More Tightening & Pain To Come

More Tightening & Pain To Come

Thursday at 4:30pm ET we will get an updated view of the Fed’s Balance Sheet after last week’s record Treasury runoff ($49.7 billion). There is more tightening to come not only from the Fed (despite its bank bailout), but from commercial banks. As commercial banks tighten lending standards, they shrink the money supply.

The bad news is that companies such as Carmax (ticker: KMX), will see much more pain across unit sales and ASPs as we move through the May quarter (KMX reported February Q results yesterday).

Carmax earnings: https://investors.carmax.com/news-and-events/news/news-details/2023/CarMax-Reports-Fourth-Quarter-and-Fiscal-Year-2023-Results/default.aspx

Commercial Bank tightening will hit the Commercial Real Estate (CRE) industry hard as well as levered-up Tech & Media companies, Retail, you name it. The more the money supply shrinks, the deeper the U.S. recession will be. The good news is that Bank tightening will dampen price inflation.

Money Supply as measured by M2. Source: Federal Reserve: https://fred.stlouisfed.org/graph/?g=12rzG

Ultimately we believe it is the CRE market (a core Private Equity sector), that will cause the Fed to eventually cave on rate increases and QT. When? It depends upon how many Private Equity CEOs call on Fed Chair Powell (Powell is a former partner at PE firm The Carlyle Group, ticker CG). The CRE industry has not suffered enough to date for Powell to pivot. One could argue that Blackstone (ticker: BX), co-founder & CEO Stephen Schwarzman (pictured above) is the power behind the Fed’s throne and has set interest rate policy through the QE years. Blackstone just closed its latest real estate fund ($30 Billion) yesterday, which is 48% larger than the real estate fund it closed in 2019.

The only difference one would guess is that this latest fund will deploy more equity as a percentage of each deal versus in 2019 when PE firms went long everything using close to 100% debt. Are you really a smart guy if you leverage up every deal with cheap debt (pre Q2 2022), and lose all valuation discipline? I say “no”. Perhaps you are an effective asset gatherer, but a monkey can pay 20x trailing EBITDA and sell it to his buddy for 23x EBITDA 3 years later. When Schwarzman cries “uncle”, the Fed will pivot.