Wednesday morning, Sam Zell, billionaire chairman at Equity Group Investments, spoke with Stephanie Ruhle and David Westin on Bloomberg’s “GO” TV.
Zell discussed a wide variety of topics from the Federal Reserve rate hike, the risk of a near-term recession, real estate, energy, and various foreign investment ideas. The interview was before the Fed announcement.
I put a spotlight on some interesting Zell ideas. Everything below is a selected quote except for two comments by me in braces[].
Twenty-Two Ideas
- Economy: High probability that we’re looking at a recession in the next 12 months.
- Rate Hike: Interest rate hike is probably 6 or 8 months too late. I think that the economy is closer to falling over than it is to going up.
- US Dollar: Devalued currencies make it very difficult for the US to compete internationally.
- World Trade: World trade is slowing. Currencies continue to be manipulated. You’re looking at the beginnings of layoffs in multinational companies. Weakness is going to be pervasive.
- Global Deflation: You can’t put aside China. You can’t put aside Europe. If China’s numbers turn out not to be as accurate as we think, China could go into a recession. That’s about as deflationary a scenario as you could possibly come up with. And one that would for sure impact growth and affect Janet Yellen’s decision.
- Fed Tools: “Uh” … [as in the Fed has none]
- Asset Prices: Assets will get cheaper.
- Cash: With zero interest rates the penalty for holding cash is not very significant.
- Stock Market: Nothing cheap. A number of falling knives that have been obfuscated by Amazon and Facebook et cetera. If you take out those stocks, the stock market isn’t doing real well.
- Mexico: Mexico is terrific. I think there’s extraordinary opportunity there.
- China: I don’t think China is growing as fast as it reports to be. And I think that the world has a significant deflationary risk coming from a slowdown in China which I think would impact the cost of goods all over the world.
- Brazil: Brazil is obviously suffering significantly. On the other hand, as an investor I’m always looking at where nobody else is willing to go. We’re there already and under the right set of circumstances wouldn’t have any problem investing in Brazil today. I just think you can’t lose sight of the fact that this is a country with 180 million people. It’s still growing. It’s self-sufficient in water, oil, food. It’s an extraordinarily badly managed you know entity. But the extraordinary part hasn’t changed. I’m somewhat of an optimist and I think this whole process will be a cleansing process.
- Oil: It’s not so much prices as it is specific opportunities. What makes the opportunity is the distress of the situation.
- Natural Gas: I’m probably more focused on gas than oil. And it’s, you know, it’s a little bit like real estate. I mean we made a fortune because we bought real estate at a discount to replacement cost. Well we’re buying gas in the ground, gas that’s been drilled. People have spent $10 million a well, we’re buying wells at dramatically less than that. So it’s the same kind of creating a competitive advantage by virtue of your entry price.
- Real Estate: It’s very hard not to be a seller. And so we’re in effect fulfilling in some respects our longer term strategy in AQR where we’re liquidating the remaining garden apartments we have. I’m not a big fan of buying at these cap rates.
- Blackstone: Blackstone is just buying brick and mortar. And they’ve been able to raise staggering amounts of money. And they’ve got to put that money to work. That’s something we’ve never wanted to be in a position of having so much capital that it affects our decision-making on an ongoing basis.
- Currencies: I’m very concerned about what’s happening in currencies. I think that you know Bretton Woods in 1948 was the allies coming together and saying we can’t recover in the world without growing free trade. We can’t create growing free trade without stable currencies. So let’s make sure we have stable currencies. That worked for a long time. Now we have very unstable currencies. World trade is slowing.
- Dodd-Frank: I’ve never known of a single situation in my life where reduction in liquidity was a plus. And effectively Dodd-Frank has dramatically reduced liquidity and that’s a big negative. And that’s something we haven’t dealt with yet.
- Politics: The American people are extraordinarily angry. The American people are extraordinarily depressed. The last time we had anything like this in my opinion was 1979. [To a statement regarding Trump’s popularity Zell responded]: It’s because you guys are sitting here in New York City and you’re not in Des Moines. And you’re not in Boulder and you’re not all over the country. And you’re not seeing the enormous disparity that has existed between you know the coasts and the rest of the country. We have a lot of very unhappy people and I think this election is reflecting it. And I think it will be very dangerous.
- Flat Tax: I think if I were given a straight choice I would be in favor of a simple flat tax.
- Government Bonds: I’m not a big lender of money to governments period.
- Climate Change: The level of certainty of exactly what is happening has a lack of humility and arrogance to it that scares me. As far as I’m concerned, conventional wisdom is my greatest enemy. And this strikes me as an awful lot of conventional wisdom.
It was a fascinating 2-hour interview. I stripped off the intro, the rest appears below. It’s well worth a read.
Zell Transcript
RUHLE: We are 5 hours and 56 minutes away from the Fed announcement. And what is it? Clearly we are expecting them to have a rate hike. Sam let’s talk about the rate hike for a minute. Let’s assume we get it. Even if we do, we are moving inches. Given where interest rates are, even with the hike, how concerned are you about asset bubbles?
ZELL: Well, I think that the interest rate hike is maybe going to begin the process of reducing the asset bubbles. But look at the screen this morning. Futures are way up. Futures are way up because interest rates are going up. That’s indicative of the way the market has responded for the last six months.
RUHLE: Perversely.
ZELL: Yes, exactly. And I think that this interest rate hike is probably 6 or 8 months too late. I think that the economy is closer to falling over than it is to going up.
RUHLE: Hold on a second. If it’s 6 to 8 months too late and we’re closer to falling over, what exactly does that mean? How bad is it?
ZELL: Well, I think that there’s a high probability that we’re looking at a recession in the next 12 months. I think that the strong dollar is having enormous production on US production and US businesses. And they’re being competitively disadvantaged by an extraordinarily strong dollar. To some extent it’s a function of the fact that we’re better than other places. Not necessarily good but better than other places. But those places are now competing with us with devalued currencies. That is making it very difficult for the US to compete internationally.
WESTIN: So take it into your view of the US economy. Because you’re invested in a lot of different places, you monitor things. When you say there may well be a recession in the next, I think you said 12 months?
ZELL: Yep, within the next 12 months.
WESTIN: What are the things that are indicating that specifically to you? Where do you see evidence of that?
RUHLE: And what’s going to get hit?
ZELL: World trade is slowing. Currencies continue to be manipulated. You’re looking at the beginnings of layoffs in multinational companies. We’re still looking all over the world for demand. And tell me where the demand is? That’s ultimately what’s going to rectify and move us toward growth.
And it’s very hard to find any place in the world maybe other than South Sub-Sahara Africa where there is better growth but no scale. So when you look at those factors it’s hard to see where you know strength is going to come from. And I think weakness is going to be pervasive.
RUHLE: But it’s hard to see any of those outcomes being different had Janet Yellen raised rates six months ago.
ZELL: Except that if she’d raised rates six months ago we would have begun adjusting to that. And I think that she would then have more room if in fact a recession is on the way.
RUHLE: OK, then help us understand. Granted, you’re not in Janet Yellen’s head, if you see a recession on the horizon, we’ve heard that from the likes of Carl Icahn, what is Janet Yellen looking at? And do you think she’s just not doing a good job then?
ZELL: I don’t have an opinion of how Janet Yellen is doing. I think the Fed as a whole is very conservative and very cautious. And I think that–
RUHLE: Too conservative? Too cautious?
ZELL: If I think she should have raised interest rates six months ago–
RUHLE: Fair point.
ZELL: I think the Fed is very concerned. And I think to some extent they should be concerned. Because they’ve got to be looking at the same numbers I am. And those numbers are not robust from where I sit. The improvement in employment is impressive but the improvement in employment is very much at the low end of the scale. And I think that’s another factor in this whole evolution.
WESTIN: Far be it for me to argue Janet Yellen’s side of this, but she would point to unemployment rates. Also some wage pressure, we’ve some seen wage increase. Not huge, but noticeable wage increase. Consumer spending pretty good right? So nothing is shooting the lights out. But I think she’s looking at sort of steady progress in terms of the US economy. Put aside China, put aside Europe.
ZELL: Well, but the answer is you can’t put aside China. You can’t put aside Europe. If China’s numbers turn out not to be as accurate as we think, China could go into a recession. That’s about as deflationary a scenario as you could possibly come up with. And one that would for sure impact growth and affect Janet Yellen’s decision.
So I don’t think the Fed’s position is easy. I think that zero interest rates are a very negative thing. And I think that they’ve contributed to the fact that we’ve had such an anemic growth since the big recession.
RUHLE: All right, let’s say you’re right and by the end of next year we do fall into recession. What tools does the Fed or the US government have to help us out of it?
ZELL: Uh–
RUHLE: Because that’s many peoples fear, she’s got no tools left.
ZELL: Yeah, well, I mean the answer is, that’s many peoples fear because they can’t come up with any answers either. In other words you can’t lower interest rates although you’re seeing negative interest rates in Europe. So you may see something like that.
RUHLE: OK, then help us invest out of that. If that’s what you believe, and Janet Yellen doesn’t have any tools left, we see you selling some assets. Holding on to that, are you keeping dry powder because you believe assets will get cheaper next year and you want to buy them?
ZELL: I think there’s very little doubt in my opinion that assets will get cheaper. And I think that again with zero interest rates the penalty for holding cash is not very significant. So you have the kind of flexibility in a zero interest rate environment that you wouldn’t otherwise have if the cost of holding cash was much more prohibitive.
RUHLE: Specific asset classes, will they look cheaper if we do head into a recession next year? What will you want to buy the most?
ZELL: Well, I think the answer is that I think the stock market is above its long-term average. At a time when world trade is slowing and activity is less than 2%. So I don’t understand the stock market. I don’t see anything cheap there at all. And we’ve had a number of falling knives that have been obfuscated by Amazon and Facebook et cetera. I think if you take out those stocks, the stock market isn’t doing real well.
WESTIN: There is one other tool we never talk about which is fiscal rather than monetary. We’re so focused on monetary. What about the possibility of fiscal stimulus? I mean real big infrastructure packages, things like that.
ZELL: I think that would be a great idea. I think this President tried to do that once before. I think the term was shovel ready.
WESTIN: Right.
ZELL: And most of it was just shoveling.
WESTIN: There you have it. OK, so Sam Zell of Equity Group Investments is with us for another hour, I’m happy to say.
JASON KELLY, NEW YORK BUREAU CHIEF, BLOOMBERG NEWS: Hi guys. Well, specially curated for Sam Zell. We sort of looked into some of the things you’re interested in. And I wanted to start by keying off the discussion you guys were talking about the Fed with a little bit of a twist.
So this comes from Well Fargo, Investment (INAUDIBLE), Paul Christopher who’s the Global Market Strategist talking about Mexico. “There are a lot of institutional investors who hold Mexico as a proxy. This has led to Mexico being the whipping boy.”
You’re in Mexico?
ZELL: I am.
KELLY: You like it, right?
ZELL: I think Mexico is terrific. I think there’s extraordinary opportunity there. I think Mexico is the answer to the single supply chain that used to come out of Asia. I think that you know, like everything else there’s short-term scenarios and maybe they’re the short-term whipping boy, but I’m not a short-term investor.
KELLY: Right.
ZELL: And so I’m going to be there at the end.
RUHLE: Have you shared that view with Donald Trump. You must know each other through the real estate game.
ZELL: I know Donald Trump. That doesn’t mean I agree with him.
(LAUGHTER)
KELLY: But you built an airport in Mexico, right?
ZELL: No, we built a border crossing.
KELLY: Border crossing, yes, sorry.
RUHLE: Well, what happens if Donald Trump is the next president and he builds a great big wall there?
ZELL: Well, I think that our bridge will kind of–
KELLY: Fly over it.
ZELL: –go through the wall. But the answer is the other side of the bridge is the Tijuana Airport. So effectively and a big portion of the Tijuana traffic comes from the US because San Diego doesn’t have international airport. So effectively this is going to make it very easy for US people to come, park their car on the US side, walk across the bridge and you literally end up at the ticket counter. And that gives you access to Asia. It gives you access to all kinds of cities in Mexico.
We’re in the kind of try out period. I think we’ve had about 7,000 people walk across so far.
KELLY: Amazing. So you mentioned Asia, so let’s talk about China with the next quote. So this is from Hugo (INAUDIBLE) he’s an Economist at (INAUDIBLE). He’s talking about China. “This is not cyclical this is prolonged deceleration to a new structural growth. Get used to it.”
You’re bullish on China, right?
ZELL: No, I’m not bullish.
KELLY: You’re not. God.
ZELL: I mean, the answer is I don’t know. Every decision you make has to be individual. And big macro ideas should lead to you know, effective individual decisions. I don’t believe the numbers China produces.
KELLY: Right.
ZELL: I don’t think China is growing as fast as it reports to be. And I think that the world has a significant deflationary risk coming from a slowdown in China which I think would impact the cost of goods all over the world.
RUHLE: Are there other emerging market nations you wouldn’t touch because you think China’s so bad? Brazil for example?
ZELL: I think Brazil is obviously suffering significantly. On the other hand, as an investor I’m always looking at where nobody else is willing to go.
RUHLE: And do you want to go there?
ZELL: We’re there already and under the right set of circumstances wouldn’t have any problem investing in Brazil today.
WESTIN: Where are those other opportunities, Sub-Saharan Africa? Southern Africa?
ZELL: I don’t think there are simply because there’s no scale. And there’s no capital markets. And those even though those communities in Africa are growing relatively fast; it’s a very, very thin middle upper class. And as an investor in the emerging markets I think the criteria that we’re looking for is a significant aspirational growing middle class like Brazil, like Mexico and like Columbia and some other countries.
RUHLE: All right, we have to take a break. Jason, Sam, stay with us. If you thought talking Brazil meant you were going to see a beautiful shot of Brazil and Brazilian women, guess again! We have a better shot. Sam Zell kicking back in his office Chicago-style back in 1994. Take a look at what’s in front of him. No I don’t mean his black loafers I mean his old school, original Bloomberg Terminal. Do you use the Bloomberg every day Sam?
ZELL: Yes.
RUHLE: There you go. There you go. Sam using his Terminal. Glass is there. That’s Sam Zell 1994. When we return we’re talking energy assets being in distressed. We’re going to ask Sam what he is buying because he certainly is.
break
RUHLE: We have been tracking volatile oil prices including recent lows for the year in crude. But one man’s crude is another’s treasure. Investor Sam Zell maybe loading up on distressed energy assets and Jason Kelly is with us too.
Sam, let’s talk energy, distressed energy. First of all, do you think prices are low enough, and if you do, where specifically are you buying?
ZELL: Well, first of all, again, it’s not so much prices as it is specific opportunities. In other words, obviously prices are down. But what makes the opportunity is the distress of the situation.
RUHLE: Like what? Where?
ZELL: Well, you know, we’re investing in the Piceance in Colorado. We’re investing in the Permian Basin. We’re responding to the difficulties that other people are having. I mean in the last few months all the banks have redone their reserve reports. And all the numbers of availability of cash in the energy space are way down. So there’s a lot of pressure.
Currently like in real estate in ’09 the energy lenders are playing pretend and extend. And they’re going like this and don’t tell me how bad it is. But the reality is, that’s going to move forward and continue to cause upheaval in the energy space and that kind of upheaval adjusts and creates opportunity in pricing.
WESTIN: Are you looking principally at oil in the ground or also oil services, exploration, rigs, pipelines?
ZELL: Yeah, I think that I’m probably more focused on gas than oil. And it’s, you know, it’s a little bit like real estate. I mean we made a fortune because we bought real estate at a discount to replacement cost. Well we’re buying gas in the ground, gas that’s been drilled. People have spent $10 million a well, we’re buying wells at dramatically less than that. So it’s the same kind of creating a competitive advantage by virtue of your entry price.
RUHLE: All right, well, clearly you’ve got interest in the US oil patch. How about investments overseas?
ZELL: We, overseas in the energy space the only thing that we’ve done of any significance is that we were one of the founders of a company called Kuwait Energy which was the first Arab-owned independent oil company. And we’re drilling and producing in Iraq, in Yemen and Egypt in Kuwait. The company is doing very well. The premise of the investment was that when the Middle East oil markets gets more liquid and more fluid an Arab-based company will have a significant advantage. And I think that’s proven to be the case.
SCHATZKER: Is there any sort of real estate play around oil and energy at this point? It seems like we saw a lot of people pile in to David’s point to some of the sort of ancillary opportunities. Do you see anything there?
ZELL: Well, I think you have to be careful of all of the variables. I mean I took a trip to Williston in South Dakota a year and a half ago. Williston been up for grabs–
RUHLE: Sam, we have to take a break. You’re not going to get to hear about Williston but we’ll come back to it.
(LAUGHTER)
RUHLE: Housing starts and building permits rose 10.5% in the month of November. Is this a surprise to you? And Sam is this something you track that closely?
ZELL: Yeah, we’re the largest owner of multifamily housing in the United States so; we’re very focused on single family. I don’t think this is any big adventure. I think this is a one month blip.
RUHLE: So for you, when you look at real estate in the United States what is the climate? What is the landscape look like? Because people say, they keep seeing you sell–
ZELL: Yeah.
RUHLE: We’re worried that this is a top.
ZELL: A lot of people have accused me of that. I didn’t try to make a top in ’07 and I’m not trying to make a top now.
RUHLE: But you’re making a statement if you’re selling.
ZELL: Well, the answer is if you look at the world as I look at it and you look at the pricing that is currently available in the commercial real estate market, it’s very hard not to be a seller. And so we’re in effect fulfilling in some respects our longer term strategy in AQR where we’re liquidating the remaining garden apartments we have. So that shouldn’t have been any big surprise to anybody.
The difference was we did it all at once because the market could absorb it. As opposed to our original plan was it would take us 4-5 years to do the same amount.
SCHATZKER: Sam, do cap rates help to explain your point of view? If we look for example on cap rates on retail, if we look at it on multifamily, office, hospitality, we can bring it up here from the Bloomberg we can see that the cap rates are the top line and then the green line helps to illustrate the spread over Treasuries which is the gray line on the bottom. And we see that in pretty much every single case but hospitality they’ve been ticking ever downward. Which suggests that there isn’t nearly as much value there as there once was right?
ZELL: Well you’re talking about cap rates. I don’t think cap rates have moved dramatically–
SCHATZKER: No, no they haven’t. If we go back and look at that chart. But the trend has been–
ZELL: The cap rates going down means values are increasing. And as somebody who’s been selling a lot of real estate, that’s a terrific thing.
SCHATZKER: That’s why I say does it help explain your point of view.
ZELL: Another way to put it is, I’m not a big fan of buying at these cap rates.
SCHATZKER: How long will it take before we see those cap rates at a point where you feel it’s good to buy?
ZELL: I don’t think that I’ve ever bought or sold real estate, I’ve sold real estate based on cap rates, I don’t buy real estate based on cap rates. So I mean there’s nothing more relevant than replacement cost. And so you can generate values that are way above replacement cost by virtue of very low cap rates. And that’s a sucker’s bet.
WESTIN: Sam how much of it is geographic? Regional? I mean you’ve sold a fair amount in Chicago including a pretty good sized building downtown right? On Wacker?
ZELL: Yep.
WESTIN: So how much of it is regional?
ZELL: I think it, some of it is regional. But I think the basic decision from our perspective in the equity commonwealth situation is that equity commonwealth had accumulated a lot of what I call B assets. And I don’t think this is an environment to own B assets. And so we’re liquidating them accordingly.
RUHLE: Is it at all political? I mean Chicago is your town. And to make big sales in Chicago are you making a statement about what it’s like there right now? I mean it’s gotten very unsafe.
ZELL: I don’t think it’s gotten very unsafe. I don’t think it’s any more or less safe than it was–
RUHLE: Really?
ZELL: Oh come on the numbers about murders go back 15 years ago and the numbers were much larger than they are today.
RUHLE: Is Rahm Emanuel doing a good job there?
ZELL: I think Rahm has the toughest job in America. So therefore the fact that he gets up every morning and goes back at it says he’s doing a great job.
RUHLE: All right.
ZELL: But that doesn’t mean that he’s not subject to everybody picking on him right and left.
SCHATZKER: I like talking about Rahm Emanuel, Sam, but I want to go back to replacement cost. The point you were making about where to find value in real estate. Where is it? Bruce Flat of Brookfield told me they’re buying in Brazil because you’re acquiring top quality at least for the Brazilian market office space at way below replacement cost. Is that the best value in the world right now?
ZELL: I don’t think I want to make a statement on what is or isn’t the best value in the world. But ultimately if you have the staying power and Bruce certainly has the staying power, I don’t know any other way to sleep at night better than buying than less than it costs somebody to build to compete with you.
SCHATZKER: So where do you like?
ZELL: I think that I’m not a big buyer of real estate today.
RUHLE: So what does that say when you say to Barry Sternlicht, right? Barry’s your friend. He’s been a partner of yours in many different ventures. Obviously you’re not in Barry’s head. But what is Barry thinking that you’re not or vice versa?
ZELL: Barry has a different kind of money. Barry has a different kind of investor.
RUHLE: Less than you do.
ZELL: Well, I mean–
RUHLE: I’m just messing with you.
ZELL: You go look at this situation, he bought this portfolio from us. Number one the portfolio is in fabulous shape physically. Number two it’s fully rented. Number three there’s an existing cash flow. Current interest rates allow him to borrow money at less than the cap rate he’s paying. So the spread means that on his equity he’s going to earn 9 or 10%. And I think he’s going to do great. I think this is one of those scenarios that’s a win-win on both sides.
WESTIN: Sam, let’s go tech. There are reports that some large landlords are in discussions with Airbnb to possibly rent out apartments through Airbnb. Have you looked at that kind of possibility? Could it change your business?
ZELL: The answer is that Airbnb has interfaced with I think all the multifamily companies. And for sure has approached EQR and they’ve had some conversations. I don’t think that the overall scale of Airbnb is going to change the multifamily business. It might create, particularly in certain situations, scenarios where maybe a rental project is much better suited to be used as a semi-hotel in an Airbnb situation.
WESTIN: But could it help to soak up some excess capacity if you have some units that are not–
ZELL: Yeah, but there is no excess capacity. In other words, 97 is the old 95. 97 is the new 95. In other words we basically, I mean look at the numbers. I mean for 20-some odd years we built 1 million single family houses a year. We’re now building 500,000 a year even with your–
RUHLE: You’re in the multifamily business. Is this because you think people can’t afford to buy homes and they have to rent?
ZELL: Well, it doesn’t matter whether they can or can’t afford it. If you’re building half the number you used to build and people are still copulating, then the number of overall people is going to increase and demand for housing and shelter is going to increase. And if you’re not building houses then they’re going to fill all the apartments. And that’s what they’re doing.
SCHATZKER: Sam, apartments have been a great business for you. RVs and mobile homes have been an incredible business for you.
ZELL: That’s right.
SCHATZKER: How much longer can that continue? If you were to look at the returns of equity residential which has done well against equity lifestyle, your RV park and mobile home park business–
RUHLE: Erik’s an expert in RVs, I’ll warn you. I’ll warn you.
SCHATZKER: Look, if we bring up the chart, equity lifestyle–
ZELL: Equity LifeStyle since the beginning of the modern writ era is the number one–
SCHATZKER: Look at that.
WESTIN: Wow.
ZELL: Is the number one performing reach along with Simon Properties. And it’s very simple. We are not building any more manufactured housing communities. Not in my backyard.
SCHATZKER: Fixed supply.
ZELL: Fixed supply. And therefore demand is increasing, the supply is limited.
SCHATZKER: So that line we were just looking continues?
ZELL: I don’t know of any stock or any company that I’m involved with that has a better prospect than Equity LifeStyle.
SCHATZER: Really? Than mobile homes and RV parks.
ZELL: Yes, because basically there is no supply. Everything, I went into class at the University of Michigan in Economics 101 and it said on the wall, supply and demand. Nothing’s changed. Supply and demand is what it’s all about.
RUHLE: All right, Sam, our viewers want to participate. We’ve got an Instant Bloomberg question from Esposito Trading. They want to know your thoughts on Blackstone and its REIT acquisition activity. What do you think about what they’re doing?
ZELL: Well, I don’t know. I don’t look at what Blackstone is doing as a REIT acquisition strategy. I think they’re just buying brick and mortar. And they’ve been able to raise staggering amounts of money. And they’ve got to put that money to work.
RUHLE: Do you like that strategy?
ZELL: I didn’t say I liked it. I think that John Gray is a very smart guy and I think for a very, very large entity he’s doing that which he has to do. Which is invest the capital. That’s something we’ve never wanted to be in a position of having so much capital that it affects our decision-making on an ongoing basis.
RUHLE: We’ve got more to cover with Sam.
(BREAK)
RUHLE: Sam Zell, Founder and Chairman of Equity Group Investments is still with us. Also our own Erik Schatzker. Sam, Carl Icahn has said we’re in a disastrous situation. Specifically the high yield to junk market is going one way, down. Other people see this as a buying opportunity. Where are you?
ZELL: Well, obviously if it’s going down maybe it is a buying opportunity, OK? But the numbers are, again, relatively simple. Since Mike Milliken created the junk bond world, the average spread has been 588. In the last 24 months the average spread has been 240. That means that “the risk has gone down by some huge percentage.” The answer is–
RUHLE: The perception of risk.
ZELL: Well, the answer is, you know, there was a shortage of income. People flooded into junk bonds. They took junk bonds that should have had a 5 or 6% spread and bought them at 240. And guess what? Too much money chasing too few opportunities leads to disaster.
RUHLE: So what’s going to happen? Are we headed to disaster in the junk bond market when many non-sophisticated investors have piled in to high yield because they couldn’t make any money in the government bond market?
ZELL: I mean, first of all, very large percentage of the junk bond market is in energy. Energy pricing has gone down. Therefore the margins have gone down. And there’s all kinds of junk bonds that are being renegotiated. And there’s beginnings of bankruptcies. So there’s little doubt I think that the junk bond market is going to suffer.
Now is it going to be the disaster Carl Icahn describes? I don’t know. Because again I don’t buy the market. I buy individual special situations. Individual situations where the circumstances create an extraordinary, what I believe is an extraordinary opportunity.
SCHATZKER: Do you feel the credit cycle turning?
ZELL: I think so, yeah. I think, I mean turning is too strong a word. But I think we’ve seen–
SCHATZKER: Cresting.
ZELL: Yeah, I think we’ve seen the lows on the credit cycle obviously. I think they’re going to raise interest rates today. I don’t think it’s going to make any difference.
SCHATZKER: What will make a difference?
ZELL: I don’t know. I mean there’s lots of things that can make a difference. I’m very concerned about what’s happening in currencies. I think that you know Bretton Woods in 1948 was the allies coming together and saying we can’t recover in the world without growing free trade. We can’t create growing free trade without stable currencies. So let’s make sure we have stable currencies. That worked for a long time. Now we have very unstable currencies. World trade is slowing. You’re not going to recovery growth–
SCHATZKER: What’s the fix? Surely not going back to the gold standard?
ZELL: No. I don’t think that is. I think that you know frankly from my perspective if you took all the regulation that exists and cut it in half, that would be a big step forward. Dodd-Frank I think is a job killer and a very, very negative scenario for the American economy.
WESTIN: So in that world that you look at of possible turmoil, possible credit tightening, where does it create opportunities? What does that mean you do buy or look to buy?
ZELL: Well, I don’t buy anything without an edge.
RUHLE: What does an edge mean though?
ZELL: Well, an edge means that if you and I are competing for something–
RUHLE: You win.
ZELL: Maybe I win. Maybe you paid too much and you win. But the answer is we’ve got a lot of involvement in net operating loss carry forwards. Where we monetize them. That gives us an edge. Buying in the energy patch when everybody else is running out the door. That’s an edge when you’ve got the staying power and the guts to believe that you’re right. So those are the edges. And there are lots of other obvious edges.
WESTIN: Do those tend to be distressed situations? I mean like the oil patches are distressed situations, they’ve got to sell whether they want to or not.
ZELL: Sure. Well, probably. I mean you know, in many cases they’re going to go bankrupt rather than take the hit. You’ve got all kinds of issues right now in the oil patches. Do you sell midstream assets and keep your exploration opportunities? Do you keep the exploration; sell your midstream, et cetera, et cetera. I mean the holy, pipelines were supposed to be the Holy Grail. All of a sudden pipelines are having an issue.
So I think there’s a lot of things happening in the space and the question is can you look at that picture and see a year down the road or two years down the road, I think there’s been much too much pessimism about the price of energy. And I think that you know, it’s about everybody talks about massive oversupply of oil. There’s 93 million barrels a day demand and 95 million supply. That’s 2 million barrels in the world. That’s not very much. You know one bomb in the Straits of Hormuz would change that overnight.
So this is not the kind of oversupply like we confronted in the real estate industry in the early ’90s where you could shoot a cannon through office buildings in lots of cities and hit nobody.
RUHLE: All right, well, you say oil and the high yield market overall is under a lot of pressure. But you also say you don’t like Dodd-Frank and it’s a job killer. The fact that we have Dodd-Frank and banks can’t take big positions anymore, isn’t that protecting banks from this high yield situation? Getting contagious and really hurting? Because in a different environment, high yield traders would have been loaded up on inventory.
ZELL: And all I can tell you is, I’ve never known of a single situation in my life where reduction in liquidity was a plus. And effectively Dodd-Frank has dramatically reduced liquidity and that’s a big negative. And that’s something we haven’t dealt with yet.
RUHLE: If I was permitted to give an opinion I’d say true that.
WESTIN: And that’s the last word on that subject. So Sam Zell is staying with us. When we come back we’re going to ask Sam what he thinks about the presidential race.
(BREAK)
WESTIN: This is “Bloomberg GO” and we have to turn to politics now after last night’s Republican debate. Sam you are a consummate fiscal conservative I think it’s fair to say, but a social liberal.
ZELL: That’s correct.
WESTIN: You also had the “honor,” I think I put that in quotation of once having Donald Trump ask you for some money to invest. So you know Donald a bit.
ZELL: Yeah, I know Donald. He didn’t ask me for money, he asked me to be his partner. I didn’t think that was a good idea at the time.
WESTIN: Why was that?
ZELL: I didn’t think it was an appropriate decision and I didn’t think he and I would do well as partners.
RUHLE: Would he do well as president?
ZELL: I don’t know. But I would say that everybody should not underestimate Donald. I think he’s competent, accomplished, smart. I think he’s a little off in different directions, but I think he’s a competent individual. I don’t think he would be my choice for president. I think that a lot of his views are more extreme than I could be comfortable with.
RUHLE: Are those views handing this presidency to Hillary Clinton? As David said conservative on terms of fiscally, liberal on terms of social views. When you hear some of the things Donald Trump says, whether it’s about Mexico or keeping Muslims out. There are many people who sit in the middle who are basically landing in Hillary Clinton’s lap because Republicans are saying crazy things.
ZELL: Well, first of all, you know, the fact that some of the Republicans are saying crazy things I don’t think necessarily is going to be determinant what happens next year. I think there’s a disconnect between the talking heads and what’s going on out there.
The American people are extraordinarily angry. The American people are extraordinarily depressed. The last time we had anything like this in my opinion was 1979.
RUHLE: So why doesn’t the Republican Party pull it together? Why doesn’t the Grand Poohbah say–
ZELL: Well, I think that the kind of statements that you’re referring to and maybe the extremes that are reflected are very much reflecting how frustrated the American people are. And I think it would be a mistake to assume what the American people are responding to today is what they’re likely to respond to 4 or 5 months ago.
WESTIN: But to your point, we need to ask ourselves why Donald Trump is appealing to so many Americans.
ZELL: It’s because you guys are sitting here in New York City and you’re not in Des Moines. And you’re not in Boulder and you’re not all over the country. And you’re not seeing the enormous disparity that has existed between you know the coasts and the rest of the country. We have a lot of very unhappy people and I think this election is reflecting it. And I think it will be very dangerous. There was this guy Santiana (PH) who said–
RUHLE: You’ll tell us after the break.
(BREAK)
SCHATZKER: It’s time for the five stories that matter to markets now, and, Sam Zell, I want to begin with this. We touched on this earlier, number one; the House is scheduled to vote today on a spending bill that would not only prevent a government shutdown, thank goodness. But also extend and enshrine benefits for medical device makers, health insurers and renewable energy. There’ll be tax credits for business research and development as there have been, as well as charitable giving. But the difference here is that they would become permanent.
Now we spoke moments ago about the fact that you’d like to get rid of half the regulation out there. You think that would be a big boost to the economy. How do you feel about tax credits? Using tax policy as an economic instrument?
ZELL: I think if I were given a straight choice I would be in favor of a simple flat tax.
SCHATZKER: You’re a flat taxer? Really?
ZELL: No deductions, no nothing.
SCHATZKER: Where would you set it?
ZELL: I don’t know the answer to that. Somewhere 10, 12, 15%. Maybe two levels.
SCHATZKER: Flat tax for business and individuals or just on the corporate side?
ZELL: Particularly individuals.
WESTIN: And Sam, what do you think about this export ban on oil? For it? Against it? Make a difference?
ZELL: I think we never should have banned exports in the first place. And I think the idea that we were the largest importer of oil in the world and we banned exports. We’re in surplus on natural gas and we’re just now beginning to export natural gas. I think it was a stupid political decision and it’s great that it’s being fixed.
SCHATZKER: One quick question, wouldn’t a flat tax wreak havoc with your business? Getting rid of tax deductions for interest payments for example? Getting rid of tax deductions for mortgage interest?
ZELL: I think that the beauty of the American system is that we have always been part of how the world changes. And we have been better at adapting to change than almost any country in the world. So yeah it would be a lot of change. And yeah it would require a lot of adaptation and America’s probably in a better position to do so than any country in the world.
WESTIN: We figure it out in other words.
ZELL: You got it.
RUHLE: All right, let’s give you number two. Haliburton and Baker Hughes are delaying the closing of their proposed $26 billion merger until the end of April. The oil services company say they simply need to satisfy government concerns. Haliburton says it will set assets to avoid anti-trust issues.
Now is this a case where you’re also saying you know the government should stay out? I mean the government’s got to get involved in anti-trust.
ZELL: I’m not. I mean, there’s a big difference between anti-trust and day-to-day regulation. Anti-trust is focused on a major competitive decision that could affect the industry. I mean they’re making a career out of this one deal. And it’s probably being dramatically impacted by the fact that the assets involved are becoming worth less every day. So I think that’s probably part of this deal too. But it’s real hard to negotiate with the government. I’ve been involved in many anti-trust scenarios. Sometimes they’re very reasonable and very logical. And other times you just say, I don’t get it.
WESTIN: They’ve also got to be getting jammed up at the Department of Justice and FTC there are so many–
ZELL: Many deals.
WESTIN: –of these proposed mergers. They just have so many people to work on them.
ZELL: You bet.
WESTIN: So number three, this is one that we touched on earlier Sam. Brazil. Brazil will start the New Year with some big bills to pay. The country owes almost $38 billion in local and foreign bonds. The biggest monthly debt payout for the country until 2020. Brazil’s borrowing costs have climbed after a corruption scandal that’s helped tip the country into recession and led to a surge in bankruptcies and joblessness.
You said earlier, Sam, as I understood it, there are real opportunities in Brazil. But boy, it’s a mess right now. And it’s hard to see when and how it comes out of it.
ZELL: Well, I don’t think there’s any question that Brazil is a mess. But I just think you can’t lose sight of the fact that this is a country with 180 million people. It’s still growing. It’s self-sufficient in water, oil, food. It’s an extraordinarily badly managed you know entity. But the extraordinary part hasn’t changed. And I’m somewhat of an optimist and I think this whole process will be a cleansing process.
SCHATZKER: That may justify equity investments in a place like Brazil. But is lending money to the Brazilian government, especially on a short-term basis, just throwing good money after bad?
ZELL: Well, I’m not a big lender of money to governments period.
SCHATZKER: No, I know that. I know that.
ZELL: I don’t know whether lending money to the US government or the Brazilian government represents very similar risks.
RUHLE: Wow, there you go. I’ve got to give you number four, Valiant shares, this doesn’t happen every day, are up in pre-market trading after the company cut its earnings guidance for next year. In a statement today Valiant said its adjusted EBIDA will be lower than it previously predicted and fourth quarter earnings will be lower than expected. However the 2016 EBIDA is still slightly over the Street’s consensus. Valiant will host a meeting with investors later today. This is Erik Schatzker’s favorite thing. Numbers just dancing around. Analyst’s estimates. All you have to do is jump over a tiny, tiny little math–
SCHATZKER: Adjusted EBIDA, what does that mean to you Sam? Anything you want it to mean I suppose.
ZELL: Yeah, just make it up as you go along.
(LAUGHTER)
RUHLE: Sam, do you have a view on drug pricing scandal really one would call it. You’ve got politicians involved now. These drug companies that do more research than anyone since there’s no NIH funding and they’re really under scrutiny because of pricing.
ZELL: Well, I get only involved in one clinical trial myself in a particular investment we made. And it was a horrible experience.
RUHLE: Why?
ZELL: There was no certainty. You wake up every morning and it’s another 3 weeks or another 3 years or you don’t know what’s going to happen. How do you plan? How do you allocate capital? So I think the whole R&D side is an enormous challenge. And ultimately if you don’t pay the companies then you’re going to eliminate R&D.
Valiant in my opinion is an example of somebody saying OK I’ll show you want we can do if we don’t do R&D. Well they’ve produced extraordinary numbers because they’re not spending it on R&D. But that’s, in my perspective, pretty short-term view.
SCHATZKER: All right, Sam, here’s number 5 of the 5 stories markets are paying attention to. And this is a bit of theme. Let’s look at the temperature today in New York City, 51 degrees. It’s probably pretty warm in Chicago as well. Unseasonably warm for sure. But the National Oceanic and Atmospheric Administration says that the arctic is warming fastest of any place on the planet and temperatures there are the highest since record keeping began in 1900.
And of course the finding here underscores what we heard from Paris and COP21. The risk of rising sea levels and the dire consequences that it may have for low lying coastal areas including Miami and Boston for example. OK it doesn’t affect Chicago but I would like to know, are you factoring climate change into real estate investment decisions you’re making?
ZELL: Not really. I mean, there’s some of it. I mean I’m not sure–
SCHATZKER: Do you buy coastal property on Miami Beach?
ZELL: Maybe.
SCHATZKER: Really?
ZELL: I mean, yeah. I don’t, I fall into the group on climate change that says I don’t have the certainty that a lot of other people have. That doesn’t mean I disagree with it. I just don’t, and the level of certainty of exactly what is happening has a lack of humility and an arrogance to it that scares me.
Anytime there is this giant consensus, as far as I’m concerned, conventional wisdom is my greatest enemy. And this strikes me as an awful lot of conventional wisdom.
RUHLE: Climate change aside, we only have time for a final thought. I go to Miami which many people think was the epicenter of the housing crisis just six years ago. What a tremendous comeback we’ve seen. Is it authentic? Is it real? Or is that town being set up to fail yet again?
ZELL: Well, I think in very simple terms, the recovery of Miami is directly related to Brazil and Venezuela and Argentina et cetera. Without that enormous inflow after the crash, Miami would not have recovered as fast as it has.
RUHLE: Well now those countries are in trouble.
ZELL: That’s correct. But not necessarily the people. So I don’t think necessarily they’re going to exit. They bought the stuff in Miami because they wanted a place to go. And now having a place to go looks like a damned good idea.
RUHLE: What a perfect final thought.
SCHATZKER: Sam, we thank you so much. Those folks are the five stores that matter to markets now. Sam Zell of Equity Group Investments.
ZELL: My pleasure.
WESTIN: Thank you for being here.
Mish Comment
I cannot say I agree with Zell on everything, but in an interview that long, it’s quite rare for me to be in major agreement with anyone on so many topics.
This was a very refreshing interview.
Mike “Mish” Shedlock
