For more than a year, investors have been hopeful that the Federal Reserve will be able to bring inflation down, and guide the economy toward a soft landing.
Oaktree Capital’s incoming co-CEO Armen Panossian is skeptical about investors’ rosy expectations, though.
“2023 is in shockingly good shape,” he said in an interview in New York. “The consumer has saved more than expected. Home prices have not fallen. Inflation is heading in the right direction. People think we are getting a soft landing.”
He — and Oaktree — see danger lurking, though. Oaktree Capital, a $180 billion credit asset manager, has been underwriting the firm’s investments as though a recession is on the horizon — among other potential outcomes.
“We don’t predict recessions,” Panossian said. “We underwrite to recessions.”
But, “I have the sense that in a year from now, we’ll look back on this euphoria and we’ll say, ‘of course this happened,’” Panossian said, pointing to a few factors driving his skepticism.
First, the yield curve. Historically, according to Panossian, an inverted yield curve has always meant a recession is coming. Ten-year Treasuries have yielded less than two-year Treasuries (that is, the yield curve has been inverted) since July 2022.
Although ten-year yields are creeping back up, the threat of a recession is still very real — if investors use the curve as an indicator.
Panossian says that there are other reasons to be worried, too. Typically, a recession hits roughly 18 months after interest rates peak. With one more hikes on the horizon, “it’s too early to declare victory,” Panossian added.
There are also concerns over what’s driving lower inflation: A drop in energy prices is what has driven falling inflation numbers, while other consumer categories still remain high. Panossian noted that if energy prices were to rise, inflation could again, too.
Corporates will be unable to refinance loans. “As we think about the future, we will experience distress,” Panossian said. “Corporate borrowers will approach a maturity wall. This will create opportunities for rescue lending and distress.”
Oaktree will take advantage of these opportunities, both within its existing investment portfolios, as well as within a new $10 billion direct lending fund that the firm is raising money for.
According to Panossian, brick-and-mortar retail, and even online retail, is not particularly attractive right now given the operating leverage and the declining availability of consumer capital. Likewise, the firm is concerned about housing-related investments due to the high cost of borrowing.
The technology sector is a “story of haves and have-nots,” Panossian said, which makes it “not a good investment for us.” That said, there are areas of business services that use technology that can be attractive.
Claims and revenue management in healthcare, for example, are attractive. The players in that sector are enmeshed in the business — it’s hard to start a new claims management company and have it take off quickly. What’s more is that it’s a sector that is necessary even in downturns. “You can craft a bespoke financing arrangement that is completely uncorrelated with GDP,” Panossian said.
