said, amid a series of rate hikes, that the Fed was “a long way” from what it considers a neutral rate, indicating that more increases were on the way. He further rocked investors in December when saying the Fed’s balance sheet reduction program, which was helping to tighten financial conditions, was on “autopilot.”

And the market sold off yet again when Powell in July called that rate cut part of the mid-cycle adjustment. though that now does not look quite so off-base.

“He’s looking brighter by the day,” Paulsen said.

Powell ‘putting his foot in his mouth’

Markets will be watching the Powell remarks closely but also will be looking at the Fed statement and how the central bankers are measuring the oil price spike amid all the other economic trends.

“Powell has been putting his foot in his mouth at post-meeting press conferences. Will he suggest that this mid-cyle cut is at its end?” said Michael Arone, chief investment strategist for State Street Global Advisors.

The market and the Fed actually have come closer to together in recent days in terms of the outlook for rates in the longer term. But the two sides still remain a fair distance apart, as the Fed ultimately sees the rate cuts ending and the funds rate actually drifting higher, while the market is still pricing in about three more rate cuts before the cycle ends in mid-2021.

That dichotomy has kept an element of volatility in the markets as conditions develop.

Arone sees the U.S.-China dispute as key to what happens ahead.

“The market is pricing in a great number of cuts over the coming quarters than perhaps the Fed is willing to suggest at this point,” he said. “Investors have concluded that without the U.S.-China trade conflict, it’s probably not likely that the Fed would be cutting rates at this point.”

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Oil prices, Fed meeting and global economy



Asia markets declined in early trade on Tuesday following overnight losses on Wall Street.

In Japan, the benchmark Nikkei 225 was fractionally lower while the Topix index was higher by 0.13%. South Korea’s Kospi index fell 0.11%.

Australia’s S&P/ASX 200 was down 0.3% as most sectors traded lower. But the energy subindex added 0.59% as energy names in the country gained.

Oil remains in focus after prices surged in the previous session. West Texas Intermediate futures gained more than 14%, notching its biggest one-day gain since 2008. International benchmark Brent also jumped more than 14% for the session.

The sharp moves came after a series of drone attacks hit the world’s largest oil processing facility in Saudi Arabia over the weekend, forcing the Kingdom to cut its oil output in half — which is about 5% of global oil output. The attack was claimed by Yemen’s Houthi rebels and the Trump administration has blamed Iran. A Saudi-led military coalition said Monday the attack was carried out by “Iranian weapons” and did not originate from Yemen.

The Kingdom’s national oil company, Saudi Aramco, reportedly aimed to restore about a third of its crude output, or 2 million barrel by Monday. But media reports suggest it could take weeks before Aramco restores the majority of its output at the affected production site.

Saudi Arabia’s “spare capacity and existing stockpiles (~26 days of export) should mitigate some of the lost output,” Vivek Dhar, director of mining and energy commodities research at the Commonwealth Bank of Australia, said in a morning note.

Asia-Pacific Market Indexes Chart

Oil prices came off their session highs after U.S. President Donald Trump said he was authorizing the release of oil from the Strategic Petroleum Reserve to keep markets “well-supplied.” Analysts have said that energy prices could climb further if there is a military response from the Saudis, the U.S. or others.

“The surge in oil prices also reflects an increase in geopolitical premium,” Rodrigo Catril, a senior foreign exchange strategist at the National Australia Bank, wrote in a morning note. He said the weekend’s incident showed Saudi Arabia’s vulnerability to more attacks while at the same time, there’s heightened risk as both the Kingdom and the U.S. point fingers at Iran.

“For now is probably safe to say that there is a lot that we don’t know and as such oil prices are likely to remain elevated and volatile,” Catril said, adding that “higher oil prices will have implications to the global growth outlook which was already facing a challenging environment.”

In the currency market, the U.S. dollar index, which measures the greenback against a basket of its peers, last traded at 98.627, climbing from levels below 98.00.

The U.S. Federal Open Market Committee is set to meet on Tuesday and Wednesday and markets expect the central bank to cut interest rates by a quarter point. Global growth outlook remains subdued amid the ongoing trade war between the United States and China.

Elsewhere, the Japanese yen traded at 108.06 against the dollar, strengthening from an earlier level around 108.18. The Australian dollar changed hands at $0.6863.

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