Joan Solotar - Head of the External Relations and Strategy Group, Senior Managing Director AND Senior Managing Director for External Relations & Strategy
Byron Richard Wien - Vice Chairman of Blackstone Advisory Partners Lp and Director of Blackstone Advisory Partners Lp
The Blackstone Group L.P. (BX) Money is Everything... So Far Conference March 28, 2013 11:00 AM ET
Hi, I'm Joan Solotar, Senior Managing Director of External Relations & Strategy at Blackstone. Thanks for joining us today for the webcast, Money Is Everything... So Far. featuring Byron Wien, Vice Chairman, Blackstone Advisory Partners. Following Byron's formal comments, there'll be an opportunity for you to ask questions. If you look at the lower left-hand corner of your screen, you'll see a Q&A box. Feel free to click on that at any point to submit your questions anytime during the webcast. At the bottom of the console, you'll also see a series of widgets. This interactive feature allows you to access additional functions by scrolling over them. That includes Twitter, Wikipedia, download slides and Refer a Friend. We plan to keep the webcast to 60 minutes, including the Q&A. At the end of the PowerPoint, you'll also see a full list of disclosures. Thanks for joining us. And with that, I'll turn it over to Byron Wien.
Byron Richard Wien
Thanks, Joan. So this webcast is really focused on 2 things. One, the impact of the extraordinary liquidity that's being pumped into the economy pretty much around the world, particularly in the United States, Europe and Japan, but also in a number of other countries, and also the prospects for earnings disappointment. Everybody knows about the liquidity, but the earnings disappointment point is more controversial, so I'll try to support that as we go through it. As you know, last time that we had this webinar, we talked about the Ten Surprises. I'm not going to dwell on that at this point. Iran is still moving toward a nuclear weapon. The market hasn't had its correction that I thought it would have, but I'm still of the belief that a correction is brewing here. Financial stocks are holding their own. Obama is more concerned about conservation and the environment than he is about stepping up oil production. And the Republicans, in my opinion, are missing an opportunity because they aren't seizing the leadership in terms of immigration. I think China is going to grow at 7%, and I think it will be a fruitful area for investment. Commodity prices haven't taken off, but climate change is still with us. I do think that the Japanese market is going to be a favorable place to invest this year, and it's working out that way. And finally, I think Europe will muddle through, but the European markets will have trouble as well. This is my radical asset allocation. It is a portfolio probably more volatile and less liquid than most of you are used to, but if you want to have a high single-digit return as an institution, this is the asset allocation I would recommend. I've now gone around the world a couple of times, talking about this with various sovereign wealth funds. I can honestly say, I haven't gotten anybody to adopt this program totally, but I've budged a number of portfolios in this direction. 10% in high-quality multinational growth stocks. I'm sure most of Western portfolios in Europe and the United States are already there. 15% in emerging markets, all the Asian portfolios are there, very few European or American portfolios are there. 15% in hedge funds, many European and American portfolios have more than that, and that's all strategies, long, short equity down to distressed. Then in private equity, 10%; 15% in real estate, which continues to do well, because there wasn't the overbuilding at the end of the last cycle that had to be worked off. Real estate bottomed when the economy bottomed. 5% gold, continues to be very controversial in the United States, embraced more in -- certainly in Asia and also in Europe. Agricultural commodities another 5%; 20% in high-yield securities, very -- I don't mean conventional high yield, which has now gotten to the yield point where I think they're expensive. I'm talking about mortgages, leveraged loans, mezzanine financing. And finally, 5% in cash.
These charts show corporate bonds and conventional high-yield bonds, and what you see is that yields have gotten down low enough so that the issuance is really greater than I think it's ever been. Even marginal companies can come to market with reasonable maturities at very low interest rates. So as a result of that, I think I would go further out on the risk curve. I don't see a recession in sight, and I think you're paying -- being paid adequately for the default risk at the riskier end of the high-yield spectrum.
And these are the things I'm going to talk about today, monetary policy, which I think is driving the market; the higher taxes and reduced government spending, and what impact that might have on the economy; energy and housing is the 2 most favorable aspects of the current U.S. economy; valuation; Europe; China and Japan.
Now this is probably the chart that tells it all. It's hard to believe but in 2008, the Federal Reserve balance sheet was only $1 trillion, and it was all U.S. Treasuries. And then we got into the subprime crisis and everything changed. Over a very short period of time, the Federal Reserve balance sheet increased from $1 trillion, all Treasuries, to $2.5 trillion in a hybrid of mortgage securities and Treasuries. And the European Central Bank went up in sympathy as well. Then neither did much for a while, then the Fed got involved in QE2, and now QE3. When Italy got into trouble, the European Central Bank escalated its monetary expansion. So now the Fed has $3 trillion on its balance sheet, and the European Central Bank has EUR 3 trillion. But that isn't the end of the story. The Fed is putting $85 billion of -- or buying $85 billion worth of securities every single month. That means that this year alone, the Fed will add $1 trillion to its balance sheet. Every month, they are buying $40 billion in mortgage-backs, $45 billion in Treasuries. So this year, they'll add as much to the balance sheet as the whole balance sheet existed in 2008. It's no wonder that the stock market is reflecting it. The Fed's purpose, of course, is to get the real economy going, but a significant portion of that $1 trillion that's being added -- and they've signaled that they're likely to do it all year -- major portion of that flows into financial assets, keeping interest rates low and stock prices rising. So if you don't think that money is everything, you've got to look at this chart hard because this chart tells you, explains why the market, having been up 16% on a total return basis last year, is up almost 10% this year. And almost everybody feels they can buy equities today with impunity because the Fed has said it's going to continue to pursue this program, and I'm worried that when people -- when something's too good to be true as it seems to be right now, you should be looking at flaws in it. And most of the rest of the presentation is devoted to trying to seek out those flaws.
So on the left-hand side, you can see that the quality of the balance sheet on the -- at the Fed has deteriorated, about 1/3 of it is mortgage-backs. On the right-hand side, you can see that government debt continues to increase, but the leverage in the private sector has been drawn down. Taking a look at the U.S. economy, I'm still using 2% growth. I know with the stock market having risen, a number of observers have stepped up their estimates, but -- for GDP growth this year, but I still think it's more likely to be closer to 3% than the 3% -- closer to 2% than the 3% some people are using.
The Economic Cycle Research Institute survey or projection for economic growth is pretty closely watched because they were correct in both 2011 and 2012 in signaling the second half slowdown. As you'll recall, the economies in both of those years were pretty strong in the first quarter as the employment figures are indicating for the U.S. this year. But then there was a softening during the summer and people are wondering whether that's going to happen. The Economic Cycle Research Institute still thinks we're going to see a slowdown. I think there is a strong possibility of that as well, but most people think that we're not -- that sell in May and go away isn't going to be operative, that the market is likely to head higher for most of this year. In audiences that I've been speaking to, I've asked how many of them think -- how many of the participants think the market is going to be up 20% this year. And I'm surprised at how many hands go up.
This is a chart that -- a form of which I showed a few years ago, and I thought I'd bring it back. It really explains probably better than anything I can show you what the dilemma of the United States is. In the postwar period, capital was very productive. In essence, this is a chart of capital productivity. And you can see here, for every $1 of debt that we took on in the United States in the postwar period, up until 1980, we produced a tremendous amount of gross domestic product. But today, $1 only produces $0.29 of gross domestic product increase. You, in effect, have to put $3 to $4 to work to get $1 of GDP growth. So that's why we keep on incurring debt and the economy grows very slowly. This tells the story of the declining productivity of capital more effectively than any words I can give you.
In terms of what the economy is likely to do this year, I think it's useful to look at how projections have been coming down. They've turned up because of the stock market. But still, I think that the consensus is for 2% or less growth in 2013. The economy is doing well, however. Industrial production, real GDP, operating rates, all indicate that the economy is growing, but it's just growing at a very modest rate of about 2%.
In terms of inflation, I've been maintaining for several years now that inflation is not something you need to worry about. Unless you get house prices really soaring and wage rates going up, I don't think inflation is going to be a serious problem. House prices are going up, but they're going up very gradually and wages aren't going up at all because there's so many people unemployed that really want a job. Here are 3 measures. On the left-hand side, I thought you'd be interested in seeing where there's a lot of talk about the cost of education. Tuition as a percentage of per capita income has actually been declining. It's the other expenses associated with education that have been rising. Food has not been going up in any kind of dramatic way, so food costs seem to be under control. And overall, the overall CPI seems to be increasing very modestly. So one thing we can be encouraged by is the fact that inflation isn't a problem for the economy right now.
Retail sales are now exceeding. These are real numbers. They are now exceeding the numbers before the recession. So retail sales have stayed strong in spite of the fact that the 2% payroll tax holiday ended on January 1. I thought that had the potential to dampen retail sales, but consumers feel good about things maybe because the stock market is up, maybe because their houses are appreciating, but they're going out and spending, not irresponsibly, but retail sales are pretty healthy.
In terms of productivity though, which has been the major factor increasing profits, productivity has come down sharply. And I think that's going to be a problem for profits going forward. We're going to look at that a couple of different ways as we move forward in the presentation. Here, you see housing starts rising and house prices rising. And so I think we can take heart in thinking that housing is going to be a favorable part of the U.S. economy, maybe adding as much as 1 percentage point to real GDP growth. And here, you see that the -- one of the reasons that house prices are doing well is both the inventory of new houses and existing houses is very low, and so that's pushing up the price. The second area that's positive for the U.S. economy is oil. We're importing less oil than we have in some time, and we're producing more oil than we have in some time. And it's pretty clear to me that North America is going to be self-sufficient in energy production before 2020.
If you look at this chart, you can see almost an exponential rise in oil production in the United States. And the most dramatic component of that is what's going on in the Midwest. The Bakken Range of North Dakota was only producing 100,000 barrels a day of oil out of rock through hydraulic fracking in 2005. At the beginning of 2012, it was producing 500,000 barrels a day. At the end of 2012, in December, it produced 728,000, and I think it has a good chance of producing 1 million barrels by the end of this year. So what's going on in hydraulic fracking in the United States is very important. It could be going on elsewhere in Poland, Ukraine, even in China, but they're moving much more slowly. And think of the geopolitical implications of this. If the world becomes less dependent on Middle East oil, what is that going to mean to the political balance in the Middle East? So that's something to reflect on.
We all talk about our infrastructure. I thought we'd -- I'd take a look at it from a corporate standpoint. Manufacturing plants are getting a little long on the tooth and so is equipment. We've got a lot of old corporate infrastructure out there that needs replacement, and you would expect capital spending to pick up, but capital spending for new plant and equipment has been very slow. What companies have done is they spent money on capital equipment to replace labor. You can see here wage rates are pretty flat, and that's a favorable aspect of the inflation outlook. And I wanted to focus on the left-hand side of this for a moment. There's a lot in the press about how manufacturing plants are moving out of China and back to the United States. I really don't think that, that's an important wave. That's happening. There's no question about it. But manufacturing has now descended to a relatively small part of the U.S. economy. So sure, some plants are going to come back, but we've really shipped a tremendous amount of manufacturing jobs abroad that won't come back. And what's more, for the manufacturing that is going on in the United States, we're doing that much more efficiently through the increase in productivity that's taken place in the last decade. And if that doesn't make sense to you, take a look at the right-hand panel here. You can see how in recessions, how rapidly the workforce came back. This cycle is very different from any other cycle. Wages -- employment went down more sharply than it ever had in an earlier cycle, and it's coming back more slowly. In a typical cycle, when things are good, when the economy is booming, the unemployment rate is 5%. In a recession, it goes to 10%, and then it goes back to 5%. Here, we are 4 years into the recovery, and it's still 7.7%. And this chart shows how slowly it's coming back, and that's the most serious problem facing policy makers.
Consumer sentiment took a sharp downtick in the University of Michigan survey, which is the one I use the most. It was 77%, and it was very encouraging to people, but then it dropped 6 points in a single month. And I was kind of surprised by that because if you look at the right-hand side as a result of house prices rising and the stock market rising, consumer net worth is now higher than it was in 2007. So you would think that consumer sentiment would be favorable, but it isn't. And I think that may have an impact on spending going forward.
This is one of the pages that you should focus on. In a -- I've shown it before, but it's worth repeating. In a typical cycle, after the recession ends, sales come back very strongly. Then laid off workers are hired back, and the workers who stuck it out during the tough times are given raises or bonuses. And profits are -- come back, but at a shallower amplitude. But look at this cycle. It's different from any other. Profits increased faster than sales as a result of productivity improvement. And right at this point in time, profits are moving back down below sales, but labor has suffered. So companies have focused on increasing their profitability, not in compensating labor. Wage rates have been flat and profits have increased impressively, driving profit margins to an all-time high. You can see here though in spite of that, trailing 12-month earnings year-over-year are decelerating. And if you look at the right-hand part of this, you can see that actual -- that earnings estimates by analysts are very favorable. They are probably -- the bottom-up estimate is probably between $115 and $120, but earnings have a tendency not to come in as high as the analysts expect, and that's what I think will happen. The consensus earnings right now is about $110, and I think earnings are going to be closer to $100.
Now why do I think that? I think that because I believe that profit margins have peaked. On the top panel here, you see profits as a percentage of national income look like they are starting to come down, and profits as a percentage of sales are well-above the mean and median and they're going -- they look like they're flattening out and about to come down. So I think what analysts are assuming is that profit margins are going to stay high, and I'm skeptical of that.
Here, you see a few warning signs. If you look at the left-hand side, you can see that, while Purchasing Manager Index for manufacturing and services is above 50, the guidance that companies are giving is on the negative side. And that's one of the things that's disturbing me. Most of the guidance today is negative. And if you look at the right-hand side, the -- over 60% of companies were missing their sales expectation in the third quarter. But in the fourth quarter, it improved to only 33%. So that's a favorable sign offsetting my skepticism, but we've got to keep an eye on that. But in any case, there seems to be more negative than positive guidance. You could see it here, where the guidance has dropped below 0.5, meaning more negative guidance than positive guidance. And on the right-hand side, you can see that bottom-up estimates by analysts, which tend to be more optimistic are trending down, and I think you're going to see that trend maintained through the year.
This is the Ned Davis Crowd Sentiment Poll which I've used for years. We -- at the beginning of 2012, when I was quite bullish, investors were pretty pessimistic. But now, you see they're on the brink of euphoria. We all know the best time to buy stocks is when investors are pessimistic. Now they're perhaps not as extreme in terms of their optimism as they ever have been, but they're clearly optimistic. So if you have earnings disappointing and investors optimistic, you have an ideal circumstance for a correction. Here you see, the Consensus Inc. survey of investors, very optimistic and the put-call ratio, that hasn't gotten to an extreme level, where there's a significant amount of puts bought in relation to calls, but it's in very neutral territory.
In terms of valuation though, this is very different from the situation in 1999. In 1999, valuations were extreme. Now valuations are more normal. The market is not overvalued in terms of valuation. It's not at bargain levels, but I would describe it as fair value. I would say that if earnings disappoint and if investors are as optimistic as the various sentiment measures show, the market is clearly going to have a pullback here. On the other hand, here's a matrix that shows that you would think -- I was interested when Larry Kudlow on CNBC this morning said, earnings are the mother's milk of market performance. Well, they're only 50% of the mother's milk. When earnings are rising, the market does well 50% of the time. But the market does well 23% of the time when earnings are disappointing. But that, I think, is when we're coming out of a recession. The market performs poorly 19% of the time when earnings are growing and 8% of the time when earnings are negative. So 27% of the time or a little more than 1/4 of the time, the market goes down no matter what earnings are doing.
Let's talk about the fiscal situation. As we all know, we're trying to do something to reduce the deficits that we're incurring, and here's a breakdown which you can use if you want to retrieve this webinar to see where the money is being saved in the $4 trillion that the government is trying to cut expenditures over the next 10 years. The really disturbing part of it is how little is coming out of entitlements. It doesn't seem that either political party has the appetite to dig into Social Security, Medicare and Medicaid, and I think that's a mistake. We've just got to get those costs under control. We also have the sequester, and the government accounts for more than 20% of GDP, and the sequester is $1.2 trillion over 10 years. And the sequester hasn't really kicked in yet. It's supposed to start in March, but it really is going to start in April.
Now here you see why I'm so focused on entitlements. Right now, Social Security, Medicare and Medicaid are taking about 10% of GDP. But if they stay on their present trajectory with the population getting older and requiring more medical care, by 2050, Medicare, Medicaid and Social Security will take 18.5% of GDP, and that's the total amount the government expects to be collecting in taxes in 2050. So that would crowd out defense, interest payments, every other government program. That's why we've got to do something about this, and the elected officials don't seem to have the appetite to do it. What's more, we're not collecting the 18.5% now. We're only collecting probably about 16%. We don't really collect a lot unless the stock market is roaring. Maybe it will this year, and we have big capital gains taxes.
The government thinks that the $1 trillion deficits that we're currently running are going to come down to $400 billion or $500 billion, but I don't think they're going to do that unless we really take aim at various entitlement programs. The real money is in Social Security, medical, Medicare and defense. Unless we're willing to trim those back, we're not going to make major progress in the budget deficit. You can see here that government receipts are going to stay just below 20%, but if we don't tax some of these items because of cost increases and changes in demographics, our expenditures are going to be rising seriously when we get into the next decade.
On the left-hand side here, you see health care spending continuously rising and net interest costs are going to be rising, too. And right now, think about it this way. From 1792 until 2000, the United States accumulated $6 trillion in debt. That's through all the wars, revolutionary, 1812 civil, Spanish-American first, second world war, Korea, Vietnam. We had $6 trillion in debt. The blended interest rate was 6%. $360 billion in debt service. Today, we have $16 trillion in debt. We're paying 2.13% on that. We're paying the same $360 billion to service the debt, but I don't think we can assume that we're going to get away with 2% 10-year. If interest rates rise to where the 10-year usually sells for, which is a yield equivalent to the nominal growth rate of the U.S. economy, which is 4%, then our interest costs are going to rise a lot, and we know that health care costs are going to rise a lot. So we have that staring us in the face. We not only have entitlements staring in the face, but we have the possible rise in interest costs threatening us as well. And there's no reason we're spending 17% of gross domestic product in health care. France spends 10% and has arguably a comparable level of service, so we've got to do something to bring our health care cost down and pay for service is what we have to alter.
We're going to hit the debt ceiling. We've been using continuous budget resolutions to do it. But during the summer, we're going to hit it again. We can't keep deferring it, and so we've got to have some discipline on the fiscal side. This shows that we were spending well over 20% of GDP on various government programs. With the sequester, we can bring it down to 22%. But don't -- make no mistake about it, the government is a very important factor in stimulating the economy on the fiscal side.
This is one of the most disturbing charts. I showed it last time. What you see is the 1% is, in my judgment, paying its fair share, 38% of all federal income taxes. But the troubling part of this chart is that about 1/2 the population, which is getting Social Security, Medicare and Medicaid, unemployment benefits, supplemental housing benefits, food stamps, pays only 2.2% of all federal income taxes. So we have almost 1/2 the population getting major benefits, but not paying much for them. And in my judgment, they're not going to vote for anybody who gets up there and campaigns on a platform of fiscal discipline and says, in order to achieve it, he's going to have to vote to take things away from the population. That isn't likely to happen. Most people out there, 1/2 the population is scared, worried about tomorrow, and they're going to vote for the people who are going to maintain the benefits that they're enjoying. It wasn't always this way. As few as 12% of the population in 1970 were paying no federal income taxes. 34% in 1990 so -- I'm sorry, in 2000. So the current phenomenon is a result of some changes in the tax law. The current phenomenon is relatively new.
I'm bullish on gold. I have been for some time. It hasn't done anything for a couple of years. It probably won't do anything unless we have a serious correction, but its been consolidating, and the sentiment on gold has turned negative. But gold tends to follow the balance sheet of the Federal Reserve, and the balance sheet is continuously expanding. And as you see and as a result, I think the price of gold is headed higher.
Just take a look at Europe. It's still in a recession. Industrial production is declining. In spite of all of its financial problems, it's not likely to grow this year. You can see here that consumer spending is down and unemployment is high. And in terms of China, which everybody is focusing on, I do think that China is going to grow at 7% or more. And so I'm optimistic about it. China has been growing and the stock market hasn't been doing much. I attended last night a debate between Steve Roach, the former Head of Morgan Stanley Asia and Jim Chanos, the notorious short seller of China. And while China's growth has been terrific, its stock market has been poor, and the question is, is that going to turn. I think this year could be a more favorable year for Chinese stocks.
This shows -- 60 Minutes had a pretty devastating program on empty cities, but you can see here that the Chinese housing market has been pretty healthy. There are empty cities, but I think they will be filled up. The city that they highlighted in 60 Minutes was in Mongolia, but cities closer to the east are doing well in terms of their housing crisis. The working age population for China because of the one-child policy is a serious problem because working age population is going to peak in 2015, but the most serious problem China has is this one. The Five-Year Plan they introduced in 2010 was designed to get the consumer, which had descended to about 35% of GDP to get the consumer back into the 40s, which it was about 15 years ago. But you can see here, China is still very much an investment economy, who are spending on infrastructure and state-owned enterprises to produce goods for export, is still dominating the fiscal program of the Chinese government. They haven't been able to get the consumer to spend. This is their most serious challenge, and what they have to deal with going forward.
Here's something else to worry about with China. In the 1980s, they filed virtually no patents. They are now on track to file more patents than we are. Now maybe they are not as innovative as our ideas, but China isn't going to be satisfied to just be the manufacturer of ideas that are developed in Europe and the United States. China is going to want to develop ideas on their own and manufacture them on their own. So keep an eye on this.
Turning to other emerging markets, the emerging markets have lagged the S&P 500. I think they're going to do some catch-up this year. I like Brazil and Mexico. I also think that Brazil is going to have a satisfactory real GDP growth, and their industrial production is going to be favorable as well. Same is true of India. GDP will grow 5% or perhaps more, and industrial production will be favorable. And I do like Japan. It was one of my Ten Surprises. Shinzo Abe is -- in spite of the high level of government debt in Japan, is spending more to stimulate the economy, move out of a deflationary recession into a somewhat inflationary expansion, and he isn't worrying about how much debt is on the balance sheet. The yen is depreciating, which will help Japanese exports and Abe has decided that he is going to let the budget deficit increase in order to achieve his growth objectives. You can see here the Japanese stock market is responding to those policies. I definitely think it will get to 12,000 this year.
So that concludes the formal remarks I wanted to make, and now I'd like to turn it back to Joan who will field the questions that have come in from all of you. Thank you for your attention.
Great. Thanks, Byron. And just a reminder if you look at the lower left-hand corner of your screen, you'll see a Q&A box to submit any questions that you have. So now for our first question, when you look back at the corporate margin chart, the last 2 times margins peaked, we were about to head into a recession. This time, we have corporate margins peaking, but we're still coming out of a recovery. So why do we really care. Can't profits continue to rise even if margins contract?
Byron Richard Wien
Well, they can if revenue growth is strong enough, but I just don't think in a 2% real GDP, 4% nominal growth environment, that's going to be enough to offset the decline in margins. Of course, it depends on how much margins do decline. But I think you could see at least a 1 percentage point decline in margins, and I don't think the revenues will be there to offset that.
And so does that also tie into your lower-than-consensus S&P earnings estimate? I mean, are you suggesting that the multiple appears reasonable on current projections, but those projections are actually high?
Byron Richard Wien
Look, I'm not -- Joan, I'm not saying we're going to go into a bear market. I just think that the market is fairly valued on current earnings projection. But my view is earnings are going to disappoint. Investors are very optimistic and so a change in that optimism could cause the market to correct. I don't expect a bear market. I just think the market is going to have a pullback here. And because investors think they're investing with impunity, the dimensions of that pullback could be greater than people currently anticipate. When I talk to portfolio managers, they'd say, "Oh, sure, the market could correct 5% any time." I don't think people are prepared for a 10% correction, and I think we could see one.
So along those lines, I know you've said in the past that most of the investors you speak with are rowing the same way, and we're seeing a lot of money flowing into equities at the same time. Folks are worried that there's a bit of a credit bubble perhaps. So what happens to the capital flows? What does it take for those flows to go the other way?
Byron Richard Wien
Well, I think up until now, we've had a situation where people have been disappointed in the stock market, and the money going into financial assets has been going into bonds very, very heavily. We've now begun to see, because the stock market did so well last year and is doing well this year, more money flowing into equities. And I'm not so sure that, that's going to reverse. But what I do think is this, that we have a situation where people aren't selling. Since everybody thinks that the market is going up because there's so much liquidity being poured into the system, we have an absence of sellers, and there's some buying at the margin. So if you look at New York Stock Exchange volumes, they're relatively low. So a little bit of marginal buying is driving prices up. If you have that marginal buying dry up or at least diminish, and you have people concerned during a correction that maybe stocks got ahead of themselves and earnings are going to be disappointing, you may reverse that and have more sellers and fewer buyers and that could produce the correction.
Okay. You also noted that in the past, workers participated much more significantly in the recovery than they have this time. So what are your thoughts around an increase in the minimum wage to 9%, and then indexing that to inflation?
Byron Richard Wien
$9, you mean.
$9, excuse me. And then indexing that to inflation growth. Does that squeeze profits? Does it drive jobs out of the U.S.? Or is it actually a benefit, overall?
Byron Richard Wien
I'm not for that. I'm not for increasing the minimum wage. I think we're going to run into all kinds of problems when ObamaCare kicks in because I think that's going to increase the cost for small business. I already hear smaller companies saying, they're doing everything possible to make sure they don't have 50 employees. So I think when you raise the minimum wage, you're just tempted to pay people off the books or do something to avoid it. My own view is that a lot of jobs are being held by undocumented people and raising the minimum wage just increases the propensity for that. So I wouldn't do it. But look, all -- raising the minimum wage is one way to drive productivity down. I mean, I just think it increase the cost of doing business, and therefore, it's going to reduce the profitability of companies. If larger companies, obviously will have to pay the $9, but I don’t know how many -- what percentage of the workforce works for the minimum wage anyway. And so I just don't know how dramatic the impact is going to be.
Okay. We have one question asking for any update you might have from the Smartest Man, and I'll tag on to that since we know the Smartest Man resides in Europe, if you can give us your thoughts on what's to come in Europe?
Byron Richard Wien
Yes, I've gotten a lot of inquiries. I guess people are tired of listening to me, and they want to hear what he has to say. And I did talk to him a couple of weeks ago, and a lot of people think he's the Smartest Man in the world. I only think he's the Smartest Man in Europe, and I haven't backed away from that. Look, he thinks the European situation is very difficult. He thinks that all the measures that they are taking are temporary, that Europe should be moving toward a fiscal convergence. They haven't even been able to achieve what their objective in terms of forming a banking union. They hoped to have a situation where every one of the 17 members would submit their budgets to the European Commission, and if they didn't meet their budget deficit targets, that they exceeded the budget deficit targets, they would be disciplined in some way. The Cyprus situation, everybody says, no don't worry about Cyprus, it's a 0.5% of Europe's GDP, but the fact is, this is a $20 million -- $20 billion economy with a banking system 3 times that size, and they're going to put a pretty severe haircut on deposits of over EUR 100,000, which is the bulk of the money in the banking system. So all of these things destabilize Europe, make people worry about the stability of deposits in Spain and Italy. So I think Europe is a long way from out of the woods. Europe needs growth to solve some of these problems, and Europe is still in recession and at the time that they're trying to take some of these remedial steps. So as a result, the Smartest Man continues to be very cautious. He's investing in real assets. He's still buying gold. He's buying the currencies of countries he thinks are on solid footing. He was positive on Japan as I am. I don't know where he stands today on that, but he was positive on Japan, so that's a summary of his most recent thinking.
Okay. And shifting back to the U.S., when you look at the Fed balance sheet, both in terms of just unprecedented size, but also an unusual mix of assets today versus any other time in history, how does that resolve itself? Does it need to? And then what's the impact of any unwind?
Byron Richard Wien
Well, if Milton Friedman were alive today, and he would take a look at that chart that I showed you on the balance sheet of the Federal Reserve and the European Central Bank, he would be very upset. He would be quite shrill in saying inflation is right around the corner. And the luxury that both Mario Draghi and Ben Bernanke have is that they -- since inflation seems to be very tame, they can expand the money supply vigorously without worrying about accelerating inflation. And that's what they're doing. The hope being that they jumpstart the economy and get the economy growing close to 3%, getting it growing in Europe and growing close to 3% in the U.S. So far that hasn't happened, but they're hopeful that it will happen. And everybody ask the question, when will they reverse this? I guess reversal means roll it back and shrink the Federal Reserve balance sheet, but I don't think we're ever going to see that. The Federal Reserve balance sheet at the end of this year could be $4 trillion, and I think the most you can expect is that it'll stabilize there. The Fed won't -- the Fed is selling securities. I don't think it's going to buy securities back and shrink its balance sheet, but that's what people are looking for. I just don't think it's going to happen. What you're going to see is the $85 billion. You've even seen it in the Fed minutes so far. The $85 billion may be shrunk to $50 billion of purchases, some combination of mortgage-backs and Treasuries, I don't -- maybe $25 billion, but the Fed is still going to be buying securities and pumping money into the system for some time to come. The most they'll do is get to 0, but I don't think you'll see a contraction of the Fed balance sheet.
And as you look at your radical asset allocation today, how would you or would you change it versus where you were a few months ago?
Byron Richard Wien
Well, I did change it. Last year, I had some Treasuries in the portfolio. I thought that what was going on was likely to -- I never thought 2% was a good return on Treasuries, but I thought that during 2012, there was a possibility of yields decreasing and yields did. I was rewarded during 2012 because interest rates at the Treasury, at the longer-dated Treasuries did appreciate. But I thought 2% was as low as rates were going to go. Maybe that won't be the case, but I sold all the Treasuries, so that's one change I made. I also had 20% in emerging markets, and I reduced that to 15% because emerging markets have disappointed me, and I thought I was a little overexposed there. I also changed the mix in the fixed income. The -- I had 15% in high-yield securities. I sold the conventional high-yield, the higher quality high-yield securities and only had the riskier high-yield securities and sold the Treasuries. So it was 15% high-yield, 5% Treasuries, now it's 20%. The riskiest portion of the high-yield market, mortgages leveraged loans and mezzanine financing. So those are the changes I made.
You recently published your life lessons, which have been widely circulated globally and gone virtually viral, I would say. But if you had to impart for us your #1 investment lesson, what would that be?
Byron Richard Wien
Well, I think my #1 -- I mean, I've got -- those weren't exactly investment lessons.
No. Those were life lessons.
Byron Richard Wien
Those were kind of life lessons. Maybe there's a whole new group of 20. For those of you who are unfamiliar with it, you can go on the Blackstone website and get life's lessons, 20 thoughts that I had that I've learned over the course of my career. I think that one of the things, the most important lesson, this is hardly a breakthrough thought, is to remain flexible. This is an extraordinary business that we're in. We only have to be right about 60% of the time to build a very significant net worth. I think I've been -- if I look back over my decisions, I've probably been right about 2/3 of the time, which -- and I've built up a substantial net worth doing that. Think about if I had just -- when I was in college, I was thinking about becoming a doctor. I think if I had become a brain surgeon, 1/3 of my patients died. I don't think my reputation would be very good. So the point is, if you can let your winners run and cut your losses, there are very few places where it's as easy to do that as it is in money management. So what you should be doing is testing every decision you have to see whether it's right or wrong. One of the reasons I do the Ten Surprises is to stretch my thinking because what I'm trying to do is identifying non-consensus ideas that turn out to be right. Now I've never gotten all 10 right. I've gotten 7 right a number of times, but most of the time, I get 5 or 6 right, and I'm pretty comfortable with that, because I'm trying to think of ideas that other people don't agree with. If you do come up with an idea that others don't agree with, like Japan is in that category, you can make a lot of money on it without taking a lot of risk. So being -- recognizing you're going to be wrong some of the time, being willing to cut your losses, don't assume you're early, assume you're wrong. If you can do that, you can do very well, if you implement it effectively.
Great. Thank you very much. Thanks, everyone for joining.
Byron Richard Wien
I look forward to talking to you again 3 months from now. Thank you very much.
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