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Editor’s Letter: Fear and loathing in the markets

As we take this issue to press, the financial world is spiraling into a vortex of pessimism. The markets have been battered on various concerns, primarily a downturn in China.

Oil and gas, which has been such a big driver of economic growth in the United States, is a shambles as overproduction and falling demand, especially in China, put pressure on the sector as a whole.

And the expected benefit of low fuel prices — more money for consumers to spend — hasn’t played out. Falling retail sales caused economists to lower growth expectations for the fourth quarter of 2015 and the first quarter this year, according to the Wall Street Journal.

These factors point to a weak start for the U.S. economy in 2016, but what does it mean for private equity? Negative sentiment usually takes a bit longer to penetrate the private equity world, which is less tied to the daily swings of public marks.

GPs who are sitting on near-historic piles of capital have ample resources to scour the market and make acquisitions. In that sense, many GPs appear to be biding their time, waiting for that perfect opportunity to arise and avoid paying the high prices that have characterized the deal environment in 2015.

This is a good thing, though GPs have a time limit to deploy their capital.

Where the industry has been feeling changing sentiment is on the M&A side, where the debt markets have tightened and financing on bigger deals is getting harder to secure.

KKR & Co knocked on the doors of 20 banks to finance its acquisition of Mills Fleet Farm for just over $1.2 billion, but it still couldn’t get enough money to pay for the full deal, Reuters reported. KKR eventually chose to finance the deal on its own, issuing and underwriting more than $700 million of debt.

Other areas where we’re hearing concern include energy private equity, where funds with exposure to oil production are marking down portfolios. Falling oiling prices, which dipped under $30 a barrel for the first time since 2003, affect not only producers but ancillary businesses, such as companies that provide oil field services.

Also, some developed market LPs are selling, or are considering selling, their stakes in some big Brazil funds on the secondary market, one secondary buyer told me recently. Brazil has turned into a basket case, with the political environment in turmoil, the country’s president the subject of impeachment proceedings and the state-owned oil company roiled by a corruption scandal.

Brazil lurched into recession last year and doesn’t appear to be headed for a recovery any time soon. It wasn’t that long that developed market LPs were clamoring to get into private equity funds targeting the emerging market.

The problem now is not only the stumbling economy, but the currency. Roughly, one U.S. dollar is worth just over four Brazilian reais.

Many of the biggest Brazil funds of the past few years were raised in U.S. dollars. These funds call capital in U.S. dollars and convert to reais to make investments, according to Andrea Minardi, professor at Insper Institute of Education and Research, writing for the Emerging Markets Private Equity Association. Upon exit, firms receive proceeds in reais and convert them back into U.S. dollars, which means they take a hit on the currency spread, Minardi wrote.

“As performance and profits are measured in dollars, and as the investments are in reais, funds run currency risk,” she wrote.

My hope is we’re experiencing another volatility spike like others we’ve seen over the past few years. But so far, 2016 is looking pretty ugly from a financial markets perspective.

Photo: A screen displays the Dow Jones Industrial Average after the closing bell on the floor of the New York Stock Exchange January 15, 2016. REUTERS/Brendan McDermid