Expert: Chris Joye – Mortgage holders are in for the mother of all shocks

Bryce: [00:00:30] Welcome to another episode of Equity Mates, a podcast that follows our journey of investing, whether you're an absolute beginner or approaching Warren Buffett status. Our aim is to help break down your barriers from beginning to dividend. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How you going? 

Alec: [00:00:48] Very good. Bryce. Forgot your name there. 

Bryce: [00:00:50] I realised that I've been putting the disclaimer in all GSI episodes, but not Equity Mates. Right. So what do you want? 

Alec: [00:00:56] To just give it to us now?

Bryce: [00:00:58] Sure. So here's the disclaimer. While we are licensed and not aware of your personal circumstances, all information on this podcast is education and entertainment purposes only. Any advice is general. 

Alec: [00:01:09] Advice and what I for Sale number. 

Bryce: [00:01:11] 54069700. Next question. Anyway, we are here Ren to introduce our guests for today, the one and only Chris Joy, co-founder and portfolio manager at Cool Bar Capital and contributing editor at the IFR, and he is a prolific writer on on markets and specifically the housing market here in Australia has made some very bold calls, so we're super excited to have him on today.

Alec: [00:01:42] Yeah, in October 2021, in the midst of the euphoria that was the Australian housing market at that time, he made the call that we're going to see a 15 to 25% correction which Australia is now tracking towards, But at the time in the era of cheap money, he was very contrarian, but it was a great time to get Chris on because he's been really focussed on. So he mainly invests in bonds in fixed income and obviously this banking crisis that we're seeing at the moment is very focussed on the bond market. Silicon Valley Bank bought a lot of long term fixed income investments and then their depositors tried to pull their money out and that created a problem for them. And similarly, some of the other US banks that we're saying struggling at the moment are in similar predicament. So it's certainly the time to get a bond market expert on to help us understand it. And Chris did that. This is a pretty jargon heavy filled conversation. So just fair warning. If you're new to investing, some of these concepts may go over your head. But I think it's worth sticking it out because some of the stuff he told us was fascinating and some of the calls he made, including that the stock market's been a Ponzi scheme. 

Bryce: [00:02:58] Yeah, well, pretty big. Some big calls in there. Yes. So he starts by discussing how overnight he was trying to trade $100 million of UBS bonds. And for context, he traded about $86 billion worth of bonds last year. So a massive bond trader. But stick with us through the opening part of the conversation, because then we get to a little bit more of a macro discussion around interest rates and housing market and what's going on with by Silicon Valley Bank. So some really interesting commentary from Chris in the latter half of the interview. 

Alec: [00:03:32] And then after the break, we get into the Australian property market and that's it. He made the call in 2021, we're going to say a 15 to 25% decline and we wanted to take his temperature on where to now. 

Bryce: [00:03:43] No better expert to join us. It is our pleasure to welcome to the Equity Mates Studio. Chris Joye. Chris, welcome. 

Chris: [00:03:48] Thanks boys, for having me. I enjoyed the first iteration and it's definitely fun to re-engage. And what a time. Just as a little aside, last night I tried to buy $100 billion of UBS senior bonds. Right? And these were bonds that were being completely trashed in the market. So they spread as senior bonds and generally a very safe bond and A-minus rated and highly rated to deal with Credit Suisse. You know, people have probably heard about UBS buying Credit Suisse, but it's a very sweet deal for UBS. The Swiss government is taking up to 9 billion of potential future losses and providing them with a super cheap hundred billion Swiss franc loan. So, you know, it's all interesting. And what's particularly interesting is that banks globally have been selling UBS bonds over the last week and the spreads moved about 110 basis points wider, which is for an A-rated bond know extremely unusual and they look crazy cheap. So I went to my traders in London last night to pick up a hundred bucks for them and there was basically no offer in the street. Nobody had them, which is kind of weird. If you'd said to me, okay, you got UBS bonds, they've moved 110 basis points in a day, maybe 150 to 200 over the last few weeks. You know, what sort of inventory would you expect in the street? And I would say at least 500 billion to $1000000000. These bonds should have been available and we could find only €8 million. Right. There was nothing and the whole street was short. So that was short selling the bonds. And when we came in to buy. We are a little bit of a gorilla. The whole story went dead, right. And what that means is every bank in the world was trying to bomb. There was literally no inventory. And the telling this and the reason I know this sounds probably inside baseball, but bonds rule the world in many respects. Risk free rates are incredibly important. Borrowing cost is very important. And that's all expressed through the bond market. But it's how in this that's fascinating to me, guys, is it demonstrated to me last night that this was a speculative attack. Right. So the short sellers have been attacking Credit Suisse and UBS. And when you look into the whites of their eyes, they folded, as in the last night in the European session, again, UBS bond was going 110 basis points. I've never seen that happen before in a single session for a highly rated bank. And it should have been $1,000,000,000 of stock available to buy. And there was not nothing at Credit Suisse was a basket case like we had been short selling Credit Suisse bonds in 2022. And I've been telling my clients to get out of Credit Suisse in February 2021. Right. So we identified years ago that Credit Suisse was an absolute basket case. It was always a destined to have problems that they experiencing what appeared to be an ineluctable decline. But having said that, it was a global bank. It did have government guaranteed deposits. It didn't have. What's really interesting about Credit Suisse was it didn't have huge credit losses on its balance sheet in the sense, too, it wasn't like a subprime bank that, you know, we saw in 2008 that was blowing up. This wasn't a credit event. It was truly and exclusively a crisis of confidence. And a lot of our trading counterparties in Europe basically told us that they thought Credit Suisse was an engineered short selling kind of tack, even though Credit Suisse, according to trading relationships, had actually been a hedge fund hotel, quote unquote, that were mostly friends with long Credit Suisse. Not sure. But if you think about what triggered the collapse of Credit Suisse, it was a Saudi national simply saying who owns you know, the Saudi one of the Saudi banks owns a big chunk of Credit Suisse, 9.7%. And he simply repeated a statement he said previously, which was, for regulatory reasons, we can't buy more than that. That one site is just a repetition of what he said in the past, triggered, I think, Credit Suisse's shares on that day. So 30%. Yeah, right. So it was kind of a bit of a fabrication. That was and a lot of the traders have been incredibly critical of the mainstream reporting on Credit Suisse, which I think has been manipulated by a very small number of short sellers. So, you know, Christmas is a I think, a bad bank. It's not a great bank. Probably deserved to be absorbed by some sort of institution. But it comes back to the point that the genesis of all of this is a bank none of us have ever heard of. Silicon Valley Bank. Yes, that was absolutely a bank that deserved to die. We can talk about this later. It had fundamental problems, but the collapse of one relatively small US bank has triggered a crisis of confidence globally the other way around doing a lot of talking. And guys, but one other quick point I want to make in case I forget it, is I think it's fascinating to see Bitcoin rally. I know there'll be a lot of crypto junkies listening this because I've been critical of crypto since December 2021 when I first wrote about crypto and basically said I thought this is a Ponzi scheme and if it collapses, you know, 70, 80%. But the interesting thing is the crypto crowd, you've seen Bitcoin jump from $9,000 to 28,000 U.S. and my contention is nobody who is outside of crypto is allocating any money to crypto right now. Everyone seeing crypto collapse, Everyone's seen the exchanges collapse, the lenders collapse, the crypto fund managers collapse and freaking hell. Two other banks that were big, it morphed into crypto banks, namely Silvergate and signature. They collapsed. So you had traditional banks trying to become crypto banks and because of how toxic crypto is, they blew up. The highly zealous, almost ideological crypto crowd have beat up crypto, specifically Bitcoin on the basis that oh, look at the bank. We told you banks with we're fragile, banks are going to fail and we told you you needed an alternative to bank cash, you needed a digital alternative to conventional money. But what's fascinating about all this for me, boys, is that not one US depositor, not one European depositor has lost a single cent of money. Governments have completely guaranteed all bank deposits. So despite the huge turbulence, the massive ructions, despite the fact we've seen in Silicon Valley and still get three US banks collapse, we've seen credit been bought, all the deposits haven't lost a single cent and if you look crypto, well, most people who invest in crypto. A year or two ago, again, 70, 80%. So I don't think the use case for crypto at all. In fact, I just think this reinforces the safety of conventional cash and bank deposits because we've seen unlimited, unconditional government guarantees rolled out by the US government. So with that, I'll be surprised and you can help me with questions that require telemetry. 

Alec: [00:10:49] No, I love it. I love it. There's so much to unpack there. I think the Bitcoin side of it is just a classic case of confirmation bias. You know, if you say Bitcoin is the solution, you get to say it as a solution to whatever the world throws at you. But let's hold on to Silicon Valley Bank and sort of where we are with this banking crisis because you wrote a piece Why Silicon Valley Bank Died, which we saw getting shared around Twitter and getting a lot of, I guess, up applause from the fintech community. So I would love to get your thoughts on Silicon Valley Bank. We've also seen your writing about, you know, zombie companies and what's going to happen next. And that's probably the more interesting part of the conversation at this point. So let's start with what happened and then move to your view of sort of what happens next. 

Chris: [00:11:40] Let's start with Silicon Valley Bank. You need to understand the idiosyncratic contours of the US banking system before you jump into SVP. So before the GFC in 2008, there were, I think more than eight and a half thousand US banks. The US banking system is really unusual. Most banking systems around the world have a very small number of national champions. It's inherently oligopolistic. I look at Australia four banks control 85% of the market in the US because of its federated structure. You've always had this massively fractured and decentralised banking system that's also inherently fragile. So US bank failures are really common. Since 2001, on average, 25 US banks have died every year since 2012. On average, seven US banks have died every year and they had very kind of typically similar to Silicon Valley Bank, what I call SVB. They tend to be small, tend to be very regional, they tend to be very industry concentrated. And as a result, if something goes wrong in that region or industry, they tend to blow up. Now deposits is about out because the US has a government guaranteed deposits, but the bank kind of disappears. It CB I think was just an extension to SVP. It is kind of almost endlessly fascinating to think about it because of just the second and third order dynamics. But HCB was geographically focussed on Silicon Valley. Almost 100% of its deposits came from tech. All of its loans went to tech and it was enormously telescoped on tech, and that was the first order problem. The reason Silicon Valley Bank failed is when the Fed raised rates, as we argued they would aggressively back in late 2021, when the Fed cash rate was at near zero, we argued they'd lift above 3% and the US ten year government bond yields would rise about 3.2% and that was a very contrarian view. In December 21, the bond market was saying the Fed would not lift its cash rate above 1% and we were saying they'd go more for three and the ten year US bond yield was only one. And so that meant we were very negative on fixed rate bonds or what is known as duration, but we're also very negative on credit spreads and we were very negative on growth. So in January 22 last year we argued the US would go into recession because of these rate hikes. And we've argued consistently that you'll see a big default cycle and that's kind of what played out with this. B So with this, between January two and March this year, it lost 30 billion of deposits. And the reason it lost deposits was the tech venture funds, which were amongst its biggest depositors. Those guys were losing money and not raising new money, so they were pulling cash. And then the tech companies they use, SBB, were burning through their cash. So the first problem was they were losing deposits. Their loan book was ostensibly okay, but there was a second problem. So this was a second order problem, and that was that basically FCB was run in a really reckless and irresponsible way and complex because normally what a bank does is it takes in deposits and makes loans with all of those deposits. If they didn't do that, they had 173 billion in deposits and they only made about 74 billion alliance. And so they left with about 100 billion. They actually had about 120 billion of free capital. And they put that money in super superficially safe assets so that I'll talk my head about circa 24 billion went into the US government and foreign government bonds are safe and liquid assets and they put in another. I think 90 to 95 billion in residential mortgage backed securities and commercial mortgage backed securities. Again, super safe. Superficially safe. Definitely liquid. And if you look at that balance sheet, you said, okay, they've got 183 billion of deposits. They've made 74 billion of loans and they've put the rest in superficially side by side. There's nothing wrong with that. The first problem, of course, is that they are 100% tech dependent that had no diversification geographically or from an industry perspective. The second problem is this and this is the complex problem. Normally when a bank takes out deposit, so we're lending money to the bank that when we put money in a deposit. Most of the time it's call. And that means the bank has what is called a short term interest rate liability. So A on a bank's balance sheet, a deposit is called a liability. And when a bank makes a loan, that's an asset for the bank. We think of it the other way around is we look at it from our perspective. For us, the loan, when we take it home loan, that's our liability. And when we put money in a deposit, that's how asset the for the bank is the other way round. Anyway, deposit attach it. Most deposits are at cool. And what that means is if the cash rate goes up and down, the bank has to pass the interest rate that goes up or down. So what banks do in Australia is when they make 30 year home loans, they always heads the home loan risk back such that the home loan interest rate risk matches the deposit risk basically. In simple terms, they want a floating rate interest rate profile. If you take out a five year fixed rate home, that's a fixed rate profile. If you take a variable rate home loan, that's floating rate. And a central mission for banks is to ensure that the interest rate risk on their deposit matches the interest rate risk on their loans. Now, all banks do that generally. It just so happened that Silicon Valley Bank decided they wouldn't do that. So I didn't hit anything at all. And what that meant was they had roughly what's called a 100, 220 billion in bonds, and the average maturity was about 6.2 years. And all those bonds were fixed rate, they weren't floating rate. And then they had all these at deposits that were floating rate. And what they should have done, which is very easy to do, is just with basically a click of your fingers, you hedge the bonds to match the interest rate risk, give you deposits. But they didn't do that. Why didn't they do that? Well, because if you hit it, you reduce the interest rate you earn. Because if you have a 6.2 year fixed rate bond, you're going to earn generally more interest than if you have an actual deposit. So Silicon Valley Bank was being cheeky and I thought, you know what? And you've got to ask yourself, why would they have done this? And I think the reason I did this was I had the richest people in the world depositing with them. The average value of their deposits was 4.7 billion us. Well, 91% of their deposits were above the 250 K US government guarantee threshold. All the, you know, everyone in the tech world deposited with them or borrowed from them. So I was just sitting back there like 21 thinking high tech is going to boom forever, Rates are going to remain low forever. Rates will never increase because that was the prevailing paradigm. Crypto growth are kind of universal constants and are changing the world and we're riding that wave. They never imagined that you have. The Fed lifted the cash rate from 0% to 4.74% currently. And if you hold fixed rate bonds that are paying a fixed interest or coupon and interest rates rise, unless you hedge that the value of the bond will fall if rates rise to make you equivalent. So again, just very simply, imagine, you know, a six year bond is paying you 5% interest. And then imagine the Fed lifted straight to 10% for the bond to make you out or to give you an equivalent yield. The bond price has to fall because it's only paying 5% interest and it'll fall until the bond price will fall until you're earning a 10% yield. Now, that's a huge risk. And as it turned out, that, roughly speaking, on Silicon Valley's 100 billion to 120 billion to bonds because they didn't hedge the interest rate risk on my numbers, they lost 10 to 15% of the value of those bonds because we had the biggest move in interest rates on a relative basis, basically ever. And certainly fixed rate bonds suffered in the US last year, their biggest losses in about 100 years. And according to ZeroHedge, the total unrealised losses on Silicon Valley's balance sheet was about 15 to 16 billion and they only had 15 to 16 billion of equity. Now where it gets even more complex is normally if you hold bonds on a bank's balance sheet and they've lost money because you haven't hedged them, you either have to report that through your profit and loss or you report that through something called your equity capital levels. So you reduce your capital, say, Hey, we've lost money on our bonds, we have less capital. That's what banks do and that's what big banks to Silicon Valley Bank had lobbied the Trump administration to exempt them from these rules and some other liquidity rules, and they were exempted. So not only do they have certain. $16 billion of losses on bonds because they had chosen to hedge, which is super unusual for a bank. But they also weren't reporting those losses. And so what happened was when the deposit outflows started to accelerate that, to sell 20 billion of bonds to make the deposit outflows. And they turned around and said, we've got $1.8 billion of unrealised losses that were just realised because we've sold those bonds and they went to the market and said we need to raise 2.25 billion of equity to cover those losses. And the market was like, we didn't know you had these losses, you didn't report them why we erased risk. And then if you extrapolate out and you know, the market said, well, if all the deposits disappear, then you have to sell all your bonds and you have no equity left, so therefore you'll be insolvent now. The key point to understand is this was all triggered by a deposit run. So basically the 2.5 billion is in Silicon Valley. So, oh, man, we've been pulling money. So Peter Thiel was like, get your money out. But if the US government had turned around and done one week earlier what they eventually did, which was to say all Silicon Valley deposits are going to be government guaranteed irrespective of size, then there never would have been a deposit run and no one would have pulled their money because it was 100% guaranteed and Silicon Valley Bank wouldn't have died. So the consequence of these to understand the ramifications is the US banks have actually become safer because the government has been forced to guarantee all their deposits. And the corollary is that it'll be very, very hard to ever have a US bank run again because deposit is going to not hide. President Biden told me my deposits are 100% guaranteed, so I'm going to chase the highest interest rates. It also means US bank bonds are safer because the main way banks die is through deposit runs. So you can't have deposit runs then? It's very hard to have bond defaults. And interestingly, in the case of Credit Suisse, just to kind of extend from ECB bondholders, got nothing. So the equity was not extant, wiped out. The equity hybrids were completely wiped out, but the subordinated bonds, senior unsecured bonds and super senior bonds didn't lose anything. And obviously depositors were also made good. So that's my summary, basically be nice. 

Bryce: [00:22:40] Well, we'll definitely include a link to your article on Live Wire, where you sort of spell out everything that you just spoke about for those listeners that are interested. We'll put that in the show notes. But Chris, you've made some pretty big contrarian calls in the past and been right on them. So we're really interested to get your view on perhaps what happens next. Is there a contrarian call to what happens post SVB? Is it shedding a light on a bigger issue at play here? 

Chris: [00:23:07] Our central thesis is I don't think this is particularly contrarian because it's playing out right now. It was different. Constraining like 21 as the central thesis is really as follows. This is the way we see the world playing out. We think inflation is going to be persistently problematic. The bond market is assuming financial markets and therefore equities, which is obviously your wheelhouse. Yet everyone is assuming that inflation straight lines down to the central bank targets, which is generally 2% right. So inflation rates globally, core inflation rates globally as somewhere between circa five and say circa seven and a half per cent and we're kind of hoping that we will linearly kind of converge back to the central bank targets of 2% because the bond market is basically saying the hiking cycle is all but over. All the central banks are about to pause, which I think they will, and then they're going to start cutting rates and the only way they'd start cutting rates is if inflation's under control. The central bankers are preternaturally hawkish right now, partly because there's not political resistance. In the past, politicians have tried to politicise central banks. They tried to jawbone them. We saw this with Trump, with many politicians, to get them to do what the police want them to do. But when inflation became a cost of living crisis, it also became a political crisis. And, you know, these intrinsically myopic politicians want to blame someone else, so they shift the crosshairs to the central bankers. Right now, the central bankers have been drinking their inflation fighting Kool-Aid for the entirety of their career. And the only thing the only job they really have is to keep inflation at 2%. And inflation has gone to the highest levels in 40 years. And the central bank is correctly concerned about their own credibility. All their research shows that if you're non-tradable, then inflation can kind of explode out of control. So they're actually really motivated. This is important to understand. Now, you equity jockeys, you stock jockeys, possibly you guys early last year and was telling me when when the Fed going to bail us out, you know, and show you how far the S&P 500 have to fall and the crypto guys were on to the same vein, right. They're like, oh, sure, who's going to bail out Bitcoin? I call it Bitcoin, Correct? I'm like, I argued in January 22 that the power production is dead. And that's absolutely been demonstrated over and over again. The only thing that has given the central banks the willies, which it absolutely has, is the spectre of what we face right now, which is a bit of an existential banking crisis. Now, I don't think there is going to be a next central bank crisis because it's resolve. The crisis of confidence is resolved by government guarantees and that's what we're seeing playing out. The central banks are really motivated to crush inflation and they're really, really focussed on doing everything humanly possible to make sure inflation converges. Nick Cave says his words with certainty to 2% and they absolutely do not mind pushing economies into recession. They don't want the banking system to blow up because if obviously you have a situation where people are not willing to put their money in bank deposits, then banks can't create loans. And if you can't convert savings into loans, you don't have an economy that is kind of a absolutely first order problem that they want to avoid, which is why they've acted with such force and ferocity. Even I've been really surprised by how emphatic and implacable they've been in terms of providing these government guarantees and insuring banks about it. Basically, the risk here that we're worried about and he's the kind of contrarian view is that you see core inflation. Bob Brown three to say 5% so you don't get a straight line mean reversion back to 2% and we don't have strong conviction that this will necessarily materialise. We're just saying in my view is it's probably 5050 and it's a very significant risk and if we see persistently problematic inflation and it doesn't normalise straight down to 2%, what does that mean for markets? It means that the central bankers are not going to cut rates at all. Rates again remain high for a very long time. Most of them are actually not forecasting that they'll cut rates till 2025. Right. And it means that and here's the scary part. There is a risk we get a second hiking cycle which is not priced into bond markets or equity markets. If inflation sort of bobs around three to 4 to 5%, anything above three, we really risk getting a second hiking cycle. And one of the problems that the central bankers have faced is there was so much fiscal stimulus governments through so much money and households and businesses during the pandemic that we did put up a lot of cash, These big cash buffers. Yes. If you look at the household savings rate, you know, a lot of people have noted that the household savings rate jumped to record levels like 23% here in Australia, but it's kind of back ends normal. But that's just the marginal flow of savings into, say, bank accounts. We still have kind of squirrelled away these big cash buffers and a lot of people are still spending like it's not 99. What that means is that households may be more resilient to rate hikes than they have been in the past, and it may mean that central banks need to raise rates further than they might otherwise. So I remain very negative on the economic outlook. I remain very negative on equities and any risk asset classes, and I may remain particularly negative on illiquidity. So let me just kind of expand on that. We think the US is going to go into recession. All that modelling implies the US is going to recession within a year of kind of recession. We think there's going to be a global recession. We think stocks have priced in and this is the good news. You stock jockeys, soccer practice. Stocks have priced in the increase in interest rates. So the stocks have got the discount rate story, which is the interest rate story. But we do not think that stocks are pricing in an earnings recession. And we think on a cyclically adjusted basis, share valuations in the US or cyclically adjusted price earnings multiples still look way too high. In December 21, I argued that US equities would fall at least 3%, it would pay for 26, Nasdaq fell 36, but our range is actually 30 to 60 and I think you could see no returns or very poor returns from stocks for a protracted period like years because we're going to have, in our view, recessions. And then crucially, we're going to have a big default cycle, which we haven't really seen in Australia since 1991. We haven't seen the US since arguably 2008 or 2002. And the thing to understand this is a second big idea. I've got a few big ideas I want to share with you guys. So the second bigger idea is you need to understand that for 30 years we've had declining interest rates and we've had particularly sharp declines in interest rates since 2008 when they went to zero. And what that has bred high industry cycles that were predicated on the assumption that rates would remain a life long, that would conditioning their businesses on the perpetual availability of cheap money. You know, my peers at PIMCO, PIMCO, one of the world's biggest bond managers, coined this term the new normal, and that was this low rate for long. Pardon? I said that call that we run 4 billion in assets of 35 staff. We're very active bond traders. So last year we tried $86 billion in. Bonds. But I should have called out on the basis that we want to run floating rate strategies that that don't have interest rate risk. And this was in 2011 because I thought that it's the policy making impulse. I've always kind of liked zero and printing money endlessly to bid up the value of all assets. My view was that that would ultimately propagate a big inflation cycle where fixed rate bonds would perform very poorly and other asset classes would get smashed and floating rate assets would pull growing like cash, and my bonds would perform best for a 20 to the best performing asset class on the planet was cash, and after cash it was probably floating rate liquid credit. If you ignore the illiquid stuff. So I think we're going to have a big default cycle. And that default cycle is going to wipe out these companies and asset classes that were conditioning themselves on the low rates for a long idea. And when we look at the proportion of listed firms, so companies on the stock markets in the US, UK, Australia and Europe and we look at the proportion of companies using if Y 21 financial data that did not produce sufficient profits just to pay the interest to get the principal just the interest on their debts. Ten years ago I was about 5% of all firms, as it is for 21 it was about 10 to 15% of all firms. And that was before the rate hikes. If we kind of market to market today with the rate hikes, it'd be a much larger number. So those zombie businesses, the fintech start-ups, the crypto companies, but anything that was kind of growth. All of those are probably going to die and that's going to increase unemployment, which is exactly what concerns a central bank is want to kill businesses. They are actually explicitly targeting what they call demand destruction, which means kill businesses. They explicitly want the jobless rate to rise. They explicitly want wages to fall. And they're hoping that that reduces inflation. So big idea number one is we're going to have a multi default cycle. A lot of the businesses that we've become accustomed to seeing are not going to exist and the world is going to have to fundamentally rewire itself to be able to survive in a high interest, higher interest rate climate. A second big idea, guys, that I want to ventilate quickly is that don't expect a big rebound in prices. So if the secular decline in interest rates for 30 years pushed up asset prices aggressively, then the secular normalisation of interest rates back up higher will have to push down asset prices permanently. And that's what's happening here. As that borrowing capacity changes, asset prices have to adjust. So in the case of housing, roughly speaking, every percentage point increase in the RBA cash rate or mortgage rates, that reduces our purchasing power by about 10 to 15%, so the RBA lift its cash rate by 300 basis points. All things being equal, if you assume no wages growth, you assume the supply side restrictions. House prices shoot for about 30%, but we argued, as you said, in October 2021, I think you mentioned this, that we saw Aussie house prices would fall 15 to 25% after the RBA started raising rates. Thus far Aussie house prices are four and 10% Sydney house prices fell on 14%. Interestingly, it looks like there's a little bit of kind of bottoming out in the housing market. Whether that stance is not in question, we're sticking to our forecast and we'll see what transpires. But don't expect guys that are going to get the massive asset price booms that we got in the past. Those asset price booms in the past were a function of the central banks cutting interest rates to zero and printing money to buy everything. They're not going to do that this time around. And one anecdote I made a mine this model, a God love him, who inherited 100 million bucks from his property development. Dad comes to me and says, Oh, Chris, I made what should I do with this hundred million bucks? And I'm like, Put it in cash. Yeah, that's a great idea because you basically are putting in cash. Commercial property is going to fall 25% and I'll pick up those assets and make more than 30% and I'm like, Well, how do you make 40%, Well when prices kind of go back to normal and they never go back to normal? If interest rates remain structurally high, those prices need to remain structurally low. So the outlook for asset prices, once we get through this default cycle and once interest rates do eventually decline a little bit, is that asset prices will probably track income growth. So GDP growth and wage growth and changes in purchasing power. The other point to note here is in contrast to past cycles, central banks are going to be incredibly nervous about cutting rates, and that's because they don't know with a so-called neutral cash rate or normal cash rate lies. It's not observable. And they're going to be really, really anxious about reigniting inflation pressures. So I see rates remaining high for a long time. I think the central banks, barring a complete sort of GFC and in a financial system collapse. So sitting out that scenario, the central banks, whenever they do come to cut rates, the rate cuts are going to be quite shallow because they're going to be experimenting with where the normal rate is and they're going to be. Very, very keen to ensure that inflation does stay low for long term. 

Bryce: [00:35:34] A lot to a lot to consider there, Chris.. We're here with Chris Joy, co-founder of CORE, about Capital, and we are about to jump into the housing market. Chris October 20 and 21 As you mentioned, you forecast a peak to trough correction of between 15 to 25% and that's certainly playing out, although I must say, Chris, I am in the market for a house at the moment and I'm not feeling the 25% price drop. It seems like everything is going above what's being listed at the moment. So there's still demand out there. But anyway, nonetheless, we're really keen to just get your thoughts if you're able to kind of summarise where the Australian housing market is currently at to begin with and then where you kind of see this, the market over the next 12 months in light of RBA commentary and and also your forecasts back in October 2021. 

Alec: [00:36:36] I know we've asked you a lot of questions, Chris, but maybe one more. Any recommendations on where Bryce should be?

Chris: [00:36:41] I think well I should say that, you know, obviously I can't provide personal financial advice, but I returned.To that disclaimer in the chart a few things. You know, we all do. Our modelling implies house prices should fall 15 25%, as I mentioned, capital city prices are off about 10%. It's almost the biggest decline ever. Sydney prices are off about 14%. There has been a curious and somewhat surprising mini bounce since February. Now there is a lot of seasonality in housing data. What that means is prices statistically tend to rise at a through multiple months because that's like a very strong demand part of the cycle and the little bounce has not been at all. SHARP It's kind of like, yeah, it looks like a dead cat bounce. So we're sticking to our 15 to 24% expected total drawdown. As I mentioned, we're kind of ten percentage points to the way there. One of the interesting positive dynamics that does give us a little bit of pause is a forecast we made in 2021 and July 21 where we're just coming out of lockdowns and we argue that after the federal election, basically we would see a huge record increase in migration as borders opened up and as we got a tsunami of skilled migrants and students flooding back into the country. Now, a lot of people argued that we were wrong. They basically said none of Australia's looking at all the cities. We're going to really struggle to convince people to come here. And moreover, you know, unemployment rates globally are at six year lows. It's not hard to find a job anywhere. So why would you come to Australia? As it turns out, we have seen the highest migration in 20 years and unambiguously that's fuelling a bit of a bit in housing. Anecdotally, we're hearing a lot of reports in Sydney, Melbourne of the return of the Chinese bid, which also makes sense. So how that plays out in terms of the price discovery process, it is an open question, but the flip side of that coin is we know that the RBA has no interest in cutting rates. The RBA probably has ones too hard left in the system, although they look like they're going to pause in April and those hikes may not materialise. But even if they don't materialise, we also know a few important things. We know that one in four Aussie Home Loans in 2023 switch from their 2% fixed rates to 6% variable rates. And this is going to be the mother of all shocks for household balance sheets, according to the ABS on analysis last year, when the cash rate was 2.7%, they said What does the world look like for Australian households and borrowers, particularly when the cash rates at 3.6%, it just so happens that's exactly where the cash rate is today. And what they found was that at a 3.6% cash rate, 15% of all Aussie borrowers had negative cash flow. What does that mean? They took their income and they did okay mortgage repayments and then they accepted their essential living expenses. Now I'm not talking about tax measures, I'm not talking to discretionary spending any reduced that only kind of crimped off the essential living expenses. So I think that's pretty frickin sobering that 15% of all borrowers are at risk of default. We're definitely saying in our analysis of home loan arrears, we're seeing a sharp pick up in defaults. So you know how that plays out in terms of the price discovery process for housing is, I think, interesting. My own view is that prices will really struggle to appreciate the next year or two If the RBA maintains its current path for its interest rate profile, we will kind of experience peak to trough drawdowns of around 15 to 25% do. I think it's an amazing buying opportunity. It it does look at and this is where I think people are getting kind of head fights. It does look like there are amazing opportunities. If you compare prices today to where they were 12 months ago or any months ago, you know, very clearly like I was looking at a property in grower, two properties in growth south of Sydney. These were properties on a beach. One was knocked down and the guy had paid 4.35 million for it. I was the underbidder years ago. He put it on the market for six plus, then dropped it to five, seven, five, then five and a half to five. Anyway, long story short, today he's searching for one. That seems like a bargain. But, you know, it may not be a bargain in 12 months time. Another property a few doors up, which has just been really and very expensively redeveloped. They wanted eight and a half to nine and then they and they stayed at eight for like 12 months and ended up selling for six and a half. And that was a brand new build on the beach. You know, the land's probably, I would argue, the last three with 3 to 4. The build would definitely have been, you know, four plus. So, you know, potentially that that's an interesting opportunity. But I do think you need to condition expectations for an ongoing adjustment in valuations in light of this structural increase in interest interest rates and the structural decline in purchasing power. So my own view is I wouldn't be rushing to buy a property right now. I'd be looking this is again, I'm not giving you my personal advice, but I'd be looking myself in the next 6 to 18 months and you want to make sure that the market is cleared. You want to make sure that all those fixed rate borrowers on 2% loans, that go to 6% who won't be able to afford them and need to sell their homes. And that'll be a bit of a supply side response that will probably come in the second half this year. At the same time, the market conditions are slowing down. You probably see more bargains, I think, in the back end of this year and early next year. I am a big believer in the the one two down on down under the eased the Aussie economy. I think it's one of the most elastic and agile economies on earth. And we have been incredibly successful in dodging crises in the past. We didn't have two quarters of negative GDP growth in 2008. You know, the unemployment rate I think only went to 5.6 or 5.8% in 2008. You know, we're one of the best performing economies during the pandemic and it is definitely the best country the world to live in. I've spent a lot of time overseas and nothing compares to Australia if I had to pick an area. Sunshine Coast is unbelievable just in terms of it's incredibly cheap and the climate's amazing. You don't have crocodiles or box jellyfish, it's warm all year round. You get a bit of monsoon rain in December and January and and within the Sunshine Coast I'll plug my own long exposure. I love. I like a pristine beach, dirt cheap like you can buy on the beach for a few million bucks. You know you're 14 minutes from moves that 15 minutes from an international airport. Yes I presume beach got out and bit it up so I was like a mathematician again gains my own property is. 

Bryce: [00:43:27] Going to get one here first Chris but that's on the list. 

Alec: [00:43:31] So Chris one one question I just wanted to ask before the break. When you were talking about what equity markets have priced in, and I do love your term stock jockeys. I think that goes well with Equity Mates. So we might have to steal that from you. You mentioned there that the there's potentially another tightening cycle to come, that the markets haven't priced in. If that does play out, how do you think that affects property? 

Chris: [00:43:59] That's diabolical. Typically, I probably didn't express any apologies. I'm conscious. I do speak quickly and in my fourth to raise some time. So if anyone the audience is struggling to keep pace or understand, I apologise in advance, but I'm all belatedly. So yeah, I think it's a disaster, an absolute disaster, but it's not abnormal. We've seen it before. You know, Citibank raised rates, they in Portugal and then they had to do some more hikes. And I said it's a 5050 scenario. Hopefully, you know, I hope we straight line to 2% inflation. I hope these hikes are all we need. But I do think your best performing know which sounds like a plug for my own portfolios but back in like 21 I. I was arguing the credit president made more than 100 basis points water in investment grade credit which is my asset class, which is terrible for my asset class. I argued that long term interest rates on fixed rate bonds were going to rise hundreds of basis points, which means that fixed rate ones, we're going to get smashed. So we were super negative in our own asset class, in fact, over 22. So between June 21 and June 22, in total, we put $10 billion of short positions and hedges to work in credit and bonds. So we're super negative. So I'd like to think I come from an authentic perspective. I do think your best performing asset class for the next year or two will be cash. You know, the central banks are trying to calibrate their cash rates such they get a positive view. As I say, if you get a positive return above the rate of inflation and if you think about cash in right now, you can probably get four and a half, 5% term deposit rates. So why would you buy resi property on three 4% yields when you hit four and a half to 5% on cash on bank bonds? We re getting as much as 6 to 7% on major bank bonds. So again, if CBI bonds are paying 6 to 7%, why would you buy CBI equities, which right now are paying a fully franked dividend yield of only 6%? And for them. Again, apologies to this doctor. He's probably not behind everyone listening to this. But why would you buy all the equities which are also paying you with franking credits are crushed up. A 6% dividend yield doesn't make sense. So in commercial properties going to be disaster. You know, commercial A-grade office property is still trading on use of 40%. Rental property I think is going to be intrinsically problematic. Anything that's a liquid takes time to adjust like years and years to adjust. You see in the way that house prices are slowly adjusting, commercial properties even slow the raise your property, private equity and venture capital completely screwed. Right? Because they're going to tell you again, you need to adjust the two sectors. It for me most about junk bond market or the high yield bond market and the private loan or private credit markets. Because in 2008 when we had all these credit blow-ups that hurt banks, the regulators came along to the banks, okay, you can't extend loans to these zombie borrowers anymore. All these risky borrowers and the two sectors that are often replete with the largest relative numbers of zombies are actually real estate and tech. And in Australia, the banking regulator has consistently argued that the biggest bank killers are residential development loans. So residential property loans for developers development purposes and commercial property exposures in a serious position we had in Australia in 91, ANZ and Westpac almost blew up because of their commercial property export exposures. We saw the same thing with commercial property in 2008 and most of this finance or a lot of these finance has shifted off bank balance sheet since 2008 and they borrowers have got funding from non-bank borrowers and I think the non-bank market is a bit of a disaster waiting to happen and the private loan and high yield markets are really, really problematic. So to be clear, to answer your question, if in the 5050 scenario we get a second hiking cycle that's not priced at all, it's a disaster for frickin everything. And the only thing that will do well is cash and possibly will probably, in my view, very highly rated, very liquid liquid high grade bonds. So government bonds and high grade bank bonds, they're probably my three preferred sectors having been super negative on bonds in late 21.

Bryce: [00:47:52] We might have to do a pivot and call ourselves cash mates then. 

Chris: [00:47:58] I love it. I love it. Yeah, you need it with that. It's something like equity hedged, made or long. It's in equities is what all the equity investors need to understand. I kind of made this point, but to reiterate it, it's been a bit of a Ponzi scheme for a long time. It's all been on the great good on the greater fool theory that growth and these tech companies going to take over the world and they're going to grow at insane rates forever. But the reality is there's going to be no freaking growth, right, for next years. The world is not growing. It's going to contract and equity valuations. I do think this is equities have adjusted materially, but I still think there are probably big adjustments to come. And and the other thing is to remember the kind of steady slide, the option to wait is very valuable. There's value in the optionality of just pausing, sitting on the sidelines, capitalising on the liquidity of cash or high grade debt or bonds and just watching what plays out, because you're not going to be seeing a rally of all these bear market bounces have been absolute beast ride Every time the S&P 500 gets up to like 4200, 40, 300, wherever it was, you know, it's been highly probabilistic that you'd get smashed back down again. That's exactly what's transpired. I think another thing for Equity Mates and your listeners is this and this is my final big idea of the day, because I think I've dispensed a sufficient number. It's really actually importance in superannuation. Australia was set up in 1992 and we're now putting all of our income into super. It is a form of forced savings and it's started really, really well. But during the 1990s and 32,008, it was basically in Aussie Equities, one big bull market. So the super funds that did well well with the super US that had the highest equity rates and because we rank super on pure returns on the volatility of their returns, basically everyone was chasing risky. Right. And what that meant was that by 2008 Aussie super funds had the highest rise of any pension funds globally in the OECD, a much, much abnormally high exposures to equity, and that includes Aussie equities, global equity, property equity, infrastructure equity, private equity, venture equity, etc. They basically had no caption fixing come to speak of. If you look at Aussie Super 28, it was I think 7% or maybe was 11% total exposure to cash in the kingdom. Now that we've moved into a world in which interest rates are suddenly much higher and frankly it's 6 to 7% interest rate on say, bank debt, it creates an incredibly high hurdle for everything else our listing. And so I do think you see a structural shift in asset allocation within super funds away from equities back into cash in high graded. And this is also amplified. This is probably complicated bit defined benefit. Pension funds globally. These are super funds that have to pay a specific return on their promise to pay. Those guys didn't have enough money to pay out that return for a very long time. For decades, they ran something called a funding deficit or funding gap. And so for decades they were told by their advisors, you have to be in equities because it was to be the highest rate of return. And high equity returns will help close the funding gap for defined benefit pension funds because of the huge increase in interest rates. Most of those defined benefit pension funds have close that gap and then have to lock in the the so-called surplus they've got by buying long term high grade fixed rate bonds. So I think globally, you're going to see a massive shift out of equities, venture capital, private equity and out of commercial property into bonds because the high returns on bonds. And I think that's going to be a big structural headwind for Aussie Equities in particular. I think the biggest tailwind for Aussie equities in the last three years is unambiguously been super. And I think that tailwind, could the margin turn into a bit of a headwind? And that's all I have to say, I guess. 

Bryce: [00:51:45] Love it. Plenty of massive ideas for us to ponder over there, Chris, but we have run out of time. Thank you so much for sharing so much of your time with us today. It's been absolutely fascinating. I do have one question, though, too, to finish. In the process of setting up this interview, I received an email from you at 2:28 a.m.. So do you ever sleep? 

Chris: [00:52:08] It's a very good question. So I decided to have 35 guys. I have eight traders away from me. I have six people in London, and the London guys are calling me all day, every day overnight because, you know, we're doing hundreds of millions of dollars of trades in the US dollar and euro time zone. So that kind of does beg the question, what's the optimal time zone for me to be in? It's probably not Australia long term, but yeah, my sleep patterns, I don't need, I don't need consistent sleep. I'm very good at being woken up in five times, then I've got no problem with that. I probably only need about 6 hours sleep, but if I can get 5 to 5 and a half hours of sporadic sleep, I'm fine. Just like a lot of power. No power nap sport. Yeah, that's the mentality I adopted. It's a positive mindset. Always sleep with one eye open. 

Bryce: [00:52:58] I love that. I love that. Well, Chris, we do finish all of our interviews with our guests with a final question. By being on the show, you automatically go into the running for our Expert of the year, which is voted by our community. At the end of the year, they vote on which interview they took the most value from. And we like to give them a bit of insight into who our guests are beyond their realm of expertise. If you were to win, where would you put the coveted Equity Mates Expert of the Year trophy? 

Chris: [00:53:32] I will firstly have an I already won. 

Bryce: [00:53:35] This is a good day for my birthday. It's in the mail. 

Chris: [00:53:40] I probably said to my son, Oh. 

Bryce: [00:53:42] Nice, nice, nice. Good answer. Well, look, Chris, thank you so much. Will include all of the links to the articles that were referenced throughout this episode on Survey Bay, on housing, on the zombie apocalypse. There's plenty there, so we'll put them all in the show notes. And if you're not following Chris already, jump on to his Twitter feed. Follow him on live wire. I'm incredibly good at keeping us updated with what's going on in markets. So, Chris, appreciate all the work that you do and look forward to catching up again in the future. 

Chris: [00:54:11] Thanks, boys. I love it. You're champions.