Admired economist Nouriel Roubini and hedge fund manager Sander Gerber are both worried about a new phase of the credit cycle and other phenomena that might not bode well for investors.
In a recent webinar, Roubini, a researcher long sought after for his insights, professor at New York University and CEO of Roubini Macro Associates, talked with Gerber, the chief executive and investment officer of Hudson Bay Capital who challenged and then collaborated with the late Harry Markowitz.
During their sprawling conversation just before the July 4 holiday for Hudson Bay’s investors — but shared with Institutional Investor — Gerber said that continued interest rate hikes by the Federal Reserve, and higher long-term rates, will make it harder to service loans and result in losses.
“I think that the credit cycle is looming. In particular, if we’re going to get down to the theoretical 2 percent target, I don’t see how we’re not going to have a credit crisis,” Gerber said.
Roubini agreed. As rates rose rapidly, investors suffered from their duration risk. Now, as the economy slows, credit risk will emerge, he said.
“In a world in which there will be a recession, however short and shallow or more severe, and where nominal and real rates are higher, I would say we’ll have a migration from duration risk to credit risk. And those institutions, private and public, that are highly leveraged, are going to experience severe debt servicing difficulties,” Roubini said.
And beyond what part of the credit cycle investors are facing, Roubini and Gerber also shared other things they find troubling right now: bubbles and markets they are watching, the negative consequences of generative AI, and some “known unknowns.”
The economist and investor were also both leery of the U.S. stock market, which has bounced back with the help of only a handful of companies whose shares have soared. Some recent performance has been related to recent breakthroughs in artificial intelligence, which Gerber said reminded him of the dot-com crash.
“We’re still early on in the AI transformation, which I think is perhaps even more momentous simply because the internet was a gradual adoption, and the generative AI is a very quick transformation. This bubble might also go quicker than the internet bubble, which took basically the late nineties into 2000 to explode,” Gerber said.
The hedge fund manager said AI might actually reduce the demand for labor but it will take time for that to happen and before then, there will be enthusiasm in markets.
“The ability to replace human analytics, at least low-level analytics, is something that’s unprecedented and, frankly, was unexpected,” he added.
Gerber posed Roubini, author of MegaThreats: Ten Dangerous Trends That Imperil Our Future, And How to Survive Them, a related question: "....had generative AI been where it is now, when you wrote the book, would you have included that as a mega threat?
In a way, Roubini’s 2022 book did include generative AI as a mega threat. There’s a chapter about “transformer technologies,” including AI, that could radically change the world. The positive thing about generative AI is the potential productivity growth. “We have not yet seen it in the macroeconomic numbers, but I would expect that, like in the case of the first internet revolution. It took a lag of a few years, but eventually we saw the increase in potential growth,” Roubini said.
There are negative aspects, too, he said. There will be more displaced workers — even some lower-level cognitive jobs could be displaced — and the technology could also increase income and wealth inequality because they’re capital intensive and labor saving; those who own those machines stand to gain.
“The big question is: can we make this AI more inclusive ex ante, as opposed to exploitative by having them eventually to compensate those left behind with universal basic income, or universal basic provision of services, or something along those lines. Great opportunity, but the distributional effects are going to be very complicated and may actually exacerbate some of this backlash against liberal democracy,” Roubini said.
Gerber was less sure that AI was a threat to democracy. But he said that he believed, in the wrong hands, AI will make more potent and sophisticated digital attacks that could have huge consequences.
On potential threats to the world and portfolios with a cloudy likelihood — what Roubini labeled “known unknowns” — the economist said geopolitical conflicts are top of mind. No one knows what the tension between, for example, the U.S. and China will be like a decade from now, he said.
Roubini also mentioned non-linear or sudden, dramatic changes to the global climate. For example, scientists are worried that massive chunks of ice near the Earth’s poles could break off, drift, warm quickly, and then raise the sea level dramatically over months instead of the expected decades.
“God knows whether something even more freakish than Covid-19 could show up again,” said Roubini. “We don’t know what’s the probability, but those are the kind of things that scientists are starting to think about when it comes about climate change and its correlation even with global pandemics.”
