Transcript: Maria Vassalou – The Big Picture
The transcript from this week’s, MiB: Maria Vassalou, Goldman Sachs Asset Management, is below.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra, extra special guest. Maria Vassalou has a fascinating history and background, London School of Economics to Columbia School of Business, where she actually was a professor for over a decade, and started consulting to the hedge fund and financial services industry. And that led her to various jobs at Wasserstein Perella McKinsey’s Asset Management Group.
She worked with George Soros, she worked with Steve Cohen at SAC Capital, and ultimately ends up joining Goldman Sachs Asset Management Group, as co-CIO, a fascinating approach to macro, very quantitatively driven and very academic research-oriented. She wants to know exactly when this, that and the other thing happens, what does it mean for this segment of the market? When do you own growth? When do you own equity? Why does certain anomalies persistent? And why do some seem to get arbitrage away fairly quickly?
I found this to be an absolutely fascinating conversation, and I think you will also. With no further ado, Goldman Sachs. Maria Vassalou.
Tell us a little bit about the sort of work you did, how relevant was the academic research to what you’re actually doing today.
MARIA VASSALOU: Well, actually, it sounds very unusual to go from academia to the industry, and usually it’s not considered a very successful path. But in my case, it was very helpful because I had the opportunity to spend over 10 years doing intensive research in the intersection of macro and finance and asset pricing. And all these questions that I was trying to answer had direct applications to hedge fund strategies and portfolio management.
And so, actually, part of the reason I moved to the industry was because while I was doing this research and presenting it around, and publishing it in academic journals, it was attracting attention from the industry. And I had the opportunity to be a retained consultant for Citadel, for Deutsche Asset Management, and then eventually also for Soros Fund Management. And so along the way, I was getting offers to join the industry. And finally, I decided to join the Soros.
RITHOLTZ: So it wasn’t like a big eureka moment, it just gradually became apparent that you were working in a space that was very valuable to people managing capital on a very, let’s call it, aggressive basis. Just, hey, we’re looking for alpha, we’re looking to outperform. And what Maria does could be really useful to us.
VASSALOU: That was certainly part of it. There was also an intellectual, like, curiosity aspect to it. Because when I was doing that work, it was also the time where behavioral finance became more prevalent, if you like, and I was always on the camp of rational, risk-based explanations for various asset pricing phenomena. And my view was always if an anomaly persists and it doesn’t go away, then —
RITHOLTZ: Maybe it’s not an anomaly.
VASSALOU: — maybe it’s an anomaly. Maybe it’s risk based and it’s a risk factor that we haven’t really accounted for. And so, a lot of my research was related to trying to uncover what were the underlying risk factors. And the place where I was looking for this risk factors was in the real economy. So I was relating asset prices to GDP growth, to investment growth, to default rest, to factors like this. And so, I was providing explanations for asset pricing anomalies such as the small cap effect, or the value effect.
RITHOLTZ: Those were the first two that popped into my mind when you said, hey, is this truly anomalous, or is there a risk factor? Some people have said small caps tend to be more volatile, more risky. That’s where the additional performance comes from. When we look at value, a lot of people say, well, they’re widely disliked that’s why they’re cheap. So there’s a behavioral side. How do you crunch the numbers on that, and where do you come out on small cap and value?
VASSALOU: Yeah. It was actually very interesting because when I looked at the small caps, actually, if you dissect the small caps, you see that the small-cap effect always exists in the smallest of the small caps, and it’s related to default risk.
RITHOLTZ: Wait a second. So there’s a small-cap effect. And then within small caps, there’s a micro-cap effect and even smaller-cap effect?
VASSALOU: Yes. And what happens is, the small-cap effect is related to the default probability. So I have a paper where I computed default probabilities based on Merton’s model, and I did this for the whole cross-section of assets. And then I sorted them, and created the deciles and so on, and tracked how the behavior is over time. And of course, you see that depending on the part of the business cycle you’re going through, the default probability varies over time, and it increases during downturns of the business cycle, and so on.
And when that happens, then the small-cap effect becomes much more prominent, and so you see it in the whole cross -section of small caps. But when the default probabilities are lower, and you look at the whole cross-section of small caps, it’s not so apparent. So people say that it goes away, but it doesn’t really go away. It’s a matter of magnitude than where you’re looking for it.
RITHOLTZ: Oh, that’s really interesting. What about in the value space, do you see the same issue of what Benjamin Graham called stubs or cigar stubs? Is that the same default risk when stocks become very, very cheap, or is there something else at play there?
VASSALOU: In the case of value versus growth, it’s more related to the level of GDP growth and investment growth, and the different sectors of the economy. So it’s not so much a default aspect, but it has to do with a variation of real GDP growth.
RITHOLTZ: So when GDP is growing rapidly, I would assume you would want growth stocks. And when things are going sideways, there’s a greater margin of safety with value. That’s the way to go?
VASSALOU: Exactly. And that’s why you saw last year, for instance, when GDP growth started becoming a little bit more muted and expectations were for a lower GDP growth going forward, value stocks outperformed growth.
RITHOLTZ: By a huge margin, right?
RITHOLTZ: Big, big disparity.
VASSALOU: Yeah. So at that time, I would go to conferences and publish papers and then make those arguments. And then I had other colleagues that I would try to provide behavior explanations. And similarly, with the momentum effect, which I had related to corporate innovation, as I was calling it, which was —
VASSALOU: Innovation, which was really a firm level total factor productivity, so how much innovation companies produce, and how long they can remain leaders in that innovation to really maintain that momentum.
RITHOLTZ: So a company becomes very innovative, you get a little bit of a flywheel effect.
RITHOLTZ: And that innovation DNA starts to spill over into everything they do. Is it just that simple?
VASSALOU: Right. But then it’s a matter of being able to maintain this. And —
RITHOLTZ: Can companies maintain this indefinitely, or is there a sell-by date?
VASSALOU: Usually not.
VASSALOU: And so they go into cycles, and it also relates to when they are losers, you know, what’s the probability of recovering, and it really has to do with whether they have the ability to innovate and get out of that trap. So you can see a very high correlation between losers and winners with respect to how they perform on that measure.
But, anyway, I had all these ideas about how all these different phenomena were formed and what was driving them. And of course, my colleagues on the behavioral side had different ideas. And so, we were always debating these topics at conferences and through publications. And at some point, it became to me a little bit repetitive and I felt like nobody could unequivocally prove their point as to —
VASSALOU: — who is really right. And so at some point, I thought, well, if I can go and manage money based on these risk-based explanations and based on the way I understand how the world functions, how the markets functions, if that works, then that’s one form of justification of what I’m doing.
RITHOLTZ: Really intriguing. It’s sort of like the John Saxe poem about the blind men describing the elephant, one doesn’t have to be right or wrong. They could both be right; you’re just approaching it from a different angle. Is that fair? Or is it clearly one is right and one is wrong, and that’s that?
VASSALOU: I think it’s much more nuanced. And as the time goes by, I think the two lines get blurred also because of technology, because of the increased presence of retail investors in the markets. The market microstructure has changed. And so it’s much more common now to see prolonged deviations from fundamentals in the market, and we’ve seen that recently as well. And so I wouldn’t say that one approach is right and the other one is wrong. But maybe it’s a matter of timing. I think the risk-based explanations need longer time to play out. Some of these behavioral drivers are more short-term drivers.
RITHOLTZ: So you were consulting to the industry while you’re in academia, that had to make that transition when you finally decided to jump in with both feet. I’m assuming you were prepared for what you were jumping into. It wasn’t a big shock. Or am I wrong? Once you left the quiet confines of academia, Wall Street is still a shock to the system.
VASSALOU: Well, it was certainly not exactly a shock, but I had to get adapted to it. But I am someone who is quite adaptable. I left my country. I lived in six different countries. I came to the U.S. And so, you know, I’m used to changing environments and try to adapt to these new environments.
Certainly, going to Soros was a big eye-opener. And also, I was there during a very interesting time in the markets because —
RITHOLTZ: What years were those?
VASSALOU: I joined in the summer of 2006.
RITHOLTZ: Were you there for the financial crisis?
VASSALOU: Pretty much. Actually, I developed my strategies and built the quantitative strategies group from the summer of 2006 onwards, and I started running my strategies with money in March of ’07, so soon before the quant meltdown —
VASSALOU: — which was interesting. And so, certainly, I had a baptism by fire in the markets, but they do us a great experience. We did very well during the quant meltdown. And it was also an opportunity to see up close what was happening behind the scenes in the markets, how the financial crisis was developing. And also it was very interesting because even though George Soros had to retired from active investing, when he saw what was happening in the markets, he came back. And so I had the —
RITHOLTZ: Undecided (ph).
VASSALOU: Yeah. And so I had the opportunity to observe him up close, to listen to his views, to interact with him. And that was certainly a great experience.
RITHOLTZ: I can imagine. So when you go through a substantial macro event, whether it was the quants crash, or the financial crisis, or even the pandemic, does that send you back to your models to tweak them? Do those giant events affect how markets behave subsequently, and that leads you to have to make some changes, or, hey, the model is going to do what the model does and it doesn’t matter what happens out there?
VASSALOU: Well, quant models always need to be evolved. So you can’t build it —
VASSALOU: Yes. You can just build it and then forget it. But it has to be done in a way that keeps up with the developments in the market. So for instance, when the British referendum happened, well, we didn’t have such an event before in the market.
VASSALOU: So that’s not something where you want to make your model adapted to, because we’re not going to be having these events all the time. But that’s an instance where you want to take your model and stress test it to see how it will behave depending on different scenarios that may transpire as a result of this event. So that’s what we would do, and then we will decide is whether to take down risk or leave the risk on and so on.
If you have other phenomenon like, you know, changes in correlations between assets, or changes in the level of volatilities, these are things that you want the model to adapt to going forward and incorporate this information into the model. So, in that case, you want to evolve it, or there maybe factors that were not present before and you want to inform the model with it, for instance, how the monetary policy changes over time, the fact that we had QE for a long period of time. All these things are things you want to include in the model. But you have to be selective and really treat each case separately.
RITHOLTZ: So you’re working with George Soros, known as a big macro trader. He makes big bets about these large events. You end up going to Steve Cohen in SAC Capital. He’s much more of a granular trader. He is not necessarily looking at the big events. He’s looking at things really where the rubber meets the road, so to speak. What was that transition like to go from a very top-down approach to somebody who’s, you know, right there in the weeds with the rest of the trading desk?
VASSALOU: Yes. Another the great lesson, and I was still a global macro portfolio manager with my own silo at SAC Capital. But as you said, at Soros, it was all about big macro bets. And at the SAC Capital, it was all about risk management. So even though when I came from academia to Soros, I would look at how they were running the portfolios and I was constantly scared because I felt they were taking way too much risk compared to what I thought from an academic perspective they should be doing. Of course, I was nervous at that time in the profession.
Then I went to SAC and I realized that, actually, being careful with risk management is very much respected, and even more than what I thought should have been happening at Soros. And so I spent the subsequent years trying to refine my models, make them much more smooth in terms of their return stream. I’ve focused much more on risk management, downside risk hedging. And I think the models became better as a result.
RITHOLTZ: So let’s talk a little bit about how you ended up at Goldman. You were at Columbia School of Business, where you were teaching. You were at Soros and SAC Capital. What attracted you to Goldman?
VASSALOU: Well, actually, the whole asset management business is changing. So we went from a period where hedge funds were really the hot area to be and, of course, there are all these big hedge funds that were developed over time. But over time, as you know, there was this big shift towards passive investing. And so, that was a big challenge for hedge funds.
At the same time, we had all this decrease in volatility and financial repression because of the QE. And now, the extra liquidity that was in the markets that made trading in hedge funds much more difficult, if you like, in terms of providing superior returns.
RITHOLTZ: I’m glad you brought that up because if you look at hedge fund performance before the financial crisis, there’s a lot of alpha generators. The hedge fund industry, generally, is outperforming their benchmarks. I mean, not just the top decile, as a group, they seem to have done very well. And then post financial crisis, it became very hard to generate alpha, and there was a huge gap between the big winners and the losers. Are you attributing that to zero interest rate and quantitative easing, or did things just change so much, people didn’t adapt quickly enough?
VASSALOU: I mean, my strategies were always in the space of relative value across asset classes. So there, there was all —
RITHOLTZ: Didn’t make a difference.
VASSALOU: Yes. There was always some volatility to pick up, and so the strategies kept working. But by and large, in the overall industry, if you look at long/short equity, there was very little, you know, within asset class, volatility to pick up. And also you have a period that because of this extreme liquidity and quantitative easing, equities were performing extremely well. And so being passive and just holding the index —
RITHOLTZ: Without a fight.
VASSALOU: — you were doing great.
VASSALOU: So what was the point of getting into hedge funds, having zero beta exposure, or going into other strategies? And so, you saw that the hedge fund industry started changing over time. A lot of traditional macro funds actually started becoming more equity-oriented funds, so including a lot of equity exposure, just to try to pick up beta in their strategies. And also, there was an increased consolidation of the industry towards bigger managers.
But to me, at the same time, I was finding this concentration on passive investing also problematic because passive investing works when the markets are efficient, and the markets are efficient when there is enough trading happening for new information to be incorporated in the prices. If everybody is a passive investor, then you don’t have this mechanism in place to incorporate information in prices right away, to really benefit from them. So —
RITHOLTZ: So how much active management does there have to be for price discovery to really take place? And I’ve asked people like Andrew Lo in MIT who said, you can have 90 percent passive, the remaining 10 percent is where all your price discovery will take place. Does that sound like it’s a lot, or do you agree with that perspective?
VASSALOU: Andrew’s answer I think derives from the idea of the marginal investor —
VASSALOU: — as we say in academia. So all you need is a marginal investor to —
RITHOLTZ: Who’s rational and always ready to take advantage of opportunities.
VASSALOU: Yes. But it’s not very clear who the marginal investor is in practice —
RITHOLTZ: Or if they even exist.
VASSALOU: If they exist. Then what I have noticed through the 15 years that I’ve been managing my own strategies is that the markets have become a little bit less efficient over time —
VASSALOU: — in the sense that you see longer deviations from fundamentals. Eventually, they do correct, but you see longer deviations from fundamentals. Sometimes you see more intraday volatility in certain events, especially around announcements and so on. And so maybe this is attributable to an increased exposure to passive management, maybe it’s attributable to more noise traders, what we used to call noise traders —
VASSALOU: — which are effectively retail investors.
RITHOLTZ: Right. Well, let’s stay with this a second because I’m intrigued by the concept of the market becoming less efficient. When I look at the ‘60s, the ‘70s, the ‘80s and ‘90s, it seems as if we’ve gotten more and more heavily focused on technology and program training, and now algorithmic and high frequency trading. And I would assume that that would make the market more efficient and harder to spot arbitrage opportunities and these various anomalies. You’re suggesting passive is creating less efficiency. Does that mean there’s more opportunity for active traders?
VASSALOU: I think there is more intraday trading now than it used to be. So you have the passive investors and then you have a lot of intraday trading, and that’s based on algos that are looking for short-term trends to capitalize. Some of them are AI-based, so they may be looking for particular words, and then they will extrapolate from that. For instance, it was interesting to notice in the last Fed meeting, Chair Powell used the word disinflation a few times and —
RITHOLTZ: Not deflation, just slower rate of inflation.
VASSALOU: Yeah. So that means that the inflation is coming down. And the markets will start rallying as soon as he will pronounce that, not because he was suggesting an inflation, by and large, is coming down. But he did say that in certain segments of the CPI, we were observing disinflation, such as in the goods markets. And that could have been a case of, you know, AI-based algorithms that were utilizing words to really take advantage of developments in the markets. And the following day, the market will reverse the rally, once people will digest what he actually said.
RITHOLTZ: So perhaps some of these algorithms are making markets less efficient then because they’re keying on a word, but not necessarily the full meaning of the speech. Is that what we’re thinking?
VASSALOU: They certainly create more intraday volatility. Maybe in some cases they make them more efficient, maybe in some cases less efficient. But I think what is likely the case is that they create more intraday volatility.
RITHOLTZ: So let’s bring this back to how does this attract you to Goldman Sachs? You know, back in the ‘80s, and ‘90s, it seemed like these young hot shots would start at Goldman. They’d put together a trading record. Goldman would basically seed them, become their prime broker and send them out to be hedge funds. Now, it almost sounds as if the opposite is happening. Hey, at a big firm with Goldman, we have so many different tools that you can use, that you don’t get at a small hedge fund. You’re better off working at the big firm. Did that play into your thought process? Tell us a little bit about that.
VASSALOU: I think the future of the industry is really in the solution space.
RITHOLTZ: Solutions space?
VASSALOU: Yes. That’s really what institutional investors need. And what we needed —
RITHOLTZ: Let’s define that a little bit. In other words, we’re not just looking for alpha, we have a problem and we’re looking for a solution to that issue.
VASSALOU: Well, yes, we’re looking for particular solutions, whether that’s a liability, whether it’s a completion of existing portfolio, whether it’s a particular return target they have, whether there is a particular liquidity profile that they need to achieve. There are all kinds of needs that institutional investors have, that they cannot satisfy by just investing in the hedge fund industry, because the assets they manage are many times larger than what the hedge fund industry can absorb.
At the same time, just being passive is not really the way to go. And so what I think is happening is the two areas are merging somewhere in the middle, where really what the demand is, is for creating holistic portfolios that incorporate asset classes from the whole spectrum of assets out there, whether it’s in public markets or private markets, focus on portfolio construction, with good risk management framework and try to provide the right profile of risk-adjusted returns for the particular needs of the investor, incorporating alpha in there. But now just focusing on the alpha component.
And I think this is interesting in many respects. You’re really fulfilling a big need of this institutional investors. You’re bringing together skills from the whole spectrum of the industry, and you get to create that bespoke customized solutions. So for someone like me, who started my career in academia and spent my research years thinking about portfolio construction, asset allocation, macro, asset pricing, and then I went into the hedge fund industry. This is an area that really straddles the whole spectrum of things that I have done, and I think it’s really where the future is.
RITHOLTZ: So when you talk about clients, I’m assuming the bulk of your clients are institutional, foundations, endowments, family offices, things along those lines?
VASSALOU: And sovereigns as well.
RITHOLTZ: Sovereigns. Okay.
VASSALOU: Central banks.
RITHOLTZ: Oh, really. So that runs the gamut of the largest of the large sort of clients. I’m going to assume that each of those clients have a very different profile and are looking for a very different sorts of solutions.
VASSALOU: That’s true.
RITHOLTZ: So we were talking about when you joined Goldman, you picked quite a time to come into Goldman, just about the top of the market. Tell us a little bit about what that transition was like when you started at Goldman.
VASSALOU: It’s certainly a time when we need to rethink the way we approach investing. That’s because now we are dealing with much higher volatility than we did in the past. Instead of ample liquidity in the markets and accommodative monetary policy, we have a reversal of the monetary policy and then and actually, withdrawal of accommodation.
At the same time, we are going through tectonic changes in the world economic order. We’re going through deglobalization process, where we see that actually onshoring becoming more and more a topic of discussion. There is fragmentation in the goods markets. There is destabilization that we are observing in the geopolitical front that can significantly change. Also trade patterns, but it also affects alliances at the political level.
We have changing demographics. We have the decarbonization process that it’s also affecting investment production processes across the board. And we also have the digitization process that has been going on for a long time, and it got accelerated with the pandemic. So there is a whole host of factors that affect the background of the environment in which we operate, and how growth and inflation is going to evolve over time. And at the same time, we have also a number of short-term drivers to the markets that we need to take into account.
RITHOLTZ: Before we get to the short term, let’s stick with these big long term macro deglobalization and geopolitical unrest, and a new rate regime and on and on. How do you work these big factors into your process? Do you create a model where each of these factors have a specific way? When you’re looking at the world from a top-down perspective, how does that find its way to be expressed in an investment posture?
VASSALOU: We have a dual approach. So we certainly have a research process that is based on models that we have created, and we keep evolving. But we also have a qualitative approach in investing, and that comes through the experience of our analysts and researchers on particular asset classes, but also in terms of our ability to think through the macro environment and the implications that they may have on the investment environment and the various asset classes. So one of the things that I do is to really try to think through all these developments that are happening and the effects that may have on the markets and on our investments.
RITHOLTZ: And then you mentioned there are shorter term inputs that drive volatility and obviously affect price. How do you incorporate that into your process?
VASSALOU: Those are easier to incorporate into the process, because they’re things that you can observe at higher frequencies and you can incorporate into the models through quantitative approaches. The hardest part is to incorporate the bigger picture, and that’s really where the qualitative overlay comes into play.
RITHOLTZ: Very, very intriguing. So you’re looking at the world late 2021, markets are just about at their all-time high. And yet, it’s pretty clear, inflation has ticked up. The Fed hasn’t begun raising rates, but they’re talking about it. At what point do you start to say the 2022 and forward era has looked very different than the decade from 2021 back? Where do you say, all right, this is the line in the sands and we have to very much adapt to what’s coming?
VASSALOU: Well, I joined the Goldman in July of 2021 and —
RITHOLTZ: Which was a pretty good year in the equity markets.
VASSALOU: Yes. But by the fall of 2021, and particularly November, I was convinced that we needed to start cutting risk in our portfolios because we had a period of the pandemic where we so a reversal of monetary policy back to zero rates and increased QE, at the same time as we had massive fiscal accommodation, and that had to be inflationary. And so I was very concerned about this effects, and how inflation will play out and how growth will react going forward.
RITHOLTZ: Only a handful of people were saying that in mid to late 2021. Jeremy Siegel at Wharton was warning about it mostly on the fiscal side. And some of the people who’ve been complaining about inflation for a decade, warned about it, but I think they were generally ignored. When you bring up this regime change to your investment committee that you’re co-CIO of, what sort of pushback do you get? Oh, we’ve had no inflation for decades. Or are people very much looking at the data and saying, well, rates haven’t gone up yet, but they have to. How is that internal discussion? Like, what are the key points that everybody focuses on when the market is still going higher week after week?
VASSALOU: We had a rigorous discussion on the topic and not everybody was on the same page, but we have a collaborative approach. So it was also part of my task to try to convince people that, you know, we had to moderate risk. And so eventually, we did do that. But it’s always good to have a plurality of views and debate them, because that’s how we all become better at what we do.
RITHOLTZ: And your title is multi-asset solutions. What sort of assets are we looking at? Is it completely unconstrained and you could look at anything, or are there certain things you’re really focused on?
VASSALOU: We can invest across all asset classes, both in private and public markets. It depends very much on the mandates that we have and the —
RITHOLTZ: For each individual investor?
VASSALOU: For each individual investor, we have different channels that we do cluster the mandates. But effectively, we can provide any solution that an investor may need.
RITHOLTZ: Really, really —
VASSALOU: And we can tap on all the capabilities of Goldman Sachs across the firm, and really service our investors using the one GS approach.
RITHOLTZ: So let’s talk about that one GS approach. I’m a fan of the Goldman soft landing basket. I just love the name of that. Tell us a little bit about that. It’s been doing really well because it looks like the economy is holding up better than a lot of people expected last year. Tell us a little bit about the soft landing basket.
VASSALOU: Yeah, At the multi-asset solutions, we are not in the camp of soft landing. That’s where we disagree with our friends there —
RITHOLTZ: You’re in the recession camp, right?
VASSALOU: Yes, we are in the recession camp. That’s where we disagree with our colleagues at the GIR, but that’s a healthy disagreement. We think that given where inflation is and where the forces of inflation are, and given how stubborn inflation seems to be on the services sector, ex-housing, it’s going to be almost impossible for this to be reduced without loosening up the labor market significantly. And if you loosen up the labor market significantly, you’re likely to see negative GDP growth at some point.
We don’t expect it to be a deep recession, because we are starting from good initial conditions. So balance sheets are not over expanded. Consumers are not overleveraged, and so on. But we do think that we are likely to see a recession eventually.
RITHOLTZ: So let’s take that apart a little bit. So the soft landing basket, those folks who are saying, look, consumer spending is robust. Unemployment is at, you know, near record lows. The economy looks pretty good. But I suspect your perspective is something along the lines of, but inflation is sticky. The Fed keeps telling you they’re not done raising rates. And at five and a half or 6 percent, that’s going to cause an increase in unemployment and a short, shallow recession. Is that what you’re looking for in ‘23, or ‘24?
VASSALOU: I don’t know if it’s going to be short. I hope it’s going to be shallow for the reasons we discussed that we are not getting into this environment with high leverage and high, you know —
RITHOLTZ: Low unemployment —
RITHOLTZ: — and household wealth seems to be doing pretty well. Back half of ‘23 or ’24?
VASSALOU: It could be the second half of ’23. We could still have a scenario where the GDP for ‘23 is not negative, but we have started entering a recession. We don’t expect the Fed to cut rates this year. We think that right now, the market is pricing a terminal rate of around 5.3 percent.
RITHOLTZ: Right. Which is above where we are today.
VASSALOU: Yes. We may actually go higher than that. I had said a few weeks ago that we may go up to 5.5 percent before we are done with the rate hikes. And again, I think what the Fed will do is it will continue hiking and then pause, and depending on how inflation evolves, they may have to do more. I think that inflation will come down to around 3 to 4 percent, and then it’s going to get very sticky, and that’s the —
RITHOLTZ: Right. 2 percent is done. We’re done with that, right?
VASSALOU: I think it’s really hard for them to get back to 2 percent, and I’m not sure that 2 percent is the right target level anymore, because of all the other factors we discussed, the deglobalization, all this segmentation in the markets that we are observing, the geopolitical developments, decarbonization, et cetera. I think all these developments are inflationary.
RITHOLTZ: So given the past decade of zero interest rate policy and quantitative easing versus the current policy, for you as a top down macro strategist, which is the more challenging period? Because I recall a lot of macro strategists couldn’t wrap their head around how positive ZIRP and QE were for equity markets, and they seem to be fighting the tape quite a bit. Which is the easier environment to navigate through?
VASSALOU: I don’t know if it is a matter of easy versus hard environment. I would say that the investment approach has to be different.
RITHOLTZ: So which one do you find, you could go to the playbook and I have a solution for this, as opposed to we’ve never seen this before and let’s see if we can figure out what we can do?
VASSALOU: One of the things we’ve been doing at Goldman Sachs and my team is really to rethink our playbook. So what we are seeing now also means lower correlations across different markets. So there may be more opportunities for relative value trades, or more opportunities for diversification. You need the lower leverage than you used to need before. You have to lean on diversifying strategies and uncorrelated strategies. We think this is a great environment for alpha. It’s a great environment for active management. But you cannot run the size of assets that we are running with just active management. And so —
RITHOLTZ: So you marry beta and alpha together?
VASSALOU: Yes. And the importance of risk management and downside risk control becomes even more important in this environment. You have to be very conscious of the potential for external shocks, and constantly evaluate what the probability of those shocks to materialize is, and how they will affect your portfolio. So it’s a little bit of a different environment than the previous one, where we were in a low volatility environment, correlations were pretty stable, and really the way to play that market was very different.
RITHOLTZ: Really quite fascinating. Let’s talk about how to apply your discipline within the current environment. And I want to start by giving you a quote from you, which is “We expect the U.S. economy to enter recession in 2023 as the Federal Reserve pushes borrowing costs to 5 percent or higher.” So clearly, a lot of Wall Street thinks we’re going to duck now a recession that will end up with a soft landing. You were firmly in the recession camp, in the hard landing camp.
RITHOLTZ: And we talked earlier, you said we can see a terminal rate of about five and a half percent. Now, is that historically a very high number? Forget the ‘70s, even the ‘80s and ‘90s, mortgages were 7 percent. Five and a half percent doesn’t sound that bad.
VASSALOU: No, it doesn’t. And actually, you know, a lot of people were talking about being in a restrictive territory already in terms of the monetary policy. Most likely, we’re not at the restrictive territory yet because you see how strong the labor market is.
RITHOLTZ: Labor market is strong. Consumer spending is strong. The one area we’ve really seen the rubber meets the road in terms of rates having a negative impact is housing. Housing really is doing as poorly as it’s done in a long time. How does that translate into future economic contractions?
VASSALOU: Well, housing is having some cooling effects manifesting recently. But at the same time, we haven’t really seen the housing rollover, and the way that it did during the financial crisis. And that’s because most U.S. households have 30-year mortgages. They had the opportunity to refinance while the rates were at zero, and so they don’t necessarily need to tap the mortgage markets right now.
RITHOLTZ: I think it’s —
VASSALOU: And others are really waiting for prices to come down before buying.
RITHOLTZ: So I think the number is 75 percent of households with a mortgage are paying 4 percent or less. Is that keeping people locked in place? Is that part of the inventory shortfall?
VASSALOU: As long as they have jobs that pay decently, I think, you know, they don’t really need to sell and they don’t need to relocate.
RITHOLTZ: But for real estate, the rest of the economy seems to be doing pretty well. This year, the market started out really hot, what, we’re up 10 percent in January. What do you make of that? Is that just the reaction to how oversold we got in 2022? You know, 10 percent is a good year, forget a good month.
VASSALOU: Yes. One of the things I have said, though, in another interview was that we had a year in January, and now we should focus in on alpha. But, yeah, the January performance was largely driven by thin trading, positioning, short covering, and also a number of very strong economic news. But I think, in a way, the market is misinterpreting the Fed here because strong economic numbers, strong labor market data do not imply to me that we’re going to have a soft landing. What it implies is that the fact will have to go higher, and therefore we’re going to see, you know, a higher probability of recession going forward because —
RITHOLTZ: So —
VASSALOU: — the segment of the CBI where inflation is concentrated is in CERT core services, ex-housing, and that’s directly related to disposable income and to the labor markets.
RITHOLTZ: So what do you make of the market not taking Jerome Powell at his word? They’ve been pretty clear, hey, we’re going higher, and we’re going to keep it higher for longer. And anybody who thinks we’re done raising rates isn’t listening to what we’re saying. And the market says, yeah, you’ll cut later this year. How are we supposed to interpret both the equity and the bond market really not listening to what Fed Chair Jerome Powell is saying?
VASSALOU: The equity markets have been conditioned to always buy the dip and to really not fight the Fed in the sense of not fighting the Fed when the Fed kept doing QE and increasing the monetary accommodation. But now, they are doing the opposite. So right now, not fighting the Fed means actually selling. It doesn’t mean buying, because the Fed wants to tighten financial conditions. The Fed wants to loosen up the labor market. So in fact, what the market is doing is fighting the Fed. The bond market is doing better than the equity market. So I think what the two markets are pricing is not exactly the same thing.
RITHOLTZ: So the odds of a rate cut in 2023, they’ve gone down a lot since that big move up in January. I’m going to assume you are definitely not in the Fed will be coming in 2023 camp. You think they’re going to continue tightening, and perhaps tightened too far?
VASSALOU: I don’t see any reason for the Fed to cut this year. We are not seeing any loosening up of the labor markets, which means that the monetary policy hasn’t really become restrictive enough to have an effect on the real economy in a profound way yet. Inflation continues to be elevated, still very far away from their target. The only case in my mind in which the Fed may cut rates is if we have some significant external shock that necessitates them to intervene in the market, something like what happened in the U.K. with the LDI crisis, or, God forbid, some geopolitical event of great significance. In other cases, I don’t expect them to cut.
RITHOLTZ: So I look at rates alone as a very blunt tool, especially when we’re looking at the labor market where we have a shortage of workers now across all sorts of skill levels. Housing, there’s a giant inventory shortfall by some estimates. We’re 2 to 3 million single family homes short. Even things like inflation in cars and used cars, you know, semiconductors are still way beyond the sort of yields that we’re used to. How much can the Fed really fix the things that are broken, and are causing prices and wages to be as elevated as they are? Are these things really that susceptible to ongoing rate increases short of a full recession?
VASSALOU: Well, the Fed can help with certain things. They can’t fix everything. And I think the factors that you pointed out suggest that it may be very difficult for them to go back to 2 percent under all this conditions. They can certainly go down to 3 to 4 percent of inflation. The question is whether they will be satisfied with that and they will declare, at that point, that because of all these changing geopolitical and economic conditions, that 2 percent is no longer relevant and they will move their target, or whether they will insist on continuing to reach 2 percent and then the process overtighten and really damage the economy.
There is a question of credibility of the Fed. And so they will have to be very careful with how they message that in order not to damage the credibility of the Fed in the long run. In terms of the wages, it’s interesting to see also the evolution of the share of labor as a percentage of real GDP over time. And what you see is that the share of labor was much higher in the ‘90s. And as globalization started expanding, the share of labor went down. And obviously, the share that would go to capital increased.
But since the pandemic, this process has reversed and the share of labor is increasing again, which means that it compresses the share of real GDP that goes to capital. Now, that makes it less attractive for capital to invest, and obviously, less profitable for them. And part of what the changing Fed policy is doing is redressing the balance of the shares between labor and capital in real GDP. So what we’re likely to see is a decrease again of the share of real GDP that goes to labor, which in the short run will be negative for risk assets. But in the medium to long run, it will actually increase the profitability of companies and also the incentive to invest.
RITHOLTZ: So let’s fast forward a year out. First or second quarter 2024, CPI has come down to let’s call it three and a half percent, and the Fed is at five and a quarter and they are no longer raising rates. What does that mean for the equity and bond markets a year out? Can you think in those terms? Like, do you have a sense of where the Fed wants to navigate to? And what does that mean for the outlook barring exogenous events and all sorts of unanticipated surprises?
VASSALOU: I think that as inflation is coming down and stabilizes around the levels that you mentioned, around 3, three and a half percent, the Fed will become much more attuned to its dual mandate and start focusing on how the labor market is evolving. And I think that’s obviously one of the factors that they’re very focused on already. But at the moment, because the labor market is so tight, they’re single-handedly focused on the inflation side of their mandate.
Once inflation starts coming down and to the extent that unemployment starts rising, they will start balancing out the two sides of their mandate. And that’s really where the policy be will be determined. If unemployment starts rising rapidly, then they will give up part of their inflation fighting in order to stabilize the labor markets. If labor markets react more positively and we don’t see a massive increase in the unemployment, they are more likely to persist with our inflation fighting mandate.
RITHOLTZ: And then last inflation question, China has ended their zero COVID policy, they’re reopening. How potentially impactful is China on global GDP and to some degree, global inflation?
VASSALOU: Certainly, the reopening of China has a positive effect on global GDP. It will also potentially have a positive effect on inflation in the sense that the demand for commodities will increase as a result of China’s reopening. The question is whether that will translate into more inflationary pressures that we’ll see a backup and inflation in the goods markets, or whether demand have moderated enough in other places to keep prices contained there.
RITHOLTZ: Lastly, as a multi-asset manager, what are you looking at in this current environment that you think today is suddenly much more appealing and exciting than it might have been last decade? What asset classes suddenly have become, or not so suddenly, have become much more interesting given the world we’re in?
VASSALOU: Well, certainly, fixed income is more interesting now than it was in the past because real yields are positive. We are getting closer to peak rates, and so locking in some of these rates make sense. Credit will become an interesting area as we’re going through this process. We expect the default rates to rise a bit, but not that levels that we saw in previous crisis.
But it’s also interesting now because we need less leverage to achieve our return goals. And so, in a way, cash is king again, whereas before it was not. So the way we look at portfolios, how we invest is different. And I think it is an environment that favors active management. So stock-picking will be a really important component.
As we are going through this deglobalization process and restructuring of supply chains, there will be opportunities across the board in different industries to capitalize on this changes in the economic structure of different countries. And some of these opportunities will manifest themselves in the public markets and some in the private markets. So the way we look at portfolios is holistically across private and public markets, and really focus on the opportunities that may exist.
RITHOLTZ: Really interesting. So let me jump to my favorite questions that I ask all of our guests. Tell us what you did to stay entertained during the lockdown and afterwards. What were you streaming? What was keeping you occupied?
VASSALOU: Well, one of the things I used to do was go for long runs in Central Park. So that was one of the things that was keeping me sane during the lockdown. And otherwise, I watch all the usual shows that everybody was watching at that time on Netflix and Amazon, and the various other streaming platforms.
RITHOLTZ: Tell us about some of your mentors who helped to shape your career.
VASSALOU: I had the opportunity to meet a number of very interesting people through my career. And I can’t say that I had mentors early on in my career, but I certainly was around very interesting and impressive people that I was able to observe and learn from them. In a way, because of my process, because of my path, starting doing my PhD at London Business School, then coming to the U.S., without having studied in the U.S., I was a little bit of an orphan when I came here. And so I didn’t have an obvious mentor through the process. And perhaps that’s one of the reasons why I tried to find my path on my own.
But over the years, as I became more advanced in my career, I started meeting people who have been acting as mentors. Certainly, at Perella Weinberg Partners, Joe Perella was someone who spent a lot of time talking with me, and I learned a lot from him, both about the profession and his experience. And I’m fascinated by the interest of my colleagues at Goldman Sachs to guide me through the firm, make my transition easier, mentor me. And I find this extremely impressive and very grateful that they are willing to spend the time to do that. So I must say not so many mentors early on in my career, but actually more mentors later on.
RITHOLTZ: Very interesting. Let’s talk about books. What are some of your favorites, and what are you reading right now?
VASSALOU: In the old days, I was reading a lot of literature. And so my favorite book was Proust’s Remembrance of Times Past, which I read both in French and English, and also various books by Dostoyevsky whom I like very much. But this day, so I read a lot about what’s going on in the markets, the world, and I’m trying to think about those things. So one of the last books I read was unrelated to that but it was Art as Therapy, which I found very interesting. And it’s one of those topics where once you read the book, you think that makes a lot of sense and you should have known this all along, but obviously I didn’t before.
And now, some of the books that I have on my side and starting reading is 21 Lessons for the 21st Century by Yuval Harari. And also Leadership by Henry Kissinger, because I think we are in a very important time for global world order. Nothing geopolitics will be really important, and the leadership that the world leaders will show now and in the coming months and years could shape our world in a profound way.
RITHOLTZ: Very interesting. What sort of advice would you give to a recent college graduate who is interested in a career in macro or multi-asset investment?
VASSALOU: I think they need to have both good technical skills, but also understand macro. So I think this combination used to be rare. I think it becomes more and more important to be able to combine STEM skills with more of the economic science and thinking that will help you understand the markets better.
RITHOLTZ: And our final question, what do you know about the world of investing today you wish you knew 25 or so years ago when you were first getting started?
VASSALOU: When I first got started, the world was different than it is now. I think what is important is to be cognizant of the fact that conditions change, the world changed, and we need to evolve with those conditions. So obviously, I learned along the way. But I think what I know now was not necessarily applying 20 years ago, and vice versa. So if there is a lesson for all of us to learn is that we need to keep evolving. We need to keep learning and we need to keep adapting to our environment.
RITHOLTZ: Very interesting. Maria, thank you for being so generous with your time. We have been speaking with Maria Vassalou. She is co CIO at Goldman Sachs Asset Management.
If you enjoy this conversation, well, please check out any of the previous 470 something we’ve done over the past nine years. You can find those at YouTube, Spotify, iTunes, Bloomberg, wherever you feed your podcast fix. Sign up from my daily reading list at ritholtz.com. Follow me on Twitter @ritholtz. Follow all of the Bloomberg family of podcasts @podcast on Twitter.
I would be remiss if I did not thank the crack team that helps put these conversations together each week. Atika Valbrun is my project manager. Sarah Livesey is my audio engineer. Sean Russo is my head of Research. Paris Wald is my producer.
I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio.
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