Investment Strategies For High Inflation, Panel From Alts Expo Dec. 2022

In this panel from Alts Expo December 2022, four experts discuss effective investment strategies in an environment of persistently high inflation.

The panel was moderated by Andy Hagans of AltsDb; panelists include Jason Cross of Redbrick LMD, Kara O’Halloran of FS Investments, and Cullen Roche of Discipline Funds.

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Episode Highlights

Analysis of the “official” measures of inflation such as CPI, and discussion over whether those metrics actually reflect the rate of inflation (including limitations in measuring the rising cost of services).
Discussion of expectations for both inflation rates and interest rates in 2023 and beyond.
The likelihood of a possible over-correction by the Fed, that could lead to deflation or worse.
Analysis of inflation’s impact on traditional asset classes, and a discussion on the strategies and asset classes that have historically performed well during periods of sustained high inflation.
The impact of labor shortages on inflation, including the likelihood of moving back to a pre-COVID environment with a reduced government role in labor markets.
Live Q&A with conference attendees.

Panelists

About The Alternative Investment Podcast

The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.

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Show Transcript

Andy: Inflation has been high for the last 12 or 18 months, but I think a lot of investors have questions right now, “Is inflation going to stay high? And if so, what are the strategies and what are the asset classes that will outperform in this environment that we’re in?” So, I’m gonna introduce our panelists real quick, and then we can dive into the content. But I’m gonna start with Jason Cross, managing director, capital markets and head of investor relations at Redbrick LMD. Redbrick LMD is a vertically integrated real estate management and development company with a primary concentration in the Washington D.C. area. And Jason leads Redbrick LMD’s Investor Relations Group. And, Jason, I know that you’re a former licensed securities professional. You have a lot of experience working with high-net-worth investors and family offices, so we’re very happy to have you with us today.

Jason: Well, thanks so much, Andy, and Jimmy, and the whole team. It’s a pleasure to be aboard today, and I’m thrilled to be here with our panelists and get into a stimulating conversation around investing during this inflationary time. So, thanks so much.

Andy: Absolutely. And by the way, everyone, excuse me if I sound a little bit like a frog. I think I have the same cold that Kelly referenced that she has. Hopefully, Zoom can’t spread any germs. Next, we have Kara O’Halloran, director of investment research at FS Investments. So, FS investments, in case you’re not aware, they’re a leading asset manager providing access to alternative sources of income and growth with over 35 billion, that’s billion with a B in AUM. FS Investments manages a growing suite of funds that are designed for advisors, individuals, and institutions to achieve a variety of financial goals. So, Kara is a friend of AltsDb. She recently appeared on our podcast where we discussed her take on real asset strategies. And I have to say that was a great episode, Kara. So, you’re always more than welcome here.

Kara: Well, thank you, Andy. I’m excited to be back. I enjoyed our conversation a few weeks ago and inflation certainly remains a very timely topic. So, excited to dig into all of that.

Andy: Absolutely. Last but not least, we have Cullen Roche, founder and CIO at Discipline Funds and author of “Pragmatic Capitalism” at pragcap.com. Maybe our producer can link to Cullen site in the chat. That honestly is one of my favorite investing reads. It has been for about a decade, and Cullen did not pay me to say that. But I wanna mention that Discipline Funds features the Discipline Fund ETF. So, that’s a low-fee, tax-efficient, globally diversified fund of funds designed to help you behave better and stay the course. Really interesting research behind that fund and investment thesis that ticker is DSCF. So, I encourage everyone to check out that fund. Cullen, welcome

Cullen: Andy, thanks. Checks in the mail for the pitch there. So, yeah, but I’m excited to be here. It’s always riveting talking about inflation, right?

Andy: It is for us. I mean, for us four here it is, and I think everyone who’s joining us today. So, I want to thank all of our panelists for joining the panel. And before we dive into the content, just a few quick announcements. If any of our attendees have any questions for me or for our panelists, please do use that Q&A function in your Zoom toolbar typically at the bottom of your screen. I’ll make sure to leave some time for Q&A towards the end of the panel today. So, the first question…I’m gonna begin with you Kara, and then we’ll get to the other panelists, where is inflation right now? Does the CPI accurately reflect what inflation truly is? And based on leading indicators, what kind of inflation rates do you think we’ll see going into 2023?

Kara: Yeah, so, I think if we look at what the actual CPI number is right now is 7.7% headline last month, we’re expecting 7.3% next month. But let’s talk about whether that actually reflects… I think that the question we really wanna answer is whether that actually reflects true inflation. And I think the first place that we often go and we’re thinking about whether that CPI number can truly capture, you know, it’s really hard to sum up our economy and inflation in just one data point. And I think this kind of goes to show that. So, I think rent and kind of the cost of shelter, so, owner’s equivalent rent is really the first place that we might look to say, “Hey, is this CPI number truly representing the inflation that we’re all feeling?” So, rent really lagged CPI on the way up.

So, we had these real-time data measures, things like apartmentlist.com that’s showing rent really, really accelerating before we saw it reflected in CPI, and we’re starting to see it…just because of the way that it is calculated in CPI, we’re starting to see rent moderation that is not necessarily reflected in the CPI. So, the real-time data is showing us that rent is moderating, but the way that CPI accounts for it, maybe it’s not fully reflected. I think it’s important to differentiate between a moderation and a decline, right? We’re not seeing… I don’t think anyone’s gonna walk into their landlord’s office next week and they’re gonna hear, “Oh, yeah, “your rent’s gonna be $600 cheaper next year.” Yeah, wishful thinking, right?

But I think it’s important also when we think about policy because that’s really what all of this boils down to. The Fed is aware of this. The Fed knows about this difficulty in calculation. We have these kind of problem children when it comes to trying to measure inflation, rent being one of them. Healthcare is another tough one. It’s very easy to measure goods inflation. It’s much more difficult to measure services inflation. So, the Fed is aware of this. Powell cited the apartment list data in his most recent speech, so he’s aware that we’re seeing some of these more real-time indicators showing that rent is moderating a little bit. That said, I think we might be a little…if we think about 2023, we might be a little out of consensus here with what we’re forecasting for CPI.

So, we think inflation’s going to remain pretty stubbornly high. So, I think we’re calling for roughly 5.5% in the first quarter of next year, probably moderating to about 3.5% by year-end. Really, that is coming now from wages. Wages have risen 5% or 6% year on year, depending on your preferred indicator. So, starting to see, you know, that wage-price or that wage pressure, very sticky area. So, unfortunately, 3.5% still uncomfortably above the Fed’s target of 2%. And still, you know, a heightened inflation environment that we’re gonna have to continue to invest through for the foreseeable future.

Andy: Kara, I think the Fed will be leaping for joy if they hit 3.5% by the end of next year, but maybe they will. Cullen, what do you think? Where’s inflation right now? Where’s it headed in Q1, in Q2?

Cullen: Yeah, it’s an interesting time. Kara’s comments are great. I agree largely with her broader thesis that disinflation of positive inflation is gonna continue to be, I think, the dominant trend in 2023. And that’s gonna be in large part contributed by the factors that Kara talked about with rents moderating and services starting to moderate as well. I think that the commodity markets are clearly reflecting right now that there’s a broader disinflationary trend. And I think that this is the point in the market cycle that gets kind of interesting because last year was, I think, a story all about really inflation risk and interest rate risk. And we’re now transitioning into more of a portion of the market cycle where I think the credit risk becomes potentially a bigger issue.

And you get into this situation where the Fed has moved so far so fast that now you’re getting into the point of the cycle where credit markets now have to start revolving all of this debt at higher rates, and that to a large degree creates this sort of unknown risk of actually, “Is there more downside risk to the inflation story going forward? Does this turn into more of a credit type of event going into 2023 and 2024, especially as housing remains relatively stagnant with the, you know, the surge and mortgage rates?” And so I agree with Kara. I think that, you know, the Fed likes to look at core PCE. I see core PCE falling to 3% by the end of 2023. So, I think the next year’s gonna be a pretty persistent story about disinflation and, you know, a falling rate of positive inflation, but still it’s gonna be uncomfortably high for the Fed, which in a weird way I think is sort of worrisome in its own way because it means that the Fed is likely to remain tight for all of 2023, essentially.

So, I don’t think that the Fed is gonna make this big so-called pivot until probably at best late 2023 or 2024. I think they could start to moderate the language. They’re certainly gonna start to pair back, you know, the size of the rate increases, or they’re gonna perhaps halt rate increases at some point in 2023 when they’re comfortable with where inflation is at. But I think there’s a rising risk here that the Fed is going to stay tight for longer than they probably should. And it creates sort of the opposite effect of what we saw in 2021, where the Feds stayed really loose for longer than they should have, even though a lot of the data was starting to confirm that inflation was problematic. And certainly, financial markets were already reflecting that, sort of a lot of the craziness that we saw in 2020 and 2021. And I think that there’s a rising risk that the opposite is happening now. And so, even though I see…

Andy: So, Cullen…and that’s actually what I wanted to ask about next. And, Jason, I wanna let you chime in in a second. But, Cullen, because you and I discussed this recently in a podcast episode, you think that the Fed might overcorrect and we might actually get deflation, or they might essentially tank the economy even harder than they mean to?

Cullen: Yeah. I don’t know if you’ll get outright deflation. I mean, that would be more akin to a true sort of credit catastrophes more akin to like a 2008. And I’m not there at all. But I do think that there is…I think there’s a significant risk or a rising risk that the Fed is gonna find themselves in a position in late, say, 2023 or early 2024, where the unemployment rate has moved uncomfortably high relative to their target. And they’re gonna find themselves in a position where they’ve gotta moderate the Fed funds rate back to, say, I estimate it’s gonna be back…we’re gonna be back to 2% to 3% faster than we’re…we’re more likely to move back to 2.5% or to 3% on the Fed funds, you know, with greater probability than we are to see a surging sort of 1970 style Fed funds rate that moves in the opposite direction.

Andy: Okay. Jason, how about you? What does your crystal ball say?

Jason: Well, let me take a look here. Well, you know, the interesting thing is that, you know, with December 14th coming up and, you know, the Fed meeting approaching and looks like the market’s pricing in about a 50 bp rise as opposed to the 75, it’s, you know, been the most recent movement. You know, to the point that Cullen and Kara mentioned as far as, you know, potentially easing off that accelerator, you know, we see that, you know, these macro effects have micro impacts locally. And so as real estate developers in D.C., we’re really looking at, you know, “What’s the impact on rents for the multifamily portfolios that we’re actually in development on right now?” And by the way, we think it’s a good idea to be delivering product a couple of years from now into a, you know, potentially supply-constrained market.

It’s interesting to consider that, you know, what we’ve seen in D.C. is that, you know, historically, we’ve had some resilience where our highs haven’t been too high, the lows haven’t been too low. And so, that whole lag that Kara was mentioning, we’ve seen that, it actually took some time for that inflation to show. But, you know, September ’21 to 2022, we saw, you know, 9% year-over-year growth here in this particular market. And you see that, you know, NMHC, National Multifamily Housing Council, is showing potentially another year locally of 7% to 10% growth. So, we still have a ways to go. And so, that’s where that whole lagging indicator if there is, you know, continued movement, you could see that lagging indicator because necessarily, the impacts of Fed action don’t show up sometimes for, you know, a quarter or two.

Andy: Yeah, that’s absolutely right. And that’s an interesting point about Washington D.C. being resilient. As far as I know, no one ever gets laid off in Washington D.C., right? Well, assuming then that inflation is gonna be persistent, it sounds like no one on the panel’s predicting deflation. And even if we hit like that 3.5% percent number, it’s still higher than the Fed’s target. So, you know, I think it’s a safe assumption, maybe not safe, but investors should have that assumption, you know, inflation may sustain for the indefinite future to just be higher than that long-term target. So what are the asset classes? What are the strategies that investors should use that have historically performed well during periods of higher sustained inflation? Jason, why don’t we start with you?

Jason: Sure. Well, you know, I know everyone’s stunned that we would, you know, recommend residential multifamily real estate, right? But really, when you take a look at that asset class, the fact that you do have, you know, dynamic cash flows in place, meaning that, you know, you can actually track with inflation and when you actually see wage growth and you’ve actually seen some evidence to suggest that, you know, there’s been rental recovery as far as incomes for renters. And so, when you actually can reset income, reset rents to track that income inflation, that puts you in a good position. I’d also say that when you look to markets that are supply constrained, there’s safety there as well. So, you know, in D.C., we have a multitude of factors that drive our economy.

Yes, you know, the government. But we also have the private sector, which has been, you know, recently diversifying. And so, you know, you look to markets where if one particular sector, say the public sector has to, you know, buttress the fact that the private sector is falling behind, that gives you, again, a lot of that stability. So, you know, looking into rental real estate, into markets where there are diversified opportunities for income and supply constraint in our case, it’s because of a height limitation of all things. Those are some areas that people can look for investment.

Andy: And, Kara, how about you? I know in our podcast episode, we talked about the RICE assets. Would those be your suggestion for investors who are concerned about inflation?

Kara: Definitely. But I think it’s also important before we go into the strategies for investing during inflation to talk about what inflation does to your traditional assets. I’ll go very quickly. We did do a deep dive in our podcast, so listeners can head over there. But I think, you know, if we talk about a 60/40 portfolio, I think the bond side, the fixed income impacts are pretty well understood. You know, your inflation is eating away at your income, and bond prices are being pressured by rising interest rates. We’ve done a lot of data or a lot of research. We have a team of brilliant quantitative strategists here who have done the research and the data has shown us that during periods of high inflation that is rising, so inflation probably peaked in June, but just a few months ago we were in this period of high and rising inflation, your forward 12-month return for equities is negative.

So, I think it’s really important just to set that stage, you know, to remind people that we are still in this environment that we’re probably gonna muddle through this volatility going forward. And inflation is really impacting both sides of your traditional portfolio and it also impacts the relationship between the two. So, during periods of inflation higher than 2%, the correlation between stocks and bonds typically turns positive. And we’ve experienced that this year and in painstaking fashion. So, yeah, I think these real asset strategies are going to be just continually important going forward. So, yeah, I use the RICE mnemonic, I’m a big sushi lover, so that helps me remember it. But it’s real estate infrastructure, commodities, and energy. Jason, we are totally in the real estate camp, too. So, we’re with you there.

I think when it comes to real estate, we really like real estate debt right now. I think if we think about the fundamentals still look good. I think, you know, if you’re thinking about it being more of an income-generated market next year given rise and cost of finance, I think we really like, you know, getting more defensive, being at the top of the capital structure benefit from that subordination because equity evaluations in real estate still do look pretty high. So, I think real estate debt is a really exciting area. But more broadly, I think just these real asset portfolios that can go into those four different asset classes and really be active, really be tactical, and develop more of kind of a full strategy solution is how we would recommend it.

Andy: Absolutely. Interesting points about that 60/40 portfolio. Cullen, I’m guessing you might agree with some if not all of that point about the correlation with the 60/40. So, you might have a slightly different philosophy here, though, you know, given your ETF and the strategy behind it.

Cullen: Yeah, I mean, our ETF is kind of a…to be blunt, it’s sort of a boring core holding. We, typically, in an environment like this, I would advocate for holding sort of an insurance sleeve of a, you know, portfolio to account for the uncertainty of the next 18 to 24 months. So, you know, like I alluded to earlier, I think we’re transitioning into this sort of strange environment where this has been an interest rate risk story and it’s evolving more into a credit risk story. And I think the question that the equity markets are gonna have to grapple with in 2023 is, “Does this turn into a real, you know, earnings recession and potentially a real credit event?” And in that situation, you know, it’s sort of strange because even though we’ll have…you know, I’m calling for 3% core PCE by the end of next year, it’s the rate of change that matters.

And that disinflation story is sort of the polar opposite in a lot of ways of what we’ve seen in 2021 and 2020 with the rising rate of positive inflation. And so, in that sort of a scenario, a lot of this from a global macro perspective becomes, to a large degree, a dollar story. The dollar has rallied because the fed’s been really aggressive on, you know, a sort of, I think, a flight to safety basis. The dollar has been the go-to. And as this evolves into more of a credit event, it’ll be interesting to see what foreign central banks do, how much, you know, their relative rate of change in their policy changes operates versus the Fed. I think foreign central banks are gonna be much more aggressive. The Fed is closer to the end of their cycle than they are relative to other foreign central banks.

And that means that the dollar story probably starts to flip around, which is interesting in the sense that when you look at sort of the falling rate of inflation and inflation hedges in general, I think that things like gold-managed futures, and weirdly super short-duration things like treasury bills are actually sort of a gift right now. I mean, I can’t remember being able to buy treasury bills at 4.7% for 20 years. So, in a weird sort of way, being able to lock in a 4.7% interest rate relative to what is gonna be in a year from now, I think a rate of inflation that’s much lower than that treasury bills, the safest instrument in the economy actually operate as a pretty good inflation hedge, certainly as a nominal principle hedge.

And so, the next 18 to 24 months I think are gonna be fraught with uncertainty. Even though it’s gonna be a positive rate of inflation, it’s going to be a falling rate of inflation that is consistent with probably, as Kara alluded to, negative equity prices. If you’re looking this on a global basis, the dollar story probably means that foreign inequities are more attractive than domestic equities. But even in that situation, I think it still makes a lot of sense to hold an insurance leave for the next 18 to 24 months here.

Andy: Yeah, I can’t argue withholding insurance. And I agree, there’s just uncertainty. So, that being said…and Jimmy gave our standard disclaimer at the beginning of the show, which applies to the whole show, and we’re not giving personalized investment advice here. But that being said, Jason, I’ll start with you. How do investors then approach allocating a portion of their portfolio to Alts or how should they otherwise, you know, tweak their portfolio in a sort of general way, given this uncertainty that we’re looking at, given that inflation is high likely to remain high-ish for the foreseeable future?

Jason: Sure. Well, Andy, I think it really underscores the importance of this particular forum, and what you and Jimmy and company are bringing to bear as far as different concepts and ideas that are timely here in the market. And at the same time also, you know, bringing to bear those advisors, you know, the CPAs, the financial advisors that can provide this type of counsel because, you know, these are historic times that we’re coming out of and going into, even at the same time. And so, I think it takes a team. You know, we’re very much focused on a team, and so, you know, that allocation is gonna be very personal based on, you know, risk tolerance, time horizon, suitability, all the things that we know make a difference. So, you know, it has to be done in consultation I think with advisors and investors. But what we find is that there’s often a sleeve that makes sense for all these different strategies based on, you know, one’s personal situation.

Andy: Fair enough, fair enough. That’s an answer that won’t get you sued, that’s for sure. But that’s an important point that, you know, tweaking a portfolio is always gonna depend on an investor’s individual situation, their timeline, their goals, and so on. Kara, do you have any, you know, rule of thumb? I guess that’s really what I’m asking for, if there’s any rule of thumb, or, you know, tidbit that an investor could take?

Kara: So, I don’t know about a rule of thumb, but I will …you used the word, how do investors tweak a portfolio? I might actually adjust that language to, I really think investors need to really rethink their portfolios given inflation, all of the uncertainties that we’re thinking, or that we’re experiencing, excuse me. You know, I think inflation’s…we’ve discussed on this panel, I think inflation’s going to remain uncomfortably high. Yes, it should decelerate, but it will remain uncomfortably high. And we talked about just the challenges that traditional assets face. And I think that whether we get inflation back to the 2% target, you know, whenever that happens, I do think that for the longer term, we’re entering a period, it’s called the end of the great moderation, we’re big proponents of that, where we’re really going to enter a period of higher macroeconomic and then market volatility.

So, we had, you know, this decade of falling interest rates, low stagnant growth, little volatility inflation in macroeconomic indicators that really translated to really low market volatility. And I think things like de-globalization are going to be big themes going forward. De-globalization has a direct link to inflation. And so really just, we’re in such a macro-driven market right now, and I think that just this…we’re gonna be in a period for a number of years of this macro-driven market that’s going to cause volatility. So, I think investors need to…you know, you really need alternatives now and going forward. So, Cullen, I totally agree with this, you know, the insurance sleeve, and I think, unfortunately, it tends to be that we bought the insurance after the accident already happened, right? And it’s not too late. I think we’re gonna be muddling through this challenging environment. I know, Andy, you’re probably looking for me to…I think we talked about a 60/40 becoming like a 50-30-20 or whatever it is. And I don’t know if that’s…again, it’s so personal, it’s so hard to come up with that rule of thumb, but I do think that alternatives need to be a very core part of investors’ portfolios next year and going forward.

Andy: I appreciate that. And, you know, the de-globalization, I know that FS Investments doesn’t have that trademarked or anything, but just because you and Laura mentioned it on our podcast , that’s really stuck with me. Cullen, do you have any thoughts on de-globalization? Is that gonna help set a floor on inflation rates going forward?

Cullen: I mean, honestly, I kind of think the de-globalization narrative is a little bit overblown. I mean, that would imply that, like, American consumers and American corporations are gonna stop outsourcing the production of goods and services to places like China and Vietnam and Malaysian. To me, Americans, like, they’re inexpensive goods and services, they like to be able to buy their cheap trinkets from overseas.

And that arbitrage does, especially as I think technology, you know, makes the world a smaller and smaller place. I think it actually makes it more and more attractive for globalization to actually increase. You know, the politics of this all get sort of messy and complex. But I think as a baseline long-term trend, I don’t think that the shrinkage of the global economy, I don’t think is changing. I don’t think we’re all going back to this world where, you know, we’re all like a 1940s Japan or something, where, you know, we all live on our own island and make our own stuff. I don’t think that American corporations ar…they’re a little too greedy, I think, to probably move in that direction and for the benefit of all of us, frankly. So, I don’t think that de-globalization is likely to be a meaningful long-term impact on inflation. I think that’s more of a sort of a narrative that I think was probably sort of a lot politically driven in the last, you know, four years or so.

Andy: Well, you know, I have a few questions. I wanna move into the Q&A because we actually have a couple questions that relate to that idea of de-globalization. And I think I agree with both of you that it can become a political narrative that, you know, maybe has been overblown. But, you know, at the same time, we’ve seen a lot of headlines of chip manufacturing and all kinds of manufacturing coming back to the states for various reasons. And we also, you know, coming out of 2020, in 2021, we saw how fragile our supply chain really was, and, you know, I don’t think it’s out of the question that we’re gonna see another geopolitical shock like we’ve seen in 2020, like we’ve seen in 2021. If it is the end of the great moderation, we may see a shock like that every year for the next 10 years or so.

We have a couple questions about labor shortages and how that’s driving inflation, which relates to domestic manufacturing, but also, you know, services and how that all affects the CPI, as well as we had another question about the wage demands of unions and just how some small businesses or even mid-size businesses, corporations really feeling that pressure, and that sort of, you know, again, raising the floor of the inflation rate, you know. I’m not claiming it’s gonna stay at 8% forever, but it may never get back to 2%. Jason, what do you think? You know, where does labor shortages fit into this conversation?

Jason: Sure. Well, I mean, it’s definitely a driver. You know, we’ve been fortunate, you know, here with our just experience around, you know, construction. We did experience impacts of inflation due to supply chain, not so much with labor. And that’s an area where we actually saw definitely greater than 7%, 8% growth that we saw in some categories over 20% inflation. But it’s since moderated. But we’ve been fortunate where we have been able to, you know, bring our resources to bear at the time that we’ve needed it and haven’t had any challenges from a labor perspective.

Andy: Kara, how about you?

Kara: Yeah, I think I agree. I think it really just adds to that…you know, it’s one of the stickiest areas of inflation, so, I think it just adds to those pressures, and we’re really starting to see, you know, those wages contributing meaningfully to CPI.

Andy: And, Cullen, you think that the, you know, labor, obviously, as Jason, Kara alluded to, it’s been this big component. Do you think it could roll over and stop driving it upwards, or do you think this shortage is just gonna continue for the foreseeable future?

Cullen: I do think it’s gonna moderate. I think a lot of the shortage…I mean, there’s a messy sort of demographic debate in all of this. You’ve got slowing rates of population growth, but you also have a shrinkage in the size of a workforce, the working-age workforce. So, it’s sort of this, you know, tug of war I think between those two big trends. In the long run globally, I think that the falling rate of population growth is the bigger driver I think in the long run here. The last few years were really messy in large part because, you know, the federal government was so involved in everything. And, you know, I mean, it was the perfect recipe for inflation and labor shortages in large part because the government was paying people to not to work.

So, you know, I think we’re slowly evolving back to this sort of pre-COVID type of environment. Are we gonna get back to, you know, the world of the 2010s? I don’t think we’re gonna get quite there, but we’re starting to see a lot of things sort of just, you know, revert back to where they were pre-COVID. Almost like, you know, the last two years, were just sort of a bad dream. And so I think that, you know, when you start looking at a lot of these things like commodity prices and shipping rates and even rents, I think you could even, you know, look at real estate and say, you know, “Hey, was the 40% to 50% bump in national home prices? Was that sort of just too good to be true?”

So, yeah, long story short, I think a lot of these more sort of…you know, I think of the global macro trends in sort of a lot of secular forces where you’ve got these trends of sort of globalization and technology and demographics, and I think that those are just a big anchor pulling down inflation. And, you know, the tricky part is that those are big slow-moving, you know, factors in the global macro economy, and it’s just not gonna happen quickly. But I think in, you know, by the time we get to like 2025, I think a lot of people are gonna look back at the sort of COVID period and say, “Man, that was a weird stupid time for the entire economy in the financial markets.”

Andy: It sure was. Yeah. I think we could all agree that we’ve been in for probably a weird couple years, even a weird decade, and point taken, Cullen about, you know, birth rate and demographics and, you know, we’ve all seen what’s happened in Japan where they’ve been fighting off deflation now for decades. Although in the United States, we have a much more open and generous immigration policy or effective policy where we still have positive demographic growth even though we don’t have a birth rate at the replacement rate. So, relating to all this, I had a question for Jason from one of our attendees. He says, or she says, “I’m curious about Jason’s comment about feeling good about delivering new inventory in about two years.” Jason, do you see current rates of inflation significantly impacting housing supply over the next couple years? And wouldn’t this then further fuel inflation at least in rents?

Jason: Absolutely. And so, you know, the opportunity to…in our particular case, you know, we’re delivering product that in our submarket because of our sustainability initiatives and the rest, there’s really no competing product that’s in our particular marketplace. And so to be able to deliver that will be considered a category-killing product into a market that’s already supply-constrained. If you’re looking from a real estate investment standpoint at opportunities to be able to, you know, outpace inflation, those are some market drivers and dynamics that are very positive. And so, that’s a key theme for our investment strategy.

Andy: As a real estate investor, do you worry about demographics at all, you know, with the birth rate and…

Jason: Pretty much so.

Andy: …being so low in the United States, you know, or do you just expect inflation, or, excuse me, immigration to basically overcome the demographic headwinds?

Jason: Yes. And that’s also why we are very particularly focused in a particular market. You know, our managing partners, you know, for a time had built and developed in some cases outside of market, even globally. But we have very strategically focused all in on D.C. because of the diversification of that particular market and the resilience of multiple different points, you know, defense, cyber and intel as a driver here to help buttress any types of softness in other parts of the economy in the labor market and, you know, people still coming into this region. So, that very much is a factor for, you know, where we are very specifically choosing to invest because we invest alongside of our partners, of our LPs. You know, we’re very much in alignment.

Andy: That makes sense, that makes sense. Kara, I have a question specifically for you. It’s my favorite mnemonic RICE. This attendee asked you to go through that RICE acronym one more time for us.

Kara: Sure. So, it’s real estate, infrastructure, commodities, and energy. So, really just making up what we view as a well-constructed or well-rounded real asset portfolio would have elements of all four of those.

Andy: And I have to plug the podcast episode that we did because it was all about investing in RICE in 2023. So, that’s on altsdb.com. And, Kara, you have your own podcast, could you give a plug for that as well?

Kara: Oh, sure, yeah, I’d be happy to. So, I do, I host the FS “FireSide” podcast. So, anywhere you get your podcast, Apple, Spotify…and, Andy, we’ll have to have you on. I’ll touch base with you after. We’ll do a little crossover. But, yeah, it’s available anywhere you get your podcast. We bring in our chief economist, she’s awesome. She was on your podcast, Andy, as well as other experts around our firm and we run a sub-advisor model here, so, a lot of our great industry partners as well.

Andy: Awesome. And I’m a listener, by the way. That’s a great podcast. Most investing content, I have to say, everyone, it’s pretty boring, right? I mean, I have to listen, I have to read sometimes because it’s my job, but honestly, the FS podcast in Cullen’s site, I honestly just read for years just because it was like my morning read. I don’t know. It’s a great read. And, Cullen, this question I’m gonna direct at you first, is our unemployment rate underestimating the true rate of unemployment? The questioner asked, “As Cullen alluded to the government was paying people to not work for far too long, the labor force participation rate is still at historically low levels. Any long-term concerns there?”

Cullen: It’s really easy to beat up on the BLS, the Bureau of Labor Statistics about the way that they measure all these things.

Andy: Well, let’s do it. Let’s beat ’em up. Come on.

Cullen: Well, it’s…you know, I used to do this a lot. I used to beat up on the way these things were measured and stuff, and then I really dug down deep into how they were measured and just it…this is really hard stuff to measure. I mean, measuring, getting an accurate read on inflation, for instance, is an impossible task. And that’s why there are 20 different measures and a million different components and, you know, they all weight things a little bit differently. So, I don’t want to be an apologist for the BLS because, you know, there’s weaknesses in what they do, but at the same time, these are really difficult things to measure. The way that they measure the unemployment rate with, you know, people falling out of the workforce, for instance, after, you know, they stop looking for a job after a little bit, you know, any, I think, common sense person would look at that person and say, “That person did not just choose to stop working. They’re actually unemployed.” You know, things like that. It gets tricky.

So, are we underestimating the current unemployment rate relative to the size of the workforce? I mean, sure, you could look at things like the U-6 rate, which is, you know, people would argue is maybe a little more reflective of an accurate unemployment rate. But that’s why there are…you know, it’s useful to look at all these different measures because you don’t have to only look at the CPI. You don’t only have to look at, you know, PCE for inflation, and that’s why the Fed does rely on all these different metrics. They like to strip out certain items because, you know, oil will go crazy over the course of a month and contribute, you know, a sort of misleading read on inflation to some degree. So, you’ve gotta look at a broad set of data. I think it makes a lot of sense to not just look at the headline unemployment rate, but to look at some of these alternative rates and, you know, there’s some phony information out there about a lot of this stuff, sort of conspiracy theory narratives. But it’s useful to look at a lot of these sort of more alternative sort of data points, I think.

Andy: Fair enough. Yeah, and that brings me, I have time for one more question. We’re about out of time. But I want to give each of our panelists the brief floor here to answer this one. I think this is a really good question. And this is more of a macro question versus being specific to inflation. But we have one attendee who asks that, “There seems to be a disconnect between the level of anxiety over the economy and inflation versus some of the other high-level economic or macro indicators. For instance, unemployment rate is low, the Dow is still pretty close to an all-time high, yet everyone,” the questioner says, “Everyone is anxious.” I think that’s virtually true. It seems like almost everyone is anxious. So is there a disconnect? Are investors overly anxious right now? Kara, let’s start with you.

Kara: No, I mean, I think that it’s a hard question to answer, right? I mean, I think there’s just so much uncertainty. And I think, like, markets are still just on a daily basis trying to price what’s gonna happen. You know, we get a strong jobs report and the market sells off. So, it’s just there’s…I don’t know about a disconnect. I think we’re just still facing so much uncertainty that we’re trying to price this in daily and figure out, you know, there’s still people out there that say maybe the Fed’s gonna engineer a soft landing. At the end of the day, I think, you know, whether or not we enter a recession next year or not, growth is slowing significantly. And we’re still just so much uncertainty. You know, I wish I had an accurate crystal ball, but I don’t know about necessarily a disconnect.

Andy: Fair enough. Jason, I imagine from your standpoint being in D.C. you might say, “What recession? What the heck are you guys talking about?”

Jason: Well, you know, that keyword that Kara was mentioning, uncertain is so key, as far as the, you know, the questioner’s query there because we know that, you know, the market is psychology, right? And the market can take good news, the market can take bad news, but it’s the uncertainty that is brutal. And I think that’s what, you know, you’re sensing right now. And, yes, D.C. can be a bubble. And, you know, we’re not complaining about that fact.

Andy: Cullen, last word.

Cullen: I think that we’re just sort of digesting a lot of the…you know, the way I actually like to think of the last sort of 10 years is one cycle. I don’t think of COVID as it’s, you know, its own sort of event. I really think of COVID as sort of the…it was the inevitable sort of blow off top of a bull market. And I think that a lot of the things that the government did and just the unique factors of COVID itself just exacerbated a lot of that. And so, we got this big blow off, you know, everybody, you know, stayed at the punch bowl a little longer than they should have, went back for more, and then, you know, dumped their head into the bowl during COVID. And now, we’ve all sort of woken up and realized, you know, “Hey, maybe we drank too much. And so, we’re just digesting this.”

And this is part of what makes, I think, processes like this somewhat difficult for the markets to digest is that this is not an event that happens quickly. Digesting, you know, the big excesses of the last few years especially takes time, and especially when the central component of this is real estate-driven, which I think a lot of this is, a lot of this…the current slowdown is revolving around residential real estate, that is just an inherently very slow moving sector of the economy. And so, this whole process is just…it’s gonna take longer than is comfortable. And so, in a way, you know, to use an analogy, this is sort of, I think, reminiscent of like the 2001 recession to some degree, where it’s just sort of this rolling slow-moving beast that is just a digestion of a big blowoff that occurred previously. And in the long run, it’ll all take care of itself. We’ll all look back and, you know, I have no doubt that the S&P 500 will be much, much higher in 10 or 15 years than it is today. But I think that the next, you know, sort of two to three years are fraught with uncertainty as we just sort of digest, you know, the big excesses of the last few years.

Andy: I think that’s a good way to put it, Cullen. Stupendous insights here from our panelists. We’ve run out of time officially. We have our next fund presentation is up here in a minute, so, I’m gonna cut all of you loose. Thanks again to Jason Cross from Redbrick LMD, Kara O’Halloran from FS Investments, Cullen Roche from Discipline Funds. Very good insights today. And, Jimmy, I’m gonna turn it back to you.