Byron Wien: The Worried Extrapolators
As my long-time readers know, every year I organize a series of lunches for serious investors who spend a part of their summers in eastern Long Island. Over 100 people in all attend, with 25-30 at each, and they include major hedge fund managers, real estate titans, venture capitalists, some academics, scientific entrepreneurs, and technology experts. While the purpose of the lunches is to gain an insight into how the following years will develop, the lunches of 2019 did not anticipate anything like the COVID-19 pandemic. However, participants in the five virtual lunches of 2020 thought we would be in a recovery period in 2021, even though last summer we had not yet developed a vaccine to deal with the virus.
This year, the group generally agreed that the economy in the United States was doing well. Office workers had adapted to working remotely, and workers who had to be physically present at their place of work were showing up in sufficient numbers to get the goods and services delivered. The U.S. economy had recovered the ground it lost because of the virus-induced lockdowns, although was not where it would have been if it had maintained the trajectory it was on in 2019. Around six million lost jobs were yet to be replaced, and a significant number of workers who wanted a full-time job were working part time. Leisure and hospitality remained furthest behind of any sector, but there were some encouraging signs in the July employment report.
Nearly all of the attendees believed some secular changes had taken place although some were cautious in concluding the changes were permanent. Many employers are going to embrace a hybrid “three/two” model, where office workers will likely come into the office three or four days per week on a sustained basis. Remote learning might enable educational institutions to cut costs and increase enrollment, unencumbered by the limits of a physical classroom space. Cultural organizations were in tough financial shape and would take a while to recover. Most expected cities like New York to be back to a reasonably pre-pandemic “normal” by the fall, but the Delta variant had temporarily slowed the reopening process down. The 20% to 30% of people who are hesitant to receive a vaccine added uncertainty to the pace of the recovery. Slower recoveries and lower vaccination rates abroad were a source of concern, as was the need for booster shots. The overall feeling was that traces of the virus would be with us for some time, but participants were attending private dinners and socializing. I sensed they were doing it with some restraint, nonetheless.
The real estate people were more upbeat. Leases were being signed for apartment rentals, and expensive condos were selling. Commercial real estate was facing somewhat more difficult circumstances, and New York City was expected to have a significant revenue shortfall while costs were increasing and some of the biggest taxpayers were moving to Florida and Texas. There was concern that the quality of life in New York City was deteriorating because of issues such as rising crime. Tourists are coming back, but slowly. In the view of some, continued differing views among stakeholders, including teachers unions, could delay efforts to resume in-person schooling. Hotels are filling up, but room rates remain down in some markets. Business travel is not where it was in 2019, and may be one area that undergoes secular change; as many people have discovered, “Once you make the initial contact, the relationship can be maintained via Zoom.” There is some evidence that younger people are emphasizing remote work flexibility in their employment decisions and taking jobs based on the “back to office” leniency of their prospective employers. The big problem with a remote workforce is that it is hard to maintain a great corporate culture if people were not in the office. Not only is it hard to mentor new and junior employees, but creativity is likely to suffer if people were not in the same room exchanging ideas with each other or having “two-minute manager moments” in the aisles or hallways. People have become comfortable buying online, and that has long-term significance for the retail industry, the commercial tax base, and real estate properties linked to logistics and shipping. I came away from the lunches thinking that there was too much complacency about the recovery, and the fall may not be as “normal” as people think, partly because of the Delta variant and the other variants that may follow it.
Most believed that the U.S. economy was doing so well because of the fiscal and monetary policies of the federal government. Real growth was expected to be 6% to 8% this year and 4% in 2022, but most believed the long-term growth of the U.S. to be 1% to 2%, with one percentage point each coming from population and productivity growth. Because birthrates are down, we are more dependent on immigration for population growth, but little progress has been made on the immigration reform front, so challenges remain in this area. We should always remember that some of our most successful entrepreneurs and job creators are immigrants, while recognizing that any country needs reasonable border security and control. Nearly everyone was worried about the huge build-up in federal debt, now accumulating at a rate never before seen in peacetime, as well as the doubling in size of the Federal Reserve balance sheet, from $4 trillion to $8 trillion over the past year and a half. The Fed may taper, but monetary policy is likely to remain expansive with the likelihood of some form of the American Jobs (infrastructure) and the American Families plans likely to be passed this year. The budget deficit problem is on a path to get worse. Few thought that higher taxes would enable the packages to pay for themselves, and higher taxes may have some negative implications for investment and growth.
Almost everyone was worried about the recent rise in the inflation indicators. Many thought that the Federal Reserve’s bond buying program is the only reason that interest rates remained so low. One participant pointed out that our Treasuries yielded more than the government bonds of most European countries and Japan, implying that the Fed’s actions alone might not be the cause of depressed Treasury yields. There was the general observation that inflation was already here. With the Consumer Price Index growing at 5%, rents rising by 6%, the Employment Cost Index increasing 5%, and producer prices rising, most thought this phenomenon was not simply “transitory.” Nobody felt strongly that Fed Chairman Jay Powell would not be re-appointed when his term ends next February, but with the “sticky” elements of inflation in the mid-single digits, one would be challenged to argue that lower commodity prices and improved supply chains in the fall would drive inflation back down to the 1% to 2% range.
The big question, then, is when, not if, interest rates will rise and what impact that will have on the economy and equity markets. Most were comfortable with the idea that the equity markets could handle the 10-year Treasury yield rising to 2%, but if it rose to 3% or 4%—which I view as a real possibility—it would spell trouble for equities. Despite this, most remained pretty committed to equities, with one describing himself as a “fully invested bear.” Somehow, the group felt the coming year would be okay. It was yet to be seen whether that level of optimism will be rewarded.
For a long time, I have believed that the most important international and geopolitical issue is the relationship between the U.S. and China, and we had a lively discussion of this at every lunch. The U.S. went into the meeting in Anchorage earlier this year with a tough-minded approach. America was still thought of as the largest economy in the world, although it is not on a purchasing power parity basis: China is 15% bigger. Innovation was occurring here and our leading universities were continuing to turn out exceptionally capable students. In the eyes of the U.S., China may have a powerful manufacturing capability and economic momentum, but their actions in areas such as intellectual property warranted sanctions and tariffs. China was not accepting that position. It believed it had earned the right to equal status with the U.S. and made it known that it expected to be treated accordingly. Reflecting this newfound confidence in its place on the world stage, China has taken a more muscular stance in the region in areas that are of strategic geopolitical importance to it. Even so, the Benchmark group largely anticipated that China would not make any significant foreign policy changes in the region that would upset the existing balance.
Xi Jinping has been successful in creating a strong economy and a significant number of jobs, and continuing to do so is critical to maintaining support. He has been determined to increase China’s independence in key segments of the economy like technology, and his progress towards his “Made in China 2025” plan is a testament to the goal of independence. China is running into a soft patch economically, with imports and exports off their peak, and we’ll have to see how that develops. Business on the ground in China continues to be strong, however. Clearly, one point the U.S. and China agree on is that both countries want to prevent technology companies from becoming too powerful. China has four times the number of engineers that we have, and they reportedly work much longer hours, with some on a “nine-nine-six” schedule of working 9am to 9pm, six days per week. China has made clear its intention to be the market leader in areas of emerging importance to the world economy: software, artificial intelligence, transportation, synthetic biology, energy, and surveillance. China has a clear strategy and is putting money behind it. The U.S. lacks a strategy. Perhaps we could pivot to a policy of cooperation on mutual goals, including global health, cybersecurity, and more open international trade. The Chinese originally thought that President Trump’s policies towards China would be less contentious than his rhetoric on the campaign trail, and that President Biden’s policies would be more like his traditional Democratic predecessors. Neither of these turned out to be the case. The Biden team believes that we should wait to begin negotiating with China until we have COVID under control, and until we do, there is unlikely to be much further progress on this front. National security issues will be important in any negotiation, and there was concern in the group about China’s rapid advancement in military technology, such as development of missiles that can travel faster than the speed of sound and against which are hard to defend. Some in the group were avoiding public markets in China given new regulations in tech and property sectors. Private and real estate investors cited opportunities in logistics, commercial property markets, and healthcare sectors. Emerging markets that sell into China could be another way to gain exposure to the growth in China.
There were a number of people knowledgeable in the technology sector present at all of the sessions. I posed the (highly controversial!) question of whether the next 30 years would bring about as much change as the past 30 years, when the internet transformed the global economy. The people with expertise on these issues felt strongly that there would be more disruptive innovation ahead. They expect advances to be made in voice and facial recognition, payment and delivery systems, self-driving cars, cures and improved therapies for heart disease, cancer, Alzheimer’s, diabetes, Parkinson’s and other common illnesses. Technological innovation, accelerated by the pandemic and the necessity to increase output despite a tight labor market, is already creating massive bursts of productivity growth in many areas of the economy. One example we discussed is how “telehealth” will democratize medicine by expanding access to healthcare and giving people of limited means and in far-flung places the ability to be treated by specialized doctors, not limited by geography or their ability to fly to a prestigious clinic. Life expectancy should increase and there will be a serious need for more healthcare workers. There will be a greater interest in wellness and quality of life issues. The most important result of all of this scientific and technological innovation would be to provide more opportunity for socioeconomically disadvantaged people and the marginally educated, thereby reducing the inequality which has worsened in the last four decades. However, some participants worried that the capacity of innovation to expand opportunities is tied to the availability of appropriate training for workers.
The group was generally positive on President Biden’s performance during his first year in office, although this did not take into account his recent handling of the Afghanistan exit. His appointments to his Cabinet and top-level agencies have been qualified and experienced, and his communications with the public have been balanced. While his desire to deal with our decaying infrastructure, poverty, inequality, and other social issues is noble, we have been trying to make progress on these issues for some time. We continue to lag behind many other industrialized countries in terms of the quality of our public education system, even though this problem has been recognized for half a century. A fundamental question is whether we can make improvements in this arena without attracting better teachers to the system. There was hope that technology could reverse the negative trend in public education, much as “telehealth” will do for the healthcare sector.
I challenged the group by saying that I thought the country was shifting to the left politically, and I got a lot of pushback on that: at one lunch, 75% of the room expected that Republicans would re-take the House of Representatives during the 2022 midterm elections. Few thought that the propagation of critical race theory is having as much of an impact as one might be led to believe by the media. This idea and other left-leaning concepts are promoted by the liberal press. It was the feeling of many in the group that unless one has a kid in a New York or California private school, one is generally unlikely to hear much about it in the rest of the country. The group noted that the number of moderate politicians seems to be dwindling; gerrymandering has resulted in “safe districts” wherein one party’s primary determines the election, and there is usually a race to the bottom in terms of courting that party’s most extreme voters. But it does seem that there are some recent developments that run against this trend. Biden campaigned and was elected as a moderate, even though some of his policies in office seem to echo those of Senators Bernie Sanders and Elizabeth Warren. The nomination of Eric Adams, a self-described moderate and retired police officer, as the Democratic candidate for New York City mayor—along with other local elections around the country—reinforces the feeling that the political balance is close to the middle of the spectrum. Some in the group felt that the traditional “left/right” political spectrum is not necessarily the best way to think about politics today, and that people’s political beliefs split more along cultural lines than economic ones. In this view, people’s politics are about “density and diplomas”; the urban/rural and college/non-college divide is more determinative of one’s political allegiance than tax policy. But it’s my view that there are really four blocs out there: the far right who supported Donald Trump and continue to do so; the moderate Republicans; the moderate Democrats who support Biden; and the progressive Democrats who support the policies of AOC, Sanders, and Warren. The future will depend on how the economy does, the success of the Biden agenda, and the ability to control COVID-19. Biden’s popularity rating slipped when the Delta variant erupted and the economy lost some of its momentum. Now, the collapse of Afghanistan’s government and the subsequent chaotic evacuation of American citizens and allies have likely caused further damage to Biden’s popularity, and have hurt his credibility abroad.
While there is widespread support for reducing world dependence on fossil fuels, the participants who were familiar with the oil industry felt that we are a long way from being able to depend entirely on green energy. The problem is cost. If all of the pledges of the Paris Accord were met, oil and gas would still be 46% of the energy mix in 2040. The number of people employed by the industry in the U.S. ranges from low-single-digit millions to 12 million, depending on which estimate you trust. China is dependent on imported oil for 80% of its needs, while the U.S. is energy independent. This is strategically important. While subject to short-term fluctuations, the price of Brent is likely to be in the range of $65-$75 per barrel over the next few years. In the 2030s, aggregate oil demand may plateau, and the price would subsequently decline. If we succeed in expanding the use of electric cars, we will necessarily increase our consumption of electricity (which raises questions about how that electricity is produced), but we will subsequently also need to increase the storage capacity of the electric grid, which is already aging and strained. Think summer blackouts. The cost of producing renewable energy sources is declining, and that is a reason for some optimism. Climate change is the most important scientific challenge of the current century.
There is no question that the environment, social change, and governance are going to be important investment themes going forward. The big banks are being forced by clients and regulators to implement the concept in their portfolios. This will supplement various governmental programs. All the big European pension funds are ESG-focused. There will be some impact on profitability as companies comply, but it is not expected to be great and may be offset by the current improvement in productivity.
On investment themes, one investor thought that over the next 15 years, there will be ten disruptive companies that are small now, but will reach FAANG scale. About 20% of the attendees owned Bitcoin, and they were mostly the younger participants. Few expected the 10-year Treasury yield to get to 2% this year. About half thought that the market’s next 10% move is “higher.” No one had any conviction that the next 10% move would be lower, though one attendee was cautious for the near term. Residential and industrial real estate were cited as attractive areas for investment. The group attending these lunches are mostly bottom-uppers. They don’t associate themselves with any theme or concept. While they were generally bullish about the next 10% move in the market being higher, in spite of unease about increasing budget deficits and an expanding Federal Reserve balance sheet, few ascribed to Modern Monetary Theory. They were concerned about the impact of the policies on the dollar and its future as the world’s reserve currency.
Last year’s version of this essay was titled “Plenty to Worry About, but Not Much to Do.” I concluded the piece by saying, “Looking across the conversations at all four lunches, there was a sense that…somehow we would all be sitting at these lunches a year from now with a little more net worth, but similarly confused about what the future might hold for our grandchildren.” That turns out to have been right, on both accounts. The alternative title for this essay could have been “Tomorrow Will Be Like Today”— the participants had a general feeling that there were issues to be worried about, but that the trends of today are likely to be extrapolated to the future, so concerns don’t warrant any significant changes to investment strategies. When the consensus view is that tomorrow will be like today, expect anything but.
With Taylor Becker, Associate
The views expressed in this commentary are the personal views of Byron Wien and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Byron Wien as of the date hereof, and neither Byron Wien, or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.
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