Wall Street experts are alarming about a storm coming

Wall Street experts are increasingly sounding the alarm on the massive amounts of leverage present in the US market, which they say could threaten the current market cycle.

Several investment managers have cited the behavior of hedge funds as particularly troublesome.

Also complicating matters is the degree to which investors seem willing to ignore these mounting headwinds and keep their existing holdings.

It seems like every time Joseph Harvey opens the Wall Street Journal, he’s presented with a fresh batch of signals that the current market cycle is nearing its conclusion.

Speaking at last week’s CIO Global Forum in New York, hosted by UBS, Harvey — president and chief investment officer at Cohen & Steers — told the room of attendees that he’s been increasingly bombarded with red flags, even as the equity bull market has plowed ahead into its ninth year.

One recent story that caught his eye addressed the rapid surge in leveraged-buyout (LBO) activity, which is on pace to have the highest dollar volume of LBOs since 2007, according to Dealogic.

To him, this type of activity — which involves borrowing a bunch of money in order to buy companies, and is frequently done by private equity firms — is a glaring late-cycle warning. And while Harvey admits he has no idea when the inevitable downturn will strike, he’s doing what he can to withstand the turbulence.

“Investors should absolutely be shifting their portfolios, given where we are in the cycle,” Harvey told the crowd. “You should respect it, and get more conservative. I have in my personal portfolio.”

His comments were echoed by another panel member at the UBS conference — Michael Fredericks, head of income investing for BlackRock’s multi-asset strategies team. He too has noticed the massive amounts of leverage being built up in the US market, and he’s similarly troubled by what it means for the continued health of the current cycle.

A big part of it stems from the flawed investor mindset that, with so much money on hand, they have to buy something, even if it wouldn’t be as appealing under normal circumstances. Fredericks has heard about the dilemma first-hand.

“Everyone I know from the private equity world is talking about companies to buy, and wanting to buy private companies,” he told the crowd at the UBS CIO forum. “While the multiples they’re trading at are at levels they haven’t seen for a very long time, there’s so much cash on the sidelines that they have to put it to work.”

The connective tissue between the arguments made by Harvey and Fredericks is two-fold: they involve private equity firms, and focus on exorbitant leverage. And while the massive debt loads held by both consumers and corporations is a widely-publicized issue, the role of private equity shops in amassing that leverage has largely slid under the radar.

Jim Paulsen, the chief investment officer of Leuthold Group, expressed similar worries in a recent interview. A private equity meltdown isn’t his base case, but rather a mounting risk that, in certain scenarios, could come out of nowhere to surprise investors.

Source: BI

 Trader Georgi Bozhidarov

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