Hollis Johnson/Business Insider
- There are unique uncertainties around how the next downturn will unfold and how policymakers can combat it, according to Karen Karniol-Tambour, the head of investment research at Bridgewater Associates, which is the world's largest hedge fund.
- In an interview with Bridgewater co-CEO David McCormick, she identified at least three unknowns that investors must grapple with even as recession concerns rise.
- She also explained why the impact of political tensions has become the most important of them all.
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After overcoming the worst crisis since the Great Depression, you might think the global financial community has figured out how to deal with a milder downturn.
It's not a far-fetched assumption: Most investors are well-versed on what normal boom-and-bust cycles look like, and what indicators to watch for changes in either direction.
However, the next inevitable crisis is full of various unknowns that could render this assumption incorrect, according to Karen Karniol-Tambour, the head of investment research at Bridgewater Associates, which is the world's largest hedge fund.
"We're potentially facing a next downturn where we genuinely don't really know what might be effective and how policy makers should go about that," Karniol-Tambour said in an interview with Bridgewater Co-CEO David McCormick on YouTube.
She added: "We're looking at a time where the cycle we're really familiar with might play out in very, very different ways."
One of her research priorities these days is digging into places, including China, where unconventional policy tools are being used to solve problems. That's because the reaction function that policymakers have relied on for decades may prove ineffective going forward.
To that end, she identified three big "unknowns" about how the next crisis - and the next crisis response - will unfold.
The first is that we genuinely don't know anymore what tools will effectively fight a downturn. Simply look back at the past 10 years of recovery to understand the deficiencies of some well-traveled options.
Record-low interest rates, for example, have been a mixed bag. They have revived consumer spending, enabled businesses to borrow at record-low costs, and fueled the longest-ever bull market in stocks. However, many experts still can't explain why inflation never picked up the way it was expected to.
"We're seeing a lot of experimentation," Karniol-Tambour said. "But every time the experimentation happens, there's more unknowns than knowns."
One of the more controversial experiments after the 2008 crisis was quantitative easing, the Federal Reserve's massive bond-buying program that swelled its balance sheet and injected liquidity into the financial system. Despite its success in years past, printing even more money is less likely to be as effective going forward, Karniol-Tambour said.
Her second big unknown about the next crisis relates to negative interest rates, which several countries including Japan have already employed.
Negative rates were once unthinkable in the central-banking universe. Officials used to worry that benchmark rates well below zero would encourage people to hoard cash under their mattresses or in other forms of self-storage. After all, the whole point of saving would be turned on its head since banks would effectively be charging on deposits instead of paying interest.
But we've barely seen this widely assumed outcome play out, Karniol-Tambour said - and it means rates could fall even deeper into negative territory. Moreover, the shift to cashless payment systems in many countries could mean that interest rates can be lower than conventionally thought, since the hoarding effect would be diminished.
Investors can no longer ignore political outcomes
The third unknown that Karniol-Tambour identified - and perhaps the biggest, according to her - is about how the political tensions borne by inequality will play out in the next crisis.
Her premise is that, since the financial crisis, the share of gross domestic product that accrues to corporate profits has risen, while workers have received a smaller share of the pie.
The need to adjust these divergent trends has not gone unnoticed. From CEOs in the Business Roundtable who no longer want to prioritize shareholders to politicians like Sen. Elizabeth Warren and Sen. Bernie Sanders, there's a widespread recognition of the inequality that has brewed since the last crisis.
The implication for investors is that political tools are now being centered as the solutions to economic problems in ways they were not used before, Karniol-Tambour said. Additionally, the US-China trade war has demonstrated once and for all that geopolitical outcomes are not siloed from market outcomes.
"Tariffs were not commonly applied to solve economic problems, let alone immigration problems or border problems like they have been suggested in places like Mexico," she said.