Lowering our expectations

And hard truths about private markets

Photo by Tim Gouw on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that’s hoping higher rates will end our collective madness.

Higher for longer means higher forever

It seems that with every passing day and the release of more economic data, we watch markets give up on their dream of a 2024 rate cut (let alone seven of them). I have more bad news for you: We are never going back to 2019 interest rates. I mean, sure, the Fed will probably cut rates eventually when the economy starts to weaken—they will freak out and cut rates back to zero. People are deluding themselves if they think inflation will gently go back to 2% when demand is this tight. But even when the Fed does start cutting, even if they cut to zero again, there are reasons to believe we are in a higher rate environment going forward.

Some of it is because the mythical r-star may be higher. Also, because the rate you should worry about is the ten-year, and the term premium is back—or it will be soon. We are in a riskier, less stable inflation environment, and much more debt is issued—it all adds up to higher rates. Our holiday from history is over. And there is not much the Fed can do because it mostly controls the short end of the curve (unless massive QE is now a regular thing—which can’t be ruled out—but that creates other issues).

So, what does that mean for the economy? Hold on to your 3% mortgage for as long as you can! But it’s not all bad. We’ve had periods of highish (if you call 5% high) rates and lots of growth. Capital will be more expensive, and we probably won’t lavish unlimited capital on anyone who has a tech idea anymore. But that can also mean a healthier and more balanced relationship with risk and a more thoughtful allocation of capital. A zero-rate environment always felt unnatural, even if it was mainly due to market forces.

Yup, higher for longer may just mean higher forever—and it’s not all bad—even if no one told the stock market yet.

Private markets aren’t risk-free

But it’s all good, because we’ll just go private anyhow and won’t be subject to the indignities of market prices on our assets.

It seems like private investment will be coming to a trading platform near you.

I understand he has an interest in saying so, but I was still dismayed to hear Mark Rowan insist that we should invest our 401(k) in private equity or credit. He argues you are investing for the long run, and private assets offer a premium for giving up liquidity (though Cliff Asness may disagree), so you may as well invest in them. He says Australia is doing it with their super (the most Australian name ever for a pension scheme), and things are going great. He explains that we are wrong to assume private markets are so risky—especially if you don’t need liquidity.

But they are risky. Because, and this seems like it should be really obvious, they are not transparent at all. There is no market price, which means no one knows what they are worth until the funds mature, and that’s many years away. That makes them more risky. The risk is not just about liquidity—the whole market price conveying information and holding people accountable thing is a very big deal. Why do so many people not realize this? I get why managers of private assets say so; they want to be in charge of all the money and not be beholden to pesky things like prices providing easily observable information on how their investments are actually doing. But why is there no pushback when they say liquidity is the only risk here?

Also, there is so much dry powder already. Where are private managers going to invest all this money? I am not against private markets, but I do think they work better when they are relatively small. But, somehow it has become conventional wisdom that they are low-risk and need way more capital.

There is one golden rule of investing: If someone tells you they can beat the market without taking on more risk, you should not invest in whatever they are selling.

Many people think risky markets are riskless these days. That’s what happens when you have ten years of zero rates. Even the biggest names in finance forget what risk means. I, for one, welcome higher forever; the madness needs to end.

Losing their ambition

In the meantime people aim to de-risk their income. It is graduation season, and this year, college grads are dreaming of a life…in the Civil Service. Not that there is anything wrong with that. Civil servants make the world go round. But it seems sort of sad to dream of such a life when you are 22. You should still believe you will change the world…in a big, exciting way, not a bureaucratic one. And it’s good for the economy to be a little deluded and ambitious when you start out; sometimes, it can be self-fulfilling.

True, it’s a small survey, and it’s still only 7.5% wanting to work for the government. But they also said what they want most out of a job is stability. The least popular attribute is a fast-growing company—which is how you make money and advance quickly. A desire to work in tech or finance is way down.

The other growth area for jobs is manufacturing. I always thought the big problem with industrial policy is that it diverts capital to the government and its favored industries—when it would be more productive in more dynamic, fast-growing places. I guess that is true for human capital too.

And speaking of realistic expectations, I am quoted in this great article on retirement spending in Baron’s

Until next time, Pension Geeks!

Allison