Market Thinking

making sense of the narrative

The Petrus Indicator (and others)

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After the GFC I was on an investment panel and we were asked what Central Banks should look out for as an early warning of another bubble before it bursts. I suggested slightly tongue in cheek that they employ the services of a financial headhunter and monitor where the ‘economic rents’ were rising sharpest, ie where the salaries and bonuses demanded were rising fastest, since this would indicate where supply and demand were most out of balance and thus, most likely where balance sheets were being geared up to inflate a bubble. Japanese Warrant salesman in the early 1990s, followed by junk bond traders, then tech analysts and Bankers in the late 1990s and Mortgage Backed Securities and credit derivative traders and salesman in the mid noughties.

Of course there are always the hedge funds and the traders who sit in front of a lot of leverage in the fixed income markets, but these represent an attractive (for them) compensation strategy rather than any potential systemic risk. The latter of course often contribute heavily to another of my tongue in cheek indicators, the Petrus Monitor. A clear indicator of where the compensation to input ratio is most out of line tends to be the parties that pay tens of thousands of pounds for a single bottle of wine, usually a Grand Cru Bordeux in a high end restaurant. I called it the Petrus Indicator after the original (for me) incident back in 2002 when a group from Barclays Capital (bond traders) splashed out over $60,000 on fine wines, including a 1945 and a 1947 Petrus at a London Restaurant of the same name. The fact that they tried to pass it on as expenses meant that most of them were subsequently fired, including one Dayanandra Kumar, who was in fact teetotal, further highlighting to me the symbolism of the extravagance. 

Today of course, some of the biggest buyers of high end wines in high end restaurants are coming from the Private Equity industry, including a recent tale of some Australian PE managers spending several hundred thousand dollars on a wine fuelled ‘celebration’ dinner.

Another indicator would be the use of the terminology ‘rock star’, as in Rock Star investor, and as such we should be nervous of scenes like those at the recent WebSummit in Lisbon, where over 70,000 tech start up types mingle with the VC and the PE industry in a world where companies are now expecting to remain private in perpetuity. As Felix Salmon points out the rockstar allure of private money is such that VCs report 75% of their liquidity this year has come from selling to PE investors, who in turn sell on to other PE investors. The WeWork debacle may have announced that In Real Life, the extravagant valuations dreamt up by the Investment Bankers count for little, but in the closed bubble of Private Finance, no one seems to care. There is simply too much money swilling around, driven by the Alice in Wonderland regulatory logic that says because Private Equity, Private Credit and Leveraged Loans are less volatile than quoted Equity that they are therefore less risky and thus by implication prudent long term asset liability managers like Pension Funds and Insurance companies should allocate more capital to them.

At the top of the chain, the Venture capital industry has around $120bn in cash at hand according to PitchBook, which is up around 20% from last year, while downstream the fact that the amount of dry powder in PE funds is estimated by Preqin to be around $2.44tn should of course be the biggest warning indicator of all.

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