Unfazed by the Turmoil

For the past several decades I have organised a series of lunches on summer Fridays with a number of hedge fund activists, corporate chiefs, venture capitalists, private equity stars and others. Many are well-known and there are more than a few billionaires. The goal is not to see how much net worth I can cram onto a shaded terrace, but how much wisdom I can focus on the key investment issues facing all of us. And whilst I think it’s fair to say that last year nobody anticipated the sharp drop in the price of oil, the Greek crisis or the Chinese devaluation, over the years there have been a number of impressive insights.

World equity markets were weakening during the four weeks the lunches were taking place, but few anticipated the precipitous decline we all painfully experienced in August. In spite of that downturn, most believed that the United States would avoid a recession and grow 2% or better; housing would be the driver. China would have a soft landing. If these conditions prevailed, we were only going through a long, overdue correction (it has been more than three years since the Standard & Poor’s declined 10%) and the market would recover afterwards. Many believed the S&P 500 would deliver positive performance at year end.

Those in the group who were close to operating companies said that the problems in China had not yet had an impact on their business. They offered that investors were overreacting to China’s softening. Only 1% of US corporate earnings came from China out of 38% from all foreign sources, one participant pointed out. Lower oil and commodity prices were a positive, and US companies were able to borrow at attractive interest rates. Most economic indicators, such as durable goods orders, supported the view that the US economy was still okay. The main concern however was the contagion effects of the Chinese slowdown. China is a major consumer of commodities, and a high percentage of commodity production comes from emerging countries. These markets, including China, account for 40% of world GDP. If 40% of the world were in recession, how could the developed economies not be affected?

Some complained that overall demand was soft and it was hard to increase revenues. This explained the vigorous merger and acquisition activity undertaken by chief executives desperate to increase earnings and making strategic acquisitions to do so.

At the beginning of August, most attendees thought the first Fed tightening would be in September, but by the end of the month there was much more uncertainty. A sizeable portion of the group thought the first move would be in 2016 because of the unsettled markets.

One guest pointed out that the only reason the world economies seemed to be doing well was because companies had access to cheap debt. This may be at the heart of China’s problems because many of the loans there are thought to be in default and the market may sense a credit meltdown is occurring. In the United States, the Federal Reserve increased its balance sheet from $1 trillion to $4.5 trillion between 2008 and 2014 and this kept the economy growing at a modest rate. Easing across the world has sustained growth everywhere, but the main purpose of the monetary expansion was to trigger a natural economic momentum that would continue when the central banks became less accommodative.

There was good news and bad news on the technology front. A senior executive at one of the major internet companies attended one of the lunches. I asked him my favourite question: “Will developments in the next thirty years match those of the last thirty?” I just cannot conceive of the next thirty years producing anything comparable to the internet and the smartphone. He answered without hesitation. The advances of the next thirty years will be more dramatic. He said there are hundreds of entrepreneurs coming up with change-the-world ideas and seeking capital from venture capitalists.

He cited artificial intelligence as a fertile area. Any repetitive function done by a human being can be done by a computer. This applies to many white collar jobs in the government, law firms and media. Just as technology hollowed out a large number of jobs in factories, it will eliminate a number of jobs in offices. This brings us to the bad news. The elimination of a large number of well-paying positions in offices will add to the problem of middle-class unemployment.

Back to China and the group believed that what may come out of this turmoil is a more cautious Chinese leadership. They may move slowly on their rebalancing efforts, and they are almost surely going to pull back on any territorial expansionist efforts to concentrate on keeping the economy growing.

A chief executive of a major oil company participated in one of the sessions. He said the drop in the price of crude had really hurt smaller exploration and production companies around the world. Many companies have suspended their efforts to find new deposits, and energy capital expenditures are down substantially. In spite of the drop in price, companies have stepped up production from existing wells. The result is that there is plenty of supply on the market now, depressing the current price, but several years from now there may be a shortage of crude. In addition, production from existing wells is eroding by about two to three million barrels per day out of ninety-five million total, and demand from the developed and emerging markets will continue to increase as long as we do not go into a worldwide recession. So, while the price may stay at present levels or go somewhat lower for a while, if you can be patient until the end of the decade, we should see West Texas Intermediate crude back around the $70 level or even higher.

— Byron Wien is the vice-chairman of Blackstone Advisory Partners LP.