Leon Cooperman (Trades, Portfolio) is the chairman and CEO of Omega Advisors, an investment advisory firm with $3.3 billion in assets under management. In a CNBCÂ interview on July 31, the guru questioned the need for an interest rate cut by the Federal Reserve, saying that “the conditions for a big decline are not present." While I don’t personally agree a decline is unlikely, I do agree that it is strange the Fed has chosen to lower rates in what is supposedly the greatest economy in history.
No need for a cut
Cooperman’s thesis is the economy is currently doing well enough that a cut is not warranted:
“The way I look at it, I see consumer confidence high, retail sales recently strong, employment is strong, interest rates are already quite low. The economy is growing at trend, it’s not growing below trend, trend growth is about 2%. Wealth is at a record level, obviously due to the stock market. Corporate profits are decent. I they’re coming in stronger than was expected in the quarter, and stock repurchase activity to me suggests that businessmen are not pessimistic.”
With economic data looking strong, Cooperman thinks the cut is essentially insurance against the disruption caused by the trade war, which he said is a self-inflicted problem:
“I think what’s going on is that we’re rewarding one questionable policy with another questionable policy. The questionable policy was the indiscriminate threats of tariffs. I understand what we’re doing with China, it makes sense, but threatening Europe, Canada, Mexico - that’s created a lot of business uncertainty and a weight on capital investment. Now we’re rewarding that policy by cutting interest rates when interest rates are already low, and we’re just forcing people out on the risk curve.”
Low rates lead to increased risk-taking
I’ve written frequently about how low interest rates distort markets - by creating zombie companies, fuelling bubbles and incentivizing investments in cash-incinerating businesses like Tesla (TSLA) and WeWork. During the interview, Cooperman hit on another negative consequence of sustained low rates - they force investors further out on the risk curve.
“Ten years ago, people that bought T-bills said, 'I can’t survive on a near 0% [yield], I’m going to buy T-bonds.' The T-bond buyers said, 'I can’t survive on 2%, I’m going to buy industrial credits,' and that’s 4%. The industrial credit person said, 'Four percent doesn’t impress me, I’m going to buy high yield.' The high yield person said, 'I can’t get by on 6% to 7%, I’m going to buy structured credits, CLOs.' And the CLO guy or gal said, 'I’m going to put 25% of my fund in equities.' And so we’re pushing people out on the risk curve.”
In other words, investors now need to take on more risk to generate the same returns that they used to get. This is obviously bad for individual investors, but is even more worrying when viewed on a systemic level.
Read more here:
- Howard Marks: Thoughts on Identifying Investment Opportunities
- Glenn Greenberg's Investment Approach
- What Can Investors Expect From the Coming Rate Cut?
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