Chris Joye, the co-founder and portfolio manager at Coolabah Capital in Australia, is known for his often contrarian but often accurate analyses. Let’s see what he’s saying now in this
podcast at
Equity Mates published on March 27, 2023.
He makes a TON of great points and original ideas!
Below are highlights from that interview and I bolded some of the highlights as well.
“Yes, that was absolutely a bank that deserved to die.”
Silicon Valley Bank (11:40)
“The U.S. 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 U.S. because of its federated structure, you’ve always had this massively fractured and decentralized banking system that’s also inherently fragile.
So U.S. bank failures are really common. Since 2001, on average, 25 U.S. banks have died every year. Since 2012, on average, seven U.S. banks have died every year… 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.”
“Almost 100% of its deposits came from tech. All of its loans went to tech.”
“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, given your 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”
“And certainly fixed rate bonds suffered in the U.S. last year, their biggest losses in about 100 years.”
“
But if the U.S. 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 this to understand the ramifications is U.S. 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 U.S. bank run again…“
Inflation (23:07)
“We think inflation is going to be persistently problematic.”
“… 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.”
“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.”
“
The central banks are really motivated to crush inflation and they’re really, really focused on doing everything humanly possible to make sure inflation converges… they absolutely do not mind pushing economies into recession. They don’t want the banking system to blow up”
“… if we see persistently problematic inflation and it doesn’t normalize 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 3 to 4 to 5%, anything above 3, 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 threw so much money at households and businesses during the pandemic, that we did boot up a lot of cash, these big cash buffers.”
“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.”
Stock Markets
“
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 U.S. or cyclically adjusted price earnings multiples still look way too high.”
“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 in the U.S. since arguably 2008 or 2002.”
“So the second big 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 is
entire industry sectors that were predicated on the assumption that rates would remain low for long, that were conditioning their businesses on the perpetual availability of cheap money.”
Zombie Businesses
“
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 longer 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 FY21 financial data that did not produce sufficient profits just to pay the interest, forget the principal, just the interest on their debts, ten years ago I was about 5% of all firms, as of FY21 it was about 10 to 15% of all firms, and that was before the rate hikes. If we kind of mark 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 growthy, all of those are probably going to die and that’s going to increase unemployment
…the sense is central bankers 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-year 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 higher interest rate climate.”
Prices are Never Going Back to Normal
“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 normalization of interest rates back up higher will have to push down asset prices permanently.“
“But don’t expect, guys, that we’re 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.”
“
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 where 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.”
Recent Aussie house prices; “It looks like a dead cat bounce” (36:41)
“All our modeling implies house prices should fall 15 to 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 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.”
“We know that 1 in 4 Aussie home loans in 2023 switch from their 2% fixed rates to 6% variable rates.”
“And what they found was that at a 3.6% cash rate, 15% of all Aussie borrowers had negative cash flow… So I think that’s pretty frickin sobering that 15% of all borrowers are at risk of default.”
“I’d be looking myself [to buy a house] in the next 6 to 18 months.” And you would want to make sure all the ARM have already reset.
Years and Years to Adjust (43:59)
“So, why would you buy resi property on 3, 4% yields when you hit 4 and a half to 5% on cash on bank bonds?”
“So, commercial properties’ going to be a disaster.”
“Anything that’s illiquid takes time to adjust, like
years and years to adjust. You see in the way that house prices are slowly adjusting, commercial properties even slower than resi property. Private equity and venture capital completely screwed. Right? Because going to take, again, years to adjust.”
“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”
“… if in the 50/50 scenario we get a second hiking cycle that’s not priced in at all, it’s a disaster for frickin everything and the only thing that will do well is cash and probably, in my view, very highly rated, very liquid high grade bonds, so government bonds and high grade bank bonds”
Takeaway (47:58)
“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.“