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Jim Karen, chief investment Officer of Portfolio Solutions at Morgan Stanley Investment Management, he's back with us. We've got a little bit of a special treat for this last hour of Bloomberg Business Week Daily. He's joining us for the rest of the show. Jim, it's good to see you. Welcome back, Thank you.
It's great to see both of you.
And thanks for taking the time this afternoon. You know, we obviously weren't planning on starting with Alan Greenspan and his life and legacy. We're going to talk about the FED. We'll talk about rates, risk, portfolio positioning, the US versus the rest of the world. Matt Miller wants us to talk about motorcycles. Yes, I don't think I will be able to do that.
In an intelligent way that we'll I did's ride on it with two other people. That was dangerous when I was really young.
But we do want to start with Alan Greenspan in the legacy because early in your career, I mean, he was the FED chair. You knew he was it.
He was a legend. So I you know, if we put this in and I think it's very important to have context around this. He started his position as chair and nineteen eighty seven, he ended in two thousand and six. That's a nineteen year period. So for most people's that's a large chunk of their career. I started the business in ninety one ninety two. That's all I knew for fourteen or fifteen years of the starting point of my career. He was somebody that was not going to be challenged
easily by other members of the FED. It's whatever he said went and that was it. But he also did a bunch of different things. He changed things at the FED in the sense that he made it a lot more transparent, if I could say those words. So, what the way the FED operated, and we take this for granted today that you find out on Wednesday at two o'clock what the Fed's decision was and we all go to work. Prior to green Span, it was vulgar. And what happened at about four fifteen four ten on a
Thursday afternoon, you got money data. Based on what the money supply data was, that was the change in policy. You had to figure it out. Nobody told you if it was twenty five or fifty basis points you were guessing and you were trying to analyze and figure out
what that was. So what green Span started to introduce through communications and things like that was what today we take for granted, was absolutely monumental in groundbreaking as far as saying, hey, by the way, we just hiked or cut twenty five basis points and that's and that's all it is.
Is it too much?
Though, like would some say it's gone too far?
So there's been iterations like there's there's pre green Span and then there's post green Span. Right, So what happened in the nineteen years subsequent, you know, from two thousand and six, say to two thousand and you know, twenty twenty six. What we've had now is Bernanki, Yellin, and Powell, they've all followed effectively the green Span mode, but they added on to it. Now. Clearly Bernanki had a very special situation in the financial crisis. He had to do
enhance communications and things and things of that nature. I think that what is is it too much today? In terms of communication? I'm gonna say that it is a bit because what the FED is trying to do is they're trying to telegraph and televise too much such that they're actually directing and dictating how the markets should think about things, as opposed to what Warsh said, which is let the markets figure it out. I mean, so the way I think about it managed well, I mean, you
know the way I think about Kevin Warsh. If I'm going to put him in this in this period of time from nineteen eighty seven to twenty twenty six, I'm going to say that what green what Worsh is trying to do is bring us back to the period that was pre Ben Bernanke. So it was green Span in the nineteen nineties, so very similar economic setup, too big cap X cycle, big productivity boom. You know that, you
know that we're going through. And I think what Worsh is trying to do is bring us back to that period where he lets the markets assess what monetary policy ought to be, as opposed to what Greenspan did. Greenspan was the guy that really started to come in because the Vulcar and everybody else just looked at money supply M one, M two. They were you know, very very
much and that's what they did. Greenspan was one who started saying, you know, we should think about GDP, growth in the labor market and inflation, and let's talk about inflation anchoring and all of these various things. Things that we think of today is very common, it was very uncommon at the time. So I'd say, let's give Kevin Warsh an opportunity. This is his moment in history. He wants to remake the FED. But this isn't groundbreaking what
I think Warsh is trying to do. I think he's just getting back to a period that looks more like the nineteen nineties.
So it's fair to say you see a hint or more of Alan Greenspan in Kevin Worsh today.
Yeah, I do now now, Now, you know, whenever you compare somebody to like somebody who was a legend and somebody's just starting out, that's always a very very difficult you know. We'll see how Warsh does. Right, It's going to be a long journey and long road ahead. But I think on paper, conceptually, what Kevin Worsh is trying to do is get the FED back to a much more narrow focus, not as narrow as the Vulcar FED, which was just money supply, but something that's a little
more growth, inflation, outlook, jobs market. But let's ease up on the communications. I think he's really just going back to a nineteen nineties green Span model right now. And that's my perspective. And a lot of people weren't even around in the nineties in this business practicing, right, so they don't really have a good perspective on this. It wasn't chaos, It was fine. You know, you just have to get used to the new there's a new sheriff in town.
What's the downside of kind of where we are and what we expect from today's Fed.
I think the downside is that there's a lot of mission creep with the FED. Right so now we have to put this in context as well. Prior to the financial crisis, we had this much more narrow This is what green Span kind of created. I mean, he opened it up more transparency than Bernank kicked the door wide open. He had to. We had a financial crisis, we had interest policy, we had QWI, we had policy rates at zero, so we had to find a way to communicate policy
to the markets. I totally get it. But what happens is is that once the FED starts to have this mission creep and they start to be asked to do more and more, even from a regulatory standpoint, or even you know, the FED was being asked, what's your policy on climate? You know, you know, things like that. This is not what the Fed's job is. The FED and according to Kevin Warsh, should color in a very very narrow set of lines and stick to what their job is. Under Vulcar, it was money supply.
Well, what if the economy has gotten more complicated? Climate change is an issue. Companies have to think about it, you know, because it is ultimately going to impact their bottom line.
This does it affective duel mandate?
I guess some might say, well it might, it can't work, Yeah, you can extrapolate.
Right, So what Warsh is basically saying is don't ask me that question. That is an elected officials job to do. My job is Kevin Warsh, right, if you're Kevin Warsh, if you're the chair of the FED, is to is price stability in full employment and to really focus on the price stability component.
But don't you sometimes need Okay, I'm going to get into trouble by needing a figure that's not political. But we understand that politics has certainly crept its way dim into the US Central Bank. But I think there are times we look at the FED chair, even if there is a political backdrop, as being kind of a voice of reason on all of these major issues that will impact economic growth globally, will impact corporate bottom lines, Like is it not important to have that voice of reason?
It is absolutely important to have a voice of reason. But in a position like that, in the way that I believe that Warsh interprets it is that it's a very narrow remit. And one of the things that he said is that the FED should have absolute independence on a narrow set of items. Everything else this this is not this is what the FED is. That's not what
the FED does. And I think keeping that very very clear and setting these boundaries, right, you know, we all have to set boundaries, right, you know, this is a very important aspect of things. Is like, look, don't ask me these questions. I mean, these aren't questions that are
for Kevin Walsh, right, you know. So that's what he's basically saying, And what he's basically what he says ultimately is that the FED can do its job better if it's just doing the job that it was tasked to do, but is not being asked to solve all these other problems.
In the words of j. Powell, will stick to our knitting is what he said over and over exactly right. So it just reminds me of that sort of go to for him. We're speaking with Jim Karen, the CIO of Portfolio Solutions at Morgan Stanley Investment Management. So, so what does all this mean for rates under a Warsh regime?
So this is pretty clear.
Yeah, it was in the market in a very clear way.
The market well yeah, so I have a very out of consensus view on this, Okay, Okay, so I actually think Warsh was more dubvish than what the markets thought. Okay, so I know what he said in a traditional interpretation.
So market's got it wrong.
I think so so so effectively under a Bernanky, a Yelling, and a Powell. If that's your mindset, and say, look traditionally, if I think about what war said and I use that framework BERNANKI Yelling, and Powell, then yes he was absolutely very hawkish, right, you know, you know, there's no question. But I think if you read between the lines and listen to what he's really saying. What he's saying is that like is he's going to create these task forces in terms of like, so, how do we think about
the data. So if you were to ask me a week ago, two weeks ago, what is the Fed's most favored measure of inflation, I'd say core PCEE. That's the Fed's favored measure of inflation. Today. I don't know what it is. I don't know what the task force is going to say that it is. Is it year over year PC or is it month over month or is it three month over there? This is what the task
force is going to figure out. So the market, I think, for the next six months until this task force gets us all done, is going to be very confused as to what the inputs are to the fed's large scale policy model, which is there what they call the FURBUS model Federal Reserve Bank of the US model. And what Warsh is doing is he's not saying I'm going to change the model. What he's saying is I want to look at different inputs. I want to look at labor data in a different way. I want to think about
productivity differently. Kevin Warsh is a supply side economist. He's going to start to create a lot of supply side indicators to inform him as opposed to the more traditional demand side components of the economy and those indicators. This is in my career and I've been doing this since ninety one ninety two, so about thirty four years. Is the most monumental shift that I've seen take place. I inherited Greenspan. When I started, Greenspan was there. That's all
I knew. This is a major shift. And I think that people are underestimating how monumental of a shift this is. And where they going to get it wrong is by applying what they've learned over the last twenty five thirty years under a green Span to then say, oh, well, this is what it's This is how I would interpret this. I think the rules or the ground is shifting. Not the rules have change, but the ground to shifting so.
Good that it's shifting. Could that we kind of take a look at a system that we've been kind of moving along for a long time.
Well, I mean, you know, changes happened, right, So green Span changed it right when he came in because he felt that and you and you mentioned yourself the economy has changed, right, So when we look at labor data and labor statistics, I think the data has been challenged for the last five years. The non farm payroll data for me used to be the sun rose and set on. The non farm payroll data for me for most of my career, last five years not very informative. Weekly jobbles
claims were a bit better. So I think there's a lot of challenge to the data.
So what is the what's the bat I mean, there's no single best piece of data, but what's replaced the non farm payrolls.
So this is what Worsh is trying to figure out in terms of looking at the is using this task force. Right, So you've got this other series, this Quarterly Census of Employment in Wages a QCEW series. This is the thing that constantly gets revised or revises down the monthly non farm payroll numbers and things like that. So so what I think Worsh is going to try to do is use more real time estimates of the market and to try to understand whether it's inflation data, maybe even shorter
term measures. I'm not saying that we're going to live and die by the weekly jobas claims number. But I'm just saying, you know, you've got jolts, you've got these other surveys, you have other industries that create surveys of data as well. Why not start to look at this a little bit more broadly.
Well, it's interesting that you say that because we get PCE this week, right, and worsh is not so keen on this read in terms of inflation, Is he right? And is there something to maybe rethink about this two percent target that we obsess about that maybe that doesn't make sense because we can't seem to get there.
Yeah, yeah, yeah, No, I mean, I mean this is you know, same thing the nineties. We didn't really get to two percent as a target either. We didn't even really have the target of two percent at that time, which is another thing. So maybe, as I'm saying, as Kevin Warsh is kind of going back to the nineties, maybe we should think about the target. Is it more of a range or is it a specific point target?
And the other thing that I think is going to be very very different is that the way that the traditional way over the last twenty five years or so that we thought about controlling inflation was to adjust the jobs market. Right, So if inflation's running too hot, this is the irrational exuberance. How do you control inflation? You kill the jobs market, you create a recession, you get the unemployment rate up, you get prices back down, and
you tamp down inflation. What Warsh is saying is that if you're in this period of higher productivity, then lower levels of unemployment. So an unemployment rate that say falls from four point three to three point eight or something like that, doesn't necessarily mean that it's going to be inflationary if it's because you're getting higher productive growth. That's a very supply side view of the world. And basically saying that if industry is creating more efficiencies, that doesn't
necessarily create a higher inflation rate. So a lot is changing, and you know, it's a lot of people should really just you know, when they speak to say, Look, I'm not really sure, but what I think is as opposed to being so definitive. So I'm keeping a very open mind about all of this.
Does aay I completely change everything that we're talking about?
Possibly?
Possibly, you know, I mean, I think the issues with AI that I have in economic forecasting is that it's kind of just going to look at the survey data. It's it's going to look at the available data sets that are out there unless you train it to look at.
I just mean that from productivity for something. Oh yeah, that's what I mean.
Hundred yeah, yeah, I see what you're thinking.
Yeah, not on the data analysis, but just on productivity and what it does to this economy.
So in my view, it does, right. So I think the productivity, I think you're going to get a lot. I think you can get higher levels of growth and lower levels of unemployment. But if it's more productive because AI is becoming more efficient, is going to be it's going to be a positive. So when we think about AI, people think about it in terms of profit margins, right, and today the way they think about it is it reduces costs, so more AI, less junior analysts, higher unemployment rate,
and that's kind of the negative view of AI. I don't think it's going to work that way. I think what we're going to see is you're going to have more AI. It's going to create more demand. It's the Javon's paradox, right, Whereas when something becomes cheaper, you demand more of it, which is what I think AI is
going to do. You'd have more people asking critical questions of this tool called AI, and we're going to be judging the results of these things, and ultimately, if you get better, more efficient decisions and higher productivity, these are the companies that you know that actually use this. These are the winners. There's a lot of creative destruction here. There are going to be winners and losers.
Yeah, I agree. Do you think that that means that some of the companies we talk about NonStop could be a possible loser down the road?
Yeah?
Absolutely, right. So it's all about adapting and it's looking at companies that can actually use this tool very efficiently. So right now, there's a big productivity gap between the way that we evaluate this.
Right.
We're just in the infancy of all this stuff. Right, So if you ask any individual person, hey, do you use AI? Yes? I do. Are you more productive because you use it? Yes? I am Okay, Now go ask the CEO of that company if your employees thirty percent more productive? Are your profits thirty percent higher? And they're going to say I don't think so. Not yet. Over time, that gap, that productivity gap is going to narrow relative to the individual being more productive in the company, becoming
more productive. Companies right now don't quite know how to use this tool efficiently or effectively.
But I think the concern that a lot of people have is that, well, maybe when an employee leaves, that employee doesn't need to be replaced by headcount, and it's the margins that where you'll see and fewer people producing the same amount of work. Great for shareholders, not so great for those folks with jobs.
Yeah, it could be right. So my take on it is that the real power of a powerful user of AI is somebody who can ask really good, creative, insightful questions. So the work that you know, whether it's software programmers, engineers that create a lot of the software, a lot of that work is going to get displaced, I think. But the people asking the questions, the more creative questions that come in that try to solve problems, I think
that doesn't go away. And then you have to judge it, you have to interpret it, and then you have to apply it. And I think that's where the job growth is actually going to be.
So maybe that liberal arts education.
Hey one said a Boden guy here and a Colby guy here, We're getting along right now, Yes.
Exact girl here, but no, but I think about that a lot like learning how to you know, ask the right question. And we keep talking about this too. It's not these basic simple questions. It's really complicated, smart, thoughtful questions.
And the critical thinking that you develop when you're writing those papers late at night that now AI is writing for you. Unfortunately, so the kids aren't learning how.
To do well think about it. I mean, like, you know, you may not be able to code, but you can ask a lot of really good questions, right, so there you go. I mean, and if you could ask really good questions, well, don't worry about it. The machine's going to code for you.
Exactly. If you have a vision for something because you have an analytical mind, right, you have an idea for creating something, you no longer need to find that person to code for you. You can get clot code or code X from open air to do it for so.
Albert Einstein said that the true measure of intelligence is imagination. It's not all these hard technicals. Is if you're very imaginative, that's actual intelligence. I'll go with Albert Einstein on this one.
Yeah, it makes us think, you know, there are people who've been writing things about you know, you have to give you your mind, your brain kind of a moment to think, right, some space to think rather than kind of NonStop either on a computer or on your phone
and thinking things through. Having said that, we've got about four minutes, We're gonna take a break and come back and talk some more because I want to address some of the things that the President has been saying when it comes to the spend that we see NonStop, and we've been talking a lot about SpaceX now tapping the debt market. I don't know how do you work that into the investment narrative? Is it smart? Do we get nervous?
We just had our credit analyst on and kind of all in on Elon and comfortable with it that we don't even know where this is all going. But if you're going to bet on someone, this guy seems to make sense.
Well, Look, I mean things are going to go in cycles, There's no question about this. So there is a large spend right now, and everybody's going to ask a question, is the juice worth the squeeze? Right We're spending a lot of money. Are we going to get the profits? Or is this going to happen. I think it will. It's going to happen over time, but it has to be an enterprise solution, meaning that companies, Corporate America is who's going to build data centers in space for example.
Right it's going to be the need from business that says, hey, I've got a whole team of people that I just hired and they're using this AI engine, this AI tool, creating agents NonStop, and their productivity is off the charts. We need to do more of this. It's an enterprise solution that's going to actually create the profitability. And I don't think we're I don't think we're close to it yet because right now you're asking CEO's like, oh so
is this profitly? Like, yeah, I think it is. I mean they're not quite surey to measure it well.
The flip side of that is some some CFOs pulling back on those tokens because they're not necessarily seeing the ross uber for example expensive.
Yeah, yeah, yeah, it's a cost. It's a cost component. But like anything else, you know, tokenization is going to get commoditized, it's going to become cheaper. Do you remember, like, oh, don't print in color right, you can't print in color because ink was more. Nobody really says that anymore, right, you know. So I think it's one of these things that it's like, you know, I think it's going to get cheaper.
What did I tell you, Carol? When I started working here six years ago? I was like, I like working here because they don't count how many pages you print in color as opposed to where I used to work. And they're like, do not print in color, do not print at all?
Yeah, exactly, let's read off of it. Yeah, you know, it's funny when we talk and I feel like, I mean, we don't know what the timeframe is here, do we? We really don't. We're taking a day by day, week by week, month by month in terms of just kind of watching how this, you know, evolves. But what I do find interesting and we mentioned ROI like our conversations have evolved a lot more to talk about that. When
we're talking about artificial intelligence. We weren't doing that necessarily a year and a half ago.
Yeah. So I think if you look at any business cycle, right, you've got the early adopters, you've got the late adopters, right, it's never a straight line it's never like you're early then all of a sudden you kind of get through. It's it's always exponential. So you start off, there are going to be some early adopters. The way that the market's going to identify that is these are the companies who are going to get rewarded.
So Jim just adopters, early adopters. Well, I think it's fair to say some of those are getting.
Rewarded right now. Yeah, exactly.
But apart from those companies, the front the developers of the frontier models, the hyper scalers just in the last you know, forty five seconds we have with you before we take a break and come back, who else could be winners?
Like?
Where else could you find?
I think you're going to find it all across the spectrum. You know, it's not a question of specific industries. It's really a question of which companies in which sectors are adopting these tools in unlocking op grating leverage. That's going to happen in healthcare, that's going to happen in industry, that's going to happen in software and technology, it's going to happen all the sector. Financial sector, financials are pretty efficient,
but I would say, but even still financials. You know, these are all you know, managed care networks, which are very cost intensive, very heavy, you know, you know, workforce intensive. Uh. And the companies that do this right are they're going to unlock a lot of operating leverage. And those are cash flows I want to buy. So I don't think there's any one sector, one company is.
The president right though? If that war had continued, would there be an economic catastrophe for the United States?
Yeah, I think there would have been a significant slowdown. I mean, ultimately the inventories and the oil supply shortages would have caught up. And everybody is pretty well versed on the numbers.
But is the challenge now that he said that out loud? Iran knows they have that leverage.
I don't think it's news to them. I mean, I think they're following the same flow of information that the rest of us are and calculating the amount of barrels of oil that the world needs and and things like that, and it was creating some real you know, shortages and
some pressures. And I also think though that what I what I ran also knew is that the world and you know, China's a big consumer of oil for example, would have some patience up to a certain point, and then they would start to I ran would start to feel a lot of different pressure from their partners because then it would really become, you know, a much bigger issue.
But look, I mean, you know, ultimately, I do think though we're at a stage where the point of this conflict, as far as it matters to the markets with oil prices, I think is largely behind US. I mean where oil is today or you know, in the mid seventies, whether you're looking at WTI or Branch, which is around seventy seven at the moment, this is way below what I thought it was going to be. I would have said mid eighties. I wouldn't have guessed in the seventies. So
I think I think there's a lot to this. Well.
I think one challenge that that people have right now when they look at where the US and Iran are negotiations, is that there is this sort of sixty days to get to some sort of solution with the enrichment of uranium for any purpose. Yeah, I think it's fair to say if you look at the historical corollary with like the JCPOA, you know, that took over a.
Year to negotiate. Yeah, it's gonna take time.
But does that mean But the difference is we have all these US assets and service members in the region and they're kind of just there as the threat of a cudgel, right.
Yeah, and I think that there's gonna be some withdrawal of that. Like over, I think that's part of the sixty day agreement, that there has to be some withdrawal of troops from the region. I think what's different this time is that there are consequences for Iran, Whereas like the JCPOA and everything else was like, listen, we want you to have this agreement. We've come to this agreement. It's taken us a year. This is what we want you to do, and if you don't do it, we'll
just keep asking nicely. This time, I think you know what Trump is introduced in this is is that there's there's a carrot and then there's the stick. Right. There are consequences to this, and that I think is a differentiating factor, at least for me in terms of volatility in markets. I mean, we are going to go through periods where, oh, well this happened, this somebody fired on this person and this one, you know, and is a Strait's going to be closed. And oh I'm counting the ships.
I counted five less and you're going to get these headlines. This isn't going away. This is going to create volatility in the markets. But overall, on average, where the flow is, I think that the flow is going to be a lot better. And it's really about denuclearizing Iran. I think this was his ultimate gold and demilitarizing them to the point where they can't exert that kind of influence that they had in the past. Is it regime change, No, it's probably a regime evolution. But we'll see, you know
how that all plays out. But it's not over yet.
Right, And Jim to that point, President Trump said just after market closed, if Aron doesn't behave I will do what I need to do. So right, we're going to just have to kind of live with this. What do you think is the most important market conversation we should be having right now? So?
I think it's inflation. I mean, if we just look at what happened last week, right, we had some Fed governors go from zero rate hikes to two plus rate hikes, right, So it makes me wonder are they seeing something that
we're not seeing. I'm a little concerned about that. Now, maybe they're overreacting, who knows, But you know, if if they're right, and if we do have very sticky starborn inflation above three percent for a period of time, that's not going to be good for the financial markets at all. So the I think what the belief is is that what we're seeing for inflation today is it's not so much at the core, it's primarily at the headline. It's going to be it's not going to be long lasting.
It's going to it's going to filter through. But if that turns out not to be the case, then you're going to get higher interest rates in that it's going to slow the markets down, and the markets are not really anticipating that.
Maybe a good segue to talk portfolio positioning because you and the team over at Morgan Stanley Investment Management, you like the US yeap, you like Japan, yep, You're underweight Europe.
Yeah. I think that Europe is just going to have more headwinds in terms of trying, number one, to figure out what their reindustrialization plans are. I mean, Germany's been struggling for the last several years in terms of growth. They're manufacturing their autos, They're trying to figure out how to handle China with exports and imports. Energy prices are just you know, are just going to be stickier in Europe.
They don't have the energy security or the source of energy that the US has, So I think the costs and also higher inflation in Europe. Like the US can handle three percent inflation, it did it in the nineties, and you know, you know, the US economy is geared to do that. Europe is much more of a rigid economy that's based on more fixed incomes and fixed costs.
When you get an exoger and a shock of higher inflation, it really cuts into profits, so their ability to grow, and also from a political standpoint, what that does to people and how they vote and everything else can really start to blow back on industry. So it's not that we're abandoning Europe. We like Europe. It's just that if I had to choose, I would choose the US and Japan over Europe. So in a portfolio, it's a zero some game. If I'm overweight something, I've got to be
underweight something else. So I choose to be Underwait Europe can't go.
I still have more questions.
You got to get Jim bad This was amazing.
Thank you. It's great to be here with you both.
Thank you really timely and great to get your view on Alan Greenspan and then just kind of broaden it out. Thank you so much. Thank you really appreciate Jim Karen, his chief Investment Officer of Portfolio Solutions at Morgan Stanley Investment Management, joining us right here in studio