EPISODES / WEEKLY COMMENTARY

Insurance Companies Targeted By Fast & Loose Profiteers

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Mar 08 2023
Insurance Companies Targeted By Fast & Loose Profiteers
David McAlvany Posted on March 8, 2023
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  • Aggressive Private Equity Companies See Conservative Insurance Companies As Cash Cow
  • Dramatic Sudden Increase In Mortality Numbers Stymie Actuaries
  • Xi’s China: A People Control Machine

Insurance Companies Targeted By Fast & Loose Profiteers
March 8, 2023

“What the Fed is telling you this week, what they have been telling you: higher for longer. What they’re really telling you implicitly is that the squeeze is not over. And what I’m suggesting is, you still need to batten down the hatches.” —David McAlvany.

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

David, we’re sort of critical when the government revises numbers, and I remember sitting last night and we were having an unusual scotch. It was a scotch that came out of Japan, if you can call it a scotch. It was that type of whiskey we were sitting and sipping. And I watched you walk into the restaurant, and I hate to say it, you look like you were really hurting from the marathon that you had run this weekend, but you were happy because you had run so fast. Now I heard this morning that we may need to revise the numbers a little bit.

David: Yeah, well I do still feel like I got ran over by a truck or something. At least that’s the way I’m moving. But I remembered wrongly. When I ran my second marathon back in 2019, I ran fast, but I remembered running slower than I did this last weekend in California. My back-of-the-napkin math had me shaving about 35 seconds off per minute mile.

Kevin: So it was worth your limp. It was worth the stiffness that you had.

David: Absolutely. I felt pretty good about the limp because, I mean, clearly I’d been running so much faster. Ah, the data. I couldn’t find online my race results from 2019, the Rock and Roll Marathon. So I went back to my spreadsheet—trusty spreadsheet. When forced to follow the data, the story, the reality can be quite different. I remember that past race like some modified statistical governmental metric, and it made this weekend’s race look better. And I promise you it’s purely unintentional. As it turns out, my race was not faster by a cumulative 15 minutes, but by a mere 21 seconds. That was a lot of pain for a mere 21-second gain.

Kevin: Yeah, but you still beat the time. But you’re right because you were thinking, “Gosh, I beat it by 15 minutes, it’s worth the pain.” I wonder, if politicians had to be held to the same standard, where they actually went back and looked at the statistics and there was a consequence for their actions?

David: Sometimes they do. And I think that crime data mattered a great deal in Chicago. We mentioned last week, Lori Lightfoot and the election, she ended up getting roughly 17% of the vote, not enough to stay in. So, first Chicago mayor to lose a reelection in 40 years.

Kevin: Wow, that’s amazing. Nobody loses a Chicago mayorship.

David: No, it’s pretty hard in the land of the rigged election. And of course she blamed racism and gender for her election loss.

Kevin: Oh, of course.

David: But perhaps merit still matters, perhaps doing the job was in this case relevant.

Kevin: Wasn’t she “defund the police” all the way?

David: Oh, 100%. Violent crime in Chicago turned an oasis of blue votes into intolerance of a new status quo, which was decidedly light-handed on crime.

Kevin: So it makes you wonder if they want to see support for the officers in blue instead of vote for the party that is blue.

David: Well, crime’s going to be the defining issue in 2024 as it was in 2023 for Lori. Democratic controlled cities and states may face higher political costs, frankly, than politicians are interested in paying if the tone on crime doesn’t change. So it’s either time to talk tough or follow through. And again, this is where political legacies can come to an end. John Donne—you probably remember the refrain— “therefore, send not to know for whom the bell tolls, it tolls for thee.”

Kevin: Doesn’t it give you a little comfort, though, that we live in a country where the bell still can toll? You know, China, the bell may never toll for Xi.

David: No, it is fascinating. We are witness to a major shift in Chinese politics, and by proxy to the rest of the world. Xi Jinping continues to consolidate power and surround himself with long-term allies as the state prepares to extend its influence into every area of business and technology. They spent the last two days through the weekend solidifying that. And an offshoot, or consequence, is what’s called Golden Shares—one way of describing the new structure of influence and control over all companies the state deems important. If you’re going to see the implementation of the party’s prerogatives, then these Golden Shares—small, select ownership of individual companies—they’ll own a piece of every company that requires oversight and accountability. We’re solidly in a new era of the CCP control of markets.

Kevin: It’s amazing to see that because what they call it, Golden Shares, it reminds me a little of the Sesame credit system that they’ve set up as well, where it is just more and more seeping control. A little bit like Lebanon bread. Mark Mobius goes all the way back, at least from my memories, to the ’80s, when he worked for Franklin Funds, and Mobius right now has a little bit of his own funds trapped, doesn’t he, there in China itself?

David: Yeah, everyone’s referring to Xi Jinping as the most powerful Chinese leader since Mao Zedong. It’s important to think of the kind of control that Mao had in the country and what that implies. Powerful leadership is not necessarily an accolade. It’s not necessarily, “Wow, this guy’s a powerful leader.” No, what’s being said there is that the control function is so great, we haven’t seen a clamp down on various expressions of freedom since Mao Zedong was in power. 

So Mark Mobius came to fame as an international investor working with John Templeton, and describes not only the control of capital from inside to outside the country, that is capital controls. In fact, he says his HSBC account in Shanghai, he’s no longer allowed to transfer money outside of the country. But he sums up his concerns reflecting on this new Chinese trajectory, saying that the bottom line is that China is moving in a completely different direction than the one Deng Xiaoping instituted when they started the big reform program.

Kevin: We need to keep in mind, like you said, what kind of control we’re talking about. I talked to a lady last week who grew up in Cambodia, surviving. Her mom literally had to barter for four years, had to barter to stay alive. Two million people were killed during the Khmer Rouge. Now granted, that’s not China, but I remember seeing and actually having the picture of people lined up when the Mao control takeover occurred back in the 1940s. The fear on their face was amazing. It’s a different kind of control than Americans really have ever experienced.

David: Yeah, we have. We’re witness to this monumental shift in how China relates to the world. So first it’s power management within, which is necessary for power projection beyond Chinese borders to the areas they’ve sought to influence and through the areas they claim as their own, at least as they draw their maps.

Kevin: Well, maps are so important. You and I have talked about this. I just read a book on the days of Captain Cook, when the British Empire was exploring and mapping the South Pacific. Those areas worldwide remained pink on the map, which represented the British Empire. What does it look like when areas are starting to look red that we don’t really believe are Chinese controlled?

David: Well, in terms of economics, they’ve got a new growth target, 5% in China. Well off the blistering pace set in recent decades, but a healthy target nonetheless. For February, China’s services and manufacturing PMIs were very healthy. Services came in at above expectations of 54.4. They got to 55.

Kevin: So no recession there.

David: No, no, no. And coming off of January’s 52.9. Demand seems to be recovering, and the primary inconsistency to date is that commodities have yet to equally reflect that reopening. It was almost “buy the rumor, sell the news” in terms of commodity move, because we did see a sharp rise in commodity prices October forward, again, consistent with what you’d expect in terms of the Chinese opening. And there hasn’t been a lot of powerful movement—follow through, I should say—with your industrial commodities since then. The 5% growth is on the drawing boards. That’s been put out there, and the PBOC is going to find channels to push credit into in order to gin up the numbers and achieve the 5% objective. They will not fail, regardless of what’s necessary to get it done.

Kevin: And not that feeling matters, but I still feel like everyone’s still looking for a reason to continue to speculate.

David: And Tesla’s a great case in point, Tesla jumped in price when year over year car sales in China were higher, 32% higher year over year, 12% higher month over month. Bear in mind that those numbers were more dramatic coming out of the pandemic restrictions, which provide low base levels for comparison. So if you’re not selling anything for a period of time and then it increases even a skosh, then it’s a really big increase compared to that base level. But what that says to me in terms of the market’s reaction through Tesla shares is that speculators are in fact looking for confirmation to be long Tesla. They want a reason to speculate.

Kevin: Well, and you talk about numbers coming out of Asia, I mean the Chinese numbers look like things are just fine, but you just go very near to that, to Japan, and you’ve got different reads. So should we be speculating or should we be battening down the hatches?

David: Yeah, very significant contrast there. So back to the purchasing managers indices. On the Chinese manufacturing numbers, 52.6 for February, up from January’s 50.1. That hits the highest level since April of 2012. And again, this is on the manufacturing side. This strength in China’s in stark contrast with the Japanese equivalents. Also a global manufacturer, exporter first class, but their levels fell to the lowest levels we’ve seen in two and a half years.

Kevin: Quite a contrast.

David: And at the fastest pace since July, 2020. Remember, we’re in the early stage of the pandemic at that point. Pointing to weak domestic demand, and, as they described it, a global economic slowdown.

Kevin: So purchasing managers in Asia, you’ve got two extremes, but what about here?

David: Yeah, the Institute for Supply Management, this is the manufacturing numbers out last week, a little bit closer to home, they barely moved. So again, kind of ambiguous, is it as positive as the Chinese numbers? Is it as negative as the Japanese? No, we’re kind of lukewarm, right in the middle. But alarmingly, what did move was the prices paid component. It was expected at 46.5. So this is again an indication of increased inflation in some of your underlying costs. 46.5, up from 44.5, expected at 46.5, up from 44.5, but alarmingly well ahead of that at 51.3. And that just signals that corporate leadership is still trying to get ahead of future cost increases.

Kevin: So they see on the horizon higher prices?

David: That’s right. And again, some of these things may seem like boring details, but inflation expectations coming off of CPI, PPI, and PCE, now they have a confirmation of higher levels on the horizon, again, coming from more of the corporate perspective. And it just suggests that PPI is not “anchored.” So the producer price index, if PPI is not anchored, then I can promise you CPI won’t be either, because producer prices today become consumer prices tomorrow, and to the degree that they’re beginning to hedge their bets on higher inflation expectations, you can expect the same thing to be on the main or the street level as consumers do the same. 

I mentioned the contrasting Japanese and Chinese manufacturing numbers, just to show that global recession concerns are palpable amongst export giants, even as China’s return to the global economy is likely to reinforce inflationary pressures on goods. The bottom line is that stagflation is not off the radar yet.

Kevin: One of the things that we’ve talked about over and over that you watch is volatility. Volatility usually lets you know what people think as far as what direction— You’re talking right now, some extremes on the high, some extremes on the low. You’ve got speculative aspects, or speculative motivations, but what’s volatility look like right now?

David: There are many conflicting data points at present. Japanese PMI versus Chinese PMI is just one. Risk indicators relaxing to the point where you could consider the world to be operating in a normal fashion, that’s come into our conversation with the wealth management team for a couple weeks now, is risk indicators are basically saying, “We’re doing all right.” There’s not a lot to be worried about, and it would imply that there’s reduced levels of geopolitical, economic, and financial market uncertainty—except that interest rates are rising and we’re seeing more and more pressure at the periphery to the bond market. So if you’re thinking about junk debt and peripheral European or emerging market debt, rates are rising in a lot of different places.

Kevin: So when interest rates rise, what you’re really seeing is the cost of borrowing go up, in other words the fear of default is higher. So that’s in contrast to the volatility dropping on the VIX.

David: Yeah, so this is where there’s again a contrast. Equity markets have rallied in tandem with bonds since October of 2022, and the VIX has dropped, showing an options market perspective on risk. Meanwhile, what we’ve seen here recently is the equivalent index for bonds, options market for the bonds, same sort of measure of volatility for bonds that you have with the VIX in the stock market. It’s called the move index. It’s been stubbornly high, actually stuck in the late October, early November levels. So bond market participants are just not as sanguine as stock market participants. Not all blue skies for the sober minded bond investor. And I think this makes sense. It’s that inflation cannot be declared dead, rates are not finished rising, and thus the somber tone in the bond market reflects a radically different perspective than that emanating from traditionally categorized risk assets.

Kevin: Do you think that’s shedding some light, though, on what the bond market thinks Powell is seeing? Because when Powell talks, he’s going to either sound like Volker or he is going to sound like Bernanke, but which one?

David: Well, this week is fraught with financial market complexity. We’ve got two Powell sessions in front of Congress, which if interpreted as more Volker-esque, will negatively hit all markets. But then you’ve got the ADP and Jolts employment data on Wednesday followed by February’s non-farm payrolls, that’s on Friday. And I don’t think the Friday number, although it’s the big kahuna, it’s not likely to blow away the January numbers, as the January numbers had one of the largest seasonal adjustments added to it on record. So after that, keep in mind, you’re left with only one week—so go from Friday this week and the non-farm payroll numbers, you get one week until the next Friday, which is options and futures expiration both for the quarter and for the month. So you’ve got what’s known as quadruple witching. That is options and futures expiration both month and quarter end.

Kevin: So I’m going to change the subject here for just a little bit because we talk about adjusting numbers. Whether it’s you running a marathon and thinking that you were running at a much faster pace than you were—it was fast pace, I’ll grant you that—or the government adjusting numbers on employment, what have you. I would hate to be an insurance company actuarial right now if— Let’s say that I was looking at the basic curve, averages of life and death, there’ve been some radical changes that have shown up in the numbers.

David: Post-Covid, this is a really fascinating data point because the Society of Actuaries tracks the excess death numbers for group life claims. I mean, regardless of your views on Covid pandemic mandates, from masks to mass vaccination, these numbers are worth paying attention to. The 0 to 44, the 45 to 64 categories, steadily rising off of a baseline, and they’re not normal numbers.

Kevin: You can’t lie about those numbers because you have to pay the insurance policies.

David: Well, that’s exactly right. So you’ve got young deaths on the rise because of Covid complications or vaccine complications, I don’t know which. But Q4 was ugly. You can see the Q4 numbers doing this hockey stick up and to the right, and January and February are purported to be higher still. Something we know for sure is that healthcare will be impacted for years to come, and that life insurance may take on a new inflation bias as the actuarial numbers have to be factored in as lower age deaths go into the mortality stats. 

So just a practical bit of advice, and I forgot to mention this to a young man I spoke to last week in a consultation, if you’re sub-40 and have thought of getting life insurance, I prefer term just because I want it covered for the timeframe where we’re raising kids and whatever, that’s a personal preference, but you may want to do that before insurance companies increase rates more radically than they already have. Each five year increment, 35, 40, 45, 50, you see rates move up considerably. And again, it relates to these mortality statistics. Now we’ve got this skew in the data showing that 0 to 44, your odds of having heart complications are through the roof relative to what they were even a few years ago. And same with the 45 to 64 categories. Very interesting the number of deaths and mortalities. And again, no ax to grind here, Society of Actuaries tracks the excess death numbers, and I think there’s just a practical conclusion. If you’re not insured, consider getting it done sooner than later.

Kevin: Think about how the insurance industry has been so strong for so long based on bell curves. If you think about it, as long as there’s no radical shock to the worldwide system, insurance is an amazing thing. The insurance companies made it all the way through the Great Depression back in the 1930s without anybody failing because they actually self reinforced each other. If one started to get weak, someone else would come in and take over. So the insurance industry prides itself in the normalcy of the numbers can allow them to be a very strong and powerful force. But what happens when the numbers are no longer normal?

David: When you think of the largest buildings in major cities around the world, they typically belong to banks and insurance companies. So you think what a boring business to be in. And if you ever have watched Mary Poppins, you watch these old codgers telling this young man what to do with his tuppence. And oh, just put it in the bank. And we look for very modest returns. Well, the fact of the matter is, the structure of both insurance companies and banks is to have leveraged portfolios of equities and fixed income, and they typically are considered to be safe.

Kevin: Is that changing now, though?

David: Well, on the topic of insurance, there’s an article in the Financial Times, it was about a week ago, February 26th. I think it’s important to mention. Something is shifting there and it’s an ownership problem. As more private equity companies are buying up insurance companies, there is a marked deterioration in the quality of assets managed within the insurance companies’ portfolios.

Kevin: Because private equities, their goal is different than an insurance company.

David: They’re making as much money as fast as they can for their shareholders, and they’ve found a pocket of stale capital that they can invest, and it doesn’t have a particular date. The liability structure is spread out over a long period of time. So no surprise really that private equity is playing fast and loose. I wonder if there aren’t more than a few solvency shockers around the corner with those companies that have taken on bigger and bigger risks to juice the returns on their portfolio of stocks and bonds. KKR, Apollo Global, Blackstone, Carlisle Group, they’re among the private equity groups that have paid up for insurance companies over the last three, four years. I think Blackstone got this trend kicked off back in 2017 when it bought a fixed annuity in life insurance company Fidelity and Guarantee Life.

Kevin: Well, Blackstone’s been buying everything. I mean real estate, whatever it takes. And insurance companies, correct me if I’m wrong, but the key to the conservatism of insurance companies wasn’t just the normalcy of the average, but they also held large reserves. They’d ladder their bond portfolios and then they’d hold pretty good chunks of un-invested cash, wouldn’t they?

David: Yeah, the issue is how structured financial products are treated, and the insurance companies have to keep a certain—call it volatility buffer. They have a capital charge against the things that they’re putting money into that, yeah, it stands as a reserve. Every time a fixed income security is added to a portfolio, say for instance a B rated corporate bond, 9.5% of the value has to be set aside.

Kevin: So roughly a 10th, they set it aside as a volatility buffer.

David: Yeah, it still allows you to have some leverage in the portfolio. The value must be set aside. CLOs and other structured financial products aren’t in that same 9.5% category. On a blended basis, they’re as little as 2.9% as a capital charge. Within the insurance universe, not everyone sees this as a good idea.

Kevin: Well sure, because they self-insure each other. Let’s say you’re a conservative insurance company and you’re saying, “We don’t want to have to go bail out these companies that are taking risks that they shouldn’t be taking.”

David: I think it goes beyond that, Kevin, to this notion of moral hazard within the financial markets. If someone’s taking risk and it ends up imploding, everyone’s going to pay the price in some way. And we know that, at least from the Global Financial Crisis, banks became far more regulated after the crisis than they were before. And I don’t think the insurance companies necessarily want to pay that same price for having a few bad actors in the mix.

Kevin: So who’s crying foul right now on the bad actors?

David: Yeah, Equitable, MetLife, New York Life, Prudential, they’ve petitioned the NAIC, the National Association of Insurance Commissioners, for greater risk management, arguing that structured products should be treated the same at the higher numbers, and with some of the riskiest tranches even requiring 30 or 45% as a capital charge—which makes all the sense in the world to me. But there’s no surprise, the private equity guys want to continue to play fast and loose. They found these pockets of capital, tens of billions of dollars, which they can use to invest in their own products. Tell me there’s not a massive conflict of interest here, but they’ve been doing it for five years.

Kevin: It’s like, “Hey, there’s the insurance companies. I see money.”

David: I see a pot of gold, let’s go invest that money. So, again, they’re opposed to risk mitigation in that form, and they’re joined—somewhat of a surprise here—by Mass Mutual, Guardian Life, a couple of other insurance companies that are saying, “No, no, no, don’t worry about it.” They’re arguing for different treatment for these higher risk assets and the allowance for fatter spread profits. That’s basically the difference between the investment returns and what they owe to the policyholder, the obligation that they owe out. 

So they’ve got this liability. Let’s say, for instance, you’ve got a policy with me, Kevin, and I’ve got to pay you 6% per year, guaranteed. Great. Anything above 6% is mine to keep. So if I speculate and roll the dice and make 20, great. Minus your 6, I just made 14% on your money. I made 14% on your money. The incentive is there to play with OPM—other people’s money. And private equity loves to play with OPM, and they just found a pot of gold to do that with.

Kevin: So you brought Mary Poppins up again, and we talked about that last week, but you picture that banker, that conservative banker, and now the guys from Ocean’s 11 show up, right? And—

David: They’re buying an insurance company.

Kevin: It’s like, wait a second, this isn’t the same thing.

David: They can wear a pinstripe suit, but it’s really just a game, a ploy. Now there’s some industry veterans that are alarmed by the implicit volatility and risk that these structured products bring to the insurance company and to the industry. And then there are others, like Mass Mutual, clearly, that are looking for bigger paydays regardless of risk. So hopefully the National Association of Insurance Commissioners doesn’t get bullied into allowing those reckless allocations to continue. 

If they do, buyer beware with any insurance product that is connected to private equity. It’s not just CLOs, but it’s private credit and it’s real estate credit that has been commingled into the insurance company portfolios. And the reason why this all matters today and did not matter 2017 and 2018: interest rates are rising, and that increases market pressure. These are the undisclosed risks to the annuity contract holder. The fiduciary responsibility of the insurance company is, in many respects, in many instances, being set aside in favor of a larger spread profit on illiquid and quite risky structured assets. There are the more conservatively managed insurance companies, and they’re rightly describing this as cliff risk. All is well until certain conditions reveal a catastrophic result.

Kevin: So when things happen, oftentimes they happen in multiples. You think about the insurance industry already facing higher mortality rates. Now they’re facing private equity coming in and playing fast and loose. And this isn’t something new. I mean, Forbes was talking about this before we had the Covid thing.

David: But private equity, you understand, they have become standard allocations amongst institutions. I’ve seen this at the college level, and what is the standard foundation going to do with money? Well, a certain percent has to go to private equity. That’s what we do now. And it’s replaced hedge funds because hedge funds for a little while there weren’t having the same returns. Well, it’s because they were counting on market aberrations to game and to play with to make more alpha, to create some benefit to investment. And you lost a lot of alpha—hedge funds lost the ability to make much alpha—during the period of stock and bond market control. Again, this period of zero interest rates.

Kevin: So you have to go find alpha somewhere else. You seek alpha where nobody else has looked.

David: That’s right. So private equity and private credit became the next venue after hedge fund popularities leading up to the Global Financial Crisis, and even a few years after that, private equity became the next popular thing to invest in. Why? Because they could invest and capture the “illiquidity premium.” Invest in things that weren’t going to be resold for one year, two years, five years, 50 years, what have you.

Kevin: But going back five years, so Forbes was looking at Apollo and how they were going into Athene.

David: Yeah, that was one of the first—maybe not the first, but one of the big ones, an acquisition by Apollo, again, private equity, into the insurance company. And what was interesting, Athene was sitting on $85 billion in assets, and Apollo looked at that pot and said, “Well, we could invest some of that in our own funds. We don’t have to raise money from institutions. We can just self-fund everything. And if we can start the bidding— You want to participate in this fund? Great. It’s a new fund. It’s almost closed. Better act fast.” With a couple billion coming in from captive assets, if you will. 

Forbes magazine highlighted a few of those concerns, February, 2018, if you want to go back and look at it. Apollo used a huge chunk of Athene’s 85 billion in assets to fund its own private credit in real estate funds. 22% at that time of Athene’s total assets were being recycled into Apollo’s lending instruments. Now tell me there’s not a conflict of interest there. Insurance companies, in a zero rate world, were only too happy to unload the liability of a fixed annuity policy because they couldn’t meet the obligations. Just think of that. You’re managing an insurance company, have been there for 25 years, and you’re used to that laddered bond portfolio, and then all of a sudden the ladder goes underground instead of aboveground. It’s degrees of zero to negative rates, and you can’t fund your contractual obligations for the annuity policies because of the suppressed rate environment.

Kevin: And then along comes private equity.

David: Private equity says, “We can do what you can’t do. We can meet the obligations.” And the reason they’re able to is they’re willing to take on more market and illiquidity risk for the extra premiums earned.

Kevin: Lest we forget, too, commercial real estate— Private equity bought an awful lot of commercial real estate, and now when people want out, they can’t get out.

David: And this is particularly relevant when you consider the pressure on private credit and commercial real estate assets owned by private equity, or funded using private credit as a resource. We’re in the early stages of a repricing of those assets. As they get repriced, the consequences will show up in investor portfolios—and in some cases insurance company investment portfolios as well. Why? Because little did most people know, private equity has gone a-shopping. And they own a bunch of insurance companies. And what seemed like a good idea at the time—genius, no doubt—may in a different light be seen as an abuse of investor trust in those portfolios. Again, I’m thinking of an insurance company portfolio generally regarded as bulletproof.

Kevin: Yeah, bulletproof and liquidity. Liquidity runs the world, and Blackstone, when asked if people could get out of their fund, Blackstone said no. And now they’re starting to ease a little bit out, but it’s nothing like what the redemptions are showing up as.

David: Again, this is a question of mismatched assets. If these private equity companies are investing in illiquid assets to capture the extra premium, and they’re using other people’s money to do it, and they’re looking for that spread profit, and that’s the motive, what they’re assuming is that people aren’t going to ask for their money back. So part of these funds are funded with insurance money, which frankly nobody’s going to pull. You don’t pull unless it’s your annual annuity payment, and then it just trickles out. It trickles out. Life insurance is a little bit different. Maybe life insurance is a bigger deal. We’ll have to see how many people—

Kevin: And they do overlap.

David: Dropping like flies. But that’s to the earlier Covid comments. But I think the bigger question is how many of your standard private equity and private credit investors hit the doors, and what does that force, because the underlying assets are not liquid, and yet you’ve got people wanting liquidity.

Kevin: So it’s a little more Hotel California than they wanted.

David: You can check in, but you can’t check out. And it was pretty impressive. In the month of February, Blackstone met $1.4 billion in redemption requests. The problem was, that represented only 35% of that month’s withdrawal requests.

Kevin: So a little over a third got their money.

David: Yeah, this is for Blackstone’s REIT product. The connection to the earlier mentioned Financial Times article is simply that the underlying assets of the REIT are declining in price, and the structure of the product is inherently illiquid, as are the underlying assets. So as the expectation for higher interest rates continues to shift up and to the right—again, we’re all having to come to terms with this notion of higher interest rates for a longer period of time—it has real consequences for all assets, particularly risk assets.

Kevin: So does that cast light on some of these things we call shadow banking?

David: Well, I mean, what we’ve been describing really is shadow banking. The fact that you are creating loans around the traditional banking channels, and these are not your traditional bond offerings from Wall Street. Shadow banking is essentially what we’re talking about. Private equity, family offices, syndications of real estate investors pouring billions of dollars into structured products that tie to underlying assets. Many of them—particularly the structured products of your family offices and your syndicated real estate lenders—you’re talking about illiquid real estate.

Kevin: And interest rates are rising.

David: With prices of those assets under pressure because of those rising rates. So what the Fed is telling you this week, what they have been telling you: higher for longer. What they’re really telling you implicitly is that the squeeze is not over. And what I’m suggesting is, you still need to batten down the hatches.

Kevin: So speculation, maybe not.

David: No. I feel like I’ve said this for too long, but gold and cash represent a healthy way to mitigate the market volatility still in front of us, and what might turn out to be a lot of pain still ahead and not a lot of gain—again, unless you maintain adequate reserves for the final pain-filled miles.

Kevin: You’ve been listening to the McAlvany Weekly commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y dot com, and you can call us at (800) 525-9556.

This has been the McAlvany Weekly commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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