01.09.2023
Peter Kraus Year End Letter 2022
Dear Friends,
2022 was a year of some unusual anomalies. Dramatically higher interest rates engineered by the Fed drove one of the worst periods of performance for the bond market in the past 30 years and growth equity multiples collapsed. Prices and wages accelerated at rates not seen for 25 years. A geopolitical fracture within Europe caused the first land war in the continent since 1945, which resulted in a crippling impact on oil and commodity prices. All this painted an ungainly portrait of 2022. Completing the ugly image, Chinese nationalism and their restrictive Covid policy caused serious damage to their economy animating the final brush strokes.
Reacting to all that, global equity markets, while lower, were only down 18%. If this is a recession, it hasn’t been deep. If this is a credit cycle, it hasn’t been challenging. The Fed and ECB likely aren’t finished with restrictive monetary policy, and we probably haven’t seen the lows of all equity markets or credit spreads yet either. I expect 2023 will hold its own challenges.
First, what we do know:
- Equity multiple compression is ending.
- Rapid Fed rate increases are easing.
- Marginal companies with marginal balance sheets are over levered.
- Private Equity and Private Credit are overvalued and haven't been marked to the current market.
- Fiscal spending in developed markets will be higher for longer, think defense, energy transition, onshoring and investing in industrial capacity.
- The long-smoldering geopolitical rupture between autocracy and democracy has taken root; the Cold War is hot.
- Without thoughtful immigration policies, real GDP growth in developed economies will continue to move towards zero.
- Technology, near zero interest rates, and China operating at unsustainable long-term growth levels on their way to the second largest global economy won’t bail out the developed world again.
Second, what we don’t know:
- How long will inflation last and rates remain elevated?
- When does the war in Ukraine end?
- How does China actually exit Covid?
- Does China keep up the political and economic nationalism given Xi is inarguably in charge?
- Is nominal growth fast enough to offset declines in unit volumes caused by restrictive monetary policy focused on wage growth and employment?
- Has the binge on cheap leverage gone too far?
What happens in 2023
I’m inclined to believe equities will be higher by the end of the year and 2022 year-end earnings may surprise to the upside. The latter is due to nominal inflation rates driving top line revenues and, therefore, earnings. In the credit world, the market is pricing in few, if any, defaults and downgrades today. As we get further into 2023, I believe inflation will come down and pricing weaken as consumers show some resistance to recent price increases. Trading volumes will be lower, and investors will realize income and earnings per share (EPS) will go down as well. This will lead to a temporary equity market decline during the first half of the year. By the time the Fed finally reaches the point where they stop increasing rates, they will have created a decline in profits that will have already been anticipated by the equity markets. Stress in the credit market will lag and will lead to a credit event later in 2023 or possibly in 2024. Corporate credit and real estate credit will be affected, the latter more significantly than the former.
Potential Investment Opportunities
When it comes to credit, if you have investable cash, Treasuries are now paying 4%+ returns, investment grade is at 5%, and Short Duration High Yield is at 7%. I believe taking some credit risk in short maturities and waiting for the market to recognize the credit risk in longer dated securities makes sense. Spreads haven’t moved out to where we expect they’re ultimately going to go. This approach may provide additional yield and the liquidity to take advantage of any future dislocations in the credit markets.
Emerging markets have been very unpopular the last few years, and they may yet disappoint. However, the risk-return profile is more appealing than in more recent times. When it comes to emerging market credit, it may have seen its bottom. With recessions in the EU and US possible, longer term treasury rates shouldn’t go up that much more and the dollar should weaken. Duration headwinds have likely ceased, so if you’re getting paid an 8% coupon, you likely won’t experience any diminution and may see a rally that returns 9-10%.
The risk in China continues to be on the upside and being underallocated to it is, in my view, a bigger risk than being overallocated. China has reached the point of no return on COVID and will bear the cost of an open society (health cost and the associated crisis) as the country returns to its normal commercial world.
In November, I visited the Gulf States and Saudi Arabia. While it’s not a huge market, I see more growth potential there than anywhere else in the world. Yes, its growth is largely fueled by petrodollars today, but population concentration is rising in major cities, which will allow their economics to broaden and support significant economic growth.
In the End
We expect to see a range of opportunities and challenges in 2023. Aperture is built to be flexible and capable of producing alpha in any market, good or bad. We’ve continued to grow our assets with roughly $825M in inflows last year due primarily to exemplary performance since inception across all eight strategies.
A heavy dose of humility is required in all markets, and this market is no exception. Having said that, these observations may stand the test of time. After 14 years, the era of very cheap money has ended. Liquidity, whose value during that time has been consistently underrated, will be more desirable and carry a better return than it has in recent history. Leveraged returns will always appear to be more attractive than unlevered ones, but the risk to achieving these has elevated. Therefore, allocators need to re-evaluate the percentage of their portfolios invested in these areas.
Our investment philosophy is predicated on producing alpha through security selection regardless of market conditions. At Aperture, we see the fees we charge through a different lens, which enables us to align our incentives with our clients’ objectives. We view asset accumulation being subject to capacity constraints and a byproduct of our primary focus, performance for our clients. We look forward to continuing to provide that value proposition to you in the coming years.
Best regards,
Peter Kraus
Founder & CEO
IMPORTANT INFORMATION
This letter is for information purposes only and does not provide any professional investment, legal, accounting nor tax advice. All information and opinions contained in this note represent the judgment of Aperture Investors, LLC (“Aperture”) at the time of publication and are subject to change without notice. For more information about costs, risks and conditions in relation to an investment or a service, please always read the relevant legal documents. This note may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Aperture. Recipients of this information are deemed to be investment professionals and/or qualified investors that have employed appropriately qualified individuals to manage their financial assets and/or are appropriately informed and experienced as to understand the associated risks of investment. To the extent that any opinions or forecasts are provided, they are as of the dates indicated, are subject to change without notice and may not be revised, may not be accurate and do not represent a recommendation or offer of any investment. Although all reasonable care and attention has been given to the data provided, no liability is accepted for any omissions or errors. Data contained herein should not be relied upon as the basis for any investment decision.
