(Bloomberg) -- One of the main tasks of investment professionals is managing risk, and the list of potential minefields these days is lengthy.
From contentious elections around the globe to deadly wars in the Middle East and Ukraine to economies at crossroads after the most aggressive pace of central bank tightening in a generation, investors have had to navigate a uncertain path in search of returns.
But what about those risks flying under the radar?
To help gauge the dangers that may lie ahead, we spoke with three executives who’ve managed money for years about the next big risk they see coming: Angel Ubide, head of economic research for fixed income and macro at hedge fund giant Citadel; Armen Panossian, co-chief executive officer of Oaktree Capital Management; and Anne Walsh, chief investment officer of Guggenheim Partners Investment Management.
Their comments have been edited for length and clarity.
ARMEN PANOSSIAN
Oaktree Capital Management
The biggest risk that I see is artificial intelligence. AI clearly has the potential for very large economic gains, revenue increases, cost efficiencies, and that investment opportunity is really exciting.
But it’s easy to disregard the societal impacts of those efficiency gains. What happens to normal jobs that become obsolete because of AI? Think of cashiers or drivers as AI becomes a real alternative to physical labor in some of those areas. Millions of people could be out of jobs. So who’s going to retrain those people?
If we don’t figure that out, there could be social unrest.
In terms of the markets, AI clearly is getting a lot of support. But just like the internet in the late ’90s, there was this promise of revenues growing rapidly. While the gains are clear in terms of their potential, the timing of them is impossible. And if that timing takes a lot longer than investors expect, I would expect to see a pretty violent resetting of valuations and potentially some losses for investors along the way.
We are careful about to whom and where we lend. We’re not sprinkling capital across all players, but are very selective and we are participating in the growth opportunity offered by AI. With that said, we are careful not to get over our skis and get too overexposed or too concentrated into AI because we do remember what it was like when the fiber optic boom was happening.
Now, if there is a dislocation and we see a re-rating in terms of valuation of assets, we think that there will be a lot of opportunities to invest in a more distressed or opportunistic way. Oaktree has a very strong business in distressed or opportunistic investing.
But if we keep ignoring the risks, we’ll not recognize that there is a bill to pay with respect to employment and with respect to people who rely on paycheck-to-paycheck jobs, who’ll find themselves untrained and not ready for the new economy.
And we will be forced as a society to either have social unrest or have a welfare state. The risk is if we don’t do anything about it now to retrain some of these people or to prepare for a post-AI employment landscape, we’ll have issues with a deepening divide between the haves and have-nots, the wealthy and the paycheck-to-paycheck people. And that will mean a considerable amount of harm to a lot of people who don’t expect it to be coming their way.
ANGEL UBIDE
Citadel
One of the most important things for the next few years is going to be the strength and sustainability of the European economy. We are living in a new world that is very different from the last 20 years. And it’s not clear to me that Europe is ready for it.
The US, China and Europe are now competing on a variety of fronts. It’s not just economics — it’s also national security, it’s climate change, it’s technology, it’s energy independence. The US and China are adopting policies that are putting them ahead of Europe. Europe is lagging behind and my worry is if Europe is vulnerable, then what happens for the stability of the global economy?
You have a tri-polar world. The US economy, it’s more independent, it’s more autonomous. The Chinese economy sort of the same. Europe is more dependent. In terms of trade flows, in terms of alliances, in terms of what to allow and not to allow, Europe is in a more vulnerable position.
Europe needs to start thinking about its common interest rather than the interest of each of the countries. One problem with the European economy is that it’s fragmented at the national level.
In Europe, there are over 30 telecom operators. In the US there are four or five. Same with China. That means that European firms are smaller, they’re catering to their own national constituencies. Another way of saying the same statistic: Each European telecom firm services around 5 million people. In the US, it’s around 100 million people. In China it’s 500 million people.
To compete in technology, in climate, in energy, in defense, in national security, you need to scale. So European countries need to think: Do you want to compete as a small country or do you want to compete as Europe? Now, I don’t think they have a choice because the US and China have already started the race and Europe needs to follow. There isn’t a European company in the top 20 largest firms in the world. That’s a problem.
You can have more control and less growth, or you can have less control and more growth. If countries trust each other more and they build more European champions, rather than each country having its own national champion, growth is going to be better, productivity is going to be better, welfare is going to be better.
Right now, each European country wants to have its own telecom company, its own large banks, its own large energy companies. Why? Because they want to have national control. And the question is, are you willing to surrender some of this control to European firms?
There has not been progress in that direction. In some sense it’s the legacy of the European crisis. It was very scary to see the default in Greece. It was very scary to see the sudden stop of capital inflows in some of these countries. There was a bit of a decision to self-insure, how do you self-insure you have your own bank, your own telecom, your own energy. And I think that’s the issue that’s blocking the thinking about moving forward.
A weaker Europe means a more bipolar world between the US and China. I'll give you another example. I used to work at the International Monetary Fund. The IMF is a global institution. Could we be going in a direction in which countries essentially see something like the IMF as more of a western institution? And then China and its ball of influence essentially withdraws from that, and decides to run its relationships in a different way. We could be going in that direction, if Europe weakens. NATO is another example.
If Europe weakens, it gets more difficult because we don’t have a shared sense of what the forum is to resolve conflicts. The world is better off if there is a common project and there is joint interest.
ANNE WALSH
Guggenheim
There are a number of cross currents that we haven’t seen before, and I can point to being in a post-Covid world. I call this a Covid echo because we’re still recovering from the policies and programs and reactions by policymakers.
This huge amount of spending, we have to now pay the interest cost on that, and there’s a crowding out effect with regard to how capital can be deployed. One of the biggest elements I’ve seen coming out of this Covid-echo period is the unevenness of the application of capital. Normally what happens in an environment where the Fed is on hold, or tightening, is that capital gets rationed and capital goes to fund only the most deserving of business enterprises. In an environment where there’s just so much capital flowing, and so much liquidity, you continue to see uneven deployment of capital.
We have a very bifurcated economy right now. We have large businesses with access to capital. We have the wealth class in America, and then we have the working class that doesn’t have either investment in equities or savings, can’t own a house yet because of the cost of capital, and small and midsized businesses that don’t have the same access to capital and their cost is substantially higher.
The bifurcated economy that exists is made worse by the two policies that the Fed has: higher rates and quantitative tightening.
It’s going to continue as long as the yield curve remains inverted and the policies of the Fed are not yet to the point of lowering rates.
Pre-Covid, the Fed was spending a lot more time concerning themselves with this divergence of different earners and the underemployed and this dichotomy that existed. I haven’t heard a thing from the Fed in the last two years about this issue and what some call the K-Shaped economy. It’ll be interesting to see if their rhetoric returns to concerning themselves with the underemployed or the underearning part of the economy.
If I were at the Fed, I would be thinking about the tools in the toolkit differently. I would be utilizing quantitative tightening and to a great extent they have. If we look globally post-Covid, $12 trillion came into the global economy from central banks everywhere. And right now we’ve seen about $5 trillion has been hoovered back out. That still leaves $7 trillion sloshing around in the system globally relative to where we were before Covid. Now adjusting that for larger GDP and GDP growth globally, probably we need to see about $3 trillion more come out before we get to an equilibrium of where we were before Covid.
I don’t think the Fed really appreciates the quantitative tightening tool as much as I do and I think as much as the markets do, relatively speaking to their adherence to rates as almost the only tool. It seems to me a very blunt instrument.
I do think rates are important here. I believe rates should be coming down. I believe they should have come down faster. They raised rates 75 basis points after Silicon Valley Bank failed. That’s unprecedented in Fed policy action to actually continue to raise rates after we’ve had a crisis.
The government has already stepped up a lot. I’d like to see us spend a whole lot less. What we have done is we’ve moved into a world of industrial policy, using large sums of money to address and advance various political and or policy causes.
Those of us who have been in the investment world for decades look at this and go: “This is unsustainable.” But so far it has been sustained and as long as we can remain in some sort of equilibrium where we can afford the cost of debt and we can afford the debt burden, then we’re going to stay here. We have the reserve currency.
Having said all that, the cost of the debt at this level of rates of interest is too high and it’s crowding out even defense spending.
It’s Ronald Reagan who said: Once you have a federal policy, you can’t get rid of it. And that’s sort of where we find ourselves. It’s worked so far. So why not keep going? It works — until it doesn’t. It could take a black swan event, something fairly significant, for us to realize that we have depleted our ability to continue to spend endlessly.
To contact the author of this story:
Sonali Basak in New York at [email protected]
