Motley Fool Hidden Gems Investing - Generational Tailwind for the U.S. Economy

Episode Date: July 24, 2022

The Federal Reserve could hike short-term interest rates to 4%, and that still might not be enough to cool inflation. Rich Lyons is the first Chief Innovation and Entrepreneurship Officer for the University of California, Berkeley. Before that, he spent a decade as the dean of Berkley’s Haas School of Business. He joined Motley Fool Contributor Rachel Warren to discuss: - How the Federal Reserve could hit a “hard break” with higher interest rates - A venture capital view about the future of crypto - How universities are creating a generational tailwind for the economy Host: Rachel Warren Guest: Rich Lyons Producer: Ricky Mulvey Engineers: Dan Boyd, Brandon Gentry Learn more about your ad choices. Visit megaphone.fm/adchoices

The 2026 Chevrolet Equinox, awarded the most dependable compact SUV in the U.S. by J.D. Power, is designed for your every day. And with available all-wheel drive, you can handle your to-do list with total confidence. Start your build at Chevrolet.ca. Details at JDPower.com. An important part of where long-term equity returns come from is punctuated updrafts. It's the bang upward. So if something moves like quickly in a couple of weeks, it's like, wow, 10% in a couple of weeks of this kind of thing. It's not like, oh, you just need to get in and then there's this steady trend.

No, it's these punctuated updrafts. And nobody knows when those are going to happen. I'm Chris Hill, and that's Rich Lyons. After spending a decade as the Dean of the Haas School of Business at UC Berkeley, Lyons has become the school's first chief innovation and Entrepreneurship Officer. He joined Motley Fool contributor Rachel Warren to talk about the Fed, finding strong companies during a downturn, and a generational tailwind for the American

economy. I want to start off by hearing your insights and talking about a topic that I know is on a lot of investors' minds, a lot of minds of those in our audience, and that's the impact of inflation and current market headwinds on investing as we head into the second half of 2022 and beyond. And I'm curious, you know, from your vantage point, in what ways do you see the rampant rising rate of inflation and the current market dynamics as impacting investing, you know, through the next quarter? Yeah, well, you know, the next quarter and as we look forward, most economists would say inflation per se, if it's just sort of stable and everybody's living with it, doesn't necessarily have to have any foreboding consequences for investing over a quarter or

any particular horizon. The real issue here is that it's spiked up so far, especially relative to expectations a year ago, that the Fed is reacting. And it's that Fed reaction, right? The short-term interest rates, the so-called Fed funds rate, and some of the other things that are going to slow down the economy. They're designed to slow down the economy, not because that's the goal, but because that's the way you wring inflation out of an economy. So people have been watching the Fed as they always do, but we're especially watching right now. And that short-term interest rate is likely in three weeks to go up another 75 basis points, three quarters of a percent. And further beyond that, where they will stop, everybody's guessing. So the risk of a

recession, sort of negative real growth, two quarters in a row or longer, is getting very high. Now, markets are rational. So markets do their very best to forecast. And so they're already impounding the fact that the Fed is raising interest rates and is going to continue to it. So in terms of the outlook over the next three months, part of what you're trying to figure out is, is the market still a little too optimistic or is the market a little too pessimistic at this point? Everybody has their view on that, but it is really important. It's not enough just to say interest rates are going up, inflation risk is high, therefore returns over the next three months are going to be low. That's too simplistic. The question is sort of, is the market overreacting

or underreacting? My own view is that the Fed has got some more raising to do. I think I'm not very optimistic about near-term asset values. I think the Fed, to really get the interest rate in the economy to a place where inflation comes down, that that short-term interest rate has to go up a good deal further, and that's going to be painful. You know, something that I think has come up a lot in the discussion in recent months has been this idea that we continue to see inflation rise. We see the very aggressive actions the Fed is taking by raising rates to try to curb inflation. And that has kind of been the favored tool for a very long time to reduce inflation. But many of the factors we've been seeing that have fed into the current inflationary environment

aren't necessarily all under the purview of the Fed. Is there a specific reason that, you know, raising rates is kind of that favorite tool? Are there other tools in the Fed's toolkit or is this essentially what they can do? Oh, well, that's a fun question. The short-term interest rate and the one that most specifically the Fed controls that I mentioned before, the so-called Fed funds rate, has been the traditional central main instrument of monetary policy. It's sort of how you adjust the pacing of the economy and thereby adjust the pacing of inflation. Quantitative easing, we've just gone through a period where, in fact, we were trying to stimulate the economy, right?

And so back when I took macroeconomics in college, quantitative easing wasn't even a thing. So this whole idea that the Fed could adjust its balance sheet separately from the interest rate and have an effect on the economy. But quantitative easing is a sort of very dull instrument. The interest rate is really the key. So despite the fact that most people would say the Fed didn't cause this inflation, we've had a lot of shocks hit the economy, right?

The Russian invasion of Ukraine, the war, the supply chain and general disruption that was going on even before the war due to COVID and other factors. And this has been a worldwide thing. It's not just a U.S. thing, right? It's not just, hey, you can look at what's going on in the U.S. and see what happened. It's all the Fed's fault because inflation is going up through Europe and many other places. So the Fed's job, though, is given where we are and given these shocks, and the Fed didn't cause Ukraine and the Fed didn't cause COVID, but they are at the helm and they need to do something. And if I were Jerome Powell, I'll put it that way. It's sort

like your reputation is on the line. And I think he and the other fed governors are going to react pretty strongly, still, still pretty strongly. You know, I think another question that sort of comes up in this conversation is we're seeing, you know, a decrease in capital flowing into a variety of sectors right now. And then as we're looking at the current market dynamics, are there any, you know, specific industries or industry specific tailwinds that you see as kind of presenting some of the most interesting and investable opportunities at this point in time? Yeah, you know, the way I think about a question like that is maybe a little bit different than some others. I think about it a little bit more in terms of asset classes. And you could say,

well, that's kind of one level up from the question. But, you know, one of the, so I do a lot, as you mentioned in the intro, around innovation and entrepreneurship at the university level, but even more broadly, we interact as a research university with lots of founders and venture funders and so forth. So I would point to the whole private assets category. I mean, this is not a new point, but private assets and venture assets. I'm on a board or two and the investment committees and the idea is, you know, what percentage should be going into alternatives and private assets even in particular? And I think, of course, we've had a great run in a number of private asset categories, but I think there's still a secular movement toward private

assets that's going to continue. I don't see it reversing, even if in the near term returns to venture have gone down most recently and so forth. So I think of it a little bit more that way, that private assets, venture investing sort of moving further upstream in the economic value that's getting created in this very dynamic economy. That's where I see it. So for example, if you thought about science intensive companies right a lot of a lot of ventures there are a lot of a lot of entrepreneurship out there but the kind of entrepreneurship that's attracting a lot of private capital a lot of it is science-based it's like crisper right so berkeley recently won a nobel prize of jennifer down on on crisper it's like gene editing it's like wow we have just begin

begun as an economy to write the story of what crisper technology is going to do in the economy And, you know, CRISPR wasn't just an amazing scientific discovery. There's a lot of economic benefit. Now, CRISPR was sort of the original invention. It's 12 years old. It's like, show me, show me, show me. Well, it's very often in the life sciences that it's that year from 10 to 20 from the original discovery that you start seeing the major, major impact.

And that's likely to show up in the private asset category first. Yeah, I think it's exciting when we look at the age of innovation we live in. it does present a lot of opportunities that extend kind of far beyond the current dynamics that we're seeing. And that brings me to another area that you commentate on frequently, which is the crypto space. And I know this is also a segment that many members of our audience follow closely. We've seen a lot of popular crypto and crypto centric investments tumble in recent months. This has seemingly kind of disproved the idea that I believe have been out there before that crypto could be a hedge against inflation. I know there's still some mixed consensus about that. So

what insights can you share about the future of crypto based on your experience in this space? Do you think the value of startups and other companies operating in the crypto segment will remain steady in the future? Do you think regulation poses a key headwind here? What are your thoughts? Yeah, well, it's a lovely question. It's a big, big category. So I teach this stuff in my class. I teach international finance mostly, and you just can't teach international finance without talking about crypto and stable coins and things like that. So that's sort of where I come from. And I'm not just a massive advocate for the category, but one of the things that I do hear sometimes is the naysayers. It's sort of like, you see, you see, look what's

happened, blown off a bunch of value, right? And the idea is I look at the whole crypto or blockchain founded space as kind of like the way I think many, at least the smart money was thinking about the internet in 1998. I mean, it's sort of like, look, a lot of those companies didn't make it. A lot of those values lost a lot of value. And what do we have today? We have Amazon. I mean, did the world get transformed? Yes. And it's still getting transformed. So I think of it as a very skewed distribution. There are going to be some really big winners. There's going to be some transformation, folks. There's no question about it. Poo-pooing the whole category is ridiculous and naive, in my view. But the idea that they're all going to work or all not going to work,

that's not the right way to think about it. There's going to be some very big winners, and the others are, for the most part, going to go by the board. So that's just kind of, it's a different distribution. It's kind of like the distribution in venture, right? The idea is you're making venture capital investments. You just need one or two of those to pay off big. you don't expect eight of them to work that's just not what a venture portfolio looks like and i think that's kind of what the crypto world looks like another point that i would add here is look has crypto brought blown off some value yes has it has but so is the nasdaq i mean i mean just look at other asset categories it's not like yeah they have what's coming to them it's like yeah so is

your your your publicly traded tech portfolio or what have you right so um you know look there We have to be careful in any kind of new asset domain, and crypto certainly requires that care. But I'm still overall an optimist, so long as people keep thinking about this idea that it's going to be a small group of very big winners at the 10-plus year horizon. Yeah, I'm curious. We've seen a lot of mixed reactions to a growing talk about regulation in the crypto space. Do you think this will help or hinder companies that are in this area? Because as you mentioned, you know, there's probably going to be a few really key winners

and a lot that get a lot of hype and then kind of fall by the wayside. You know, I mean, ultimately, I think scaling big time scaling. I mean, you can say, look, Bitcoin is scaled. It's a global marketplace or whatever you point to here. But I think like deep integration into the economy is going to require it right before were coming, you know, when Tesla came out and said, we're going to start taking, you know, our revenues in, in, in crypto currencies and so forth. And so I, things like know your customer anti-money laundering and some of these other things, it's sort of like, I think that's going

to enable the crypto world to be central to the world economy. And I mean, central, central, right? So, so, so there's a scaling opportunity there. I think a lot of people think of regulation regulation bad. We're trying to unfetter this, this brand new market. And I get that argument at some level, not all regulation is a good thing, but the idea that we create standards, like there, there've been a lot of industries in the past, but when you think about video and other things, it's like, once a standard gets set, then the whole market can kind of start to innovate against that standard. Now. And, and so I think that if we thought about regulate some of the regulation that's coming almost surely as being kind of like standard setting that creates

platforms on which we can now collectively innovate and create private value that we can fully capture. So I'm an optimist in that space. I think there's more upside potential than downside potential. Yeah, I think it's a really helpful way to look at it. And, you know, something else you touched upon earlier that I kind of wanted to lead into a little bit, this concept that great companies are often kind of born in a downturn. I think it's something that a lot of investors are pondering these days. We live in a time of unprecedented innovation, and that's very exciting. It presents a lot of opportunities for investors, but I think it also requires, you know, investors to look carefully before they invest in a company, especially as the market

continues to be highly turbulent. So as investors, what can we look for to evaluate and find those truly great businesses, you know, in choppy and increasingly competitive markets? You know, part of what, so when we think about a down market, or if you think about recession scenarios and things like that, those are disrupted scenarios. I think that's part of why asset values blow off so much value. It's sort of like, this isn't just a small shock. You kind of go into a place where some fundamental stuff is going to get realigned and changed, right? And we say, yeah, it's a dislocation, right? And so that dislocation and it creates opportunities. And so I think that's part of it. It's sort of like when we start, there's this old

idea in economics called hysteresis, right? So if I don't have a, but imagine I had a cup in my hand and this cup is sitting in my hand and you apply a force to that cup and then you remove the force, the cup bends over a little bit, but then it writes itself. But if you apply too much of a force, it changes state and it's not coming back up when you take the force off of it. And so I think that's part of when we think about the disruption that's happening in what's currently happening, the flip side of disruption is opportunity. And so I think that would be one answer to it is kind of look for where disruption is happening and look for people who are opportunistically going after the other side of that disruption, the opportunity that's

getting created. The second thing I would point to, I'll be quicker on this one, but I think the second one is there's talent that's getting freed up. I mean, that's part, it's not just people are now unemployed, you know, it's sort of like even people who continue to be employed have more bandwidth, but some people are actually saying enough of that, I'm going to launch myself. So, So I think for a lot of people investing in new opportunities, they're investing in the person as much as other things. And so look for people whose bandwidth is getting freed up and try and invest in people and teams that are getting freed up in the disruption.

You know, and we've seen very, I think, mixed responses from individual and retail investors understandably reacting to the current state of the markets. There's been anxiety. We've seen reports about how the fear index is at an all-time high. There's been worry about the future of investments and companies across a range of sectors. And I wonder if maybe you can talk through a bit about the importance of taking a long-term view on investments versus giving into that often natural knee-jerk reaction to rising interest rates and falling stock prices. And then on top of that, how can investors differentiate between good businesses in a turbulent market versus businesses that have actually taken a turn for a valid reason, and that's correlating

to the stock price? Yeah, those are two good questions. I'll get to the second one. I think for the first one, and now I'm going to sound kind of like the academic, here comes the textbook, but the idea is, look, patient capital, I mean, study after study after study after study says, you know, people trade too much. They don't beat the market. I mean, I look, all of us have this instinct in us, all of us trying to time the market. If you were being disciplined and you looked at your own account and you really were honest about whether you're able to beat the market with your timing, you will find that you aren't okay. And, and there might be one Warren Buffett outlier in a million, but, but so, so it's, it's, I'll use the phrase a fool's errand,

But it is a very hard thing to do. And here's part of why it's a hard thing to do. It's sort of like, OK, I've heard that before. But here's why. If you look at the data, if you look at the data on equity returns and so forth, an important part of where long-term equity returns come from is punctuated updrafts. It's the bang upward. So if something moves like quickly in a couple of weeks, it's like, wow, 10% in a couple

of weeks of this kind of thing. It's not like, oh, you just need to get in. And then there's this steady trend. No, it's these punctuated updrafts. And nobody knows when those are going to happen. And if you are out when those happen, you've lost out. And if you take out the punctuated updrafts from sort of returns to equities or other asset classes, your returns are a lot, lot lower. So anyways, that's really part of it. It's, it's look, if you want to trade for consumption reasons, like I'm just having fun and I'm not trading anything that really matters for my family or for my retirement, it's like, have fun. But if you're trading assets that matter,

don't do it. Go long horizon. I think it's a really important thing to remember as well. And then when we're kind of looking at the volatility in the market, you know, are there some kind of key hallmarks to look for that differentiate, you know, good businesses with falling share prices versus businesses that perhaps fundamentally weren't as strong to begin with? And there is actually a valid reason why that stock is fumbling in the current market. Good question. Hard one to answer is, you know, I think it was a Warren Buffett quote, but some, somebody smart said, you know, when the tide goes out, we find out who was swimming without a bathing suit. Right. And it's just, it's a fun quote in part because there's so much wisdom in

And, you know, I think like, for example, in the area that I'm closest to is kind of venture investing because of the role that I play at UC Berkeley. And I think part there is sort of like, look, have you been capital efficient, right? It's sort of like, look, for a lot of startup, you know, founders, the idea is we haven't lost that much money. It's sort of like if you're the CEO of name your company, public company, if you said yesterday, we haven't lost any money until, you know, it's like, yeah, you have your stock price is 25% down. It's 25% down. Okay. Deal with it. But for a startup founder, it's sort of like,

we're the same company. We haven't lost. It's kind of like, no asset prices have fallen. You're worth 25% less. You can deny it. But for a lot of, you know, venture founders, it's sort of like, they're saying we don't need to do financing at that price. It's like, it's too low a price. it's like, yeah, probably not, maybe, but sort of like move on. And so I think part of it has to do with, I'm coming back to the capital efficiency ideas. When markets start to get tight and you start asking like, well, what are the ingredients that are gating factors on this company getting healthy again and regaining its momentum? Access to capital is very often one of those. And so part of the question there is like, how soon is this company going to need capital?

You know, can it survive from six months to a year without new capital? So those are, those are some, I maybe I'm a little too much fat capital focused, but I think, I think the, the, the way companies that their, their vulnerability to capital access is, is going to be an important factor over the next year. I think that's very key. And as well, one of the things that kind of plays into this discussion that I think is very relevant to us as investors, but also as consumers, and you touched upon it earlier, is this idea of whether or not a recession might be around the corner. We've had economists predicting, yes, it is. And we've had others saying, no, probably not. And I think probably the truth is that no one knows. So I'm curious

to hear your take if you want to share it. But beyond that, how can we reconcile the idea that the economy is fundamentally strong with some of the current turbulence that we're seeing in the economy, as well as the stock market as a backdrop against that. Yeah. So real quickly on hard to forecast recessions. I don't have a lot more information than anybody else. I just have a little bit of experience thinking about the macro economy. And I think, look, the bet is just how tough is the Fed going to be with that short-term interest rate? If you're talking about a recession in the US as opposed to Europe or elsewhere, right? But if we go in the next meeting of the Federal Open Market Committee from 175 basis points to 250, because if they move 75 basis

points, and then the next time they move 50, and they're at three, and then they're at 350, and then they're at four, could the Fed take us to a 4% Fed funds rate? That's quite possible. And I think, you know, under those scenarios, I think those kinds of, because when inflation is running well above four, think about it this way, right? Are we, do we have the brakes on or do we still have the accelerator pushed? You say, wow, we're going to go from 1.75% to 4%. That's like crazy breaking, right? But it's sort of like, if the inflation rate is six and the nominal interest rate is four,

right? That's a negative real interest rate. I mean, in kind of just economics 101, that's not a hard break on the economy. That's more of a break than what you had before, but that's still a negative real interest rate. It's not until you start getting to positive real interest rates that you really start breaking. And when you frame it that way, it's sort of like, oh, there's a lot of headroom in

Fed increases before the economy is really, really going to slow down. And many people feel the slowdown is going to be needed to get inflation down. So, so I think that's, that's the fundamental way to think about, think about that. Sorry, the second part of your question. Yeah, just looking at, at this backdrop right now and what we're seeing in the market, you know, does that reflect a strong economy, some of the turbulence that we're seeing in the market? And I think it's clear that obviously the economy and the stock market are two separate

things, but the movements of the market do often occur in response to the economy. So as investors, you know, how do we look at that? Yeah, so, you know, there are really a lot of strong points, right? The labor market is incredibly strong. That's part of what's pushing inflation up, right? I mean, even if you said there's no Russian invasion of Ukraine and there's no COVID, you get an unemployment rate that's down as low as the U.S.'s unemployment rate is. And that, look, that puts upward pressure on inflation, right?

If you are a supplier of labor, you have more bargaining power. I mean, that just stands to reason. And so, you know, and that's a very positive thing, right? If we had an unemployment rate at 8% or 9%, which, you know, and through some of the 80s disinflation, 70s and 80s, you had much higher unemployment rates. That's even tougher. It's like, wow, the Fed's tightening and we've got a 7% or 8% unemployment rate. It's like, oh, that's really tough.

So the fact that the labor market is quite healthy by historical standards is a super positive thing, right? It's a positive thing for the economy and so forth. So, you know, there are a number of, I think if you thought about kind of still kind of the innovation energy of it, well, I'll give you one small example, okay? But this is a little bit close to home, but I'll toss it in. Because one of the, what I'm going to call it a generational tailwind, like pushing us forward, super positive. When you start thinking about private assets and new companies and

entrepreneurship and so forth, right? You should see what has happened to your nations. Those of you that are Americans, your nation's universities, because I'm just going to use Berkeley as an example, but a lot, it's like, wow, if you look at the innovation and entrepreneurship ecosystem at UC Berkeley, and we've created a time-lapse, look at it in the year 2000, 05, 2010, 2015, 2020 we've got links on our website it's like wow so universities 20 years ago even 10 years ago many of them it's sort of like innovation and entrepreneurship yeah we do science we do patenting we do licensing but it's sort of like yeah we have some classes in entrepreneurship but it's sort of like no research universities part of their impact on society is being juiced

in a major major way by this commitment to innovation and entrepreneurship keeping consistent with their missions. But and so I see that as like one of these fundamental, powerful forces. This isn't just one or two or three universities, it's cross. And so that mindset,

the way we're teaching our students, the opportunities we're giving our students, if you thought about that as the ultimate engine room, I'm being a little bit, obviously, affected by my own view here.

But I think that's a terrific medium and long term engine to the economy. Chris Hill As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.