This Is What Scares Michael Bloomberg's Money Manager

With a net worth of $44.9 billion, Michael Bloomberg knows how to make money -- and how to hold onto it. While he is engaged in his business, political and philanthropic pursuits, Bloomberg relies on a few key players to handle the task of managing, protecting and growing his private wealth not tied up in Bloomberg Group stock. At the top of the pack is Steven Rattner, who heads Willett Advisors, the private investment group that handles the former New York mayor’s personal and philanthropic investments.

Rattner is no slouch when it comes to money management and economic analysis, as demonstrated by a solid track record managing private equity and publicly traded assets for decades. In a recent interview with Private Equity International, Rattner outlined some of the economic and market factors that scare him right now.

This Halloween, let’s take a look at what is keeping Rattner up at night.

Fear #1: Tariffs and trade war

Like many economists, money managers and business leaders, Rattner is worried about the impact of the current escalation of trade conflicts and rising tariffs:

“I do worry about the trade war; tariffs are a tax, slow the economy, trade is good for an economy, I think that’s been well proven, and if we get into a trade war and the amount of trade drops offs, that’s also bad for economic growth.”

Tariffs are clearly a problem. The escalating trade tension with China might not yet qualify as a bona fide trade war, but it is getting close. And while the tariffs have bitten in China, their effects have also been felt in the U.S. American tariffs are having an impact, but retaliatory action hurts American firms too. Take the auto industry, for example. China may attempt to stimulate domestic demand by lowering sales taxes. While taken as a positive sign by markets, it does nothing to alleviate the 40% punitive tariff on U.S.-made vehicles entering China.

Other industries will suffer as well, and that will have effects up and down the economy. Corporate profits will fall, prices will rise and cost of living may be diminished. With a hot stock market and a Fed trying to raise interest rates, the added weight of a trade war could well tip off a serious correction.

Fear #2: Inflation

Rattner foresees that, as the labor market tightens and interest rates remain low, the possibility of significant inflation is rising:

“The second thing is this build-up of inflationary pressures that one can vaguely see. I think it is a potential worry and something we should really keep a close eye on. I think the recent moves in 10- and 20-year treasuries may be signalling something, we’ll see, but we should be watching those unemployment numbers and the wage numbers and the consumer price index numbers and the personal consumption expenditures numbers - very, very carefully.”

For the U.S. economy, inflation is certainly an elephant in the room. Unemployment is hovering around record lows and consumer confidence is extremely high. Meanwhile, the Fed is raising rates slowly but surely. While rates have not had a marked impression on inflation thus far, it will undoubtedly trickle out ere long. When that happens, it could run the risk of putting the breaks on the roaring market. A true deflationary pressure could be a serious problem, especially given the present state of asset price levels.

Fear #3: Yield chasers

As the great bull market drives asset prices to new heights, money managers are chasing yields, and willing to take higher risks to get it, which Rattner sees as a serious problem:

“The third thing I worry about is that, on paper what’s happening in the Howard Marks (Trades, Portfolio) world of ‘too much money chasing too few deals’, is visible. You can see that spreads between high yields and investment grade loans are not all the way back to where they were right before the global financial crisis, but they’re pretty darn close. And there are other measures, like the share of deals being done through covenant-lite structures, that also tell you things are scary. And you can also look at the debt ratios that are going into private equity deals - the Fed had a policy that they didn’t want more than 6 times debt to leverage in private equity deals, that has sort of been nudged up a little bit. There’s indicators in every direction that while most of the really crazy financing structures that existed at the time of the great financial crisis have been taken off the table, the more conventional, simple act of credit quality deteriorating in a bull market is obviously well underway and is a scary situation.”

Private equity outfits are not the only ones chasing yield. Pension funds are also desperately seeking opportunities that can bring in the returns to pay out to an ever-growing bench of retirees. Yield chasing is always a bad economic sign, and a dangerous sign for markets. But it is clear that this is happening right now. Private equity and venture capital funds are awash with cash and they are competing for deals, which has resulted in prices getting bid up precipitously. This happens in the public market too, but the illiquid private market is at even greater risk in the event of a broad economic correction. Exiting from portfolio companies with staggering valuations could prove increasingly challenging.

Overall, while exotic and dangerous deal structures are not so great a problem, the simple glut of capital chasing yield could cause equally calamitous outcomes. So we are very much on Rattner’s side on this point as well.

Disclosure: No positions.