Citadel Advisors was founded in 1990 by its now-CEO Ken Griffin (backed by Frank Meyer of Glenwood Partners) when he was just 22 years old and a student at Harvard. He raised $4.6 million from friends and family before trading options in his dorm room. By 1994, the company had generated a strong track record of returns and attracted a staggering $1 billion in assets under management.
Since that point, Citadel expanded into becoming one of the world's largest hedge funds, and it has even established several subsidiaries in its quest to expand its line of services. In its latest 13F report for the fourth quarter of 2022, the hedfe fund reported ~$424 billion in U.S. common stock holdings. Citadel is one of the largest traders of equities in the U.S. due to its market maker subsidiary, Citadel Securities.
Ken Griffin is still seen as a thought leader in the world of investing. In this article, we will go over his March 2023 interview with Bloomberg, which showcased Griffin's insight into everything from the Federal Reserve to the debt limit; let’s dive in.
Perspective on stimulus
Griffin points out the reason inflation has been rising is that the Federal Reserve “printed money” and injected ~$5 trillion into the economy to stimulate markets due to the pandemic. In real terms, this was similar to the amount spent on World War 2, which of course feels like overkill. Griffin estimates the stimulus and Covid restrictions meant American consumers saved around $1 trillion, which is a positive sign, but this is currently being spent at ~$120 billion per month due to high inflation, which means by the end of 2023, this will likely run out. This means late 2023 to 2024 will be an inflection point as the post pandemic “orgy of spending” comes to an end.
Federal Reserve interest rate hikes
In order to put the “inflation genie” back into the bottle, the Federal Reserve has been raising interest rates. So far this strategy has been working as inflation (CPI) has fallen from its peak of 9.1% in June 2022 to "just" 6% by February 2023.
However, Griffin points out that the labor market is still “red hot” with an historic unemployment low of 3.4% in January 2023. We did see a slight uptick in to 3.6% in February, which could be a sign of more trouble to come for the economy.
The Federal Reserve's interest rate “tool” is like having “surgery with a dull knife” according to Griffin. It is difficult to “get the job done” as multiple sectors are indirectly impacted, from housing to manufacturing, as interest rates are risen. These parts of the economy have a “high sensitivity” to interest rates, for example with regards to mortgage servicing costs. Therefore these businesses will face an extra tough time during an interest rate hiking phase.
The challenge with interest rates rising is understanding the “lag effects” between when rates are rising and when they actually have an impact. For example, if the Fed raises interest rates too fast and high, it could send the economy spiraling into a deep recession or a “hard landing” as many have referred to it. But if the Fed doesn’t raise rates enough, inflation could still be rampant.
In Griffin's opinion, the Fed should raise rates on the side of caution, due to the potential devastating impact on the economy.
The market is currently predicting a Federal Funds rate in the mid 5% range by mid 2023, up from 4.57% in February 2023. After the peak, Griffin expects a sharp cut in rates in 2024, which is in line with market expectations.
Challenges of expected inflation
A major challenge when combating inflation is “expected inflation,” which can be dangerous and hard to control. This occurs when a business thinks prices for its input costs such as materials will go up and so increases its prices ahead of time. This causes a knock on effect of other businesses increasing their prices.
For example, major technology companies such as Netflix (NFLX, Financial) have increased the prices of their subscription service and Meta (META, Financial) has announced a paid service for verification.
For the average consumer, the “cost of living crisis” brought about by the high inflation environment (especially in key areas like housing and food that disproportionately affect the non-wealthy) will likely cause the average consumer to pull back spending. In addition, the average employee will also likely demand higher wages to cover rising costs, creating a spiral effect.
Debt ceiling and U.S. debt
The U.S. currently owes ~$30 trillion in debt and thus if it defaulted on this, it would have disastrous effects on the economy. The U.S. debt ceiling has been continually risen, and Griffin believes this is akin to “kicking the can” down the road as opposed to solving the issue. Theoretically, the debt ceiling is a “non event” until “its an event” and requires servicing.
How to invest in this environment
Citadel has positioned its capital to where it has a “differentiated view” versus the market. For example, this could include investing into a stock that has an upcoming quarter the market is expecting to be bad but Citadel thinks otherwise.
Grffin's mindset is to “accept reality” and also admit mistakes where he had a thesis that didn’t play out as planned. I believe this is an exceptional strategy for investing successfully. Some individuals may find this difficult psychologically as Griffin states this could mean going entirely against your initial thesis.
Final thoughts
Griffin is one of the wisest investors and business leaders on the planet in my view, and Citiadel plays a vital role in the stock market. Griffin's predictions on the economy are going to be interesting to watch. I believe it makes sense to be aware that we are in unprecedented times with regards to the sheer amount of stimulus combined with the U.S. debt ceiling. Thus as an investor, I believe it makes sense to diversify one's portfolio and be ready for an scenario. All eyes will be on if inflation continues to fall and the impact of higher interest rates on the economy.
