RiskBridge Road Trip

July 27, 2021


We had the opportunity to travel to the 13th Annual Rocky Mountain Economic Summit (RMES) in Victor, Idaho, near Jackson Hole.  RMES is one of the most premier and exclusive events of its kind where top economists and entrepreneurs gather from around the country to discuss economic and business issues facing the United States and their global interdependencies.  The event, co-hosted by the Bronze Buffalo Club and the Global Interdependence Center is where Wall Street theorists meet Main Street practitioners in the shadows of the majestic Teton mountains. 

Over two days, many great speakers and panel discussions covered fiscal and monetary policy, inflation, healthcare, politics, entrepreneurialism, cybersecurity, sports & entertainment, and family legacy.  Here are a few highlights.

Pandemic Update: It’s Not Over
The consensus opinion among conference attendees is that they are tired of hearing about the pandemic.  Unfortunately, Covid-19 and its variants do not care.  

David Kotok, Founder, Chairman, and CIO of Cumberland Advisors (and a RiskBridge Advisory Board member), made a convincing case that Covid-19 is not a “black swan” event.  Black swan events are defined as being a high-profile outlier. They are hard to predict and so rare that they are beyond the realm of normal expectations.  David showed a slide of 19 pandemics over the last 700 years and convincingly argued they are the norm, not the exception. 

According to Kotok, the historical analogy for Covid-19 is not the 1918 Spanish Flu but the 1957-58 Asian Flu.  

“So what happened?  President Eisenhower vaccinated the entire military of the United States.  Some of the public was vaccinated, too, but there was vaccine hesitancy.  The result of resistance to vaccination has always been more death and more disease.  Every single time.  No exceptions.” 

“So you look at the lessons, and what do you see?  You see that social distancing prevented disease, and vaccination prevented death.  Nothing has changed.  The United States and the world remain mired in a global pandemic.” 

You can read David Kotok’s full remarks at the 2021 Rocky Mountain Economic Summit here.

We believe this pandemic is not a “black swan” because we’ve seen this story before in history.  Sometimes human behavior is more predictable than disease.  

America Untethered: Migration Economics 
American businesses, C-suite executives, and employees are moving away from major coastal urban centers.    

According to one of the nation’s leading moving companies, the 2020 Atlas Van Lines Migration Patterns Study found millions of Americans relocated in 2020 because of Covid-19. 

Idaho, where the conference was held, led the nation in “inbound” moves in four of the last five years. Rounding out the top 5 “inbound” states were North Carolina, Maine, New Hampshire, and Alabama.  The top five “outbound” states were New York, Illinois, New Jersey, Louisiana, and West Virginia.  RiskBridge’s home state of Connecticut turned “balanced” after a decade of “outbound.”  Thank you, New York City.

For the first time since 1995, California was classified as “outbound” and Utah as “inbound.”  One speaker suggested the Utah Realtors Association should give California Governor Gavin Newsom the “Realtor of the Year Award” for driving thousands of families out of California and into the welcoming arms of Utah, a state with a low unemployment rate of 2.7% and a business-friendly environment. 

We believe one unintended consequence of American migration is the destruction of housing affordability.  In the last decade, the nearby town of Jackson’s cumulative population growth was 9.7%, exceeding growth rates for Wyoming (2.3%) and the United States (6.3%; U.S. Census Bureau).  One real estate mogul told the conference audience that Jackson residential construction costs currently run a whopping $1,250-$2,000 per square foot, citing a shortage of skilled trades craftsmen, rising materials costs, and an influx of new residents.  I would add the Fed’s cheap money policy to the list of causes of deteriorating housing affordability.

A Commercial Real Estate (CRE) Top?
Based on RiskBridge’s analysis, the migration of businesses, executives, and employees from major urban areas is creating a distressed credit investment opportunity related to commercial real estate (CRE).  We went into RMES to explore whether or not CRE property owners and their lenders are “hiding the ball.”  We left the conference confident that they are, and we think our investment thesis will be proven right in the next 3-5 years. 

The framework for this investment opportunity starts with historically low interest rates and CRE cap rates, rising costs for wages and materials, and the tremendous uncertainty regarding how companies will reposition work requirements for employees through the remainder of the pandemic and beyond. 

The pandemic has caused businesses, academic institutions, and government agencies to seek three things: a reduced building footprint, lower total occupancy costs, and greater flexibility.  This may be good news for employees and business executives, but it is potentially devastating for property owners and investors who have deployed capital to commercial real estate at meager yields (high prices). 

According to the same real estate mogul, some of the hottest markets for CRE space include Phoenix, Las Vegas, Boise, Dallas, Austin, and Nashville (“inbound” beneficiaries”).  This comes at the expense of “outbound” urban centers, including New York City, Chicago, Seattle, San Francisco, and Los Angeles. 

Class A cap rates in “inbound” cities are below 4%, which implies all the good news is already in the price.  In “outbound” cities, subleasing rates are high: 9% in Los Angeles, 30% in Manhattan, and 50% in San Francisco.  This is important because rising subleasing rates are a reliable and statistically significant predictor of commercial real estate market tops. 

Perhaps the most blatantly obvious sign that we are in a commercial real estate bubble, in our view, was when the Chairman of a major commercial office agency was delivered to and departed from the conference grounds in a beautiful, matte-black, UFO-like helicopter.  There’s your sign. 

There was intense debate over the future of the economy and inflation.  Most economists said inflation is “transitory,” but no one clearly defined what they meant.  Business owners and CEOs talked about raising wages to attract skilled workers and plans for higher prices for their customers.  Theorists vs. practitioners. 

Two areas of consensus among attendees: the pandemic has changed the economy forever, so we’re not going back to a 2019-style environment, and the U.S. economic activity is decelerating. Remember, the consensus is frequently wrong.

Decelerating economic activity and inflation stuck above its 2-year moving average is the RiskBridge definition of stagflation. 

Charles Evans, President, and CEO of the Federal Reserve Bank of Chicago said he expects the U.S. economy to grow 7% y/y in 2021 and slow to 3% y/y in 2022.  This is in line with RiskBridge Advisors’ assumptions.  Our agreement with Evans stops there.

Evans forecasts 4% unemployment by the end of this year, “transitory” inflation, and no policy rate hikes until 2024.  We consider these statements incongruous.  In our view, the U.S. cannot add 3 million new jobs in the next six months without higher wages; labor will take a larger share from capital. 

I had the pleasure of moderating a lively GIC roundtable discussion regarding labor productivity.  One interesting viewpoint was that the lack of investment in education and skills training had put the United States at a competitive disadvantage.  An OECD study of 15-year-olds in 80 nations ranks the U.S. 25th in mathematics, science, and reading (right behind Czechia and just ahead of France).  China ranks 1st (Beijing and Shanghai), 3rd (Macao), and 4th (Hong Kong).  Singapore was 2nd, and Estonia was 5th.  The Federal budget earmarks $79 billion for education, one-tenth of the U.S. military budget of $790 billion. 

One discussant postulated that traditional measures of productivity taught by and learned from economists might be irrelevant in today’s information-based society.  

A former central banker in attendance asked if a new American industrial policy was the answer.  Industrial policy refers to efforts to promote specific industries that the government has identified as critical for national security or economic competitiveness.  Supporters suggest it is essential to respond to China’s state-led development and secure critical materials and technologies to achieve the United States’ strategic vision and grow the economic pie.  Critics argued that an industrial policy distorts the free market allocation of resources and rewards companies not on their merits but their ability to influence members of Congress. 

One vocal attendee said an industrial policy is “un-American”, but when challenged by a comment that the U.S. military-industrial complex and the fracking industry are, in effect, de-facto industrial policies, the roundtable guest stared blankly into his cheesecake.

Bottom line:
A 60 basis point collapse in 10-year Treasury yield since March continues to be consistent with the idea that the global economic recovery is slowing.  The future path of the economy looks to be dependent on rising productivity offsetting longer-term inflationary pressures. 

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