Hi, I'm Sonali Basak and this is the
next big risk. Investing is a business of managing risk
for the long term. And in the year where recession fears
abound. A war in Ukraine rages for a second year
and geopolitical tensions across the globe are boiling under the surface.
Three Wall Street veterans look 5 to 10 years out and where wealth could be
destructed even further. Boaz Weinstein, the cyber capital
co-founder, believes that the changing dynamics of the Federal Reserve's
policies could be setting the market up for exacerbated sell offs, one that
could burn every range of investor, particularly the mom and pop traders who
have increasingly poured their own funds into a wide range of newer investment
products that could be riskier in the future than they've been in the past.
I had a new global head of Citi Private Bank says that geopolitical concerns are
at the top of investors minds. Specifically rising US-China tensions
around Taiwan. And David Rubenstein, the billionaire
co-founder of the Carlyle Group, believes inequality is worsening.
He echoes a thought from Mohamed El-Erian.
Both men believe that the American dream is at risk and mobility is compromised.
Let's begin with Boaz Weinstein. We discussed how future market sell offs
may play out more painfully than in the past because of the end of free money
and a Fed who is no longer your friend. What we have in front of us in the next
few years, and it's anyone's guess as to when that will be.
Will there be a recession in 24 or will there even be a recession but that when
we finally do have that sell off in the recession that will come, that it will
be different than in in the past number of recessions?
I was speaking with Viktor Koestler at an event recently, and he said that in
his lifetime, all the recessions were ones where the Fed was able to do
extraordinary things to support the market.
And because of the excess of zero interest rates, there is no alternative.
Tina There was malinvestment, There was a lot of money printing.
There was a lot of extreme moves by the Fed, including things they never done
before. And those things in excess is how we got
here. With protracted inflation and other
challenges. The national debt, the national debt,
not just in the US and Japan, it's it's soaring.
And the next time there is a serious sell off, which is which is not just a
three week affair, there are a number of aspects from the behavioral to also that
the Fed is not your friends and and in fact, will not be able to come to the
rescue of the market in the same way because of what's going on now.
So what's the immediate market impact of this?
There's always been that old adage, as you've been saying, don't fight the Fed.
How can that now change the psychology of markets?
And will many people get burned in the process?
Well, so it's it's the kind of thing that that probably the lessons those
there's strong lessons people learned since 2008 of of how strong the Fed is
going to be, how strong Mario Draghi was to support markets.
He said, I'll do whatever it takes. And so there is this reflexive move when
there's a sell off to buy. And and I don't and for sure, that's
that's not only not gone, it's super present.
And so I think the question is, at what point does that buy the dip, buy
the next dip turn? And then and then the psychology can
change. And so I think it is built up and fairly
hard to to bet against given the last 15 years.
But I think those lessons are not going to work so well in the acute world
because it is not just not QE, it's kind of the opposite of QE, it's like
anti-gravity. And so I think that what we saw in March
2020 where retail investors were selling out of ETFs and mutual funds and
basically created an avalanche in the bond market, the Fed was there to do
amazing things that it never done before by junk bond ETFs invest not just in in
the lending to companies, but actually in the financial markets in risky
things. Those that was shocking.
And I don't think they're going to do it again nearly as easily.
And so I'm concerned that a sell off for fundamental reasons may actually become
exacerbated for technical reasons. Markets will fall further than they
ought to because because there is so much, I'd say, contentment with with how
things have gone the last 15 years. You had a Fed put you had extraordinary
measures that with zero interest rates, that that
created an environment that was self-reinforcing, that if we go the
other direction and it's something that is we're not going to be able to get out
of in a quarter, that it's going to affect institutional and retail alike.
Is this mostly a critique on how the Fed has operated?
So I don't blame Chair Powell for his crystal ball not working very well on
what transitory meant for inflation, but it wouldn't in any case, just be
the Fed. Also, we had incredible actions from
governments to to support the markets. And and so I do think there has been
overconfidence in that in what you can see in front of your nose.
And I've talked about there being a fog and it's really hard to tell.
So seeing how hard it is to forecast what the future will be, I forgive them,
but there definitely was excessive actions taken.
What is the ultimate impact here? Is the biggest risk to markets?
Is it to the economy or is there kind of a broader societal impact here?
Well, there's there are risks for sure, to the markets and to the economy,
because this is not just derivative traders playing games.
This is private credit loans that were made to companies that would have not
been able to get them were it not for zero rates or they wouldn't be able to
support them. So a lot of the private credit market
where people are very excited now about the opportunity to make loans at 13%
interest part of that 13 a big chunk is because of T-bills having gone from zero
to now, you know, pushing five and a half percent and growing higher.
And so that 13 may sound nice if you're the investor.
How does it sound if you're the company and you started at seven, but now you're
at 13 and the economy might be slowing down while that's happening.
So there are going to be a big pickup in defaults.
I don't need a crystal ball for that. It's happening and it's happening even
absent a recession and it will grow. And S&P has the default rate doubling
into next year off of a pretty modest base.
So it's not just it is the real economy for sure, what happened with Silicon
Valley Bank and the other. No banks is going to constrain banks
willingness to make loans and a feeling of needing more capital, which will also
create that pull back, more hedging. And those things are not very good for
markets. But if you think about kind of the risks
that are compounding under this big macro issue that you've really drawn
out, how does that keep showing up in markets over the next 5 to 10 years?
There is this an endpoint where we'll see was the bond market right, that the
Fed actually is going to beat inflation and rates are going to come down
starting in the middle next year, or will the Fed be right looking at the
dots, how it's actually we're not done yet.
And look at what Bank of England did. There is a month there is a day of
reckoning where the cards are going to be turned over and we're going to see
going to know, is it happening, is it not?
And of course, can change. And we haven't even mentioned China.
So and the economic challenges they have at the moment.
So when that happens, I foresee a much more difficult time because whatever is
justified based on the actual news, we've had this sell, this this Fed and
government stepping in to to eradicate a big sell off within weeks.
And I think we're due for something where investors are not ready because
you'd need more than 15 or 20 or 30 years experience to really have seen
what it's like to go through a one year period where the markets are not your
friend. Think about Japan and what it did to the
psychology of the Japanese investor to have stocks not go up for decades.
I'm not to be clear, saying anything like that is going to happen in the US,
but if you have a protracted period, investors can shy away from, you know,
you hit them enough times, they're going to shy away from coming back for more.
And I just think it's been too easy. It kind of sounds like either way, you
expect things to be worse tomorrow than they were yesterday.
What does that look like? I think that there's a behavioural
aspect to markets, there's a psychology, there's an emotion.
Look at the meme stock craze. And the psychology has been too easy.
We've learned lessons that, don't worry, this, this sell off is a buying
opportunity. And I fear that the the behavioural
aspects could flip and exacerbate the sell off.
And that's the part that that I think the is an additional negative that zero
interest rates and QE forever created, which is a lack of
a lack of mental toughness on how to deal with selloffs.
There seem to be a lot of reasons that the selloff would exacerbate.
Yeah it the things that the Fed did in 2020 do not are not fixed they Band-Aid
it. But there has been in my career enormous
growth in retail investors for example owning junk they used to own almost none
of it. You can even junk bonds, junk bonds,
junk loans, junk closed through through structured products that are sold ETFs,
mutual funds, closed end funds, various kinds of things.
And and so private credit funds.
And so that world, it was almost considered, let's say, 20 years ago,
unsuitable for the investor. Now we're trying to figure out private
equity firms, trying to figure out how to get mom and pop invested into private
equity under some idea that it's unfair that they don't have access to those
things. Well, so so that's that's been that
trend for retail. And at the same time bank balance sheets
have dropped since so by not by 80% by like 96%.
So they are a tiny shell of what they were and they had been the shock
absorber in the past. They they're not able to do that so that
we've lost a shock absorber and we've put more money into daily liquidity
retail hands. And that is a giant risk that people
worried about pre-COVID and COVID showed that it was real.
And that's why the Fed did the extraordinary action of buying junk
ETFs, which is so uncharacteristic, doesn't even capture how extreme that
is, because the ordinary American has taken more credit risks and they're
they're even aware of sometimes, and they sell when the market falls, when
they become fearful like they did during COVID.
So they're forcing someone else to buy when there isn't a natural bid.
And and that daily liquidity avalanche and then it goes down and then there's
more selling is what I'm worried about. Coming up I'd value global head of Citi
private Bank as you think about this ongoing bifurcation between the United
States and China, it actually represents different opportunities for our clients
to position themselves. So today, emerging markets are trading
around a 40% discount to developed markets.
We think there's more upside in emerging markets in the coming years ahead.
This is Bloomberg. Welcome back to the next big risk.
When Ida Liu travels the world speaking with city's private bank clients, she
says geopolitical concerns weigh on investors minds.
She's concerned that continued US-China tensions will further impact supply
chains and the new economy. The ongoing geopolitical concerns that
investors have around the world. It is still on everyone's mind what's
going to happen with U.S. China.
I think that's the biggest question mark as we continue to see a lot of the
bifurcation and the strained relationships continuing between the
U.S. and the China and particularly around
Taiwan. What's going to happen with Taiwan?
Is there going to be a potential war between China and the U.S.
with regards to Taiwan? I think that's a very complex and
complicated question that's on people's minds and could be a black swan event in
the future, particularly around the fact that Taiwan is dominating in all of the
semiconductors. And when we think about what's
happening, and one of the biggest trends that we're seeing out there with A.I.
is all driven by the semiconductor industry.
And when you think about the fact that Taiwan clearly dominates today in the
semiconductor industry, particularly around the most sophisticated chips, 90%
of the world's supply is from Taiwan. So that is not to be underestimated.
It's a very complicated geopolitical tension and concern that we're still
monitoring. And it's something that we have to keep
top of mind over the next several years ahead.
How do you think through the worst case scenarios here and how to speak to your
clients, to investors around what could go wrong as you think about this ongoing
bifurcation between the United States and China?
It actually represents different opportunities for our clients to
position themselves. So today, emerging markets are trading
around a 40% discount to developed markets.
We think there's more upside in emerging markets in the coming years ahead,
particularly given that we think U.S. dollar strength has peaked.
There could be some very interesting opportunities in emerging markets.
And because of this bifurcation, you're seeing a new sort of pattern that's
happening in global trade. So what does that mean?
That means, for example, Mexico is going to continue to benefit from near shoring
with the United States. You know, you look at Brazil.
China is Brazil's number one trading partner today.
You look at some of the Southeast Asian countries which are benefiting from some
of the movement that you're seeing in the diversification from companies that
are based in China today, establishing more of a footprint in Southeast Asia
for diversification. Think Thailand, think Vietnam, think
Malaysia. So some opportunities there as well.
Not to mention India. So lots of different countries that we
think will be beneficiaries in the next several years and continue to be a
beneficiaries from the change and the patterns that we're seeing in global
trade. When you think about the societal
economic market impacts, which kind of aspects concerns you the most?
I think the aspect that concerns me the most is really if there is a pending
war, because then we could be talking about a truly devastating global
consequence. The hope is that it won't get to that
stage, but that's something certainly that investors are concerned about.
Right. And then just making sure that you're
having a very globally diverse portfolio will help shield against some of those
ramifications down the road of that ongoing political tension of making sure
that you're capturing some of the opportunities, as I said, from the
changes in the pattern of trading between the U.S.
and China as well. Do you kind of have glimmers of hope
here or with the way things have been going?
Do you think that there's a real risk that the US-China relationship gets
much, much worse? I would just say that
it is a big question mark. It is a big black swan event.
People have to be very, very much prepared.
Investors have to be prepared. They have to think about global
diversification and we have to monitor it very closely over the next couple of
years. But where where we see the most
opportunities, as I mentioned to you, is on the changing supply chain and
countries that will benefit from that and making sure that our investors have
some exposure to those opportunities as well.
We talked a lot about the diversification away from China.
Is there anything you could say about kind of the importance of China to the
global economy and to the investors that you speak to every day?
I mean, it sounds like from what you're saying, even with diversification, they
are not willing to let China alone. There's no question in anyone's mind
that China is a extraordinarily powerful country, the second largest economy in
the world. And that can't be ignored.
Right. If you're a global investor, you can't
ignore the second largest economy in the world.
There's so much development and progress that's still happening in the region,
including the advancements that we're seeing in AI, VR, robotics and even in
clean energy, for example. So lots of really interesting, very
innovative advancements happening out of the region.
And if you're an investor and you're looking at the second largest economy in
the world, you're also looking at opportunities for future growth, right?
And that you can't just ignore those opportunities.
I mean, do you have any thoughts here about what it means for the United
States? As well.
And this idea that, you know, China can surpass the United States in importance
both as a political powerhouse as well as an economic one.
Clearly, the U.S. is is is a dominating force and always
will be a dominating force. And I think both economies are very
important as one and two in the world. And that we've got to make sure as
investors that we're looking at where the most growth opportunities are for
our clients and how to position our clients portfolios.
And that would include both into the mix.
Coming up, David Rubenstein, co-founder of the Carlyle Group.
I think there's a lot of lip service being given to it, but no politician in
the United States will say there's there's a lack of income inequality.
Attention. Everybody recognize there's some issue
there and people are talking about it. This is Bloomberg. Welcome back to the Next big risk.
I'm Sonali Basak. Billionaire David Rubenstein co-founded
the Carlyle Group and is no stranger to managing financial risks.
We spoke about rising income inequality and how it sets us on a path towards
societal conflict. The biggest concern overall is that the
clash between the haves and the have nots in the Western world they clash, is
going to be between the older people and the younger people.
The older people are living longer and longer, but the retirement benefits are
not really going to keep up with what they expect or what they need.
And the younger people are going to have to say, we don't want to work that much
harder just so you have a better retirement.
So you're going to have Social Security in the United States, for example, not
being adequately funded. You're going to have other endowment
programs that are not adequately funded, and the result is going to be more and
more people are going to be fighting between a clash of age groups, you could
say the haves who are working hard and want to make more money for themselves
and the have nots, who want more money to be given to them for the retirement
purposes that they that they need. In the emerging markets, it's going to
be between the haves and the have nots in the sense that the haves who run the
world for the last 50 to 75 years, the Western world, Western Europe, United
States and so forth, they are they have the wealth and they have the means to
really live lives of the way they large they want to have not.
Nations, the emerging markets are going to basically say, well, we want some of
the wealth of the world. We want more influence in the world.
We want to control some of the bodies like the U.N.
and the bodies like the World Bank. And we haven't had that kind of
influence before. So increasingly, you're going to see in
the Western world the retirees clashing with the younger people and in the world
as a whole. You're going to see the people that have
had the power for the last 50 to 70 years being fighting with the people who
haven't had the power, who now want it. And that's how I think the biggest
fights you're going to see. It sounds like a lot of your concerns
come down to the distribution of wealth. Where do those concerns look the most
stark in the world or among populations? Yes, you're right.
The people that don't have the wealth, they want more wealth.
They are exposed to through social meaning, other things, how other people
are living. They now see what is possible.
In the United States, we've seen income inequality increasing, increasing over
the last ten, 20 and 30 years. And that's the opposite of what we
really should have as a society. In the United States, many people don't
go any longer believe in the American dream, whereas people come to our
country, they often believe in the American dream.
But people born in our country don't think any longer they can rise up
because they have so many social factors against them that's going to produce and
increase increasing income inequality. How much worse do you think that this
problem gets over time? When I left the White House under
President Carter, the total indebtedness of the United States was under
trillion or roughly 800 billion. Now it's roughly $32 trillion.
There is no way out of that except essentially inflating your way out.
We aren't going to cut expenses in the government.
We are going to increase tax with that much.
We aren't going to go to a bailout. But the IMF, that's not realistic and
we're not going to default. The only alternative is to inflate your
way out. So we're going to inflate our way out.
And that's not a good problem for people at the lower income parts of our society
as they deal increasingly less well with inflation than wealthier people do.
When you look around the investment community and governments around the
world, do you think that they have a handle on this problem or do you think
that this has been largely ignored? I think there's a lot of lip service
being given to it. No politician, United States will say
there is there is a lack of income inequality, attention.
Everybody recognizes some issue there and people are talking about it.
But what are people doing about it? Income inequality is getting worse, not
better. And I think politicians recognize that
government officials around the world recognize it, but I don't think they're
able to do that much with it about it. I think increasingly the people who
control the wealth and the money are going to be basically making more and
more money. Do you have any sense of what can start
to change the trajectory into a more positive direction?
Well, I think younger generations would be helpful if they got involved in in
the government more, much more. We still see a lot of the senior
government position. I'd say it's not occupied by younger
people and I think younger, more younger people would be good to get involved in
government more, but also in business. In most of the board meetings that I
attend and corporate board meetings or foundation board meetings or nonprofit
board meetings, you rarely see somebody under the age of 40 on these boards.
So increasingly, I think we should get people in their thirties and forties on
these boards because they reflect the younger generation and I think their
concerns are not reflected very often in board meetings, corporate boards and
foundation boards, nonprofit boards and so forth.
When you say that younger people should be involved in governments and in
corporations, is part of the idea here is that a younger generation could do a
better job at allocating some of these resources more equally across society.
Maybe they could do a better job, maybe not, but they could reflect the views of
younger people. I think younger people would be able to
provide ideas that maybe older people like me
can't really think of as well. And so, for example, when you talk about
AI and you have a board meeting talking about AI, how many people really know AI
who are in their 60 or 70? Probably not that much.
The people that know much about are probably in their twenties and thirties,
but you don't really see them in board meetings as much when the discussion of
AI is occurring. Now, do you worry about the political
ramifications of this deepening divide? Basically, politics is a fight between
and always has been the haves and the have nots.
And the reason our Congress is dysfunctional in some ways it can't get
things done is because you have people reflecting the haves and people
reflecting the have nots. And that is probably going to continue
for some time. I think the whole Trump phenomenon is to
some extent a reflection of people who are the have nots feeling that society
is moving away from them. If this problem isn't sorted out in the
next ten or even longer horizon 20 years, what does the future look like?
Well, remember, the United States isn't destined to lead the world the rest of
our lives, or that for another hundred years or so.
We've been the largest economy in the world since 1870.
China and India are now catching up and will pass us in some reasonable period
of time in the future. So the United States, if we're not as
wealthy as we have been relative to other countries, we will have a lower
lifestyle. So not only the haves have a lower
lifestyle, but the have nots will have a lower lifestyle than they even have
today. So that's a reason why we need to grow
the economy and then make it much more effective and efficient, but also share
the wealth much more than we are. That's it for this episode of The Next
Big Risk. You can watch previous interviews on
Bloomberg.com and on the terminal. I'm Sonali Basak and this is Bloomberg.
