Mapping the Markets: Q2 2026

In this episode, Future Standard’s Investment Research team members Alan Flannigan and Andrew Korz break down their latest publication, Q2 2026 Mapping the Markets: Shock and Awe, a quarterly macro and cross-asset chartbook illustrating the current state of markets. 

Key takeaways

• Supply-side shocks are occurring more frequently and driving persistent inflation volatility.
• AI CapEx is powering equity markets but also increasing concentration risk.
• Stock-bond correlation has risen, weakening traditional diversification.
• Dispersion across and within asset classes is creating opportunities for active management.
• Private market returns are increasingly driven by revenue growth, not multiple expansion.
• Diversification now requires deeper strategy selection, not just asset allocation.

For more research insights go to https://futurestandard.com/insights 

Transcript

Alan: 0:10

Today's episode will center on one of our favorite recurring investment research pieces, Mapping the Markets. The second quarter edition titled Shocks and Awe is now live at futurestandard.com/insights, and we hope you'll check it out. This publication is a quarterly macro and cross-asset chart book where we illustrate the current state of markets in our most timely, compelling, and occasionally profound charts. Shocks and Awe is not just a catchy title, though it is that. It's the apparent modus operandi governing markets and the economy. High-frequency supply-side shocks that spike inflation and challenge the path of monetary policy have repeatedly disrupted the orderliness of the economic cycle. At the same time, valuations of AI-focused firms continue to elevate at breathtaking speed as the AI build-out powers large parts of markets and economic growth. As we've said before, this is a system with just cause for optimism, but one in which the frictions investors must navigate are now internal to the system How is this showing itself in the economic data, and how is it showing up in markets? That's the basis of the piece and today's discussion, Shocks and Awe. I'm joined, as always, by my partner in research and, uh, colleague in podcasting, Andrew Korz, Senior Vice President of Investment Research.

Andrew: 1:35

Happy to be here, Alan. How are you?

Alan: 1:37

Thrilled to be here. This is a, a piece that we really enjoy putting together each quarter. It gives you an opportunity to step back and take a wide swath across markets and see what is jumping out, you know, what is kind of most appealing and relevant at a given point in time, and package that all together so that way people can scan through it, 10 minutes, and you're up to speed on what's going on. You know, how do you think about this piece and- Yeah … the intended use of it?

Andrew: 2:02

Yeah, no, I, I totally agree. This is one of my favorite pieces to put together because who doesn't like charts, right? Right. And it's j- it's just a, a long list of, of our, of our favorite charts for the quarter. And I think what makes this piece so useful now is that there's so many things that cut across-

Alan: 2:17

Mm-hmm

Andrew: 2:18

asset classes, right? Whether it's AI, whether it's higher for longer, interest rate complex, whether it's these, you know, geopolitical shocks that you mentioned. All of these things cut differently across different asset classes. So I think this allows us to take those themes, apply it to different asset classes, and kind of see, uh, you know, where things lie today and where we s- where we think, uh, things are going over the next, call it, three to six months.

Alan: 2:39

And we, we always like to tee up conversations with a focus on the macro. You know, we're very much long-term investors, and we think that getting that long-term view on these kind of fundamental inputs to the system are very important and, you know, kind of matches up the duration of the insights that we try to provide with the duration across which we invest, you know, within private markets primarily. And so when you think about sort of macro-defining trends, like we've talked about the shifting regime and more shocks, particularly on the supply side, you know, walk through, you know, if you will, some of the, the things that have jumped out to you the most in the quarter and some of the things you find most relevant, uh, for investors today.

Andrew: 3:16

Yeah, absolutely. I, I, I think when we think about the macro, obviously things are dominated by- The war in Iran. Right now, the risks are certainly dominated there. At the same time, I think you have an economy that continues to be what we call a three-speed economy, right? Where you've got on one side, you know, the AI CapEx boom, which continues a pace that is also helping to drive the equity markets higher, which we'll talk about in a bit, which I think, um, you know, we can argue to what extent that's helping to drive consumption-

Alan: 3:46

Mm-hmm

Andrew: 3:47

uh, especially from wealthy households who own stocks. But certainly to some extent it is. So that's sort of the part of the economy that's booming. You've got the middle, which is sort of like the broad, uh, you know, household, sort of middle class, upper middle class, the people who drive consumption in, uh, in the US, and they're holding on, right? People are employed. Uh, they're making decent wage gains. Uh, we've got consumption that's growing at about, call it 2%, uh, per year on a, on a real basis. But they're not thriving, right? They're sort of surviving. And, and, and certainly the recent uptick in energy prices is, is a concern there. And then there's sort of the third leg of the stool, which is housing other rate sensitive parts of the economy, which got another kick in the teeth this year as the, sort of the, the energy crisis set in, rates went higher. We priced out Fed rate cuts for this year. So that's sort of where things stand today. I think to your point, more broadly, you know, I think we are in this regime where supply shocks are becoming more and more relevant and frequent, right? So you think back to 2020, obviously COVID, the sort of supply bottlenecks and the inflation that followed that Then we had Russia's invasion of Ukraine in early '22. Then we had sort of the, the falloff in immigration, new immigration policy with the Trump administration. Uh, Liberation Day- Yeah … last April. It's true. Right? And now, of course, the Iran war. All of these things have been, uh, challenges to the supply side of the economy, which have driven up inflation while challenging, uh, the growth outlook, right? Which is a really difficult position for central banks to be put in, and I, I, I'm, I'm sure we'll talk about that in a bit.

Alan: 5:21

And one of the ways that you show this within the piece is using the US Economic Shortage Index. Yep. And what jumps out when you look at this chart is you have these four peaks that have occurred between 2020 and now, and you look at the intensity of these peaks back across history, and you don't see that level reached until you go all the way back to 1980.

Andrew: 5:44

Yeah.

Alan: 5:44

So you've covered a 40-year period four times in terms of the frequency-

Andrew: 5:49

Yeah… Alan: of this shock, uh, that you're Could you share a little bit more about what this index is and why it's, you know, so relevant today? Yeah, it's, and, and, and this is the first chart in the chart book, and this is really where we wanted to, to sort of set the tone. For a

Alan: 6:03

reason, I would

Andrew: 6:03

say. Yes, for a reason, absolutely. And it's a really interesting data series that goes back to 1900.

Alan: 6:09

Mm-hmm.

Andrew: 6:10

And it was, you know, basically made by this academic who uses news headlines going back years and years, uh, and basically plots the sort of frequency of, you know, mentions of shortages, whether it's energy, food, industrial inputs, labor- Mm-hmm right? And sort of plots that over time. And what you see is you get these, like, distinct periods of 10 to 15 years where you have these, like, sort of consistent up and down shocks, uh, when it comes to the supply side of the economy, which are followed by these long periods of, like, you know, a more sort of docile, uh- Mm-hmm environment. And to your point, we haven't seen one since sort of the s- the 70s and the early 80s, um, when we had obviously the oil shocks and sort of the, the transition from, you know, uh, the gold standard, things like that. So you take things to today, and I think- These periods tend to happen when you have some global disruption- Mm-hmm or change or transformation, right? And obviously we have that on, in technology with AI, we have it in global competition with China rising, right? Uh, we have it, I think, on the, you know, the, the domestic political side with sort of populism rising across the world. And all of those things are, are, are sort of interacting to, I think, drive, uh, this era where we can expect to see these types of supply shocks continue to, to sort of reverberate throughout the economy going forward.

Alan: 7:38

And this has implications for the role of different asset classes within a portfolio. Like, when inflation is very steady and sort of declining, longer duration assets have performed pretty well. Uh, bonds have a certain utility in terms of a hedge to downside risk. Yep. Now, if we got into a situation where there were a severe market stress event, you know, would we still have the same level of downside protection in long duration safe haven assets? More than likely, those assets are gonna kick in and play a role.

Andrew: 8:08

Yeah.

Alan: 8:08

But when you've got these kind of rolling fits and starts of blips and disruption and volatility in the market, traditionally folks have been able to rely on those assets to similarly play a hedge within those periods. Yep. You know, we have more often now periods where you've got spot up, VIX up, you know, bonds, bonds down, stock market down. Like, you've got this correlation across markets between equities, bonds, and volatility that you haven't seen historically in many periods. And so the role of those assets within a portfolio gets complicated and, you know, it, it extends to other parts of the portfolio as well, too. When you think, you know, one core part of your portfolio's going to perform a certain way, it informs how you allocate elsewhere. And with those relationships breaking down, you know, it elevates the need for diversification in other parts of the portfolio more so.

Andrew: 8:56

Yeah. No, I th- I think that's exactly right, and certainly we're not saying there's no, no place for fixed income in a portfolio. That being said, I think investors have been very much, uh, rewarded for taking on duration exposure for the better part of 40 years, as we've talked about. I think, uh, while yields are higher now, that- Mm-hmm … that, that calculus has, has really changed, and certainly the, um, you know, the, the correlation with equities has, has gone up over the past five years. So I agree. I think these supply shocks, you know, they put monetary policy makers in a bind. They have to choose between, you know, in the US specifically- Mm-hmm we have two, uh, dual mandate here with the Fed. They have to choose between, you know, which side of the mandate they're gonna start to, um, to, to sort of favor. And normally what we see is in periods like this, they just sort of, you know, put their pens down and say, "We're gonna wait and see," and that's, that's kind of what we're seeing now and, and we've seen long-term rates drift up as a result.

Alan: 9:47

And so that really is the precarious situation that the Fed finds himself in. Kevin Warsh coming in as the new Fed chair, uh, he's got a difficult task ahead. I think we've talked about this before. First and foremost, it'll be building consensus amongst- Mm-hmm … members of the FOMC and, you know, kind of having a common voice when the Fed speaks publicly. Ensure that sort of credibility, you know, of the institution that's so critically important to being able to jawbone markets in a direction that makes their eventual rate moves more implementable, if that's a word- Mm … that I could use. Uh, and you highlight this very well on a chart that shows where core PCE was, uh, at the start of Fed chair cycles, uh, Fed chair tenures, and where the 10-year Treasury yield was. And the- we're in a period that we haven't seen for quite some time.

Andrew: 10:35

Yeah. Yeah, I, I think, um, you know, Kevin Warsh comes in at a challenging period, as you mentioned, not only from a macro standpoint, but also from, you know, a standpoint of having to sort of win over the, the, the trust of, of his fellow colleagues. That's to say nothing of his background. I think he clearly has a background, uh, requisite of, of, of- Yeah … a Fed chair. You know, he, he, he worked with Stanley Druckenmiller, one of the greatest investors of all time. Clearly has, has s- you know, strong market acumen, which I think now more than ever is important for a Fed chair. Mm-hmm. But I think, you know, the, the sort of conditions of his elevation to the chairmanship, uh, were obviously, uh, had, had some f- a political valence to them, shall we say?

Alan: 11:16

Mm-hmm.

Andrew: 11:17

And I think he, you know, he has argued over the past, call it year or so, that, that rates should be lower. His argumentation has generally been that, hey, AI is gonna drive a productivity boom that's gonna allow prices to come down while gr- you know, growth stays strong. Uh, we can, you know, we can bring the Fed funds rate down over time. I think that argument ha- uh, you know, if it held some water maybe four or five months ago before the Iran war, probably doesn't hold it now.

Alan: 11:45

Mm-hmm.

Andrew: 11:45

Not only have energy prices spiked, but, you know, core inflation has also gone in the wrong direction, generally speaking. So I think if his You know, task coming in was to try to get rates lower. The new task, at least for now, is, is to try to prevent the rest of his colleagues from wanting to raise rates. The market is now pricing in one rate hike, uh, by the end of this year. I think if, if, if there is one, you know, point that he can sort of, uh, point to, it's, it's that wage growth continues to moderate slowly. Mm-hmm. So I think if, if you're looking longer term, you know, past this sort of energy shock, assuming it does end at some point, you would expect that moderating wage growth would eventually lead to potentially lower inflation. That being said, we've seen a strengthening in labor market data over the past couple months, which would argue that actually wage growth could firm, uh, if, if, if that trend holds. So look, I, I, I think for now the Fed is on hold. We're gonna have Warsh's n- uh, first meeting and, and press conference as Fed chair, uh, next week on the 17th. Uh, we'll see what he says. It's gonna be, you know, one of the most followed-

Alan: 12:51

Most

Andrew: 12:52

watched TV … press conferences I, I, I think in years. And remember, uh, Jerome Powell is still on the FOMC as well. So certainly a lot to watch there, but for now I, I, I think, you know, it's gonna be hard for Warsh to, to fight gravity, uh, which is clearly with sort of the hawks on the FOMC right now.

Alan: 13:08

And while there's challenges on sort of the rate fixed income side due to, you know, these shocks in the relationship with inflation, in the equity markets, uh, we're seeing a different story I would say, which is very robust performance in recent periods. Uh, updated some data this morning, and over the trailing 12 months, S&P 500's up 24%, call it. Russell 2000 small caps up 35%, call it. And since the start of the Iran war, which really jolted markets down, you know, you've still got strong performance since the start of, you know, roughly 9% for small caps, 8%- Mm-hmm for large caps, and exceptionally strong performance since the bottoms in those markets. Um, what is really driving this? Obviously the AI story. Yeah. The valuations continue to run there. We're sitting here today on On June 10th, uh, the Wednesday, uh, before I- uh, SpaceX is supposed to IPO and begin trading on Friday the 12th. By the time this episode is published, uh, there'll be some opinions being affirmed- Yeah … some opinions being disproved as to how that IPO will go and trade shortly thereafter. But in any event, it is a big event for the markets. Yeah. And by the way, OpenAI and Anthropic are queued up to follow. That's a lot of the same theme coming into public equity markets. Thus far, the optimism has been extremely high. How does this sort of unfold, and what, what do these events mean for public equity markets?

Andrew: 14:45

So I think the story so far this year has been the confirmation and acceleration of the CapEx story.

Alan: 14:53

Mm.

Andrew: 14:53

Right? I think the enterprise uptake of these AI tools, obviously Anthropic's release of Cowork and all these sort of ancillary add-ons, I think genuinely shocked a lot of people- Mm with how powerful it was. And, you know, you've seen, I think, you know, Anthropic and OpenAI's run rate revenues, you know, go parabolic, and that's sort of a proxy for enterprise adoption of, of the tools, right? So it's, it's tacitly telling us that businesses are using this stuff and they like it, and I think we hear that across, you know, industry as well. That has allowed the market to just kinda go bananas on the CapEx trade, meaning, you know, the suppliers of the CapEx boom. The hyperscalers are gonna spend 700 billion-plus this year. And, you know, you see- look, it's, it's come through in the earnings, too, right? This isn't, like, a bubble where we're just, you know, sending multiples through the, through the roof. This is actually coming through in earnings. And you saw it in Q1, S&P 500 revenues were up 11% year on year. That's double nominal GDP growth, right? EPS was up 26% year on year. We haven't seen that since- Mm … like the '21 post-COVID boom, right? And what's really happening here is you've got all of this spending Which is turning into somebody else's revenue, right? But the spending itself is depreciated over six years. So I'll give you an example, right? If you're Microsoft and you're spending $20 billion this year fitting out a, a data center, right? You need to go spend a bunch of money on concrete, on, you know, uh, energy generation, on switch gears, on cooling, on HVAC, all those things, right? And you spend all that money, and that's today, that- that's revenue today for Nvidia- Right … for HVAC companies, for cement companies- Right … for, you know, engineering firms, things like that, right? Um, and for those firms, many of them are, you know, highly capital intensive industries, which means they have high operating leverage- Mm-hmm which means a dollar of incremental revenue turns into a significant amount of that going straight to profit, right? On the other side, the Microsoft side, when they spend all that money, they're depreciating that over years, right? That's not expense today. Mm-hmm. Right? So that's expensed over, you know, again, five, six, seven years. So what that does is it sends profits through the roof for the suppliers, while the profits don't get hit nearly as much on the spender side, right? So it's sort of this lopsided, asymmetric skew towards profitability today. Now, where we see it, and we have a chart in here that I think is really interesting, is in the free cash flow of the hyperscalers. Mm-hmm. Right? These five companies, so Meta, Microsoft, Amazon, uh, who am I missing? Oracle. Oracle, um- Google … and Google. Just two years ago, they were generating about $400 billion of free cash flow per year, right? That's tw- that's, that's more than a quarter of the entire market right there.

Alan: 17:48

Mm-hmm.

Andrew: 17:49

By the end of this year, their run rate will probably be zero or negative. Yeah. Right? They've spent- through all $400 billion of free cash flow, now they're taking on debt to continue to, to, to fund this stuff. Now, markets have been okay with that for now, right? We'll see if that continues. Um, right now, again, they're, they're, they're sort of getting that, uh, that longer leash, but there's really gonna be an increasing focus on the return on investment for these projects. Um, and I think that brings us full circle to your point about, about SpaceX, which, you know, as these mega IPOs occur, it's just gonna increase the concentration of the market, right? Right now we've got, you know, $11 trillion tech companies in the US- Mm-hmm… that make up about 40%, 43% of the index. You add three more- Mm-hmm you're getting close to half of the entire S&P 500 of, you know, once those companies enter that index. So diversification is just becoming a bigger and bigger imperative, I think.

Alan: 18:46

Yep. Well, and, you know, all the spending that you just described is affecting the debt side of asset allocations- Yes … as well, too, because much of it is debt financed now, and you see that shifting the composition of high yield markets, for example. Yes. Certainly private credit, uh, has increased exposure within that market. It's a significant part of real estate strategies today in terms of the data center- Yeah … financing element of it. You know, different layers within the AI build-out, but in total, many of these revenue streams are somewhat reliant upon each other, and the debt that's being financed, as you said, you know, one person's CapEx is another- Mm-hmm person's revenue. Yeah. And without, you know, a reasonable payback period, you know, that is where you can start to have a little bit more of an issue in terms of the growing risk within the sector. We don't think that we're necessarily there yet. But, uh, what it does mean is that more of the investable assets on the debt side of a portfolio are now correlated to the same theme. So you've already got the inflation and rate side of the equation that's spiking stock-bond correlation, where it used to be much lower and provide that di- diversification. But now you add on this overlay of thematic risk across portfolios that is increasing correlation as well, and the combination becomes a bit of a challenge. And that's where we talk about this breakdown in relationship that different asset classes have historically provided, and the need to do other things and to get genuine diversification when you are going outside your typical 60/40 portfolio.

Andrew: 20:10

Yeah, and as, as we talked about in our, our annual private markets outlook, like, AI truly is eating the world and- Yes and, and capital markets.

Alan: 20:18

Yes.

Andrew: 20:18

Right? To your point, it's, it's, it's only gotten more significant as, as this year has gone on. Uh, we're seeing it, to your point, in bond issuance and private credit, in real assets, in obviously the equity markets. So I… And, you know, this is a line that you've used. I, I, I really like it. The, um, the value of differentiated growth right now, I think, is, is very much at a premium. Finding growth in areas of the economy that aren't directly, you know, exposed- Yeah … to this trend.

Alan: 20:48

Well, I, I think that's a good segue into private markets. And, you know, one of the main things that we've been grappling with from a research perspective over the past year is that, you know, we've seen some of these issues sort of building up, that the market's been reconciling. And, you know, I don't think that for folks really focused on assessing these markets, that it's been hard to see where some of the issues are coming from in terms of, you know, capital concentration within certain segments of the market, where the diversity of opportunity within that segment is more confined. I think what we've highlighted previously, and we've been talking about this for 12, 18 months at this point, is some of the risk in software loans. And, uh, you know, the high propensity of software exposure, both on the private equity side and the private credit side, at the top end of the market. Historically very stable businesses, uh, but it was kind of apparent that, like, there might come a questioning of that thesis with- Mm-hmm … the adoption and, and development of AI And I think it really requires folks to take a step back and say, "What am I investing in this asset class for? And what are my objectives?" You know, it's not necessarily your objective to, you know, get the super huge outsized performance. Like, if the amount of money that I need at retirement is X, what is my Y in terms of compounded growth each year that gets me there? And how does the volatility around that path of performance dictate where I'll ultimately be with my spending needs and that sort of thing? Yeah. And if you can get those objectives solved for with something that is different, and maybe doesn't have as wide of a range of outcomes, but hits you there kind of right in the middle of your, your central expectation, I think that's an approach that while it may not be as sexy as chasing, like, the hot dot in the market today- Yeah like, that really is the role in, in, in our view of long-term allocators and long-term investors, is to have that ability to say, like, "Maybe it sounds a little bit contrarian to do something slightly different than what everybody's talking about, but this meets the objectives that I have in my portfolio. And oh, by the way, it's different and aside from all these other things that so much money- Yeah … is chasing into and crowding into."

Andrew: 22:58

Yeah, I think, um, I mean, the good news is we all have plenty of exposure to the hot dot in our portfolios- Yeah … generally speaking, right? And I think that's, again, as, as these IPOs happen, that's only gonna increase. So, you know, to your point, the question is how do you fill out the rest of your portfolio? Mm-hmm. And as we get into sort of the private markets, I think w- we're entering this, this interesting period where if you look across the different asset classes and sort of, like, your, your modeled expected returns- Mm-hmm over the medium to long term, the gaps between the asset classes are really small, right? Mm-hmm. Like, there's a lot of overlap in terms of, like, what's the expected return for private credit versus buyout versus V- Like, you know, there's, there's obviously differences. The, the higher risk asset classes like VC or buyout are gonna have higher expected returns. Mm-hmm. But the, the dispersion between asset classes is not nearly as wide as it was, you know, during the 2010s, certainly, when anything that benefited from low rates went to the moon. Mm-hmm. Anything that, that, that didn't, um, you know, was a little more challenged. So I think- That, th- that environment requires a different skill set, right? Where it's not about, like, picking the right asset class, right? The skill set is, how do I build a total portfolio around these asset classes? And within each one, how do I pick managers and strategies and segments that fill a need I have within my broader portfolio? Mm-hmm. Right? Because I think the trade-off of less, you know, inter asset class dispersion- Mm-hmm is more intra asset class dispersion, right? So I think the, the fundamental question here is, like, each, each asset a- you know, each asset class, each exposure is gonna have to earn its way into a portfolio.

Alan: 24:35

Mm-hmm.

Andrew: 24:36

Right? And it's gonna have to offer something other than just a return. Mm-hmm. Right? There's gonna have to be, does it offer above market income that people are looking for? Does it offer, uh, a true level of diversification? With respect to what else is in your portfolio, right? So I think the, the way that we're thinking about how portfolios fit together is starting to change a little bit.

Alan: 24:55

So when we apply this need for differentiation within private equity specifically, and this is something, you know, we've sort of talked about before, which is the need for operational value creation. And one of the things that, you know, I see as a concern for investors and how people are allocating to the asset class today, you know, as a, as an aside, one of the things our team does is we keep close tabs on competitors across the landscape, how their portfolios are positioned, and try to draw insights that are helpful to the organization, you know, and inform the insights that, that, that we make here, uh, you know, in research. But what we see is investors are allocating in a way that is sort of doubling down on some of the theme- them- same thematic risks, and high concentration, you know, portfolios that are what's driving public equities. And this goes back to, like, why are you allocating to private equity in the first place? Like, why not just continue to buy public stocks? Like, you can do it for basically free. Yep. And performance has been good, margins are high. Like, what's the role of private equity? We would argue that it is to get that differentiated source of growth, and to get something outside of those same thematics, address some of your valuation risk, like, hey, maybe things have gotten a little too hot in public markets. Yeah. But we see many are buying into the same playbook in private equity as well too, when they implement these portfolios. You know, something you've talked a lot about, Andrew, is, you know, 12 is the new five, which, you know, thanks to Bain for- … you know, coining that phrase. I would point out we put out 18's the new eight- uh, several months before that. Little

Andrew: 26:27

more optimistic.

Alan: 26:28

Yeah. Well, they, they've got good reach, so- Yeah … if they're gonna block and tackle for us on that one, we're, we're more than happy. But, uh, you know, th- this is really the new return playbook in private equity. And we have a great chart in this piece that shows where performance came from for firms that were exited in 2024 and 2025, and back longer in history, but those are the years that are most relevant, as you see revenue growth being just a step higher in terms of it being a contributor- Yeah to the value that was realized within these exits. And that tells us, like, that is the driver of performance in private equity within this type of an environment.

Andrew: 27:03

That's, that's, that's the new era we're in. Totally. It's, it's, it's all, it's gonna all be about earnings growth, and specifically all about revenue growth. Mm-hmm. Right? I mean, certainly, like you'll have your margins playbook, right? Like, in, in, in some cases you'll be able to, you know, cut costs and, um, you know, you'll get some margin gains there. But, but really the bulk of- Mm … the performance is going to come from, can you grow a company's revenue? Uh, durably, uh, and then get an exit, right? And I think that's, that, that's the important thing is we're, we're not just talking about revenue growth itself here.

Alan: 27:35

Mm-hmm.

Andrew: 27:35

You can still get multiple expansion from entry to exit, right? Right. That's, that's not going o- th- that's not going away completely. What's going away is the financial aspect, the market data aspect of that, right? Where you could just come in and grow a company at a mediocre rate-

Alan: 27:50

Mm-hmm… Andrew: and sell it for, you know, than you bought it just because that's what the market dictates. You're gonna have to earn your multiple expansion through growing a company, making it bigger, making it more diversified- Mm-hmm making it more, uh, stable, right? Um, and you're also, you know, you can get that margin expansion we talked about through operating leverage if you grow it as well. So- Mm-hmm… Andrew: um, and then of Right… Andrew: where liquidity is gonna buyers for that company, i.e. did you make it better during your holding period? Yeah. Right? It's really a question of applying scale where scale didn't exist previously. Mm-hmm. And, you know, the firms where that application of scale is most meaningful, you know, are firms that are in that sort of sub $1 billion enterprise value range where-

Andrew: 28:35

Right. Well, and I, I think, you know, you talked about 12 is the new five. What I don't like about that is it acts like the private equity market is a monolith.

Alan: 28:44

Mm-hmm.

Andrew: 28:44

Right? I mean, that may be true from a very broad perspective-

Alan: 28:49

Mm-hmm… Andrew: but you're talking about massive entering from a multiple perspective and where EBITDA growth rates are, right? If you're in the middle market right now, you may be entering at 10 or 11 times. If you're in the large cap market, you're, you're, you're entering at 14 or 15 times, right? Like, you're starting on second base- Mm … in the middle market, right? Further, the growth rates are higher in the middle market, right? Where you've got EBITDA growth that's 2 to 3% per year higher than it is in the large cap market. So it's a lot easier to make up that MOIC gap, if you will, right? That return gap versus pre-COVID period, if you have a lower entry multiple and a higher growth rate, right? And one of the reasons why that gap has widened as it has is because of what's going on in public markets.

Andrew: 29:34

Yeah.

Alan: 29:34

And when you're a $5 billion private company, a significant part of your ongoing valuation is based on what the pricing is in public markets for similar assets. Yes. That's not the case for a company that's a $500 million company, a $300 million company.

Andrew: 29:50

Yeah.

Alan: 29:51

So what that tells you is the value of that large private firm- is being dictated by public markets, the very risk that you're looking to hedge by going to private equity in the first place.

Andrew: 30:02

Right, and, and it, and investors tell us that's what they want, right? Exactly. I just, I j- I just saw a Preqin, uh, investor survey where they asked, you know, "What's your, what's your number one goal with each of these private asset classes?" Two-thirds of them said diversification for private equity. Mm-hmm. Right? It's, the bigger question is digging into the different segments and where can I truly get that diversification? Because that is, that should be goal number one for every investor when we look at public, uh, public markets today.

Alan: 30:28

Yeah. You know, I'm starting to think that question is a little bit like when your doctor asks you how many drinks you have each week. You know? It's, it's … Yeah, I know what the correct answer is. I may or may not be doing it.

Andrew: 30:39

I'm not gonna say anything.

Alan: 30:42

We can cut that.

Andrew: 30:42

No, I like it. I like it.

Alan: 30:45

So pivoting to credit markets, which is one of the areas where this dispersion is appearing, I would argue as significantly as other, any other part of the market. When you look at the traded credit markets, one of the things that we, we cover in the piece that I found very interesting was the relative yield between incremental, uh, ratings differences and an, and an incremental notch in terms of the subordination- Mm-hmm … or the seniority of the position in the capital structure of the loan. And we look this back over a period of time, and what we see is that, you know, the split, uh, split B to triple C rating in the syndicated loan market, the gap in terms of the starting yield for entering into those positions is wider actually than it was during the COVID shock, during the Russia-Ukraine war shock. Like, it's, it's really gapped out in that market in terms of the compensation for additional risk, and the same thing with taking a second lien position in the syndicated loan market as well, too, which, you know, find that, you know, to be very interesting when you're in a market where there's a lot of bullishness and optimism around a lot of the risk. Now, certainly some of this is informed by what's going on with the software loans and that part of the market, but, you know, it, to me, it underscores the value of having a mandate that's very flexible, and the ability to be opportunistic in some of these areas of the market where risk is sort of being, you know, sold off, or the relative value that you may be able to pick up there is becoming increasingly attractive.

Andrew: 32:14

Yeah, I mean, you're seeing this across markets where- The headline, whether it's credit spreads, whether it's equity pri- you know, prices, whatever it is, the headline indexes continue to look really strong.

Alan: 32:25

Mm-hmm.

Andrew: 32:25

Under the hood, I think there is greater dispersion in terms of performance by industry, by security, by credit rating, certainly. And to your point, I think while that may signal some potential weakness in, in, in some areas, I think the bigger takeaway is that this is gonna provide an incredible, uh, amount of opportunity for active managers in both public and private markets, right? Mm-hmm. Because ultimately, public markets are telling you what the future is, right? And the future is higher dispersion, more opportunity to select winners, and potentially select losers as well. And again, I think that just provides more opportunity for active hands-on managers to come in and drive value.

Alan: 33:14

Yeah. But it's all occurring against a backdrop where credit fundamentals have been improving. I mean, when we think about private credit, one of the charts that we have in this piece is the share of borrowers with less than one turn of fixed charge coverage, um, you know, in terms of covering the interest expense that they have, CapEx requirements within the business sort of keep the asset base stable. And What y- this chart really shows, I think, is pretty significant, which is, you know, y- investors today really have more of a trade-off than anything. Like, there's been a lot of written about the tight- tighter spreads, but back in late '23, early '24, like, the optimism around private credit was exceedingly high because of how high the yields were, and everybody focuses on the income side of the equation. But look, those credit losses can add up and undermine some of that income that's being generated, and when you look at where, you know, the number of borrowers that were not covering fixed charges were back in the golden age of private credit-… like peak private credit enthusiasm- Yeah … you had 40% of borrowers that weren't covering fixed charges. You know, fast-forward to today, and that number is now under 20%. That is a substantial improvement in terms of the overall health of the market, and is a level not seen since the third quarter of 2022. And interestingly, when you look back and say, "Okay, what's my kind of started e- starting expected return based on where default rates were, based on, like, you know, the overall health of the market?" Like, it's pretty similar in terms of starting yields for that point in time versus where we are today.

Andrew: 34:47

Yeah.

Alan: 34:47

And so to me, it's really that trade-off question. Like, you've got a higher starting yield back in '24, but in hindsight, like, maybe that wasn't totally sustainable, and had rates stayed at that level, you'd have seen continued deterioration in borrower balance sheets- Yeah that would eventually undermine the substantial starting income that you had. Today, the health has improved. Yes, yields are down, but we continue to see default rates improve period over period and, you know, continued strong fundamental performance, you know, at a balance sheet, uh, and income statement level for the, for these companies.

Andrew: 35:23

Yeah, I think it's interesting, Alan, that, that, you know, of course, as we see fundamentals start to improve, rates have come down, borrowers look a little bit healthier- Of course, there's this growing noise around private credit, uh, both among investors. You know, we've seen redemptions in evergreen funds. But also, you know, you're seeing on Capitol Hill a little bit more, more talk about, you know, should we unconstrain the banks? Mm-hmm. Sh- you know, would, would we rather have these assets living in regulated institutions like banks rather than, you know, less regulated institutions like private credit funds? Um, you know, I think we have seen growth in bank lending this year start to, to elevate, uh, across different, you know, types of assets. I know you've done a lot of work here. Yeah. How do you kind of think about that?

Alan: 36:07

Yeah, it, it, it's very interesting that as the noise around the market was loudest, um, banks really stepped in in full. Uh, bank C&I loan growth within the first quarter, and in fact through the first five or so months of the year, is really the strongest that banks have had in a, in a long time. You know, banks grew commercial and industrial lending, uh, 7.5% year over year as of mid-May in terms of the volume outstanding. And when you look at what the net impact of that was, you know, first of all, that growth exceeded the growth, uh, of bank-held auto loans, credit card receivables, commercial real estate, consumer loans, many other categories of bank balance sheets. And when you look at net-net, what was the impact of this shift from, you know, BDCs and private credit lenders to the banks? Well, it's roughly 200 billion in additional volume that banks now hold, supported by, call it 20 billion in equity Conversely, had those loans been in the private credit world, that's 200 billion in volume supported by 100 billion in equity. That's a substantial difference. This is very important because something we always talk about is that risk is context-dependent. It's not a question of, like, how risky is something on an absolute basis. It's how risky is it relative to my risk appetite, what I'm paid for taking that risk or similar risk in other parts of the market, and ultimately, where that risk is held. Risk is very much related to the balance sheet on which it's held, and the example I like to use is, like, is a fire dangerous? It's an unanswerable question. You don't have enough to answer that question. You don't know where the fire is. You don't know how big the fire is. You don't know what's fueling the fire. Like, you need more context to know whether a fire's dangerous. And, you know, if it's in the kitchen, it's dangerous. If it's in the fireplace, it's not dangerous because that's where it's supposed to be. And the context, you know, provided by knowing where the fire's taking place is the balance sheet on which this risk sits. And, you know, how is that balance sheet financed? What's asked of that balance sheet? You know, and if things go wrong on that balance sheet, you know, how does it spread within the system? What is the risk of spreading to the rest of the house? And so right now, the debate that's going on is where this fire should reside within the financial system. Should it be with banks? Should it be with private credit? Should it be with more highly leveraged balance sheets? Should it be with less leveraged balance sheets? And, you know, the supposed problem, you know, that we're facing is that you have an upstairs bedroom that's not getting enough heat from the fireplace, and the solution that's being proposed to try to migrate much of this risk back to the banking system is akin to saying that we need to build a fire within the upstairs bedroom because it's not getting quite enough heat from the fireplace. You know, that is an obviously ridiculous proposition, but it's being supported on the notion that, okay, yes, there's a fire in the bedroom, but there's a fire truck a couple blocks down the street, so we're not gonna burn the house down. To me, that's fundamentally the argument that's being made when you're saying that a balance sheet supported by 10% equity is a safer place to hold that same fire than a balance sheet where debt and equity is matched one to one-

Andrew: 39:37

Mm-hmm

Alan: 39:37

you know, termed out financing that matches the duration of the assets. Yep. You know, this is an argument- That this risk is safer within a bank balance sheet, building the fire in the bedroom, that doesn't make sense. Yeah. It's obvious that it doesn't make sense. You know, it's safer to have the fire in the fireplace where leverage is lower and the risk of burning the rest of the house down is lower.

Andrew: 40:01

Maybe to dovetail there, you know, one place, you know, a couple years ago that, that folks were really worried about was bank lending to commercial- Mm-hmm … real estate, right? That was a big concern, especially to office buildings. Fast-forward to today-

Alan: 40:14

Yeah… Andrew: I think a lot of people have maybe it's sort of put it on the back burner, to continue your fire analogy. Um, but I think real estate's in a really interesting place right now where, you know, it was the laggard during sort of the past two to three years. I think we're now at a place where valuations have stabilized. But very much like we talked about in credit, certainly in private equity as well, there's these trade-offs, right, where on one side, fundamentals are actually improving, right? Mm-hmm. We've, we've been talking about this for a long time. Demand for most property types is, is quite strong. The economy's healthy. Uh, you look at retail, you look at multifamily. Yeah. Demand for these assets is, is pretty strong. On the other side, you've got the waning supply side, right? Where higher rates really put a damper on new construction activity in '23, '24, '25. Mm-hmm. We had very few new buildings started during that period. Put those two things together, and what you get is a pretty strong environment for property owners, right? Where rents are growing, uh, net operating income that goes back to the equity owner is growing. On the other side, rates are going up. Yep. Right? And I think what we saw was a correction in cap rates over the past few years to sort of compensate for those higher rates. Um, the question now I think is, do those cap rates go higher? Do they stabilize here? Um, obviously, uh, that's all gonna be dependent on what happens with fundamentals and, uh, and with treasury yields. But right now, we, we're still in this sort of environment where you've got strong fundamentals in the income side, but the financing side remains a pretty big challenge. Yeah. It's, it's a continuation of the dispersion theme. I mean, it, it- Yeah … showing up in each asset class within the market, in different ways I would add, and, you know, kind of different cross-sections. But dispersion is really sort of the, the governing theme right now. I

Andrew: 42:06

mean- Yeah, and I think, you know, we go back to every sort of asset class is gonna have to earn its way into your portfolio, right? Yeah. If you look over, over the past, you know, six years since the end of 2019, and you just track performance of different areas of, of real estate, whether it's value add, opportunistic, core, on the equity side versus real estate debt.

Alan: 42:29

Mm-hmm.

Andrew: 42:29

You know, real estate equity, you know, went down in 2020, then exploded in '21 and '22 during the, the sort of low rate period. Then we had the correction over the past couple years, and now we've started to go up again. On the real estate debt side, it's just basically been a linear, you know, seven-ish percent per year up. And what do you know? You open your eyes six years later, and they're in about the same place.

Alan: 42:53

Yeah.

Andrew: 42:54

Right? So we have this sort of tightening of return expectations between equity and credit in a lot of these areas, uh, which is why we think, you know, it, it makes sense to look at areas like real estate credit- Mm-hmm where, you know, it's a different form of private credit, right? Where you've got a hard asset backing you, you've got really strong lender protections, and you've got what we think is gonna be a really, um, solid opportunity set to capitalize on growing transaction volumes from this big maturity wall that- Mm-hmm everybody's been talking about, right? Which, you know, $2 trillion or so over the next two and a half years. Quite a bit. Yeah. So I think- You know, credit has outperformed over the past couple years, which isn't surprising. But even going forward, I think equity and credit, there's gonna be a much bigger debate in terms of where the better risk return lies, uh, within the broader real estate asset class.

Alan: 43:43

And it's one of those areas that to get back to what are your objectives in adding private market exposure to your portfolio, like the yields in real estate credit may not be quite as high as they are in corporate credit and direct lending. Yeah. But the additional diversification benefit that that can add to a portfolio It, it's very substantial. Yeah. And, you know, if it is still something that's hitting your objectives, maybe it's not exceeding it by as much as other potential opportunities, but you're baking in a different source of return, a different source of, you know, sort of factor exposure, and, like, it's truly outside and different from other things in your portfolio-

Andrew: 44:22

Yep

Alan: 44:23

like, that's, that's highly value additive as well, too.

Andrew: 44:25

Yep.

Alan: 44:26

So, uh, Andrew, thanks for, for the discussion today. I… Again, this is a terrific piece. It's very helpful to get up to speed on what's happening in markets today in, you know, 10 minutes flipping through a very visually appealing chart book. Our design and, and marketing teams do a great job putting this together, uh, and making it very investor-friendly. Um, you know, in terms of major themes, takeaways, like, where do you wanna kinda land this here today?

Andrew: 44:51

A lot of it's about dispersion, right?

Alan: 44:52

Yeah.

Andrew: 44:53

And we see it on the macro, right, where you've got this AI boom, you've got housing on the other end, and everything else kind of in between. And I think the, the other D that people need to think about is diversification. Mm-hmm. Right? Because right now the AI trade is driving everything, right? It's, it's the core of most people's portfolios. It, you know, the AI theme comprises probably more than half of the S&P 500 right now. So I think as we go throughout the rest of this year and that, you know, weighting potentially grows, starting to think about private markets as, okay, how do I build a portfolio around that AI exposure, which right now is clearly my biggest risk exposure, right? And thinking about these investments not just as standalone asset classes, but- Mm-hmm … you know, what are the different segments within, right? What are the different exposures I can get, or how can I maximize the, uh, the investment outcomes with minimizing my excess exposure to that- Mm-hmm … same theme, right? So I think, um, building a portfolio today is very different than building a portfolio maybe five years ago.

Alan: 45:55

Mm-hmm.

Andrew: 45:55

Um, there are lots of opportunities that we see. I think if you look, you know, the go forward return expectations are, are, um, not poor for the most part. Um, but I think again, that portfolio construction question has become different based on, uh, just this dominant AI theme, and also everything we talked about on the macro side, uh, where supply shocks have become the new norm.

Alan: 46:14

Yeah. Requires a level of intentionality.

Andrew: 46:17

Yes.

Alan: 46:18

Thanks for the conversation today, Andrew.

Mapping the Markets: 46:20

Q2 Edition, Shocks and All. Catch it live on futurestandard.com\insights, or check the link in the show notes. Thank you.