I try to stay away from predicting the future…
But let’s talk about interest rates, economics, and how that affects asset prices.
Macroeconomics was a frustrating class in business school.
Because Economists are too confident about their predictions of the future.
They have formulas to explain the behavior of the economy, but those formulas historically have not worked.
The reason for this is Economics is essentially the study of humans, and humans are irrational beings.
I wish Economics professors would say “this is our best understanding of the topic but it’s not perfect”.
Overconfidence in their formulas leads to bad advice to our government officials which leads to bad policy which hurts our economy.
There is however one rule that is immutable in economics. Interest Rates.
The Fed Interest rate is like gravity.
Interest rates go up → asset prices are deflated
Interest rates go down → asset prices are inflated
Take a look at this graph (tweet link here).
This is the price you can pay for a house at different interest rates if your monthly payment is steady at $1,850.
—> At 2.6% interest you can buy a $462,000 house.
—> At 7% interest you can buy a $280,900 house.
That’s a 39% drop in price to simply pay the same monthly mortgage.
Buyers are in a tough spot now.
Business and home sellers are looking at 2022 and are expecting those prices.
As a seller (understandably) you are often the last person to believe the reality of the new world we live in.
So if your business was worth $50 million in 2022 it is worth $30-35 million today for private equity buyers.
And it’s not because business buyers are evil and want the perfect price. They are subject to the whims of lenders.
And the bank simply won’t give you the money to buy a business at last year’s price…
So what happens now?
It’s a war of attrition…
Buyers cannot buy at old prices with debt.
So sellers will come around slowly to this new reality.
The tide will turn.
It starts with deals that need to be creatively structured so sellers can feel like they’re getting just a small discount from last year.
If interest rates stay steady for 12+ months, sellers will capitulate and we will see PE buying at a 20-30% discount to last year’s peak.