Each year about this time, I sit down and try to cobble together predictions for the performance of the economy and the performance of the CRE market in the coming year. Of course, I’m wrong every time. It’s not for lack of trying. I do try to think hard about where we’ve come, what things are likely to impact our market, add a splash of uncertainty and voila, predictive omelet…or more likely, dumpster fire. I give up. Tee up Yogi Berra. Periodically, amongst the prognostications wrapped in faux sagaciousness, I and other talking heads actually get one or two things right. More Brownian motion than insight. If you predict enough stuff, something is bound to actually happen.
Part of the problem is that we live in a period of rapid, continuous and unknowable change. Maybe everyone says that all the time, but it seems demonstrably truer today. All is mutable. All is opaque and contagion is our reality. Things that we always thought we knew are confounded. There is more discontinuous change than in the time before.
What’s a talking head supposed to do? Everything that is good might be bad. Everything that is demonstrably bad can be good. Or both. Schrödinger’s cat. Inflation is going down. That’s bad because that means there’s a recession coming. Inflation is stubbornly high. That’s bad, of course, because that means the Fed will continue to tighten. That means a recession is coming, too. Employment stays high; employment is not high enough. Both bad, see above. The Fed is pursuing a policy of restrictive credit formation through elevated Fed funds rates while our elected leaders continue to pass more stimulation. The Federal Reserve balance sheet matters! No, it doesn’t. There’re no negative externalities from the Fed printing as much money as they need to meet all their obligations and desires. Yes, there are.
There are apparently troubling and unknown risks in the hedging posture of many financial institutions, particularly in the FOREX market, or not. Isn’t hedging an unalloyed good? The US trade deficit is bad, we’re getting outproduced! But hold on, we give foreigners little bits of paper that everyone pretends are valuable (no, not Bitcoin) which the Treasury prints without end and we get actual stuff in return, that’s good!
Geopolitical risk remains elevated (that’s such a delightfully circumspect turn of phrase used by the self-proclaimed adults in the room where “Holy Shit, we’re in trouble” might suffice). Something really bad is bound to happen, or it’s not. Maybe, we’ll just carry on with this gentle boil that we’ve learned to live with for years and years. Crime is up! No, it’s not! Pick your data set and everyone else should shut up. Democracy is under attack; we’re doomed to wear red hats! No, our democracy is resilient. No worries! American exceptionalism is fading as a totem of American political life, and that’s bad, or is it good? Inequality is on the rise, or it’s not, depending on what data set you look at. The country is riven by institutional racism which threatens the underlying pillars of civil society, or it’s not.
The yield curve is inverted. We’re doomed. The inverted yield curve has predicted 11 of the last 7 recessions. So, the yield curve doesn’t matter, and all that fancy monetary stuff doesn’t actually touch the economy. Cue Modern Monetary Theory.
It’s exhausting and one could go on in a Manichean dialectic sort of way, tit-for-tat with folks with lots of degrees and pretentious inches of print in academic publications picking sides and leaning in. (All that’s not to mention our entertainment glitterati who think, for reasons I can’t fathom, that their opinions should matter.)
So, I have concluded that bloviating with a straight face about what’s going to happen in 2023 in this chaos of fundamental disagreements over critical first principles is a waste of energy (or not serious and, God knows, we’re always serious here).
So, I thought I would take this space to describe the macroeconomic and geopolitical world I’d like to see in 2023. To hell with the facts, this is the entitlement age and I’m entitled to be a fabulist. So, here we go with a prospective alternate history, if you would.
I want inflation to begin to abate, but neither too slowly nor too fast. We’re going to have a recession and I’d like the Fed to get on with it, if it’s the nice little recession we all expect. The yin and yang of restrictive monetary policy and expansionary fiscal policy will ultimately be won on the monetary battlefield. Inflation is and always will be a monetary phenomenon. With inflation staying above the Fed’s rather phantasmagorical obsession with a 2% baseline, coupons and cap rates will remain elevated. That means a vast proportion of all hard assets and financial assets will be, in the circumstances extant next year, overvalued. Remember, there are no bad assets, just bad price points.
I’d like to see a nice little distressed debt bulge, neither wave nor ripple but bulge against an economic environment with more than a whiff of stagflation. Winners and losers will abound. The days where it was pretty easy to make money are over for the foreseeable future. Everything will be harder. I’d like to see more distressed loans and more distressed platforms. (Sorry for those of you who might own the former or are the latter.) I want to see a period of consolidation, of M&A and the structural changes attendant upon those types of transactions. I want to see legal fees go up. (Well, that’s probably something I shouldn’t say, but hey, this is my wish list not yours, isn’t it?)
I remember workouts can be fun, but I don’t expect a lot of lavish closing dinners.
I trust the government will continue to dither. Our two malignantly and reflexively hostile political tribes will continue to wrestle to little point or effect in Washington and around the country over the levers of policy. Gridlock might not always be a good thing for business, but it’s going to be our thing this year.
Notwithstanding, the government will continue to expand into the economic sphere and more and more decisions will be driven by the dictates of the regulatory state. There will be circumstances where, for reasons good and bad, risk is socialized and private return is preserved. I hope to see significant dollars flowing into those trades (think all things ESG and infrastructure).
In all other respects, the bureaucratic instinct will continue to impose what amounts to a growing transactional friction-type tax on business, making transactions more expensive. No matter how much of a fabulist I want to be, I can’t seem to gin up any energy to hope for anything much better here. I hope that while liquidity will be dear, it will be available.
Financial engineering will be king. One won’t be able to do next month what one did last month, rinse and repeat, and make money. So, those for a penchant for out-of-the-box thinking will win.
New technologies will develop and old ones, such as liquidating trusts, will be back in currency. We’ll investigate credit risk transfers and will be fascinated with risk-based capital transactions as many financial institutions’ risk-based capital ratios will face stress and bank examiners will continue to exert pressure on commercial loan concentrations (particularly CRE).
On the home front, I want to see stability in the quality of our social interactions here at home. Maybe it will continue to coarsen, but I’d like to think the social contracts will not break. Ditto, I want democracy to be safe and the broad patterns of American life not to be wildly disrupted. While surely political strife will continue, seemingly getting louder and louder, it will be contested less and less as the government is fundamentally unable to engage in meaningful, directed change.
As we begin to traverse to the formal beginning of the next election cycle (that’s pretending that there are actual cycles and we don’t just do this day in and day out in essentially a permanent election campaign), I want to see government action increasingly constrained as the tribes, er parties, begin to circle the wagons to think, almost exclusively, in a reptilian sort of way, about how to preserve their careers through the 2024 election. Gridlock will only get worse. Thank you for staying out of our way.
On the geopolitical front, let’s just keep everything on the same low boil we’ve come to tolerate these past several years. No wildly intolerable denouement in the Russian invasion of the Ukraine. Nothing kinetic pointed our way from the North Koreans or Iranians; a continuing moderately independent acting (but surely not independent) Taiwan wouldn’t be a bad thing. And while we’re at it, a more engaged and less confrontational China would be delightful. I’m not so silly as to wish geopolitical risk and violence away, but I really don’t want to have to think about digging a hole and jumping in with my go-bag.
You may have noticed that while I’m in the wish business and not the predictive business here, I’m not wishing for halcyon days of wine and roses, where life is beautiful all the time (credit to Jerry Samuels). That would be silly. I’m a fabulist, but not a silly fabulist today. What I’m hoping for is a reasonable geopolitical and macroeconomic environment not wildly inconsistent with our desire to continue to conduct business. I want to see transactional velocity return. I want to see people making bets about the future. I want to see people who think they know what’s actually going to happen putting money to work based on those theories. It will surely be harder to make money in 2023, but we can get stuff done. I want innovation and engineering to be crucial (fun for me). In chaos lies a considerable quantum of opportunity.
Look, the combined consequences of black swans, opacity and contagion surely means that more could go wrong than could right and therefore a certain amount of caution is required in executing your 2023 business plan. But, folks, there’s a pony in there somewhere and it’s our job to go find it.