Longer means Longer
Higher rates are already changing the economy and we're just getting started
Hello,
Welcome to Known Unknowns, a newsletter starting to unravel what higher for longer really means.
The tech gold rush is over.
As regular readers know, I think interest rates will stay higher for longer, and by longer, I mean longer. It is not just a matter of waiting for the Fed to cut short rates. Structural changes in the economy, beyond what the Fed does, will probably increase longer-term yields for years to come. And considering we have an economy built around near-zero rates, there may be some major dislocations.
GDP may be growing, along with productivity, and the job market is still tight, but the tech industry is having its own recession. There was only one significant venture-backed tech IPO last year! But it may have been inevitable. It is starting to seem like there was a human capital bubble in tech. In every generation, lots of people are attracted to the industry that promises a fast fortune that ensures you don’t have to work after 40. And lots of those people are not that talented; most will fail, but some will make money anyway. In 2000s New York, you’d often meet people in finance who hated their jobs and had no interest in markets, but they expected to make a fortune and get out. After 2008, the finance industry shrank, and even if it still pays better than most jobs, getting crazy rich before you reach middle age is much rarer and takes much more skill, talent and luck. I recall in 2008ish, there was lots of handwringing that finance sucked up all the talent who could be doing bigger and better things. But in retrospect, the problem was really an industry that attracted and overpaid mediocre talent. Now, the hot industry to work in has become tech.
I wrote about the end of the tech gold rush in Bloomberg. I read an article about a man who founded a tech firm that was mildly successful: he has employees, turns a profit, and provides a service people value. But now that rates are high, the odds of a extremely profitable exit seem remote. And he is frustrated that while he made good money, he’ll never make his “number” (or amount of money it will take to retire young to an island somewhere). But why should he make that much money? Making that kind of fortune should require building something extremely valuable, like transforming the economy and taking some big risks. But when you are in a human capital bubble driven by easy capital from zero rates, you get people who expect big payouts for good or just OK work.
The thing that troubles me about it is how disconnected these people are from risk. In the past, say exploration or the actual gold rush, money came from lots of risk-taking and personal sacrifice. But more and more people expect a fortune by risking someone else’s money. The man in the article thought of the venture money as unlimited. But it didn’t come from nowhere, it was largely from public retirees' pensions. Instead of the entrepreneurs taking risks, pensioners (or taxpayers) did on their behalf.
So, if high rates stick around, the tech industry will probably shrink too and offer more normal returns. What’s the next Gold Rush? My money is on Green tech, rates may be high—but all those subsidies promise money and no risk.
What’s going on with the consumer?
You’d think the high rates would slow the economy. But it just keeps going, largely because people keep spending. It could be monetary policy has long lags now that everyone refinanced and locked in rates when they were low. Or just the job market still feels secure, and people keep spending. The more controversial explanation is excess savings still in people’s accounts after the pandemic. Some people argue they still have cash, others think they never did.
The Survey of Consumer Finances came out last week and offers some answers. I had a delightful weekend digging into it on Stata. And it looks like a tale of two economies. The bottom 50% does not have much more money. Their net worth is up (which you probably read about any number of places), but much of that increase came from housing prices. Financial wealth is higher, but not much, like $100 more for lower earners compared to 2019 and still lower than it was in the past. Which does not suggest more resiliency and money to spend. Debt is down, but not that much. If you are in the bottom 50%, you are probably in better shape than in, say, 2007 but not much better off than before the pandemic.
And that means whatever post-pandemic dividend we had to weather inflation, and all those shocks are gone. Households are chugging along but vulnerable to a weaker job market, or if inflation comes back and wears away their incomes and the Fed has to get more aggressive on rates—they’ll be in trouble.
Though the top 50% is doing great. They have much more money compared to 2019, so unless asset values crash—they’ll keep spending.
I never promised you stable returns
It feels like every couple of years, we are told that the typical consumer asset strategy is failing. First, low rates showed that 60–40 portfolios did not offer adequate returns. Now that the target date funds are letting down retirees who were promised stable correlations and bond prices that would never fall. Whoever promised anyone such things?
This article in the Wall Street Journal suggests we need to rethink asset allocation. Now, I have my issues with target date funds and 60–40, but to their credit, they never were intended to deliver stable and high returns each and every year. If you are in these strategies because you want that kind of stability, you need to give up on risk (and higher returns). Or if you are in it for the long haul and accept that sometimes markets flip, and don’t look at your portfolio balance.
But more generally, it seems like we got hedging wrong. And lots of people who should know better added riskier assets to what is supposed to be the “safe” part of the portfolio. But that’s what happens when people think a zero-rate economy will last forever.
Until next time, Pension Geeks!
Allison
Your comments about 2008 and the shift of interest from finance to tech are really spot on.
I’d put the timeframe a bit later, around 2013 or so, at least in my experience. I started working at a large well-known tech company in 2010. When I joined, the company had surprisingly few employees, and they were definitely on the quirky side, with a number of people who were holdovers from a more freewheeling, “hippie-inspired” Silicon Valley of the 80s and 90s. For whatever reason, at some point around 2013, the hiring floodgates opened, but the people who came into the company were different. They were decidedly of the Ivy-League-educated, would have gone to Wall St. In my generation type, people who were maybe more career oriented rather than people who wanted to “make a dent in the universe.”
So you end up with, let’s say, 3 problems: first, just straight-up overhiring, with too many people doing too many things, and fighting each other for the tastier scraps of work; second, a bunch of people who aren’t fundamentally aligned with the core purpose and culture of the place; and, third, (and this is the most important pice, i think) a sense amongst the people who *did* get the core purpose and culture, that there were a lot of people free riding on their effort, which, even if these core people are very well compensated, is demoralizing.
My company was better than others, I think, in that it hired less aggressively and had a stronger core culture. But the dynamic was a problem. And I’ve seen it at a lot of other places, much worse. This is especially true (my impression, as an outside observer) with companies that were once-hot startups: they go through this cycle where they see incredible growth, they hire aggressively, they reach a natural equilibrium for their core “hit” product, they keep hiring, the core creative people get bored/rich and leave, the remaining people (born on third base, wall st in a different era-types) try to restart growth by creating new products that never really hit, they keep hiring... You end up with a very odd company – there’s kind of this “oil well” with incredibly talented people sitting at the core, generating all of the revenue, and then these surrounding (metaphorical) amusement parks and universities, major league soccer teams, and all of the other things that you see emirate states doing with their excess cash.
When Elon Musk bought Twitter and laid off all of those people, the news media were horrified – “How will they keep it working?”. My friends in SV had a very different reaction: “how the hell did Twitter have that many employees?”
I wouldn’t be surprised if we saw a retrenchment in tech, with the “oil wells” being extracted from the bloated organizations. Fewer free cafeterias and complimentary dry cleaners, but overall a healthier, happier tech sector.
This is overstated. Post 2008 the major investment banks either collapsed or required a bailout; Citi is still 90% down from where it was pre-bailout.
In 2023, the big tech companies are printing money.