To Our Investors and Friends,
The S&P 500 increased 1.2% in the third quarter, slightly lower than the record high seen in July. Oil prices (WTI) dropped over 7% to $54 a barrel as global growth continues to slow, despite an attack on Saudi oil facilities a few weeks ago. The10-year fell to a quarter low of 1.47%, before rebounding to close the month at 1.68%. In the US, the spread between the 2- and 10-year is a mere 0.05%. This resulted in a predictable continuation of trends in the large cap Russell indexes - the Russell 1000 Growth index increased 1.5%, and compared favorably to the Russell 1000 Value’s 1.4% increase. The small cap space behaved much more unpredictably as this year’s best performing stocks were sold off in September, while the worst performing stocks rebounded strongly. The net result was the Russell 2000 Growth index fell 4.2% in the quarter, while the Russell 2000 Value index fell a more modest 0.5% in the quarter.
September was full of surprises that went well beyond the headlines regarding the escalating China trade war and impending impeachment inquiry. Most notable was the IPO market itself, which went from inviting to hostile very quickly.
Over the last decade, IPO investing has changed from an orderly process of transferring ownership from private hands into public hands to something considerably more chaotic. After the financial crisis, many long-term investors sought better risk adjusted returns through allocating more capital to the private markets. The result was an explosion in money slated to both private equity and venture capital. Traditional pubic investors in IPOs, meanwhile, are dramatically shrinking as assets move from active managers to passive managers. It gets more complicated, because many large active managers exhaust their demand for IPOs by buying shares in the private marketplace before the companies go public. Passive investment vehicles largely do not invest in new issues for a period of time after the IPO. Who is left? The fast-acting hedge fund community that judges each investment on incredibly short-term criteria.
The changing dynamics of a larger private market transferring ownership to a smaller, more short-term public market can lead to much greater volatility. IPOs now have fluctuating initial offering price ranges, insatiable initial demand, and then massive stock volatility immediately following the offering. The last few weeks have been characterized by IPOs that immediately trade off in the public markets. Peloton (PTON) and Smile Direct Club (SDC) reversed course very quickly once going public. WeWork decided to postpone their IPO as the $47 billion private valuation was whole heartedly rejected by the public markets.
We believe the best way to approach this new world is with caution and patience. There is no reason to rush in when the investor base is so fleeting. A patient, well-informed investor should be able to translate short-term rapid market dislocations into better long-term returns. For those that have a long-term time horizon, we welcome you to join us on this journey.
All the Best to You,
AKW