BlackRock CEO Larry Fink: The Investment Opportunity of a Generation

I see AI presenting transformational opportunities. It may be the technology that can bring down the inflation. AI is fundamentally altering the economy and creating a once-in-a-generation investment opportunity. These aren't my words; this is coming from BlackRock CEO Larry Fink.

Larry Fink is frequently referred to as the most powerful person on Wall Street. When he says something, it's worth listening to closely. Fink is the founder and CEO of BlackRock, a firm whose assets under management have at times surpassed 10 trillion dollars. Fink's seat atop BlackRock gives him a truly unique view into the stock market and the economy. That's why it got my attention when he recently talked about something that has the potential to completely change not just the stock market and the economy but how people and businesses make money at a very fundamental level.

Here's what Fink had to say on the topic: Earlier, I mentioned how my time with clients has always energized me. A topic that energizes so many of our clients is artificial intelligence. My team here knows that I’m a fan of dystopian movies and books, and I won’t go down that road today. However, I really can— I want to present today a more optimistic view, and I believe it’s going to have some very large outcomes for long-term investing.

I see AI presenting transformational opportunities. I've talked about how the collapse of productivity has been an essential issue in the global economies, and I believe it is an essential reason why we have such sticky inflation. I believe that AI has the huge potential to increase productivity, increase knowledge base, and transform margins across sectors. It may be the technology that can bring down the inflation.

When I’m so confident in AI, it has the ability to accelerate scientific discovery and change how humans live and operate. The defining economic trend of recent years has been high inflation. In 2022, inflation hit a peak of over nine percent, a level not seen in roughly 40 years. Even though inflation has started to moderate in recent months, the concern among many investors and economists is that we could be entering a period of so-called sticky inflation. This is where inflation is persistently higher than the two percent goal of the United States Federal Reserve.

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Get 25% off Blinkist’s annual premium. Start your seven-day free trial by clicking the link in the description box. Now, back to the video. To truly appreciate Fink's comment, you have to understand what causes inflation at a fundamental level. Here we have a basic supply and demand graph. This line here represents the supply of a particular good or service.

In this example, let's use houses to demonstrate the mechanics of how inflation works. All of us likely either rent or own the place we live, so we have a baseline understanding of how this market works. Our supply line here demonstrates the number of houses available in a particular market. On the other side of the equation, we have our demand line. This line not only represents the number of people who are looking to buy a house, it also represents how much each buyer is able to pay.

The point at which the supply and demand lines cross represents the price for that good. High inflation happens when the supply and demand get out of balance. That is what happened in 2020 and 2021. In response to what was happening in the economy, the U.S. Federal Reserve cut interest rates to zero. This caused mortgage rates to plunge to historical lows. This dramatically impacted how much people could pay for houses because debt became cheaper.

Look at these crazy numbers. Let's say someone is taking out a four hundred thousand dollar loan on a 30-year mortgage to buy a house. Interest rates have a huge impact on the affordability of the monthly payment. At an eight percent interest rate, the monthly mortgage payment will be $2,935 a month. If we take that interest rate down to six percent, that monthly payment falls to $2,398. If things get really crazy, like they did in 2020 and 2021, we can bring that interest rate all the way down to three percent. That three percent interest rate results in a monthly payment of $1,686.

Notice how dropping the interest rate from eight percent down to three percent resulted in a 43% reduction in the monthly payment. Put another way, a home buyer can now afford to pay 43% more for a house just because of the lower interest rate. Going back to our supply and demand graph, these historically low interest rates shifted our demand line to the right. Lower interest rates meant buyers could afford to pay more for houses, since most buyers purchase using a mortgage. This resulted in inflationary pressure on house prices.

However, this only covers one half of the inflation equation. There is also the supply line in our graph here that we need to consider. This line represents the supply of that particular good that is available to be purchased. It wasn't just the demand line that got thrown out of whack in recent years; the supply line also went through a unique period of time.

Normally, the American economy is known for an abundance of supply: grocery stores with hundreds of different kinds of cereals to pick from, thousands of different colors of paint to paint your house, countless different types of cars available for consumers to buy at dealerships across the country. However, things have been different the past couple of years. For the first time since rationing in World War II, the U.S. economy went from an abundance of supply to limited supply.

For the first time—and likely all of our lives—grocery shelves were empty, car lots were barren, and the American consumer couldn't just walk into a store and walk out with the exact product that they wanted. Global supply chains were a mess. Going back to our housing example, the housing and construction market was hit extremely hard by the supply chain shortages. In fact, ninety percent of home builders reported being negatively impacted due to material delays and shortages.

Everything from the lumber used in framing new construction to the appliances that are put in right before the house is sold—all of these delays resulted in one thing: less houses available on the market for sale. Look at our supply and demand chart: demand was increasing as lower interest rates and a booming economy increased buyers’ purchasing power. At the same time, the supply of houses was decreasing due to all the construction delays and people being hesitant to list their houses during a pandemic. This is shown by our supply line getting pushed to the left.

We can see how this combination of demand increasing while supply simultaneously decreasing puts massive inflationary pressure on housing prices. I know this example is simplistic at its core, but this demonstrates the basics of how inflation works. This supply and demand dynamic applies to all types of goods and services: everything from the price of cars, food, gas, and everything in between.

In order to get this runaway inflation under control, the Fed, in Jerome Powell, had no choice but to raise interest rates. The Fed increased interest rates at one of the fastest clips in the history of the country. By making it more expensive to borrow money, the Fed lessened the amount of demand in the economy. The demand line is now shifted to the left, in line with more normalized levels. This move by the Fed has been successful in getting inflation somewhat under control.

Inflation in the U.S. hit a two-year low at four percent in May of 2023. This is only the latest sign that the Federal Reserve is making solid progress in its ongoing battle against inflation. The Consumer Price Index hit a 40-year high of 9.1 percent in June 2022, and it has been steadily falling over the past 12 months. However, inflation at four percent is still way too high; it's more than double the Fed's goal of annual inflation being only two percent.

All of the tools that the Fed has to slow inflation is focused on the demand side of the equation. In order to get inflation fully under control, the supply side also needs to improve. However, the supply side of the equation has historically been difficult to change. This is why many very smart people think that this higher rate of inflation is here to stay for quite some time. Larry Fink has a different view.

According to him, this is where artificial intelligence comes in. To understand Fink's comments, you have to understand the relationship between inflation and what is referred to in economics as productivity. So why does productivity matter for inflation? When a workforce is more productive, it produces more goods and services at a lower cost per unit. This means there is a greater supply of these things, which puts downward pressure on prices, and is therefore associated with lower inflation.

I know there may be some unfamiliar terms in there, so let me explain it using an example everyone can relate to. Let's think about it from the standpoint of the food that is in your fridge right now. The majority of food begins its journey to your fridge by being grown on a farm, so let's focus there. 120 years ago, farming was extremely labor-intensive.

Why was it so labor-intensive? Well, the tools available to farmers to make them more productive were extremely limited by modern standards. Farmers probably used some sort of small plow, powered not by an engine but by animals. Then, a few decades later, technology improved and a gas tractor was introduced. This made farmers more efficient, meaning for every hour of human labor, they were able to produce more units of food.

Decade after decade, technology improved and increased farmer productivity. Now, farming technology has gotten so advanced that the inside of the farming equipment looks more like an airplane cockpit than what most people think of when they think of a tractor. The point here being that technological advances have led to massive increases in productivity.

Again, productivity being defined by the amount of goods or services that can be produced for every one hour of human labor. This is demonstrated by the fact that in the year 1840, 70 percent of Americans worked on farms. Now that number is something like one or two percent. This massive productivity increase has had significant deflationary impacts on the cost of food over the years.

In the year 1960, the average American spent nearly 18 percent of their disposable income on food. Now, that number is closer to just 10 percent. We, as a society, have technology and the subsequent productivity increases to thank for food being more affordable than ever before in human history. Farming is somewhat of an extreme example of the deflationary impacts technology can have.

However, Larry Fink is making the argument that artificial intelligence is going to lead to significant increases in productivity broadly in the economy. Tying all this back to the supply and demand graph from earlier in the video, as productivity in the economy increases, the increased productivity causes our supply line to get pushed out to the right. As we can see, this puts downward pressure on prices. This explains why Fink is hopeful AI can be what helps end the sticky inflation.

So now that we have that background, I want to get to the million—or in the case of BlackRock, 10 trillion dollar question: what does all this mean for investors, and why is it the investment opportunity of a generation? There are two big reasons why. The first has to do with the relationship between inflation and interest rates, and ultimately the impact on stock prices.

As we discussed earlier in the video, when inflation is high, the Fed has to raise interest rates to combat that higher inflation. As 2022 showed, rising interest rates are a massive problem for stock prices. As this chart shows, 2022 was one of the worst years on record for the U.S. stock market. This is because as interest rates increase, stocks become less valuable.

This concept is referred to as the time value of money. Let's say you are going to receive one thousand dollars 10 years from now. How much is that money worth to you today? Well, it depends on what interest rates are at. At an interest rate of 5 percent, the present value of that one thousand dollars ten years from now is $613.91. If we raise that interest rate up to eight percent, the present value falls to $463.19.

Notice how the present value fell by twenty five percent, but the only thing that changed was the interest rate. This is what happened in 2022: interest rates in the economy increased significantly, causing the value of stocks to decline. However, if AI is successful in helping reduce inflation, interest rates will likely decrease back to what they were previously.

Interest rates falling would be a massive positive for stock prices. Going back to our example, if we drop the interest rate to two percent, the present value shoots all the way up to $820.35. This is a 77% increase from the value when interest rates were at eight percent.

The second reason why AI could be a game changer for investors in the stock market is the impact AI can have on a company's profitability. One way investors measure the productivity of a company is by how much of each dollar of sales ends up in shareholders' pockets in the form of net profit. The more net profit a company generates, the more valuable it is, all else being equal.

Take a look at these two hypothetical income statements. Think of this little thought exercise as almost a before and after. On the right, we have a company before AI; on the left, we have what the company's financials could look like if AI can successfully make it more efficient. Notice how the company's gross profit increased.

The thought here is that AI makes the manufacturing process more efficient and less costly for the company to produce its products. Additionally, notice how the company's selling, general, and administrative expense is lower after AI. This expense line item covers all the behind-the-scenes costs associated with running a business. Many people think AI will be able to automate many of these functions, resulting in lower costs for the business.

Think of things like bookkeeping, customer service, and other various tasks. If AI is able to automate these tasks, it will be less costly for the company to run the business. If we jump all the way to the net profit line, we see the company after AI is much more profitable. Even though both companies have the same amount of revenue in this example, the company after AI is much more efficient with its operations and has less costs as a result.

The profit is larger. All else being equal, this larger profit should make this company more valuable and increase its share price. While many people are spending time trying to think about which stocks are going to be winners from AI, it seems like BlackRock CEO Larry Fink is thinking about it differently. He is of the belief that all investors are poised to benefit from the lower interest rates AI is likely to bring and the increased corporate profitability.

So there we have it. Make sure to like this video and subscribe to the channel because it’s my goal to make you a better investor by studying the world’s greatest investors. Talk to you again soon.