A Posture to Counter Recent Economic Punches
"Everyone has a plan until they get punched in the mouth." - Mike Tyson
"Iron” Mike Tyson was one of the most feared fighters ever to lace up gloves. What set him apart from other common brawlers of the era were his unconventional combinations, none of which were more dreaded than his right hook to the body, followed by a right uppercut to the head.
Anyone watching the news in recent weeks or monitoring their public market portfolio, can probably relate, considering the global markets just got punched in the mouth. The question from here is, how will we respond?
After a historic 11-year bull market, the outbreak of the Coronavirus pandemic, coupled with a budding price war between OPEC and Russia, was akin to a Tyson combination. And at this stage, with so little clarity around the scope of the outbreak, the impact on global supply chains and consumer spending, and questions as to how the oil price war will resolve itself, investors find themselves on unfamiliar ground. It’s in these environments, however, that private equity has consistently demonstrated its role as reliable and patient capital, offering both stability and alpha for investors attuned to the opportunity.
To be sure, while some may compare the outbreak to the SARS epidemic or cite similarities to the September 11th terrorist attacks, market history offers no prior situations that precisely resemble the current backdrop. One common thread from earlier downturns, however, is that bear market recoveries have never been swift. According to Bloomberg strategist Cameron Crise, the least amount of time it's taken for the public market to return to its peak is 15 months, while the median is 30 months.
So how will Weatherford Capital respond?
Last year, we published an article, "Take What the Defense Gives You," that outlined our view at the time that a correction was "lurking around the corner." And although there was no way to predict these events specifically, as a firm, we prepared for a time such as this, in the form of conservative capital structures, pricing discipline, and efforts to further professionalize the businesses we back.
Assuming the pandemic pushes the economy into a recession, which is looking more likely by the day, we at Weatherford Capital are well-positioned to take advantage of a surplus of off-market opportunities, marked by significant valuation compression. This has historically been the lifeblood of our firm, even in a high-multiple environment.
We also anticipate that unlike past downturns, the window to capitalize on the broader dislocation will be narrower than in years past. A recent study by E.Y., predicts that investment managers, in pursuit of outsized risk-adjusted returns, are poised to put more money to work at a much faster velocity than during the 2008 global financial crisis. According to Cambridge Associates’ Q3 2019 U.S. Private Equity Report, 2009-vintage funds returned a median net IRR of ~6.7% greater IRR than funds with a 2006 vintage year.
To be expected, companies tend to have more realistic expectations on valuation during recessionary times, especially those that may have run into cash flow constraints due to excess leverage. The total issuance of corporate debt now tops that of households for the first time since 1991, we expect these dynamics to create an abundance of opportunities for us as we fight on. Moreover, as interest rates remain at all-time lows and additional monetary and fiscal stimulus are likely, we remain optimistic the consumer will return once the fear of the pandemic subsides.
In many ways, the sweet science (boxing) can offer a useful metaphor for the dismal science (economics). In the ring, Iron Mike’s sharp right hook to the kidney would jar his opponents. Their defenses would fall, and he’d quickly follow with a right uppercut and a flurry of punches that typically led to a knockout. He’d also at times leave himself exposed, which is how Buster Douglas shocked the world with his 10th-round K.O. of Mike Tyson 30 years ago. The lesson for investors is to absorb the punches, keep your defenses up, and wait for an opening.
I'm encouraged to tell you that although we, like everyone else, felt the right hook to the body. But we have not -- and will not -- lower our hands. We will stick to our plan and forge ahead capitalizing on the opportunities in front of us.
- Drew Weatherford
