Chart of the Week #46: Animal Spirits in Private Markets

One could argue that the last two years in financial markets will be remembered for the decoupling of performance between public and private markets. Following a two year bull market, the S&P 500 index cleared 6,000 for the first time in history earlier this month, hitting a new all-time high after the Republican party swept the House, Senate, and White House. Meanwhile, in private markets, fundraising and deal activity remain depressed, largely the result of the slowdown in distribution activity that we have covered in prior posts.

Yet, following the election, there is renewed optimism that 2025 could mark the beginning of the turnaround for private markets activity. There are tangible macro tailwinds that most market participants expect under the next administration – deregulation, potential tax cuts, and declining interest rates would likely lead to increased deal activity. Expectations impact prices today (finance 101!). In addition, higher expectations today can sometimes be self-fulfilling in the future, a phenomenon described as the impact of “animal spirits” (Keynes) or reflexivity (Soros). Animal spirits refers to the fact that confidence, fear, and trust – factors other than rational expectations – matter for markets.

In our view, one simple way to measure animal spirits in private markets is to track the performance of publicly traded alternative asset management firms and financial institutions (namely, full-service banks and strategic advisory firms that specialize in dealmaking). A closer analysis of the performance of these stocks shows meaningful outperformance in 2024, with 10-20%+ increases in share prices following the election across each of our financial cohorts (vs. a 4% gain in the S&P post-election).?

We view this as an indication of market confidence in increased future deal activity and fundraising, in both private equity and private credit. We believe strategic advisory firm performance, in particular, reflects positive sentiment around expected increases in M&A, IPO, and other capital markets activity over the coming years.

The increase in share prices for public alts has led to a significant increase in price to distributable earnings (or “P/DE”) multiples, as seen in the chart below.

Among the large cap US public alts firms, all but one firm is trading above the historical next twelve-month P/DE average of ~20x. The current average multiple (~32x) sits at a staggering 60% premium to the historical average.

The strong share price performance and record high trading multiples for public alts illustrate the optimistic sentiment surrounding private markets heading into 2025. Our view so far is this: whether and how animal spirits impacts actual deal activity will be a function of future policy outcomes (complicated!), Fed actions (they get a vote!), and continued asset price movements. In our view, a key ingredient to deal activity is the intrinsic value (IV) level relative to aggregate NAV – the more optimism persists, and the more growth we see in market multiples, the easier it will be for sponsors to monetize holdings. As of just two weeks ago, our IV indicator rested at (mean level) of 92% of NAV – now that figure is 97%.

Finally, it is worth reflecting that for the largest alts managers, fundraising is less of a constraint than deployment. Much of the movement in P/DE multiples in 2024 has been driven by consistent inflows, particularly from credit, insurance, and permanent capital. Traditional private equity remains more challenged. On the other hand, private credit can benefit from refinancing demand and novel sources of direct and asset-backed origination. In other words, it remains to be seen how animal spirits will manifest exactly in private markets.