- Rick Rieder, who oversees $US1.7 trillion as the global chief investment officer of fixed income at BlackRock, says the growth of technology is the most important dynamic in markets.
- In a wide-ranging discussion, Rieder also discussed the Federal Reserve’s next steps, the GOP tax plan, the equity and bond markets, and the rise of exchange-traded funds.
With even the most cursory look at the business landscape, it’s clear that technology is pervading everything around us – the places we shop, the products and services we pay for, even the way we think about the world.
Just look at Amazon‘s using its foundation as an e-commerce juggernaut to disrupt industries far and wide.Tesla, with its $US52 billion market cap, is more valuable than Ford in the eyes of investors. And Apple‘s iPhone has for years been the primary mode of communication for many of us.
Rick Rieder, the global chief investment officer of fixed income at BlackRock, is closely watching technology’s effects on the economy and global marketplace. Responsible for overseeing $US1.7 trillion, he’s a keen observer of how trends like this are developing. To him, it’s all part of the grand puzzle of how markets and the economy fit together – and understanding the big picture is crucial to his success as an investor.
In an interview with Business Insider, Rieder broke down how technology is transforming the economy and explained how the market is underestimating its impact. He also shared his thoughts on the Federal Reserve’s next steps, the GOP tax plan, the equity and bond markets, and the rise of exchange-traded funds.
It was part of a wide-ranging discussion that also included a deep dive into Rieder’s hectic daily schedule, which you can read about here.
This interview has been edited for clarity and length.
Joe Ciolli: You’ve written in the past about the adoption of technology and how it’s affecting the market. What’s your view on the role of technology?
Rick Rieder: By far the most important dynamic today across all markets is how quickly technology is changing the world we live in and invest in. I think people are underestimating how quickly technology is changing commerce in particular, and you’re seeing extraordinary dispersion happening in credit as a result.
Having said that, I’m convinced the economy is going to keep growing. But if you look at the components of inflation, services versus goods, there are tremendous differences. When the price of goods drops, consumption of those goods grows, particularly since lower- and middle-income consumers tend to consume more goods than services. So when prices come down, quantities grow as a result.
When people say the system is stagnating because inflation isn’t growing at 2%, that’s not true. Prices are dropping so far and so fast for so many consumption items – like apparel, audio and video equipment, transportation services, and more – that the quantity of goods is actually growing precipitously, just at a lower price point than anyone’s ever seen before.
Ciolli: Are there any specific industries you’d like to highlight?
Rieder: Look at motor vehicle sales, which have generally been pretty stable and pretty good. But then you get new ride-sharing technologies that come in which bring down the cost of transportation. Just look at rental-car companies’ stock prices – they then sell their fleet, so CPI trends for new and used cars are affected. People don’t consider the secondary or tertiary effects of technology. Or take Tesla, for example; they announce a car that’s $US27,500 after the tax subsidy and all of a sudden you have to deflate the whole automobile industry.
And what’s happened now with regard to food and restaurants, the whole dynamic is being changed. It used to be that you had a brand that sold through an outlet. If you walked into your local retailer, you knew they’d carry a well-known national brand. Now word of mouth is shifting the way commerce works, in that you don’t need to have the brand anymore because it’s evaluated online. The whole world of commerce is changing.
Ciolli: You’re a member of the Federal Reserve Bank of New York’s investment advisory committee for financial markets. What’s your outlook for what’s next for the Fed?
Rieder: We’ve been pretty adamant about the Fed raising rates in December and then three times next year. But the industry now thinks that the Fed is going to go four or five times next year, which is interesting because not too much happened in the past month, since the tax bill was already moving in a positive direction.
This is the first time in three years where I’m more dovish than the market on how much the Fed will move in the next year, but I do think the markets, the economy, and inflation will all give them the avenue to move.
Inflation is accelerating, and I think people are underestimating the nominal growth potential for 2018. It’s possible that we could get 5% nominal GDP next year, allowing the Fed to move but not requiring a dramatic need to brake the economy or inflation.
Ciolli: Many people have identified uncertainty around the Fed’s balance-sheet unwind as a major source of risk. Do you agree with that?
Rieder: The one thing a central bank is not supposed to be is the instigator of volatility, and they won’t be. Central banks are maniacally focused on not being an instigant to disrupt markets.
As for the changing leadership at the Fed, the Federal Reserve chair tends to act differently than an elected official. They tend to continue the path laid out by the predecessor, while an elected official oftentimes tries to shift gears.
Also, when the Fed tightens it’s different than easing, in the sense that it can be behind the curve. You want to make sure growth is still durable when you’re tightening, which is very different than the easing process, where you want to be fast and ahead of the economy. I think they will be deliberate in what they do from here.
Ciolli: What are your thoughts on tax reform?
Rieder: Before, it made a lot of sense for companies to just use excess cash flow to buy back stock. You weren’t getting any benefit from capital expenditure, and your cost of debt was extremely low. But now you have a direct expense benefit in the tax bill potentially, and global growth is going to continue to be good, so it makes more sense to invest in capex. That’s huge, and it’s just not factored in today in terms of the potential impact.
When you take your corporate tax rate to 20%, it will create a 20-25% EPS benefit for some companies or industries permanently. That has such huge ramifications for how companies look at their businesses going forward, and how they look at risk.
I’m a big believer that when you create this velocity in the system, where companies are able to spend on capex and hiring, it will pull forward growth – meaning we potentially could be in a recession by late 2019 into 2020, but it’s not a 2018 story. I wouldn’t argue with that, particularly since some growth will get pulled forward.
With all of these potential tail risks for doing capex today, I don’t see how you can go to your board of directors and say you’re just going to buy back your stock in 2018.
Ciolli: There are bull markets currently raging for both stocks and bonds. As someone with a fixed-income focus, what do you think could derail the bond bull market?
Rieder: I think both the equity and bond markets are right in what they are telling us about important fundamental and technical drivers.
There’s a demographic that we’ve never seen before: an ageing population that’s created this dynamic of needing more income, particularly for insurance companies and pension funds that are growing as a derivative of an ageing population. There aren’t enough assets or cash flow in the world relative to that demand. The long end of the bond market can stay very low for a very long time because of this extraordinary demand.
I think rates are going to move higher, but it will be a deliberate process. If you asked me where we’d be six months from now, I think the 10-year will be 2.75%, which is still pretty low in a historical context. Because there’s not enough income in the bond market, money is going to keep flowing into the equity market, pushing it higher, because that is where you can access decent cash flows today.
There just aren’t enough assets relative to income requirements in the world today. By any measure we use, the 10-year Treasury yield is between 50 to 75 basis points too low, but it’s because there’s a shortage of assets. That demand is also much of why volatility is so low.
Ciolli: We saw the high-yield-bond market hit a rough patch recently. What’s your view on that?
Rieder: This recent high-yield skirmish was a result of valuations being high, as with some other parts of the fixed-income market. I think the high-yield market got to a very aggressive valuation point in the US and Europe, and then you got some adverse news around some specific sectors. That was a pretty good wake-up call, and it showed that the markets still hold a good amount of risk.
With all of that said, I’m not worried about a dangerous credit-cycle unwind at all.
Yet we’re going to have more volatility in 2018 no matter what. When central banks pull back on the “put” they have implicitly had in the market, markets will consequently move more on organic economic conditions, which is almost by definition more volatile.
Ciolli: Do you think that these sorts of setbacks are ultimately positive for the market?
Rieder: Artificially distorted markets are super dangerous. There’s a real rhythm to markets, where historically every four years you’d get a market disruption – like in 1990, 1994, 1998, and 2002. And that creates a dynamic where markets reprice and then assets can do well for the next three years.
We should have theoretically recalibrated in ’06. The fact that we didn’t meant that ’08 was a bigger problem. Now we’re in ’17, and assets are being distorted longer. It’s really dangerous. Markets have to recalibrate and reprice.
A VIX at 9 is wrong. A VIX at 30 is wrong too. But we should really be operating between 13 and 22. And the longer you operate outside of that, the worse it ends up being. It’s like going to the dentist – you’ve just got to do it, and the longer you don’t, the worse it ends up being.
I don’t think equities are mispriced. As a matter of fact, I think they’re going to keep going higher, but parts of the debt market are too high, which can be a leading indicator or ultimately the cause in a cause-and-effect world.
Ciolli: Active managers often blame ETFs for sapping the market of volatility. What do you make of the role ETFs play?
Rieder: Passive investing has definitely made some contribution to low volatility, full stop. I wouldn’t argue with that at all.
But quantitative easing has also reduced volatility in financial systems – that’s the No. 1 influence that QE has on the economy and financial markets, I would argue. That’s because of the assumption that central banks will keep going until they solve the problem. And when you come off of that persistent monetary stimulus, volatility grows.
But I think there’s something even more important than that, and it’s the volatility of inflation.
In the ’70s and ’80s, you had a baby boom and housing inflation, and you had some energy inflation. Then in the last 20 years, particularly in the last decade, you’ve had the price of oil bouncing around due to supply and demand shocks.
Now oil doesn’t move much at all, and, consequently, there’s very little volatility in inflation. If the volatility of inflation stays low, then the volatility of markets must stay low. When you drop the risk premium on the inflation component down, then all of a sudden every financial asset can stay higher for a longer period of time.
Ciolli: What’s your biggest market fear?
Some areas of the financing market are too high. Central banks flooded the system with liquidity, and now they should pull back. If you don’t have that normal give and take that markets generally calibrate to, prices end up being too high for too long, or yields too low, and you get a complacency that’s not good.
That’s my biggest fear going forward. The longer you don’t recalibrate – and build up volatility in the markets – that can create a bad outcome with real reverberations. It could adversely affect the lending dynamics in the country and shut down companies from investing.
I think what the Fed is doing now is the exact right thing, but I think the ECB and BOJ should start moving as well. Central banks need to pull back and reach some equilibrium.
Geopolitical risk also keeps me up at night, but I don’t sleep much anyway, and that will always be there.