“Purchase price is permanent; your financing is temporary.” Higher interest rates have challenged the dealmaking environment, but Blackstone President Jon Gray sees benefits to investing before market conditions normalize. In his latest quarterly update, Jon also discusses slowing inflation, Blackstone’s longtime conviction in AI and why the commercial real estate market is more nuanced than some headlines let on.

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Elevated rates, strains on regional banks and dramatic shifts in the ways we work have raised concerns about commercial real estate. Yet today’s market continues to show strong performance in select subsectors. Global Co-Head of Real Estate Kathleen McCarthy explains the unprecedented dispersion we’re seeing and why this market cycle is different from the Global Financial Crisis. She also shares how Blackstone’s experience in prior downturns positions us to capture opportunities today.

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The tailwinds in the content creation space are powerful: annual spending on original content increased by approximately 2x from 2020 through 2022 and streaming platform subscribers have grown at a double-digit pace annually over the same period. At Blackstone, we’ve been investing in the content creation space across the firm, from studio space in the United States and Europe to businesses like Candle Media, a next-generation media company. This growth in content also leads to growing demand for data storage, further fueling our interest in investments around data centers, such as QTS, whose size has tripled in just two years through new leasing.  

The recently passed New York State budget will increase annual tax credits for productions from $420 million to $700 million, making the state an even more compelling location for productions and in turn spurring additional demand for studio space. In New York City alone, annual production spend has increased by 25% over the past two years, despite a lack of purpose-built studio infrastructure to support this growth.

In partnership with the NYCEDC, we are excited to revitalize Pier 94 and help meet the demand for studio space in Manhattan. When complete, Sunset Pier 94 Studios will enable high-quality TV and movie content to be filmed in the heart of New York City, contributing millions annually to the local economy.

We sat down with Nadeem Meghji, Jacob Werner and Mackenzie Berman to discuss how this approximately $350 million investment came together and what’s to come at Sunset Pier 94 Studios.   

Why are we interested in studio space?

Nadeem Meghji: As investors our objective is to generate strong performance, to understand how the world is changing then find real estate assets that benefit from those trends. So, when we see growth in AI and in the cloud, we invest in data centers. When we see growth in e-commerce, we invest in warehouses. We asked ourselves, how do we play into this trend around content creation—around growth in streaming—from a real estate lens? It became clear that investing in the studio business was a way to express this view.

With Sunset Pier 94 Studios, we are now invested in the top three locations for content creation globally—Los Angeles, London and New York City.

What are we building at Pier 94?

Mackenzie Berman: With our partners Vornado and HPP, we’re developing a 266,000 square foot studio facility that’s going to be on the West Side of Manhattan at Pier 94. It will include six state-of-the-art soundstages that cater to all types of film and television production, including live audience programs. Our stages will also have the technological infrastructure for virtual production, a fast-growing technology in the studio industry.

Jacob Werner: Part of the project will also include revitalizing the pier itself, which has been underutilized for the past decade. Our development will include building public amenities that serve the adjacent Hudson River Park, and will include a new pedestrian walkway around the pier with incredible skyline views.

Why was New York City the desired location for this development?

Mackenzie Berman: When you think about how many TV shows and movies are set in New York City—and in Manhattan specifically—you’d think there were dozens of large studios nearby. In reality, there are only a handful of smaller soundstages in Manhattan, which cannot handle newer production specifications. This is going to be the first purpose-built production facility in Manhattan, which is a top desired location for talent within the broader New York City market and creates strong natural demand for studio space here. 

Plus, the location of the studio at Pier 94—54th Street and 12th Avenue—is close to popular outdoor filming locations in Manhattan like Times Square, Central Park and the New York Public Library, which makes it especially convenient for productions that require filming both on location and within sound stages. It’s also very close to the office hubs for big content creators like HBO, CBS and Disney. We’re planning to break ground imminently and expect to deliver the facility within the next two to three years.

Jacob Werner: This investment demonstrates our continued commitment to New York City and our conviction in investing in this market because it is a hub for talent. That’s especially true in entertainment and media. We believe we have all the ingredients to do something really special.

How were we able to get this deal done given the current environment? 

Jacob Werner: We’re fortunate to be able to utilize the scale of the Blackstone platform to inform and reinforce the trends we’re seeing. We were able to get insight from Candle Media, one of our private equity portfolio companies, about where they saw the biggest need for studios.

Furthermore, we benefited from strong relationships with Vornado and HPP, enabling us to pull this transaction together.

Mackenzie Berman: New York City is one of the biggest partners in this as well. This is a true public-private partnership because we worked hand in hand with the New York City Economic Development Corporation to restructure the ground lease and commit to invest capital to reinforce the pier. It’s a special situation where we’ve been able to partner with all parties to creatively develop the best studio complex in New York City. It is truly a win-win-win-win.

Certain information within this article was obtained from an economic impact analysis prepared by AKRF, Inc. and sponsored by a joint venture of Blackstone, Vornado Realty Trust and Hudson Pacific Properties. Blackstone has not independently verified, and no representation is made, as to the accuracy of such information. Such information is subject to change without notice and may differ from opinions expressed by others. Any projections, expectations or other forward-looking statements set forth herein are based on assumptions that are believed by Blackstone to be reasonable as of the date hereof. Actual results are inherently uncertain and may vary materially from the themes set forth herein.

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Several themes emerged from the discussions. First, the workweek has changed with more people working at least part of the time at home. Second, climate change is real and will have an indefinite impact on weather patterns and profitability. Third, the conflict between democracies and autocracies is likely to persist, increasing the cost of defense. Fourth, budget deficits at the Federal, State, and local levels and abroad are likely to keep interest rates high and put pressure on equity price-earnings ratios. Fifth, artificial intelligence is a game changer, much like the internet was, and is likely to improve productivity, but its impact on employment is hard to determine.

Lifestyles are clearly changing with more people putting working at home or free time on an equal footing with financial success. We discussed the profound effect this is having on the office real estate market, with occupancy throughout the United States being impacted. Vacancies among office buildings in major cities are around 20%, which has an impact not only on the value of the properties but also on the real estate tax revenues of state and local governments. If rental income from a building is down sharply and the landlord has a mortgage, giving up ownership to the holder of the mortgage may be sensible. This will put pressure on banks and insurance companies who are traditional holders of mortgages. The large money center banks that loan money to major corporations will be less affected, but regional banks will suffer a greater impact.

On climate change, the world is falling behind on its goals of reducing carbon emissions. Even if the United States stops emitting carbon, we will still have a problem because China and India are generating much of the electricity in their countries with coal. Using nuclear power could be part of the solution; France generates 70% of its electricity using that resource, but today it’s a political non-starter in the United States. Despite the improvements that have been made to the safety of nuclear power plants, these sources of power are making slow progress. The oil experts attending believe we will be using fossil fuels to power transportation for at least the next twenty years.

On the economy, the strong performance of the stock market and the recent report on Gross National Product has led the consensus to believe we will have a soft landing rather than a recession. As a result, the consensus was that the Federal Reserve will pause in making further rate increases to make sure that the economy remains on a growth path. A minority of participants felt that, despite the combination of an inverted yield curve of 100 basis points and the leading indicators headed lower, the Fed will be encouraged to increase interest rates by 25 basis points one or two more times given the Federal Reserve target of 2.0% inflation and the Personal Consumption Expenditure Price Index still above 4%. Inflation is, however, clearly coming down on virtually all fronts and that is what is encouraging the optimists. Favorable news on the economy has preceded most recessions before a sudden drop in business activity occurs. Be wary of extrapolating present market performance into the future. Monetary tightening works with an eighteen-month lag, putting the start of a potential recession late this year or early 2024.

We had an extensive discussion on artificial intelligence at every session. Some attendees with deep experience in the area believed that the tool will be important, but the current excitement is overdone and it will take four or five years for AI to be effectively worked into the economic system. Many desk job tasks can be reduced, simplified or eliminated and productivity will improve, perhaps doubling in next five years. A few of the largest companies in the artificial intelligence field are spending as much as $1 billion each on large language models. There will be significant advances in manufacturing, healthcare, the legal profession and language translations. The big question is whether there will be a market for the product of these improvements. Some regulation will be necessary to control malevolent people from using the AI tools; the problem will be separating the wrongdoers from the positive initiators. Those who are optimistic about the future of technology believe that AI is the next phase of important breakthroughs. Doctors will make better decisions about treatments around the world. Tutors will help people to learn more effectively. Progress in climate change will occur because of new engineering, new materials, new math, new chemistry, and new advancements in biological research. New drugs will be introduced more quickly. Conversely, AI may play a negative role in the next election and we must safeguard against that. There will be cyberattacks against corporations, individuals and politicians. Biological weapons could be developed using AI tools. While AI will help offset declining populations in many industrial countries, the benefits will only be available to those with the necessary technical education to utilize the new tools.

We discussed the 2024 election at every session. The participants were with the consensus in hoping that someone other than the current presumed candidates would be on the ticket for both parties, but there was general agreement that the race would be between Trump and Biden, with uncertainty about the outcome. Trump would lose some voters because of his legal problems, but most of them would be unlikely to cast their vote for Biden. Biden, because of his age and familial problems, lacks enthusiastic support, but most Democrats would, of course, have trouble voting for Trump. This may result in low turnout, which could affect the Senate and House elections. One participant said that what was needed was better presidential leadership.

While the war in Ukraine seems endless, there was general agreement that within the next year there will be a ceasefire but no peace agreement. Putin is beginning to run into political resistance within Russia because of the economic cost and human casualties of the war. In Europe and the United States, most right-wing groups believe we should not be spending so much providing aid and arms to Ukraine when we have so many problems at home, including homelessness, housing, poverty, and immigration. Some felt that democracy is at stake. If Russia claims even parts of Ukraine through force, Putin may attempt to occupy areas elsewhere. Many feel he must be stopped and it is up to the West to provide the means to do that.

On China, there was general agreement that the economic slowdown was a significant development. Growth well below the 5.5% target was a big disappointment in spite of considerable monetary stimulus. Many housing developments, which are the principal means for personal savings, are in danger of bankruptcy. The country is suffering from deflation. Xi Jinping’s power is not being challenged. The problems at home are significant enough to discourage Xi from embarking on any military adventures abroad and that makes any attempt to take over Taiwan less likely, although some think he might try that as a distraction from problems at home. The United States has been vigorous in trying to improve its relationship with China. The Blinken and Yellen trips are examples. Trade with China, back and forth, is $700 billion, so we are both important to each other. That must be the basis for a more harmonious relationship. The ideological difference must become less important. In spite of the problems, there are a number of cheap stocks there, but few in the group had the appetite to invest.

Investors are worried that the escalation of government debt will become a major problem. Interest costs have risen from 2% to 3%, adding another $100 billion to the annual cost which is already 7% of Gross Domestic Product and will rise to 14% in a decade. There is a limit to what taxpayers will pay and lenders will provide, but the severity continues to be ignored. One in the group quoted Marcel Duchamp, who said, “There is no solution because there is no problem,” but that seems facile. At a minimum, a central debt burden is likely to mean that interest rates will stay higher. The hope is that AI will increase growth and this will help us out of the problem, but it is unlikely to be enough for the foreseeable future. We are likely to have fewer lawyers, accountants and consultants, but more health care and service workers in building trades and home assistance.

As much as I tried, I couldn’t get anyone to comment on our problems with education. We are still not getting more than 75% of our children to graduate from high school. What is the future of the 25% not graduating? Will we have enough technologically trained people to meet the increasingly complex needs of the economy? In the Middle East, the prospect of Iran having the capability of producing a nuclear bomb is increasing and that will create a power imbalance there. China is getting involved in the area. The economies are booming, so the countries want a place at the geopolitical table influencing policy.

In conclusion, a majority thought the US economy would have a soft landing. The S&P 500 would hit 5,000 sometime in the next few months. Inflation would move toward 2% but not get there. It was summer in the Hamptons and the sun was out most of the time. Most of the participants were very comfortable financially and living a good life. Returns may be lower in the future, but that won’t change.

The views expressed in this commentary are the personal views of Byron Wien and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Byron Wien as of the date hereof, and neither Byron Wien nor Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.

Blackstone and others associated with it may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary and may also perform or seek to perform services for those companies. Blackstone and others associated with it may also offer strategies to third parties for compensation within those asset classes mentioned or described in this commentary. Investment concepts mentioned in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position.

Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one’s investment and tax advisors. All information in this commentary is believed to be reliable as of the date on which this commentary was issued, and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy or completeness of the information contained herein.

This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. This commentary discusses broad market, industry or sector trends, or other general economic, market or political conditions and has not been provided in a fiduciary capacity under ERISA and should not be construed as research, investment advice, or any investment recommendation. Past performance is not necessarily indicative of future performance.

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To download the webcast slides, please click here.

For any technical questions, please contact BlackstoneStrategy-Support@Blackstone.com

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The views expressed in this commentary are the personal views of Byron Wien and Joe Zidle and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Byron Wien and Joe Zidle as of the date hereof, and neither Byron Wien, Joe Zidle, or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.

The Blackstone survey of a subset of portfolio company CEOs referred to herein reflects input from 85 Blackstone portfolio companies (63 U.S. CEOs), largely within Blackstone’s Private Equity and Real Estate businesses (the “CEO Survey”).  The CEO Survey was initiated on June 5, 2023 and closed June 21, 2023. The responding portfolio companies are not necessarily a representative sample of companies across Blackstone’s portfolio. The views expressed by responding portfolio companies in the CEO Survey do not necessarily reflect the views of Blackstone.

Blackstone and others associated with it may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary and may also perform or seek to perform services for those companies. Blackstone and others associated with it may also offer strategies to third parties for compensation within those asset classes mentioned or described in this commentary. Investment concepts mentioned in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position.

Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one’s investment and tax advisors. All information in this commentary is believed to be reliable as of the date on which this commentary was issued, and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy or completeness of the information contained herein.

This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. This commentary discusses broad market, industry or sector trends, or other general economic, market or political conditions and has not been provided in a fiduciary capacity under ERISA and should not be construed as research, investment advice, or any investment recommendation. Past performance is not necessarily indicative of future performance.

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At a Glance

• US economy shows surprising resilience in 2023
• Reduced leverage lengthens monetary policy effects’ lag
• Creative approaches to asset allocation amid uncertainties

The resilience of the US economy is unquestionably one of 2023’s big surprises. Coming into this year, I shared the prevailing view among economists calling for a recession, but if anything, economic activity appears to be accelerating. Aided by a stronger economy, and the outperformance of equities and tightening credit spreads, the soft-landing camp is winning the debate for now. A big question, though, is how do we reconcile improving conditions after a 525-basis point (bp) increase in fed funds rates in just 12 regular meetings spanning just 18 months?

In my view, economist Milton Friedman’s “long and variable” lag could, along with current household and corporate debt dynamics, help explain the economy’s muted reaction to this hiking cycle. This reinforces the need for investors to stay vigilant and not to get lulled into a false sense of security about the economy’s growth trajectory from here.

Debt’s different this time  In Friedman’s influential 1961 paper, “The Lag in Effect of Monetary Policy,” he estimated the delay at 12 to 18 months. The Fed’s been thinking about the lag, having used the phrase “long and variable” at least 17 times since last year. Some governors suggest the lag could be as short as 9 months, while others argue it could be as long as 2 years.¹ That wide range doesn’t offer much in the way of pinpointing the lag.

To assess whether the lag might differ from past cycles, our team sought to quantify the interest rate sensitivity of households and corporations by examining their debt structure. Our findings suggest that both groups have significantly reduced their leverage and restructured their debt at lower interest rates than the prevailing ones. Consequently, the economy shows less sensitivity to interest rate changes than it has had in recent hiking cycles.

For instance, approximately 42% of owner-occupied houses had no mortgages at all as of 2021.² Additionally, around 75% of mortgage holders carry 30-year fixed mortgages with interest rates below 4% (see Figure 1). I would argue that these folks don’t care very much about the Fed’s strategies. This scenario is in stark contrast to the previous tightening cycle from 2006 to 2008 when only 32% of owner-occupied houses were debt-free, and the popularity of interest-only loans and HELOCs exposed mortgage holders to greater interest rate risks.

Figure 1: 30-Year Conventional Mortgage Rate Distribution

Similarly, corporations capitalized on record-low interest rates during the COVID period by accumulating precautionary cash, leading to record-high cash percentages of liabilities on corporate balance sheets. Debt issuance surged, and the duration of the Bloomberg US Aggregate Bond Index reached an all-time high.

Figure 2: Bloomberg US Aggregate Bond Index Duration
(years)

Asset allocation should be different too  Now, these reductions in leverage and extended debt maturities do not render the US economy impervious to the impact of the most aggressive tightening cycle since the 1980s. Rather, they suggest that the lag in monetary policy effects could be lengthier than in previous cycles.

As for investors, I believe the potential for a lengthier lag and further volatility should encourage them to think about more creative approaches to asset allocation than traditional strategies like the 60/40 portfolio. Location and nerve matters in this still-uncertain environment, and disciplined, high-conviction investing can differentiate a portfolio. Instead of cause for fear, dislocations can be seen as opportunities for capital deployment. I believe private market alternatives offer compelling diversification opportunities.

With data and analysis by Taylor Becker.

1. Source: Federal Reserve Bank of St. Louis, as of 5/24/2023. https://www.stlouisfed.org/publications/regional-economist/2023/may/examining-long-variable-lags-monetary-policy
2. Source: US Census Bureau, American Housing Survey 2021.

The views expressed in this commentary are the personal views of Joe Zidle and Taylor Becker and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Joe Zidle and Taylor Becker as of the date hereof, and neither Joe Zidle, Taylor Becker, or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.

Blackstone and others associated with it may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary and may also perform or seek to perform services for those companies. Blackstone and others associated with it may also offer strategies to third parties for compensation within those asset classes mentioned or described in this commentary. Investment concepts mentioned in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position.

Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one’s investment and tax advisors. All information in this commentary is believed to be reliable as of the date on which this commentary was issued, and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy or completeness of the information contained herein.

This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. This commentary discusses broad market, industry or sector trends, or other general economic, market or political conditions and has not been provided in a fiduciary capacity under ERISA and should not be construed as research, investment advice, or any investment recommendation. Past performance is not necessarily indicative of future performance.

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When analyzing a sector for potential excess in the market, we have to look at its foundation, deeper than recent performance and hype. AI’s foundation is data and the infrastructure required to use it, which is one reason that leads me to believe that this isn’t a bubble. It’s a developing long-term growth opportunity across a potentially transformative technology value chain.

It’s early days of AI’s growth story At Blackstone, we recently assembled a network of chief technology officers to discuss, among other topics, AI’s impact and its potential. A common observation from these CTOs is that many companies are in the research phase with AI and have yet to fully exploit its capabilities for productivity. I believe these discussions leave little doubt that generative AI will bring about monumental transformations, but it will do so in ways that we cannot yet fully understand.

Yes, AI-related stocks have surged significantly this year. But as Deutsche Bank Research Strategist Jim Reid humorously noted in his “Flippant Friday” post, if this were the trajectory of AI stocks with only 50% public awareness, where will these stocks land when the entire population becomes aware of AI?

Where we are currently is the beginning of businesses and the wider economy integrating AI. With as many, if not more, questions than answers currently, what we can do is look to identify the dynamics that figure to be integral to AI’s implementation and growth trajectory.

More data means more storage needed In some respects, generative AI reminds me of the earliest days of e-commerce growth. It was clear that Amazon would fundamentally disrupt the retail industry, and that sent investors hunting for the infrastructure that would enable its success. Not so obvious initially was that warehouses would be integral to Amazon’s rise. To fulfill its promise, Amazon needed last-mile distribution, which required a massive amount of warehouse capacity near population centers. Urban in-fill warehouses were transformed.

Today, we can look at AI and data centers the same way. Generative AI models rely on robust data processing capabilities and extensive storage capacities, which should drive demand for physical data centers that can handle the intensive computational requirements of generative AI applications. Also, data centers enable distributed training and inference, efficiently coordinating operations across multiple machines or multiple other data centers. The demand for data centers has increased dramatically in recent years with storage and computing requirements shifting to the cloud. According to CBRE estimates shown in Figure 1, data center inventory has nearly tripled since 2015.¹

Figure 1: Data Center Primary Market Total Inventory (MW)

This data center growth really should come as no surprise considering the sheer mass of data that the world now produces each day. Figure 2 shows some mind-blowing examples, like that more than 230 million emails and 16 million texts are sent every minute of every day. Each minute also yields 5.9 million Google searches, 1.7 million pieces of content shared on Facebook, and 347,000 Tweets shared on Twitter.

Figure 2: Amount of Data Generated Each Minute of the Day

Opportunities in generative AI’s physical presence Now add AI to the mix. It’s natural to think of AI as an esoteric, abstract concept; a form of software that lives in the ether. In reality, real world data centers anchor AI, just as they do data storage and cloud-based applications that run on physical servers. The physical needs of AI will diverge in certain ways from existing applications and could lead to the development of data centers tailored for the new technology. Meta, for example, recently shared details on its own plans to redesign data centers projects to support its AI development.

Data demand multiplier The same impetus drives the many competing forces racing to develop both narrow and broad generative AI models. All of them heavily rely on substantial computational power, robust data processing capabilities, and extensive storage capacities. All of them are expected to drive increasing demand for data centers that are foundational to handling those intensive requirements to power generative AI applications. Moreover, data centers enable distributed training and inference, efficiently coordinating operations across multiple machines or data centers.

We may not fully understand the costs and benefits of generative AI, but I believe that it is here to stay and that it will bring a surge of investment into the field. While the tech companies battle over the development potential and applications, from my perspective, data centers seem well-positioned to thrive in the present and future of an AI-driven world.

With data and analysis by Taylor Becker.

1. https://www2.blackstone.com/e/213192/-it-impact-data-center-markets/2pkgd4/678830010?h=CrO99zrkzHmPGlGqwI7ojVpEKDF5UHwqc4ae_3ht80o

The views expressed in this commentary are the personal views of Joe Zidle and Taylor Becker and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Joe Zidle and Taylor Becker as of the date hereof, and neither Joe Zidle, Taylor Becker, or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.

Blackstone and others associated with it may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary and may also perform or seek to perform services for those companies. Blackstone and others associated with it may also offer strategies to third parties for compensation within those asset classes mentioned or described in this commentary. Investment concepts mentioned in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position.

Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one’s investment and tax advisors. All information in this commentary is believed to be reliable as of the date on which this commentary was issued, and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy or completeness of the information contained herein.

This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. This commentary discusses broad market, industry or sector trends, or other general economic, market or political conditions and has not been provided in a fiduciary capacity under ERISA and should not be construed as research, investment advice, or any investment recommendation. Past performance is not necessarily indicative of future performance.

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Market dislocation and strains on the US banking system have drawn attention to private credit—debt that is privately originated and not traded on the public markets. But in fact, private credit has been experiencing secular growth for years, expanding from 5% of the sub-investment grade market in 2005 to 24% in 2022.¹ 

While some observers may believe that private credit is high-risk, we consider it defensive—provided that lenders back strong businesses, remain senior in the capital structure and put the right protections in place. Brad Marshall, Blackstone’s Global Head of Private Credit Strategies, discusses our approach and what makes private credit attractive to both investors and borrowers today. 

1. Preqin, Credit Suisse, as of September 30, 2022. Total addressable sub-investment grade credit market defined as the aggregate of the US high yield bonds, US leveraged loans and North American private credit markets. Leveraged loans refer to broadly syndicated loans.

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Despite inflation slowing, we believe the Fed is unlikely to lower rates as quickly as the market predicts. Looking forward, “it’s really about the cost of capital and the availability of capital, and what that will mean for the economy,” says Blackstone President Jon Gray in his latest quarterly update. Jon discusses the implications of recent turbulence in the banking system, why we believe private credit is in a “golden moment,” and why much of the real estate landscape is healthier than some observers suggest. 

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This content may contain forward-looking statements within the meaning of U.S. federal securities laws. Forward-looking statements are made only as of the date of this content and are subject to risks and uncertainties.  We undertake no obligation to update any such statements. Actual outcomes or results may differ materially from these statements.

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Although the Federal Reserve (Fed) can cyclically tamp down inflation, it’s important for investors to understand that long-term issues of inadequate investment and shortages across the economy will hinder a return to the days of easy money, stability, and excess liquidity. The need for investors to understand that they can find opportunities in this environment is also important, but it requires them to implement new strategies.

Today’s underinvestment, tomorrow’s inflationary pressure As we wrote last summer, a significant factor in the current inflationary pressures is the long-standing underinvestment in crucial assets like housing, energy supplies, and public infrastructure in combination with an undersupply of labor. This underinvestment contributed to shortages that exacerbated inflation, to which the Fed responded by raising rates and shrinking its balance sheet.

Ironically, today’s higher rates perpetuate underinvestment in interest-rate sensitive sectors and exacerbate shortages and inflationary pressures on a more secular basis. We have already seen some signs of this effect in the “real economy” with slowing in everything from homebuilding to capital expenditures.

Evidence of underinvestment across sectors The US housing market, for example, faces a shortage of millions of units. Similarly, the energy supply has been constrained due to years of inadequate investment. The shift towards renewable energy and decarbonization further increases the need for critical minerals, shortages of which are expected to worsen in the coming years, also due to underinvestment. Meanwhile, the trend of ever-cheaper labor and inputs, enabled by globalization, has stalled out as firms seek to diversify supply chains and make them more resilient.

The upshot is that while the Fed can control inflation on a cyclical basis, doing so might result in inflation being structurally higher in the next cycle. In that scenario, the Fed wouldn’t have room to maneuver a return to extremely accommodative policies.

Don’t expect the last cycle I recently shared our view that the Fed is unlikely to pivot towards easier monetary policy in the near term. The market hasn’t embraced the idea of higher rates for longer and continues to price in a quick return to accommodative monetary policies, as in the last cycle. The market’s overlooking the potential for a higher trend level of inflation and shorter, more volatile economic cycles.

Turning the page In this new regime, I believe investors need to consider the changing market dynamics and reassess their strategies. Prioritizing profits over multiples and credit over duration is vital to navigating a liquidity drought. Here to discuss this regime and offer a potential solution is Joe Dowling, of Blackstone Alternative Asset Management (BAAM).

With data and analysis by Taylor Becker.

Regime Shift Calls for a New Playbook

by Joe Dowling, Global Head of Blackstone Alternative Asset Management

In BAAM, we aim to build resilient portfolios that seek to generate compelling returns across various market environments. Predicting the future is impossible, so building resilient portfolios requires us to be probability-based in our asset allocation and investment decisions. The shift from quantitative easing (QE) to quantitative tightening (QT) means less liquidity and more volatility. As a result, investors need a new investment playbook, and in our view, absolute return strategies have the potential to deliver strong returns and diversify portfolios in these conditions.

It’s a different market now For a decade, markets benefited from a favorable investment environment. Interest rates were low, inflation was low and well-anchored, and globalization enabled companies to access the lowest marginal cost for inputs. Multiples expanded, and, as a result, asset prices went up. Investors were rewarded for investing in companies that sacrificed present-day profitability to deliver long-term growth. A traditional US 60/40 portfolio annualized over 11% returns in the 10 years between 2012 and 2021.¹

But those days are over. Interest rates are high, inflation is high and unpredictable, and companies value resiliency over efficiency. In many respects, the market trends of the last 10 years reversed. The traditional strategies that worked so well in the previous environment are now exposed to an increasingly difficult investment framework. The same US 60/40 portfolio lost 16% in 2022, one of the worst returns on record for the strategy.

QT for longer Starting in June 2022, the Fed moved from quantitative easing to quantitative tightening. During the prior QE era, the Fed was a recurring and large-scale buyer of assets, including US Treasury bonds and mortgage-backed securities. This injected dollars into the economy and ballooned the Fed’s balance sheet from roughly $1 trillion in 2008 to $9 trillion by the end of 2021.

In the wake of higher inflation, the Fed is now removing dollars from the economy by shrinking its balance sheet, most recently by letting securities mature and naturally run off. The Fed set the monthly cap on reduction at $95 billion per month, consisting of a treasury cap of $60 billion per month and a mortgage cap of $35 billion per month. We estimate that it will take 2–4 years to get the central bank’s balance sheet down to an equilibrium size at this rate.²

Less liquidity creates more volatility The QE era had abnormally low volatility across asset classes, and increased liquidity suppressed market movements. In fact, equity volatility was 23% lower on average in the 10 years between 2012 and 2021 versus the prior 10 years between 2002 and 2011.³ Meanwhile, bond volatility was 38% lower on average for the same periods.⁴

QT is reversing this trend, as declining market liquidity amplifies market movements. In 2022, volatility across asset classes increased substantially, and it remains elevated in 2023. While volatility translates into increased investment risk, risk often creates opportunity. Many alternative investment strategies benefit from heightened market volatility and increased dispersion within and across asset classes.

Time to scrutinize portfolio construction A market regime shift like this one requires us to reflect on how we invest and build portfolios. This means asking and answering difficult questions, including these three.

1. Will multiple expansion continue to drive returns in this environment?

It is unlikely. US equities currently trade at 17x next year’s earnings, which is in line with the average multiple over the last roughly 30 years.⁵ High interest rates are a headwind to multiples, not a tailwind.

2. What will a portfolio return if equities are flat over the medium term?

Equities were the primary driver of strong returns over the past decade. In a US 60/40 portfolio, equities returned 16%+ annualized while bonds returned about 3%. This performance suggests that many portfolios that performed well in the previous environment were over-reliant on equities.

3. Does the portfolio have truly “diversifying” exposure?

Recent negative equity/bond correlation made it seem like traditional portfolios were diversified. However, bonds are not reliable diversifiers historically. Equity/bond correlation was positive in 62% of the last 50 calendar years, including 2022.⁶

Absolute return strategies aim to be truly uncorrelated Traditional strategies like the 60/40 are not balanced when equities and bonds are correlated. Adding absolute return seeks to provide more balance through differentiated sources of return. Based on our analysis, we believe a 60/30/10 portfolio that allocates 10% to absolute return strategies can help accomplish this goal.

Examples of absolute return include trading, quantitative, alternative credit, and macro strategies. Trading strategies provide liquidity to markets by buying and selling securities as an intermediary. As liquidity becomes scarce, intermediaries command higher returns. Quantitative strategies seek to capitalize on short-term movements in markets without taking a directional view on the long-term appreciation of assets. Alternative credit strategies aim to invest in debt opportunities that are structural and less correlated to the economic cycle. And macro strategies take long and short positions in macro markets, such as interest rates, to express relative value views.

Putting these strategies together, absolute return exposure seeks to generate consistent returns regardless of underlying market conditions. We believe that their consistency and uncorrelated nature can build resiliency in traditional portfolios that may be exposed in the current environment.

1. US 60/40 portfolio consists of 60% S&P 500 Total Return and 40% Bloomberg US Aggregate Bond Index Total Return, rebalanced monthly.
2. Assuming the Fed reduces the size of its balance sheet at $95 billion/month and using a range of $4 trillion–$6 trillion for the equilibrium balance sheet size.
3. Calculates average VIX Index level from 2012–2021 and compares it to average VIX Index level from 2002–2011.
4. Calculates average MOVE Index level from 2012–2021 and compares it to average MOVE Index level from 2002–2011.
5. Bloomberg, as of May 2023.
6. Bloomberg, as of January 2023. Equities represented by S&P 500 and bonds represented by Bloomberg Barclays US Treasury Total Return Index.​​​​

The views expressed in this commentary are the personal views of Joe Zidle, Joe Dowling and Taylor Becker and do not necessarily reflect the views of Blackstone Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Joe Zidle, Joe Dowling and Taylor Becker as of the date hereof, and neither Joe Zidle, Joe Dowling, Taylor Becker, or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.

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Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one’s investment and tax advisors. All information in this commentary is believed to be reliable as of the date on which this commentary was issued, and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy or completeness of the information contained herein.

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