Economic and market uncertainties pervade while the next fiscal year is visible on the horizon and investors are looking for insight into where to find growth potential.

THL Partners Co-CEO Scott Sperling sits down with Yahoo Finance's Seana Smith to discuss how to navigate the world of private equity, sharing how to best analyze specific sectors to find growth potential, and what investors should keep vigilant of as economic woes are compounded by prolonged recession risks.

"Looking for places where the secular growth drivers are very strong and sustainable for 10-20 years, I think in this environment, provides a lot of opportunity," Sperling explains on key points to navigating private equity picks.

When asked about the potential of AI investments, Sperling states: "We're looking at generative AI, over what was more traditional AI, because of its power to do certain things that we've never seen before available. Where it is actually appropriate to utilize that technology to dramatically reduce the cost and improve the efficacy of efforts to provide a more automated way of doing a large number of business processes."

Sperling goes on to also comment on inflation — believing it to end up with "more risk to upside than potential benefit for downside" — and recent antitrust objections from U.S. regulators.

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Video Transcript

- Scott Sperling is co-CEO of Sperling Partners. The firm's been in the market for decades. Consider this stat. THL Partners has spent almost 40 years investing. Been an operator and raised $35 billion of equity capital in the process. So at this point, please, let's welcome Scott and Seana Smith of Yahoo Finance to the stage.

SCOTT SPERLING: Thank you. Please.

SEANA SMITH: Thank you. Well, Scott, thank you so much for taking the time to talk with us here once again.

SCOTT SPERLING: You're very welcome.

SEANA SMITH: So as Tracy just laid out, it's a very tough time right now for investors when we talk about all the uncertainty that's still ahead. We have inflation that's still too hot for what the Fed would like at this point. The Fed warning for this higher for longer type of scenario. Yet we have earnings season, which actually is shaping up pretty well. What's your assessment of where we are today?

SCOTT SPERLING: So I would agree with a number of the folks who've gone on earlier this morning. I think we're in for a very choppy time. I think when you look below the surface where we've had some encouraging data, the numbers don't look nearly as good. So I think the economy has benefited from the fact that savings accumulated during the COVID break through a lot of fiscal stimulus, as well as just the ability to spend grew to two times what it normally was. That is now 90% gone.

The consumer has continuing to spend, but they're doing it by borrowing and using credit card in ways that take that to very strong highs you're already seeing slowdown in many of the key metrics for businesses. I think one of the leading factors that we look at is boxes are down 8.3%. That's a great leading indicator to future activity.

So you have to look below the surface there. The pressure on the consumer continues to grow. Everything is much more expensive. So while inflation has slowed to around 4%, which is a place where it may stay for a while given the nature of the forces that we're dealing with, that's twice the Fed objective. And so I think it's appropriate to believe that the Fed funds rate will remain a bit higher longer.

I think you have to ask yourself the question though, longer term, is that the most important factor driving rates, or is the kind of fiscal spending that we've seen, the accumulation of 33 plus trillion of debt, growing significantly. The CBO projects it to grow to 181% of GDP by 2050, 2053. How is that going to get financed, and what does that mean long term?

Now the flip side is the United States is still the best place to put your money. It is where people will go, even if you have political differences, when times are very difficult. And so I'm not projecting a return to the kind of rates that my wife and I paid for our first mortgage in 1981, which was a 17% mortgage rate. But I do think it's likely that we're going to stay in the 4% to 5% range longer term.

What does that mean for the market? It means that multiples will be under pressure. We can see a little bit more downside there. The very nature of the companies that you pick is crucially important. Now one of the things that makes me optimistic in this scenario is that innovation has always re-enabled growth in the United States, and that has tended to mitigate some of these fiscal and monetary problems that we have.

And as I look at the nature of technologies that have been developed, generative AI really came out of almost nowhere for most people. And the promise that it has for increased productivity and more of what it can do is very significant. If you look at what's going on for life science, I think that there is enormous, enormous potential in life science to not only better people's lives but to do it in ways that are longer term, much more cost effective, and also add to productivity. So I want to couple the warning about the fundamentals that we see with the nature of optimism that has always characterized this country's business and fiscal activity.

SEANA SMITH: So talking a little bit more about how then you are approaching investment opportunities. You just mentioned some of the key areas where you're seeing some opportunity for growth here going forward. But identifying what makes the most sense right now, walk us through that playbook, and how you're exactly evaluating some of those more attractive opportunities today.

SCOTT SPERLING: So the reason that private equity has benefited even in these difficult times, and in fact, has outperformed more, sorry for the commercial, but just the data, is that we can be much more selective about what we're buying. We're not trying to buy the market as a whole. We're trying to buy individual companies. And if our firm, for example, likes to buy four to six a year. So you pick your spots very carefully.

Looking for places where the secular growth drivers are very strong and sustainable for 10 to 20 years, I think in this environment, provides a lot of opportunity. Whether or not the pricing is yet there to give us the total upside of that I think is a reasonable question. The markets have been a little slower to adjust, the private markets, than we've seen in the, I think this will be my seventh recession in the 43 years I've been doing this. But the adjustments are occurring. And so I think picking those sectors with very strong secular tailwinds is really important.

SEANA SMITH: You mentioned that this would be the seventh recession I think you just said. So how does this, what we're seeing today, compare to what you've seen in the past?

SCOTT SPERLING: So one thing that we've often seen at this point in time, and I think it's interesting, not to be critical, but Janet Yellen said we're definitely looking like we're going to have a soft landing. Now she said that when she was vice chair of the Fed in 2007, two months before the Great Financial recession happened.

So one thing that we're seeing that I've seen all the time is the expectation that we're going to have a soft landing. But I think it was Larry Summers who basically said, I don't understand why we're talking about this because it's never happened. So I think we should be very careful that it's very, very difficult, given all the complexities and everything going on in the world, to navigate to a so-called soft landing.

So I would expect that it's going to be difficult. They are always difficult, no matter what the causal factors are. Hopefully relatively short lived, and many of them have been more shortlived than not. But it's going to be a difficult and choppier economy going forward.

So my expectation is we're going to continue to hear the hope. There may be data points that give the market some ability to rise, but that we're in a relatively difficult period over the course, I would suspect, of the next 15 to 18 months. And then there'll be a lot of opportunity beyond that.

And I think as you look at it during the course of when things go down, as I said to some of our younger partners, you can't imagine how much worse it's going to be right now as you look at the world. But then there will be a point where you can imagine how much better it's going to get. And we need to look through that with the perspective of having a whole series of these things to look back on.

SEANA SMITH: I'm curious to get your thoughts just on how Fed Chair Jay Powell has handled this right now in terms of the pace in which he has raised rates. The fact that he has held rates now for the last meeting. When you talk about looking ahead, I know many people are saying, it doesn't really matter at this point whether or not we see another 25 basis point hike, 50 basis point hike in the grand scheme of things. But in terms of what he has done and where we are today, what's your assessment?

SCOTT SPERLING: I think he's the first to admit they were slow to react. They let it go on too long. There was too much monetary stimulus. But they were dealing with a world we'd never seen before. We'd never had that kind of COVID shutdown. So let's give them a little bit of a break on that. I think that because they were so far behind, they had no choice but to move as quickly as they have. And this is the fastest increase that we've seen across any of the recessions since the Second World War. So they've moved quickly.

The economy is incredibly complex, and there's a lot of different forces. So again, the forces dealing with long term treasury rates is different these days than just what the Fed does. And so I think it's not inappropriate to basically say, look, let's understand how everything is working through the economy before we continue to go in one direction or another. I think they're very mindful of the lesson of the 1970s when you tightened and then you loosened too quickly. So I think they don't want to repeat that.

But they don't yet have all the data that looks at what are the implications of the 10-year moving on its own upward because of a different set of forces than just the forces of the Fed? So I'd give him a break and say what they're doing right now seems reasonable. Let's understand what the lag times are and what the impact is on the economy. And my hope is that they don't move too quickly to do some things that put us in even worse long term situation. But I think that--

SEANA SMITH: What does that worst case scenario look like?

SCOTT SPERLING: So I think the worst case scenario is a level of inflation that is not controllable. I don't anticipate that to happen. I think inflation is probably going to end up about where it is with perhaps more risk to upside than potential benefit for downside. Look, there are a lot of disinflationary forces that occurred over the course of about a 20-year period. We created an enormous amount of low cost energy. That filters through the economy in lots of different ways.

We had deregulation under certain presidencies that I think reduced the cost and help business get better. We had very little pricing power. And then we had massive fiscal and monetary stimulus that came into play. And that monetary stimulus lasted a long time because of those disinflationary forces that were very powerful.

And during a longer period, we had massive globalization to move the cost of things down dramatically by moving to lower cost manufacturing geographies. Every one of those has now either ended or been reversed. And so we don't have the benefit of those disinflationary forces, which means the base level of inflation is likely to be higher than what we saw in the last decade as those things have unwound.

SEANA SMITH: Scott, let's talk a little bit more about what has been happening down in DC. And you talked about some of the proposed changes that have been put forward from the DOJ and the FTC in terms of some of the changes that they would like to see made for the merger review process. I'm curious from your perspective, in regards to the Biden administration, have they made it tougher for PE?

SCOTT SPERLING: Yes. They made it tougher all around.

SEANA SMITH: To what extent?

SCOTT SPERLING: I think in a significant way. Obviously, the debate is are you doing this and braking, effectively creating new law that was not authorized by Congress, and therefore, we need to go to the court system in order to do what Microsoft just did, which is to basically make the appropriate argument that this was inappropriate law?

But the reality is there's a significant cost to that. And I think that's what the antitrust regulators are betting on, which is whether or not they get overturned, there's significant costs that may cause people to not do deals that, quite frankly, I think are probably better for the country if they were done in terms of bringing the costs down for consumers and the long term sustainability of businesses that may otherwise be subpar competitors, particularly with foreign competition. But nonetheless, I think there's a strong belief on the part of the people leading the FTC and DOJ antitrust that what they're doing is the right thing to do, regardless of whether or not it's consistent with past antitrust practice.

SEANA SMITH: Has that caused you to reevaluate how you are potentially looking at various investment opportunities?

SCOTT SPERLING: I think we have to keep it in mind, we generally are not doing things that would trigger the kinds of issues that they've focused upon. I think there are situations. Obviously, we've seen a couple of situations where private equity firms' strategy of buying a platform and then building on it by doing some consolidations has now come under scrutiny by those authorities. And so I think we all just need to be mindful of that in private equity as we look at investments we're making. But it's definitely a significant factor, and it's one of the re-regulations that I think increase the cost of doing business in the country that again is more inflationary than certainly not, disinflationary.

SEANA SMITH: We only have about a minute here. And I want to go back to something that you quickly touched on towards the top of our interview. You mentioned one of the reasons that you are optimistic or you're talking about you're seeing some opportunity out there right now is AI and how much focus we are seeing there. A lot of people are saying that maybe some of that hype has been overextended. You really need to find what makes the most sense when it comes to AI. So I'm curious how you're looking at that.

SCOTT SPERLING: So we're looking at generative AI over what was more traditional AI because of its power to do certain things that we've never seen before available. And where it is actually appropriate to utilize that technology to dramatically reduce the cost and improve the efficacy of efforts to provide a more automated way of doing a large number of business processes. And that will be very powerful in terms of the productivity that it can provide, as well as enabling new jobs and new companies to come to the forefront.

But we've never seen anything move so fast from a technological perspective, and we spend an enormous amount of time evaluating both the opportunities, but also how this may challenge some traditional business models, particularly the software industry. And again, may also, in and of itself, be a very powerful force for being more efficient in the creation of software. Because interestingly, one of the areas that it's probably most powerful is in code writing.

SEANA SMITH: All right. Scott Sperling. Unfortunately, we're out of time. We have to leave it there. But thank you so much for taking the time. Co-CEO of THL. Thank you, Scott.

SCOTT SPERLING: Great to see you. Thank you so much.