The “Zombie” Economy Berkshire Capital Securities LLC Wither the U.S
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www.berkcap.com | NEWSLETTER | 2nd-Quarter 2011 NEW YORK | DENVER | LONDON The “Zombie” Economy Berkshire Capital Securities LLC Wither the U.S. economy? Three years after the collapse of a credit and real is a privately-owned investment estate bubble that had turbocharged growth, America remains mired in a bank that provides merger, stubborn and unnerving slump. The unemployment rate is stuck around 9%, and acquisition, valuation and the underemployment rate is just as high. The housing market is in the doldrums, strategic advisory services with lots of inventory and nearly one-quarter of homeowners holding mortgages to clients focused in the that are underwater (higher than the value of their homes). A Wall Street Journal investment management and analysis indicates that the top-10 U.S. mortgage lenders rejected 27% of all securities industries. Since applications in 2010, underlining the shift in credit policies. 1983, Berkshire Capital has The federal government, which through two administrations avoided economic completed 250 transactions calamity with its massive stimulative and bailout efforts, is tapped out, and many (with AUM transfer of over state and local governments aren’t doing much better. As millions of Americans $600 billion and an aggregate watch their standard of living erode and fret about the security of their jobs and value of over $11 billion) and retirements, the public is in a downbeat mood. In June, the Conference Board over 200 valuations, strategic Consumer Confidence Index hit a seven-month low of 59, about half the level reviews and fairness opinions. reached during the halcyon days of early 2007. “With consumers so worried _____________________________ about their job prospects, I’m not so sure that we can count on demand picking up,” a Wells Fargo economist told Bloomberg, adding: “The housing market is Headquartered in New York dead in the water.” City, the firm has offices in London and Denver. The Following the most prolonged slump since the Great Depression, many pundits, Berkshire Capital team consists including purveyors of the “dismal science,” are searching for answers. Have of about 35 professionals and technology and globalization finally reached a critical mass to create a new support staff dedicated to our economic paradigm threatening job growth? Can the U.S. fuel solid economic mandate with more than 20 growth minus the speculative surges that goose consumer spending? Will the years’experience focused in the weight of public and private debt stymie growth for years to come? investment management and securities industries. Writing in the Wall Street Journal in June, Nobel economics laureate Michael Spence intoned that “we must stop pretending that this is only a difficult cyclical _____________________________ recovery. The root of the problem is structural.” As Spence looks ahead, he sees a soft service economy and competition for middle-class jobs from an 535 Madison Ave., 19th Floor increasingly educated population in emerging markets. “A stimulus package New York, NY10022 that temporarily restores elements of precrisis demand is unlikely to generate 212.207.1000 (phone) 212.207.1019 (fax) the escape velocity needed to get out of the jobs hole,” he says, noting that the nation might have to accept “a period of lower income growth” in order to _____________________________ restore trade competitiveness. Stephen Roach, the former chief economist for Morgan Stanley and current Yale The Berkshire Capital Newsletter faculty member, delivered a similarly somber assessment that same month in the is distributed electronically. Financial Times, positing “a new generation” of American “zombie consumers” (“the economic walking dead”). Referring to the 13 quarters since the start of To subscribe or unsubscribe, contact: 2008 during which inflation-adjusted annualized consumption growth averaged [email protected] just 0.5%, Roach wrote: “Never before in the post-second world war era have US consumers been this weak for this long.” His fear: the U.S. will endure a © 2011 Berkshire Capital Securities LLC. long period of Japanese-style stagflation as consumers seek to “recover from the All rights reserved. ravages of this bubble-induced spending binge” by cutting debt. Some information presented in this Writing in his monthly commentary in July, Bill Gross, the high-profile managing publication may be obtained from director of Pimco, decried both political parties for lacking “awareness third-party sources considered to be of the why or the wherefores of how to put American back to work again. reliable. Sources are not required to make Few economic advisors from either party ever mention structural long-term representations as to the accuracy of the information, however, and consequently, disconnects in employment — a recognition that cyclical influences will Berkshire Capital Securities LLC cannot no longer dominate the U.S. labor market.” The erosion of manufacturing guarantee its accuracy. employment combined with a “reliance on wealth creation via financial assets” that is now approaching a “dead-end cul-de-sac,” he writes, has exposed a nation that is “untrained, underinvested and overindebted relative to our global competitors.” continued on next page BERKSHIRE CAPITAL NEWSLETTER | 2nd-Quarter 2011 Page 2 While Americans considered the moribund job market, As part of an effort to expand its lineup of alternatives, Carlyle Europe continued its perilous high-wire act. As the European acquired majority shares in private equity fund of funds Union and International Monetary Fund hammered out a manager AlpInvest Partners, which handles $46 billion in Greek bailout deal in June, the Germans held their collective assets for two Dutch pension fund investors; and Emerging nose, mindful that a free fall in Greece could take Portugal, Sovereign Group (ESG), a New York-based emerging markets Spain and Italy along for the ride, not to mention many of equities and macroeconomic strategies manager. In Europe, Europe’s major banks. As part of the agreement, Greece’s Italian private equity fund of funds manager Advanced Socialist government agreed to sharp cuts in spending, Capital also made two deals: the formation of a $70-million tax increases and privatization — a program the nation’s joint seed investment with Dutch hedge fund incubator conservative opposition New Democratic Party refused to IMQubator and the acquisition of Amsterdam-based support. Holland Private Equity. At the same time, European authorities were leaning on Other European and American private equity firms that made banks to rollover their Greek bond holdings, an effective deals included Duke Street, Lightyear Capital, Millennium, default that they hoped to sugarcoat with euphemisms. In Richmond Park Partners and Rosemont Investment the streets of Athens, meanwhile, violent demonstrations Partners. Ziegler Capital, minority owned by private equity erupted that highlight the potential for political volatility in a firm Rizvi Traverse Management, acquiredLotsoff Capital time of austerity. It took the leader of the Greek Communist Management, which manages a mix of equity and fixed Party to speak plainly about the nation’s situation: “Greece income funds, as well as hedge funds. The purchase of is bankrupt,” said Aleka Papariga. “The government calls it a emerging markets specialists represented another trend in the crisis but that’s a fact. We’re bankrupt.” first half. In addition to Carlyle’s deal for ESG,Lovell Minnick Partners took a minority stake in an established Asian Again, nervous pundits weighed in. Financial Times investor, Matthews International Capital Management. economics editor Chris Giles warned that policymakers “will Ashmore Group, BMO Financial Group, Goldman Sachs not be able to kick the can down the road indefinitely” and and Principal Financial also tapped emerging markets questioned whether any crisis with a Greek default “will specialists. Emerging markets also figured in the larger M&A represent an event that might be dubbed Lehman Brothers picture, with 24% of first-half deals involving targets based in 2 and send the global economy tumbling into another those markets. deep recession.” Economist Nouriel Roubini, who leaped to prominence on the back of his sagacious call about the Although wealth management deals were small, the sector danger of the U.S. housing bubble, declared in the same did draw a number of noteworthy buyers, including BNY newspaper that a continuation of the “muddle-through Mellon, Eaton Vance Corp. and Focus Financial Partners. approach” to the crisis could eventually lead to a “breakup of SunTrust Banks, having paid off the last of its $5 billion the [European] union itself — as some weaker members crash from the Troubled Asset Relief Program (TARP), acquired out.” CSI Capital Management, which enjoys a niche in the entertainment industry. The real estate advisory sector Stock markets in the first half reflected uncertainty about recorded a much-anticipated blockbuster deal when ING a global economy tottering between a weak recovery and Groep divested its advisory business, with CB Richard relapse into recession or worse. In the first quarter in the Ellis Group paying $940 million for most of the assets. In U.S., the major indexes continued the climb that began in Europe, the marquee deal saw Henderson Group pay $520 the third quarter of 2010, on the back of strong corporate million for Gartmore Group, making Henderson the sixth- earnings and measured optimism about economic growth. largest retail-oriented fund manager in the U.K. In another In the second quarter, the bullish sentiment retreated and noteworthy development, BlackRock announced it will the Dow Jones Industrial Average registered declines for six pay $2.6 billion for the remaining shareholding of Bank of consecutive weeks — the longest such negative streak since America, which gained the stake with the 2009 purchase of 2002 — before turning up sharply (5.4%) the last week of Merrill Lynch. June. In Europe, the German DAX delivered a strong first-half performance (up 7%), with the U.K. FTSE index up slightly, as both markets enjoyed solid gains the last week of June.