Every summer for the past several decades I have organised a series of lunches for serious investors who spend their weekends on Eastern Long Island where the temperatures are cooler, the scenery is exceptional and ordinarily intense people are more relaxed.
This year about 90 attended the four lunches on successive August Fridays. Many of the participants are well known and a number are billionaires. There are hedge fund managers, corporate leaders, activists, buyout specialists, real estate titans, private equity folk and venture capitalists, providing some diversity in terms of their daily activity. The group was correctly positive during the past two summer sessions, so I was curious to see if their mood had changed with so much unrest around the world.
The answer is that the investors almost universally believed that all of the threatening geopolitical problems would somehow work themselves out favourably without significantly disturbing the United States economy or its financial markets. There were a few with negative views; one raised the possibility that a nuclear detonation from a satellite over North America could release an electromagnetic pulse which would knock out the electricity grid across the United States, causing famine and chaos. A minority were cautious because of the escalation of geopolitical conflict. But the majority held a positive view that was untempered by the fact that the Ukrainian unrest has already had an impact on the economies of Europe, with Italy in recession and Germany, the economic driver of the continent, turning down. If Europe slips back into a recession, the United States economy is surely going to feel it in some way.
Those attending were worried about evolving situations in the Middle East, Russia and South China Sea. But all of these issues did not keep the assembled from believing that the Standard & Poor’s 500 would finish 2014 above 2000, which it may reach soon. When this year’s lunches started it was at 1930. Most also thought real Gross National Product (GDP) growth would be about 3 per cent in the second half of this year, with only a few believing 2 per cent was more likely. Regarding Fed policy, most expected the Federal Reserve to increase short-term rates before June of 2015 in spite of the recent softness in the economy. No surprise here.
There was some discussion of the fact that the low level of interest rates was doing more harm than good. While low rates made borrowing by businesses and real estate developers attractive and increased values of financial assets, those living on retirement incomes were hurt because their savings in short-term fixed income instruments were earning less than 1 per cent rather than 5 per cent. Given that those people are likely to spend 100 per cent of their current income while the top 10 per cent of income earners spend only a portion of their earnings, consumer purchasing has been slowed by lower interest rates. Because those in the lunch groups benefit from appreciating investments, they were concerned about rising rates, but one attendee pointed out that it usually takes several increases in short-term rates by the Fed before stocks feel the impact, although the market gets skittish at any sign of Fed tightening.
In spite of low interest rates and increasing demand throughout the recovery, there has not been much construction of new commercial buildings and hotels. Money is being poured into established real estate in the United States from all over the world. Retail space has not benefited as much and may be held back for some time because of the impact of the internet.
We had a useful discussion about the pace of technological change. There have been so many significant developments since 1980 that I doubted that the next thirty years could match the last thirty. Those whose work involved leading edge innovation strongly disagreed. They said the entrepreneurial activity in Silicon Valley is huge and start-up companies are developing ideas that will change the world even faster than what we have experienced in the past. We will see big improvements in health care, agricultural production, energy consumption and a number of other areas. There will be collateral damage; some of the innovations will result in the loss of jobs and the demands of the workplace will be greater, requiring more education and quantitative competence. There are 4.6 million jobs open right now in the United States and most of those out of work do not have the skills to fill them.
There is also the danger of a cyber-attack affecting our quality of life. Knowledgeable attendees said that we have been both smart and lucky in avoiding a major calamity so far. Hackers, many from Eastern Europe and Asia, are trying to break into our banking system, and the inability to conduct business resulting from a major financial institution being shut down would have an impact on the whole economy. The risk is that the hackers get ahead of the people providing cybersecurity, and the possibility of that happening over the next few years is consequential.
As for other asset classes, there was almost no interest in gold, in contrast to past years. Some of the younger investors thought Bitcoin would gain in acceptance. Commodities generally were uninspiring to the group. They believed that technology in the use of plant nutrients would increase agricultural output. Most believed that the price of oil would remain around present levels. Several trillion dollars had been invested in drilling over the past few years and yet production is flat because Nigeria, Iraq and Libya are producing less. The US and Europe are reducing consumption, but that is being more than offset by increasing demand from the developing world, particularly China.
Looking at markets around the world, there was clearly concern about Europe. The impact of the conflict in Ukraine was becoming evident in Germany; Mario Draghi had to provide more monetary stimulus to prevent Europe from falling back into recession.
Most of the investors were optimistic about China. While the new leadership has been committed to reducing corruption, it will take a long time to implement reforms effectively. There will be some bank failures, but the government will engage in stimulative measures to keep the economy growing at 7 per cent. I worry that the increase in debt needed to accomplish that goal is unsustainable.
On emerging markets there was interest in India where a number of mid-capitalisation companies were believed to be attractive. The Modi election victory had generated considerable investor enthusiasm but some suspected that the Indian stock market was ahead of the potential fundamental improvements, especially since it was hard to implement reforms in India’s argumentative legislature. There was some interest in Argentina as a troubled country where there were many assets for sale on a distressed basis, while Mexico had a number of supporters because the leadership there was making both constitutional and legislative changes. The country has significant oil reserves but needs to improve its infrastructure. It will benefit from stronger growth in the US, but personal security is a problem.
All in all, As I thought about the discussion across all four sessions, I was struck by the optimism about the outlook for the US in the face of the unsettled conditions around the world. I wondered if our economy could continue to thrive in the face of so many problems elsewhere. On top of that you had the threat of cyberwarfare and terrorism. Our political process seems unable to respond to the challenges confronting the US and inequality is a growing problem. Can America move ahead economically at a satisfactory job-producing pace with all these conditions in front of us?
Byron Wien is the vice-chairman of Blackstone Advisory Partners LP
