Wednesday, March 10, 2010

Insider's view of the business cycle

What does the business cycle look like after a bust when you're the one on the inside looking out at the investment horizon? According to Bloomberg, it looks like half a trillion dollars.
"Buyout funds sitting on half a trillion dollars committed by investors may need more than a decade to put the money to work if mergers and acquisitions continue at the current pace."
(source: Bloomberg)

As readers should be well aware, nothing stays the same. The rate of M&A spending of the last year or so won't be the rate of spending in the future. As the business recovery solidifies the evidence of a "good buy" will change for the better and this money will start flowing. But notice this key point from the same article:
"“Investors only give the fund a particular investment period, typically three to six years, to invest the capital,” said Michael Harrell, co-chair of Debevoise & Plimpton LLC’s private-equity funds group in New York. “If you don’t use it, you lose it.”"

So there are two strong human factors at play there. First, those entrusted with the money don't want their clients to take it back. They will find a way to put that to work, and they have only two or three years to do so. What a coincidence this lull in M&A just happens to coincide with the first signs of recovery. (NOT!)

Second, if they don't put that capital to work, the clients who take the money back are going to have a lot of pent up demand as they seek out someone who will put the money to work for them.

No matter how you slice it, the business cycle is alive and well with capital left over from the recession looking for something to buy. 'Buy' is the operative word there. The only unanswered question is what will be in demand, and you can be sure it won't be cash and cash equivalents. After all, we're not talking about a world of Warren Buffett money managers. These are sharks looking for a kill.

But lest one gets too excited, temper the emotions with an interesting chart from the Bespoke Group. Looking at that 2009 March low, which was the bottom of that bust of the last business cycle, one should expect the 68% number will stick. Not only is the potential from here much less than the potential from 'there', but we still have a wave of news about to arrive regarding the mortgage reset wave of 2010.

We don't personally expect the news to crash the market or the economy, and don't expect a double-dip recession, but we do expect a wobbly stock market too jittery to make a firm run in either direction, albeit with a bias trend upward as happens with any business cycle boom phase.

As an aside, the astute reader should be careful to differentiate a boom from a bubble. Bubble talk won't be appropriate until about two or three years from now.

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