Rebecca Hotsko (03:02):

Welcome to the Millennial Investing Podcast. I’m your host, Rebecca Hotsko, and on today’s episode, I am joined by David Hay. David, welcome to the show.

David Hay (03:11):

Well, Rebecca, thank you for the honor of being on your show and for reading my book, Bubble 3.0, in preparation for this. And I do want to point out that, because it is important to our conversation, that we digitally publish that early in the year. And the reason I’m emphasizing early is because everything that’s been going on since then, as Bubble 3.0 has been in a rapid deflation mode.

Rebecca Hotsko (03:34):

So that is exactly what I want to talk to you about today. You wrote a book titled Bubble 3.0: History’s biggest Financial Bubble, Who blew it and how to protect yourself when it blows apart. I read this in a weekend, it was so good. There was just so many things that I kind of want to unpack with you today. So I guess to start off, can you kind of walk us through why you think we are in the greatest bubble of all time and what got us to this point?

David Hay (04:03):

Well, sorry to ruin your weekend, first of all, but I mean I think there’s a short answer, a really short answer, just a three letter word, Fed, the Fed did this. And I mean they had some help along the way with some bad policies, but I think it’s important to understand the connectivity between Bubble 1.0, which was the tech bubble of the late ’90S, really the first spectacular bubble in America since 1929. And then the second bubble, 2.0, which was the housing bubble that was kind of specially hit a crescendo ’05 to’ 07.

(04:35):

And then this is Bubble 3.0, which I would argue is the biggest bubble of them all. In fact, I think it’s, as you know, one of our little catchphrases, is the biggest bubble in recorded human history. And it really hit peak insanity last year. And the reason I say that is that’s when you had the specs going ballistic, NFTs, profitless tech, the meme stocks, of course, the cryptos. And when it comes to cryptos, I think the one that just takes the cake, I think this was the signature event of Bubble 3.0, was Dogecoin, which is the dodgiest of all the cryptos. And that’s really saying something, it’s got a lot of competition for that title, and yet it got up to an 88 billion market cap at one point last year. Which is bigger than a lot of US blue chip companies. And it’s worthless. It’s creator said, “What are you doing? This thing is nuts. There’s no value here.”

(05:25):

Of course it’s crashed. And so many of these things are down 80, 90%, including publicly traded companies that had large market caps. It’s been an absolute bloodbath and this is exactly what I was afraid of. It was what I was trying to warn people about early in the year. In fact, we actually ran one of our chapters last October basically on the European energy crisis that was already underway before Putin’s tanks ever crossed the border. So yes, I think that it’s been an epic period and it’s a culmination of 20 plus years of misguided Fed policies.

Rebecca Hotsko (05:57):

Let’s dive into some of those misguided Fed policies. You write in your book about modern monetary theory and the role that played in Bubble 3.0. Can you talk a bit about that for our listeners, how that contributed to the bubble and just maybe what that is?

David Hay (06:15):

Absolutely, and I think it was probably the main helium injector into Bubble 3.0 was MMT. And ironically, when I was first kind of creating Bubble 3.0, the book, which I was doing installments in my newsletter, as far back as early 2018, one of the things I wrote about, actually it was early 2019, I wrote about MMT. But even at that point when I would talk to our brightest clients and I would say MMT, they would say, “What’s that?” And that’s how off the radar it was at that point.

(06:44):

Now shortly thereafter, it gained a lot of momentum. Bernie Sanders got behind it. Stephanie Kelton, who was his economic advisor, I think in his 2016 presidential campaign, was the very intelligenic, very charismatic promoter of MMT as the solution to, what a lot of folks have called, secular stagnation. This idea that we’re just in this low growth era and we can’t get out of it unless we engage in something like modern monetary theory. Which basically says that the federal government, especially the US government since we have the world’s reserve currency, can just spend money without any kind of budgetary restraints. Don’t try to go through the whole budget process. If you need to spend money, just spend it.And of course, COVID created the perfect scenario for that. Initially you could say yes, it made sense during the earliest part of the COVID lockdowns. I mean people were in real trouble and you had to get them money quickly. But as the government so often does, and the Fed is notorious for that, they just keep doing the same thing over and over, like with QEs. The famous Quantitative, or I should say infamous Quantitative Easings. QE 1, 2, 3, it sounds like they’re a bunch of ocean liner. And then QE 4 actually happened under Trump, kind of accidentally, during the repo seizures of September, 2019. So that actually triggered another a hundred billion dollars a month of QE.

(07:58):

But again, once COVID hit, MMT, then basically it’s likeQE on steroids. So it had its time in the sun and it kept happening. In fact, this is one of the most amazing factoids of this whole episode, is that the Fed was still printing money, still doing QT as recently as this March, even after inflation had become a raging problem. Just like they were still buying mortgage backed securities with of course, what I call their magical money machine. This fake money they can create, even though the housing market was absolutely roaring. It was complete insanity. And yet the Fed just kept doing it. And of course they kept interest rates down to very low levels. We had the lowest interest rates in 5,000 years, when they got interest rates to basically zero in the United States. And negative, I know you want to talk about the negative part of it and Japan, but particularly in Europe.

(08:48):

And one of the most amazing parts of that negative yields scenario was that mortgage holders in Denmark were actually getting paid by their bank. So you took out a mortgage in Denmark, instead of paying the bank, the bank would pay you. I mean, how Alice in Wonderland is that? It’s just, there’s been so many things that are surreal in this period we’ve been going through.

Rebecca Hotsko (09:09):

So I want to touch on a few things there. There’s a lot of different Fed policies that have contributed to this bubble and they all kind of work a little bit differently, but they’re interconnected. So the Modern Monetary Theory as well as the QE. Can you talk a bit about how QE has been destructive in the stock and bond markets and how that works through the system?

David Hay (09:34):

Well, it’s a very good point because there is a distinct difference between QE and MMT. Because when QEs were first unveiled over 10 years ago, actually closer 12 years ago, there was a lot of angst at the time that that was going to create high inflation, even hyperinflation. But with QE, it’s money being created by the Fed. But that money basically stayed within the financial system. It really didn’t get spent by consumers, it leaked its way into things like real estate and the stock market, basically risk assets benefited from QEs. But the real economy did stay very sluggish.

(10:11):

But then COVID hits and MMT goes into full activation mode. And so the money then got directly sent. You had trillions of dollars being directly sent to people. And guess what? They spent it. Not all of it. And there’s still a lot of it’s on the sidelines, which is an interesting point and why we could actually have a pretty good economic recovery coming out of what I believe is a recession that we’re in now. But that’s another story. But the reality is, you did get a lot of spending. The Fed allowed the money supply to increase by 40% over about a year and a half period. Unprecedented increase in the money supply and you had a lot of economists, and of course the Fed itself, saying, “Don’t worry, we’re not going to get inflation. Or if we do, it’ll be transitory.” Now that was the famous word that Jay Powell used repeatedly until it came back to haunt him.

(10:55):

It was a very different application of extreme monetary intervention, a much more powerful way to get nominal GDP growing. And it did. I mean it’s still hard having, even though we’re having what is arguably already a recession, as you’re well aware, the first two quarters of this year were negative from a real GDP standpoint. But they’re still strong from a nominal GDP, like in the eight to 9% area. And as you know, that’s what I believe is kind of the ulterior plan of the federal government is how to deleverage this tremendous increase in debt that we’ve had 20 years, but particularly the last 12 or 15 years ever since the great recession, global financial crisis, when debt is basically tripled in a relatively short period of time. It’s shocking frankly.

Rebecca Hotsko (11:41):

On the debt aspect. You wrote in the book how it’s been over, what was it? 6 trillion has been added to national debt in two years. How do you think that, what is the plan to alleviate that going forward and what impact will that have on financial markets?

David Hay (12:00):

Well, it’s a great point and I don’t think anybody fully knows the answer to what the impact is going to be. Certainly initially, the impact was very powerful, very positive because you had all that liquidity, which again, a lot of that tends to go into financial assets or even real estate. We can talk about real estate because it wasn’t just the US, it was a global phenomenon. So even with COVID, you had housing prices take off. They were already high even before the pandemic and they won absolutely postal during the pandemic because you had these extremely low interest rates, and nothing benefits more from low interest rates or negative interest rates. I mean, imagine in Denmark what it was doing to housing prices to have people paid by the bank to buy a house. So a huge, huge global real estate bubble that is by the way, in the process of popping and actually the US doesn’t look too bad in that regard.

(12:45):

But as far as how do they cope with that? I think the only way that the US government can deal with it, is much like what we did after World War Two because we had a fairly similar debt to GDP at the end of World War Two. We obviously saved the world, that was a little bit more important than what we’ve done over the last 10 or 12 years, which is just really fuel asset bubbles. But nonetheless, I think it’s kind of the same game plan. So in the mid to late ’40s and into 1952, because there’s also the Korean War that happened in that period. So there were some really big deficits, there was some high inflation and the debt to GDP got down fairly quickly from 1945, where it was about 115% to about 70% by 1952. So a very rapid paydown of debt relative to GDP. It wasn’t actual debt paydown but it was just that GDP grew a lot faster than the debt level.

(13:35):

And the way that happens is by keeping interest rates well below the inflation rate. We’ve got a tremendous amount of pain in the financial markets right now because we’ve got the 10 year treasury, it touched 4% here the other day, but inflation’s, eight, a little bit over it. So you’ve still got a negative 4% yield at current inflation rates. Now that’s where it’s going to get really interesting is what is going to be the new normalized inflation rate? It’s not eight, it’s going to come down, for sure. And I think there’s a pretty fascinating story of how we could be moving, at least temporarily, from a time of a lot of inflation anxiety into actually fears of deflation. And that seems ludicrous right now. But you’ve got people as prestigious as Jeff Gundlach, DoubleLines bond guru extraordinaire, saying that he thinks there are going to be rising deflation fears. Because when you get asset prices crumbling, even crashing, which is starting to happen, and certainly has happened for what I used to call the crazy overpriced stocks, the COPs, the COPs have truly crashed.

(14:34):

And when that happen in ’07, ’08, ’09, all of a sudden, because there was a fair amount of inflation back then, was inflation fears, almost overnight, flipped to deflation worries. So I think we could be in that kind of scenario again.

Rebecca Hotsko (14:47):

The other thing that I want to ask you about the Fed, is the Fed Put, we’ve heard a lot about that this year. Can you talk about what that is and what impact that has on markets?

David Hay (14:58):

Absolutely. It’s huge. Interestingly, it didn’t start just 10, 12 years ago during the global financial crisis. It actually started under Greenspan in 1987, when we had that market crash in October. And in that one month the S&P fell 30% from peak to trough. It rallied at the end of the month, but in one day it fell 20%, I think it was October 19th 1987. I remember it vividly. I’d been in the business about eight years at that point. And that belief that when, so what Greenspan did at the time, was he flooded the system with liquidity. He just made sure Wall Street was just drowning in dollars to make sure that things didn’t collapse and then it kind of became institutionalized. And that’s where kind of like we’re talking about with QE, they say, okay, it’s going to be temporary. We’ll do QE1 and then it’s QE2, and instead of being a one year during a panic, it turns out to be a decade long experiment.

(15:47):

It’s, the Fed Put is, I think that saying, where is that now? Does it still exist? And I think that was the question that you had on your mind. That’s a brilliant question and I think it’s the multi-trillion dollar question. Does that Fed Put still exist? And I think it does. But what’s different this time, and this is something that I actually warned about in my book and in my newsletters, that it’s probably got a much lower strike price or activation price than it had previous.

(16:11):

Previously it was kind of like down 20,25 on the market. The Fed would then get into panic mode and reverse, which is what happened with Jay Powell back in 2018. He was telling everybody in October how great things were and how it was going to continue to tighten and tighten and do QT and where they do the opposite of QE.

(16:27):

And by early 2019, he did a complete 180 and then wasn’t too much longer after that he was actually cutting interest rates. But here we’re down 25% roughly, on the S&P right now. We’re down, probably 35% from peak to trough on the Nasdaq, which is where so many people have had their money. And the Fed is tightening and tightening in big amounts and the market’s expecting the Fed to tighten another 75 basis points next month. And that’s just, that’s really never happened, other than during the Paul Volcker war on inflation of the early 1980s, when he took the prime rate to like 21%. And obviously, this economy can’t handle anything close to that without crashing. Because debt back then, just as getting back to that debt to GDP. Debt to GDP, in 1979, was down around 25%. So in all those years after World War Two, up to 1979, all the inflation that we had and the economic growth, got that debt down to a very low level.

(17:21):

So Volcker had the ability to really hammer and drive interest rates to levels that nobody thought they could possibly go to. And even though inflation was running about 12, he created like 9% real interest rates. Unprecedented and it worked, but it was very, very painful. Powell can’t do that with all these high levels of debt, not just in government, but basically every… I mean consumers are in pretty good shape. Companies, especially the weaker companies, have a lot of debt. And so there’s a lot of concerns that we’re going to start to see rising defaults. And you’ve got like 20% of the US corporate bond market that’s in zombie status,where these companies don’t generate enough cash flow to service their debt. And that was before interest rates really went up. Where is this Fed Put now? I think it’s probably down 35 to 40% on the S&P, probably down 50 to 60% on the Nasdaq.

(18:10):

I think at that point the Fed is in a real pickle because then you’re probably creating, or looking at an extremely severe recession. That then what happens to government deficits in a severe recession? They blow out because revenues go down, tax revenues go down, support payments go way up and then they’ve got to sell a lot of debt to finance that. And if the Fed is actually selling government bonds instead of buying, because again, this is something that a lot of people are missing right now. Not only is the Fed raising interest rates at one of the fastest rates ever, they’re also now truly doing quantitative tightening, where they’re selling their almost 9 trillion government bond portfolio. So if they’re selling and then the government’s got to sell a whole bunch of bonds because of these exploding deficits in a recession, it becomes a nightmare scenario pretty darn quickly.

(18:56):

So the question is, what does the Fed do at that point? And frankly, I think what they do at that point, is what they did in March of 2020. And Rebecca, this is one of the craziest predictions I made prior to the pandemic, was that, and I took a lot of heat from this actually, that the Fed was going to buy corporate bonds in the next panic. And sure enough they, people said, “You’re crazy, they can’t do it. It’s illegal.” I said. “Don’t worry, they’ll figure out a way to do it.” And they did. But the amazing thing, if you go back and look at the day after they made that announcement, that was the bottom in the COVID bear market, which was pretty scary. I mean it went down almost, it was kind of like the crash of ’87. The market went down about 38% in a little over, maybe even a little under a month.

(19:37):

And then things turned on a dime because the Fed said, we are going to buy corporate bonds as needed. And frankly, it’s something I said, I was telling my readers, because my newsletter started back in 2005. So in 2008, 2009 when we were in that meltdown of the global financial crisis, I was begging the Fed to not print money but just simply borrow the money in the T-Bill market at basically zero and buy corporate bonds. Corporate bonds, junk bonds were trading over 20% back in 2009. You basically were looking at a corporate bond market that was as undervalued at heads it had been in 1932. It was way cheaper than the stock market was at that point on a relative basis, but they didn’t do it. So instead of borrowing, they printed money, that was QE1 and they bought government securities, which were the most overpriced securities on the planet.

(20:27):

They absolutely, with that opportunity, they could have stopped the financial crisis in its tracks in the fall of 2008, if they had done what they did in the spring of 2020. My point is, when they did that intervention for, because of COVID, they only invested about $18 billion in corporate bonds, out of all the trillions of dollars these guys threw around, only 18 billion. But it was just the idea that the Fed had said, we’re not going to let the corporate bond market get destroyed, which it was in the process of being at that point and it created an amazing rally. So they’ve learned from that, they go, hey, of all these things that we’ve done, that by far, the best bang for the buck. So that’s already in there too. I think if things get really bad, here’s another one of my crazy predictions, I believe they’ll buy stocks. Lots of other countries have done that. And even Janet Yellen said back in 2016, they consider that one of their solutions. Buy stocks if things get bad enough.

(21:20):

And here’s where I think they can get around accusations of being inflationary because they have about a hundred billion dollars a month coming in from the maturing of the government bond portfolio. They do have the ability to say, okay, we’re going to take some of those proceeds and use those to buy corporate bonds. We’re not creating new money, we’re just reallocating it. And I think that, I mean it’s a pretty extreme solution, but they’ve done it before and I think that’s what’s coming ,and that will be when a market, which I’m afraid could actually have another October crash, but I think that’s when you’re going to see a massive rally.

Rebecca Hotsko (21:53):

So a lot of people are likening this crash to 1970s, talking about the stagflation. But I guess, can you talk about why you think this is so much worse than that period? And I guess what is different about this period compared to the 1970 period?

David Hay (22:12):

Well again, I think the big one is that the debt levels are just so much higher. So the ability to really ramp interest rates up to a level that breaks inflation, breaks a lot of other things too. Now that’s what Powell says he’s going to do. He’s really telling people, I’m not going to go down in history is the second coming of Arthur Burns. I want to be known as Paul Volcker 2.0. But again, Volcker had very low debt levels to deal with. I think this period is more akin to the ’05 to ’08,, the whole massive housing bubble and all those crazy collateralized debt obligation CDOs where they packaged a bunch of subprime mortgages and then they diced them up into tranches, and that whole thing almost crashed the system. And that’s what brought AIG down because AIG was insuring those. And so they had a massive margin call that required the government to step in and rescue the largest insurance company in America.

(23:03):

And these things were dropping like flies back and there was a tremendous amount of contagion. I think the good news this time versus then, is the banks are much better capitalized. I don’t think that’s going to be the problem. I think the problem is more likely the shadow banking system because a lot of this riskier lending or so-called investing, that isn’t happening through the traditional banking system because of all the regulations they have and restrictions on them. But it’s happening in the shadow banking system. So hedge funds, for example, are actually considered to be part of the shadow banking system.

(23:35):

And you may be aware that back in 1998, sorry, 1998, long term capital, which was a big hedge fund, went down and it really shook the system at that point. Required tremendous intervention. That was another example of a Fed Put. But today I think that you’ve got way more leverage in those areas. I think there’s much more exposure to things going south and prices going down and these margin calls. And actually, what’s happened in the UK just this week is pretty fascinating in that regard. Were the UK pension system apparently, is on the ropes because they’re getting margin calls on their Gilts. Gilts are basically their treasuries and apparently they were using swaps and all these, there’s just so much convoluted derivative stuff out there, just there was back 14, 15 years ago during the global financial crisis.

(24:21):

So that stuff starts going haywire and it can really feed on itself. So I think shadow banking system is a big risk out there. I also think that dysfunction in the treasury market is another kind of underappreciated risk, from what we talked about, where how is the federal government going to be able to raise money at an affordable rate? Because we know they’ve got so much debt, it’s really hard for them to finance in an open market with fair interest rates. And for so long the rates have been artificially suppressed as the debt has to be these. And then you got the entitlements too. Don’t forget that we now have something like $2.6 trillion a year of entitlements that need to be funded because we so stupidly didn’t put real assets into the Social Security trust fund. And that’s a whole nother topic we could talk about. I think that’s personally one of the greatest policy blunders ever made, was not putting real, I’ll say corporate stocks and corporate bonds rather than [inaudible 00:25:13] more government IOUs into the Social Security trust fund.

(25:16):

So just a lot of stuff. Then you got, as I mentioned earlier, and I think again, this is not really getting the attention it deserves. It looks like there is a synchronized sinking going on of housing markets around the world. And Canadian, your country, where you’re sitting up in beautiful Kelowna, on gorgeous lake Okanagan, but your country has a huge housing bubble. Much more so than in America. And our housing prices are nutty enough. I mean, they’re way above where they were in 2007, 2008. You said, well, there’s been some inflation. But even inflation adjusted, they’re higher than what was supposedly the biggest housing bubble of all time.

(25:51):

But Australia’s worse, New Zealand’s worse, a lot of Northern European countries are worse. And then you’ve got the Chinese real estate market absolutely imploding right now. And there’s a lot of stuff going wrong simultaneously. And yet a Fed that seems to be focused on two things, and unfortunately they’re two of the most lagging economic indicators you could ever pick, which is, number one, inflation. Because inflation is clearly a lagging economic event. And then the jobs market, which also is very lagging. So with them concentrating on those and ignoring all these kind of leading things that are going the wrong way, it’s scary, it’s very scary.

Rebecca Hotsko (26:28):

I’m sure we could have an entire conversation on those Fed policies and just how they’re impacting markets in of themselves. But you covered so much there. And I want to touch on the housing market with you now because you mentioned that you think this period is more like the 2005 to 2008 period and you also mentioned in your book, how collateralized loan obligations surged to highs in 2021. So I’m just wondering, is that similar to what happened in ’08, ’09, with the CDOs and I guess, do you see a similar crisis today in the mortgage lending space?

David Hay (27:06):

Probably not in the mortgage lending space. Well, I think CDOs and CLOs are similar. They are different. So the difference is CDOs were made up of mortgages, mostly those sub-prime mortgages that were sliced up into different tranches or layers, slices, whatever you want to call them. The riskier ones got wiped out right away. But what really almost brought the system down at the time, was the AAA rated ones fell down to like 40 cents on the dollar. That was never supposed to happen. And even under a worst case scenario, they were worth probably 90 cents on the dollar. But you just had this, it was basically a global margin call and the selling fed on itself during that period of time. There was just really no buyers, even though it was one of the greatest opportunities of all time to buy, what was still really AAA rated paper, at enormous discounts.

(27:51):

That’s why the feds should have been in there preventing that from happening. Because they also had this crazy rule back then, and it was a fine rule under normal circumstances, but in a crash it created an absolute death spiral and I think it’s ASB 157, which required the banks to market on their CDOs. And they were thinking these things are bulletproof. And so now I’ve got to take a 60% hit on what I thought was AAA rated and that I have a ton of? Virtually every, doesn’t matter how strong the bank was, it was technically broke in 2008, early 2009, at the worst of the collapse. That was systemically shaken. Now CLOs are loans, so they’re basically to corporations, and typically they’re junk loans but they’ve got oftentimes, senior status, so they get paid ahead of when bonds get paid. So they have some inherent advantages.

(28:45):

But I mean there’s tremendous stress showing up. And one way you can see that stress is looking at the CCC junk bond market, kind of the junkies of the junk bond market is yielding 16%. At the beginning of the year was 8%. So that is an enormous increase now with CCCs because they have such a high default rate, you have to take off like 6% as a reasonable estimate of what you’re going to lose per year because of defaults, even net of recoveries. So that the default adjust interest rate is more like 10. That’s still a very big number. And I loved your podcast that you did with [inaudible 00:29:20], if I’m saying his name right? And he was talking about this, that this kind of weird thing where he’s got, I love his strategy by the way, I think it makes total sense, but he’s saying, you really shouldn’t be able to get high returns with reduced risk if you’re going to get high returns, you should be taking a lot of risk. And he’s saying that doesn’t work out that way a lot of times.And I think this is a good example with, when you think about CCC rated bonds, which are probably down 35, 40% this year, which is why the yield has gone up so much. So now you’re getting a 16%, forget the defaults, but 16% nominal yield and your bonds are discounted significantly. So they have a lot less risk today than they had at the beginning of the year. And so it’s just a bond market example of exactly what he was talking about. So anyway, I’m kind of going off on a tangent, but I do think that was a great podcast you do with him.

Rebecca Hotsko (30:07):

Thank you, I love that one. I want to talk to you about the bond bubble, but I have one more question about the housing market just because, like you mentioned, we have seen such a surge in home prices post COVID. I’m feeling it in Canada, everyone’s feeling it globally. I guess, what’s your outlook from here? Do you see it having a similar path as maybe the stock market correction, or is it going to lag a bit more? What are your views on that?

David Hay (30:34):

My view is that the US once again, is in better shape comparatively. One of the reasons for that is that unlike America, where people typically have long term fixed rate mortgages, so there really isn’t a major impact to people of interest rates going up they are. I mean it’s clobbering new transactions, sales of existing homes or new homes and refinancings of course, have imploded, but it really doesn’t hurt the most homeowners. That’s very different overseas, including in your country, which is not overseas, just north of the border. That you have largely adjustable rate mortgages, where they will adjust very quickly over a three year period. And some of those are starting to roll into a reset period. These homeowners are going to get really shocked by their new mortgage payments and at the same time, especially in Europe, but in North America, energy costs are going up significantly, particularly electricity.

(31:23):

But Europe is just a nightmare of the price of electricity there. Recently got up to the equivalent of a $1000 a barrel of oil. That’s come down significantly, but it’s still very, very expensive, natural gas, it’s still very expensive. It’s more like about $300 a barrel of oil currently, maybe 280. Europe’s, I mean I’m sure you’ve read these horror stories. So yeah, that happened at the same time that these mortgage rates were getting reset up. It’s really a very dangerous situation. Another reason why I think that we’re going to have a global recession and it’s probably going to be a rough one.

Rebecca Hotsko (31:57):

So do you see that kind of happening in 2023? I guess we talked about how you wrote this book, you started writing it in 2019, right?

David Hay (32:08):

Actually I started writing it in 2018 and it was really related to the Bitcoin. It was focused on the Bitcoin mania at that time, which Bitcoin did go down 80% after that, when I called it out. But then of course after COVID it went absolutely ballistic. And COVID had such an impact on things because of all that MMT that it created. So it just inflated, whether it’s housing prices for cryptos, or again just the long list, it just had an immense effect on asset prices around the world. So it took what was already a pretty alarming bubble and just made it truly epic.

Rebecca Hotsko (32:44):

When you started writing this then, interest rates were really low. And I guess, now in 2022 we have seen massive hikes. Prices and equities have gone down quite a bit. So I’m just wondering where you think we are in this Bubble 3.0? Has it started to pop? Where do you see us going forward over the next near term? And then maybe, which assets do you think are still in the biggest bubble?

David Hay (33:10):

It’s a goner, it’s not a question of when is it going to pop? It’s more like a question of, when is going to stop popping? This has been, and this is an amazing fact that, I know that we exchanged some emails on this, but this has been the worst wealth wipe out ever and more than COVID, more than the great financial crisis. But I guess the only other time would be that would be comparable would be the 1930s. And it’s because typically, when you have a bear market stocks, bonds go up, they have that counterbalancing effect.And that was one of the points I was making in my book early in the year, again before this really played out, was that the traditional balance portfolio was not going to lessen risk. It might magnify it because if you’re going to lose money on bonds and stocks. Then you throw in cryptos, which got up to about a $3 trillion market cap and now they’re down to about a 1 trillion. So it’s been $2 trillion loss on cryptos, which not a lot of older folks, like me have, but I think a lot of your contemporaries probably were dabbling in cryptos. And so then you’ve got real estate, which is down [inaudible 00:34:09]. So people are just getting pounded from every direction.

(34:11):

And that’s why I think that, and it’s amazing and in this regard, that I don’t see a lot of panic out there right now. In fact, if you, well institutional investors are quite conservatively positioned and I think you could say they have pretty bearish sentiment, which should be bullish. When most investors, even the professionals, are really bearish. That’s kind of a contrarian buy signal. But where you haven’t seen that, is with smaller investors, who have continued to buy. No capitulation whatsoever and nobody going, I just don’t hear the hammering or the focus on what I just said, that this has been the worst wealth wipe out ever.

(34:48):

There’s just kind of a remarkable complacency, considering the damage it’s been done, which is another reason I don’t think the worst is over, unfortunately.

Rebecca Hotsko (34:55):

So do you think that we would have to start seeing those retail investors starting to sell first? Because it is interesting, how, you’re right, we haven’t seen that in the markets yet.

David Hay (35:04):

No, we sure haven’t. And I think that’s got to happen before we have a really durable bottom. But I did answer your question about, would assets benefit? And another thing to be aware of why this year has been so painful, is what’s happened with the dollar. And that’s something I totally whiffed on. I did not think the dollar would have this kind of appreciation. Michael Kao, the urban cowboy, has called it the wrecking ball dollar. And I think that’s a very apt way to describe it.

(35:31):

So as the dollar’s gone up, it’s crushed a lot of assets, which frankly, are good things to hold in a world where we’re running out of the ability for fiat currencies to be created at will, to constantly paper over these various problems that we’ve got. And that’s why the Fed Put isn’t happening right now, is because the inflation’s running so high it’s kind of got them, the Fed particularly up. But I think all other central banks are in a real bind. Because I often said they printed themselves into a very tight corner. But the dollar going up has hurt recently energy prices, which are still very strong. That’s been one of our better calls is to be overweight energy because it has done so well this year. Did great last year.

(36:13):

In fact, over the last two years it’s up 165% versus the S&P, up 11. And two years ago, nobody wanted to touch energy, was considered to be uninvestible. But things like gold mines, which were phenomenal in 2020, coming out of COVID, have been crushed. Aluminum producers have been crushed, copper producers and copper’s going to get tremendous demand for EVs. There’s going to be an acute copper shortage eventually, but right now, economic fears and the strong dollar are just trumping all that. Emerging market bonds have, some have done okay, but a lot of them have come down really hard.

(36:46):

The dollar truly has been a wrecking ball. But I think that’s the good news, is that it’s really depressed a number of these asset classes that should do very well, if you believe as I do, that eventually the Fed’s going to have to relent. They’re going to have to first of all, pause, then I think they’ll help do something like we described with buying corporate bonds with some of their portfolio runoff. And I think, before too long, they’ll have to start cutting interest rates. Because if you get, and I know I mentioned this earlier, but just to reiterate, if you get a true market crash then inflation just kind of goes away almost overnight and people really do start worrying about deflation. I think we’re going to have a crescendo before too long here.

Rebecca Hotsko (37:23):

What do you think is driving such the strength in the dollar? Because as interest rates go up, there is kind of that historical correlation, where exchange rates, it should go up a little bit, but why is it rising so much?

David Hay (37:38):

Another really good question on your part, it’s tough to give you definitive answer and I’ve got some suspicions. And I believe that there has got to be some kind of massive short position out there on the dollar. I hear a lot about the euro dollar market, which I’m the first to say I don’t understand very well. You probably know more about it than I do. We’re partnered with Gavekal, which has got a great, the Gavekal research is not well known to retail investors, but among institutional investors they’ve got a tremendous following. And even they’re kind of perplexed by what does it really mean? And my partner Louis Gave, believes that the short position is more in the US rather than overseas. I don’t know.

(38:09):

But in my career I’ve never seen a situation where you have so much inflation and so you’ve had exploding inflation, we’ve had exploding trade deficits in the US, record breaking trade deficits and yet the dollar’s been on fire. That just doesn’t compute. And that’s what I missed is that I, because I believe that on a long term basis what you want to do, and this is stealing from my buddy, Grant Williams who stole it and turn from Tony Deaton, I don’t know if you know Tony, but a brilliant man of, Mason, Switzerland and he says investment scarcity and what isn’t scarce? Well it’s certainly not fiat currencies that have been produced in trillion dollars, just at will by the central banks. It’s certainly not in the government bonds, that are basically just another form of fiat currencies. So I think you want to own things which are truly scarce, that can’t be printed and which are going to have unusual demand drivers, and copper’s an example.

(38:59):

But I think we’re in a long term, this is where it would be similar to the 1970s because there are some parallels with the 1970s and the chronic energy shortages, recurring energy shortage of the 1970s, I think is what we’re seeing today.

(39:12):

Obviously Europe is just in a horrible situation, but it’s not just Europe. I mean China is short of oil. They consume a lot more oil than they produce. Now I know they’re going to get a lot of cheap Russian oil else so that helps them. But Japan is short of oil. Even America is short of oil because, only because of our SPR releases. So as you know, Biden administration has been releasing a million barrels per day. That’s a lot. So they’ve got the SPR down to just rock bottom levels, alarming levels. And then of course, Europe’s got a huge energy shortage.

(39:40):

So at some point, and actually what’s happening, Europe’s pretty fascinating because they are correctly switching over a lot of their electricity production where they can burn oil instead of natural gas for coal. It’s never happened before because oil was always more expensive than the coal and gas, but now it’s flipped. And so they rightfully, are preparing because you can also get oil over to them quite easily. It’s a lot easier to get oil from America or Canada to Europe than it is natural gas, which has to be cooled down to like minus 270 Fahrenheit and ship it over there, then re gasify it and they don’t have a pipeline network. But oil you could get in all those different ports. But amazingly, and I’ve written on this a lot, but just it stuns me that these big energy buyers in Europe are not taking advantage of this crash oil prices that’s happened lately because of economic fears.

(40:29):

Putting that stuff aside, oil demand is running very strong, even though the global economy has been kind of cracking here for a while, over a hundred million barrels a day and a lot of that is about a hundred, sorry, about a million barrels a day of additional demand is coming because of fuel switching that I just described. Then you’re going to have the SPR going from selling to buying that’s going to be about a million and a half barrel a day swing. I think these oil prices down around 80 are silly, I think they’re going to have a major up leg and that’s not going to be the greatest thing for the global economy either.

Rebecca Hotsko (41:00):

I was going to ask you about that because you said you were investing in energy companies and they’ve just appreciated so much to maybe the point of, if you didn’t get in last year or the year before, it’s maybe overvalued now. But I guess you still think that over the next few years there’s just so much demand and lack of supply that we could see potentially, I guess, better price sign up. There’s still more to come.

David Hay (41:23):

Well you got to believe PIM is all over these because the free cashflow yields are enormous and there has been, since roughly June 7th I think was the pivot date, energy stocks been just a lot of them are down 40%, even 50%. So there’s been a tremendous selloff and yet they’re generating these enormous amounts of excess cash, and in many cases, paying really large dividends and buying back shares and paying down debt. And what they’re not doing, is investing in producing new oil and gas. I mean they’re doing a little bit of it, but not a lot. You still have this tremendous crash that’s happened in capital spending in the oil and gas industry and they’re under tremendous pressure from ESG and try to get a pipeline built. I mean it’s one thing, find a hydro carbons, you got to get them to market and this whole amazing standoff over the Mountain Valley pipeline in Pennsylvania and West Virginia, it’s just, that thing’s like 95% built and they still won’t get it completed.

(42:18):

So, I think you’re just going to see this chronic shortage of energy because of underinvestment, for a variety of reasons and yet the need for it is still going up. And you look in Europe right now, and what’s fascinating is do a Google search for chopping wood in Germany. I mean it’s just snoots what’s happening in Europe right now. And then they also, forgetting chopping wood, they also were using wood pellets produced in the United States, but even in parts, even in Eastern Europe where they’re clear cutting these old forests to produce wood pellets that they can then burn to produce electricity. And that’s actually more polluting even than coal.

(42:52):

So some of these, unfortunately this is what I’ve called the great green energy transition, which then leads to green inflation. I think green inflation is going to be one of our persistent inflation drivers over the next 10 years. So even though I think that you’re going to have a temporary decline, just like you did in the ’70s, just getting back your ’70s comparison. There were times where the inflation rate fell drastically, even in the 1970s, but then boom, it came back up again and because we had a lot of energy inflation even back then as well.

Rebecca Hotsko (43:22):

Do you think that, I guess energy prices will be still a big and the main contributor to inflation over the next year then, as you see prices going up?

David Hay (43:33):

Yes, I think that will be one of the persistent inflationary forces. But you can get these periods where, because just like what’s happening right now, fears of demand destruction are driving down the price of paper oil. There’s the paper oil market, derivatives and futures, are like 45 times the actual physical market, which is already huge. So when you get an avalanche is selling of these paper instruments because of demand destruction fears, even though they’re greatly exaggerated, it creates these kinds of price declines. So it looks right now, we’ve actually got some energy deep deflation in the US but again, I think that’s going to turn around over the course of the next year, maybe even sooner than that.

(44:10):

So yes, I think that is going to be a persistent inflationary forcing. But you’ve also got re shoring, we’re moving away from just in time inventories to just in case and as people, or companies want to have more inventory on hand, but they’re also relocating from lower cost venues to a higher cost. And one of the amazing factoid I saw here recently is, Japan labor costs, probably because the Yen’s crashed, are actually lower than China’s.

(44:34):

So there’s going to be opportunities. And I actually think the Japanese stock market is a fascinating play at this point, once we get through the worst of this global recession. Other market of course, has got nowhere for 33 years, 32 years, since 1990.

Rebecca Hotsko (44:49):

I guess I’m wondering, where do you think there is going to be return over the next decade or so? I know you wrote in your book it used to be a bond bowl and then while interest rates were so low but then you switched to hard assets. Can you talk a bit about that and maybe yeah, where you see the yield going forward?

David Hay (45:08):

Well yeah, I think you’re going to have to think differently. What has worked for the last 10 years, even the last 40 years is not likely to work going forward. However, I mean there’s been so much damage done, when I wrote my book that was very true and it was a very good warning. But I mean things have changed. You are getting evaluation restoration process going on in the US financial markets, global financial markets. But in general, I think you’re going to have to invest in non-US equities, with some exceptions. I mean obviously, energy is an area that looks really attractive and a lot of the other hard asset plays in the United States. But some of these mega cap tech stocks, which is where the money’s been made for so long, I just, I don’t think they’re going to produce much in the way of returns.

(45:45):

Probably be doing just to go sideways. So overseas, and I do think at some point, emerging market debt is going to just be a terrific return that’s been hammered. And you’ve got countries like Indonesia, where they’ve got actually pretty healthy fundamentals and actually an inflation rate that’s below the US and much higher yields even than we have currently. But I would look to just getting back to that theme of scarcity, where is there scarcity? And I brought up copper before. I think fertilizers are interesting play, because if natural gas is going to stay high, kind of long term, which I think it will, it’ll fluctuate. But in general, I think the trend is up in the US now. Europe’s different prices are so high over there. I’m not saying they’re not going to correct over there, but if you look at summer, natural gas, summer of next year, natural gas in the US, it’s 3 to $5. That’s a heck of a bargain, relative to the rest of the world.And that does relate to fertilizers because fertilizers use a lot of natural gas. And so yes, I think there’s a number of areas to emphasize. And again, I would be focusing on those that have been crushed because of recession fears and there are a lot of those.

Rebecca Hotsko (46:50):

I’m wondering what do you think about Gold? I know that some would expect it to perform better than it has over the year. What are your thoughts on that? Do you think it’s a good safe haven asset right now?

David Hay (47:03):

Oh boy. Yeah. Another one of my not so good calls, though we did take profits on earlier in the year. Because it did, there’s a time where the Gold Miner ETF was up 25% this year. Even though the market was down about 10, at that point. But since then, again this wrecking ball dollar has just destroyed, especially the mining stocks. But even Gold has been weak as well. But it is interesting, if you look at it in other currencies, it’s been a good store of value. It’s done, if you’re a Yen investor, if you’re a pound sterling investor, a Euro investor, Gold has been a pretty good place to have your money. In a world where almost everything has gone down in price, it’s actually gone up in most of those currencies. But in the US, again, the wrecking ball dollar has been just really top on the price of Gold for American investors.

(47:46):

So I think that why it’s so critical to be thinking about when does the dollar peak out and reverse? And I do think it’s kind of like I was feeling about the crazy overpriced stocks last year, the higher they go, the worse they’re going to come down. I think the more the dollar goes up, it’s already very expensive, way overpriced on a, what’s called the PPP, purchasing power parity basis. At some point, that matters. And there’s really nothing more mean reverting over time than currencies. Because when your currency gets really expensive, then people don’t really want to buy your products. And so that tends to make your trade deficit worse, which is already terrible.

(48:19):

So at some point that’s really going to be the key thing I think, for the financial markets. When does the dollar turn down? When does the dollar break? When the dollar breaks, a lot of things are going to go screaming higher. A lot of these hard assets that we just talked about, but even a lot of these emerging markets and other overseas markets, the high dollar is, basically is telling us that we’ve got a global liquidity crisis underway. And I think we really do. As I said earlier, few times, I think we’re getting close to where it just kind of gets to the grand finale, like a fireworks display.

Rebecca Hotsko (48:49):

I want to also ask you about bonds because typically millennials don’t think about adding bonds to their portfolio. But I guess, as we kind of write about in your book how bonds were kind of the biggest bubble in the biggest bubble of all time, when interest rates were low. But now that they’ve been rising, yields are spiking, prices are decreasing. When do you think is maybe a good time for millennials to consider buying some?

David Hay (49:15):

Well, I’d say we’re probably pretty close to that. I think it certainly makes sense to be kind of gradually dipping a toe in and buying some of these. We particularly like BB, well BB minus to BB, but where the best value tends to be is with BB rated bonds. So those are the ones that are right below investment grade because they typically have very low default rates, less than 1%. And you can get six, seven, 8% with those types of bonds right now and with kind of intermediate term maturities, not 30, 40 years.

(49:43):

But I think when we get to a point with some of these types of instruments, where you want to actually be going further out, you know what they call extending duration, going at longer maturities because you want to walk, you’re getting 8% yield. And Ford Motor Credit, Ford Motor, the parent company as well, their debt is trading at like 8% yields. And so, when you’re getting that kind of yield, I think you want to walk in for a longer, rather than shorter time. So much of what we’ve done recently for our clients has been be short term because we thought rates were going to rise, which they obviously have. Be floating rate because if you’re in floating rate instruments, then you’re getting a rate increase as these rates go up.

(50:19):

But I think we’re getting to the end of that game. I think it’s time to start reversing that and extending maturities, extending duration. But I’d rather do the credit analysis and get a six or seven or 8% yield and buy a 10 year treasury at 3.8, or wherever it’s today. Somewhere around there.

(50:35):

I just say, I think millennials can do that. And if you don’t want to pick the individual bond, because it’s really tricky to do bond investing as a retail investor, but there are some funds out there, ETFs that are really effective in that. PHB is one that looks attractive. ANGL, which is the fallen angel, that’s a lot of BB rated bonds. We like that portfolio. And then, the mortgage backed security has been absolutely crushed. So Vanguard’s got the MBS and that yield is probably going to wind up being in the five to 6% range here relatively soon. But anyway, those are a few ideas that you can do pretty easily with just with a Schwab account.

Rebecca Hotsko (51:10):

Yeah, thanks for sharing that. I think it’s kind of hard for us to maybe wrap our head around how to get exposure. That’s a whole nother universe, like you mentioned about bond investing. Thanks for sharing those. I also want to ask you, I think our last question for the day will be about the passive index bubble. So you wrote about this in your book, and I just thought this was fascinating because I hold ETFs as a part of my portfolio. I think a lot of our listeners have a portion too. I was so interested when I read about this chapter and where you see the major problems with the passive indexing and the bubble it’s created. Can you talk a bit about that?

David Hay (51:48):

Absolutely. So indexing works great in both markets because with a typical index fund, I don’t know of one that’s different than this, they don’t hold cash. So you’re fully invested all the time and you also get those kind of amplification effects. Let’s say it’s what we had for so many years, the FANGS, Facebook and Amazon and Netflix and Google. And sometimes you would throw Microsoft in there too, but really those mega cap tech stocks, just kept going up and up and up. And so the index funds, by definition, have to buy more of them because they just simply replicate. So if Microsoft goes from 2% of the index to 5% of the index, that index funds going to have 5% of its portfolio in Microsoft. So as it gets inflows, those inflows go disproportionately toward those mega cap tech names. And so again, it just kind of feeds on itself.

(52:33):

But then it leads to extreme overvaluation, which is what we saw when, 2 trillion market caps. I mean that becomes pretty hard to justify even for a truly great company. And then the prices start coming down. And where it’s going to get ugly is when you get the opposite of the persistent inflows and you actually get outflows. Like we were saying earlier, there hasn’t been that fear yet, there hasn’t been capitulation. So if you start to get big outflows from those index funds and they’ve got to start selling those and who’s going to be on the buy side? I mean you’re talking huge amounts of capital and these big positions that really nobody has the ability to take off their hands. So it’s worse than being price insensitive. It’s more like the bigger the price, the more we have to buy. We have no choice. And it’s a no think approach.

(53:20):

And it actually happens with bond indexes as well. There are passive bond funds out there too. And there it’s really silly because you’re putting more money to the most heavily indebted companies because they have the most debt outstanding. So if you’re trying to replicate, that means you’re going to have the most exposure to the most heavily indebted companies, which is not what you want to do, really.

(53:39):

So this whole idea that you don’t have to think, that you can just ride the wave of the indexers, Milton Friedman said there’s no free lunch. And if you’re going to go that way, it’s certainly cheap and it does, works great in bull markets, but in bear markets, I think it’s just a disaster in the making. And I think we’re seeing it unfold before our eyes. So yes, you can tell I’m not a fan, especially at a time like this.

Rebecca Hotsko (54:03):

So then what do you think investors can do? They just have to be more active with their approach and pick the winners? This is the time to, I guess, pick stocks more than ever?

David Hay (54:13):

Well, I think so. I think you’d want to look at areas where most investors are underweight, precluded, and where the fundamentals are strong. And I can’t think of any area that’s more representative of that than energy, or where just so many people say, I won’t buy it because it’s environmentally harmful. And I think that’s simplistic and I think you’re leaving a tremendous amount of return on the table to believe that. But I know that there are people that feel very strongly about that.

(54:36):

But if you look at the United States, we have improved our air quality by 75% over the last 50 years. And we’ve largely done that by shifting from burning coal to using natural gas and renewables. And I certainly think renewables have a place in people’s portfolios. We’ve actually made good money with renewables. I think copper is one of the more fascinating ways to play that because if its essentiality in terms of the EV, we can have millions of new EVs on there, they use so much more copper than their traditional internal combustion engine vehicle.

(55:05):

There are a lot of areas out there that actually look quite compelling. But just to reiterate, the problem is when you’re going into a global recession, a lot of those things are by falling demand during a recessionary period. So I think one of the things I’ve said in our newsletter repeatedly, is to buy but buy slowly, keep huge cash reserves on hand. I really prefer government bonds, short term government bonds because these money market funds still pay almost nothing. I think that’s certainly something your listeners could look at, is where can I get a decent return and still be highly liquid? As opposed to leaving it in the bank and almost nothing. And there are ETFs like SPST, which are short term treasuries, where you’re going to get the benefit of these rapidly rising short-term interest rates.

(55:46):

S-H-Y, SHY is another one that offers that as well. And you were saying be it more active. I absolutely agree with that. I think this is a time where traders are going to be rewarded if you’re typically, you say, well, they’re the ones, the old saying is that investors drive Cadillacs and traders drive Chevrolets.

(56:01):

But in this environment, I think a buy and hold doesn’t work that great. I think you need to be willing to set it by the dips, sell the rips, sell into these bear market rallies, which we had several of this year and we were pretty vocal about doing that. Take profits, reduce your exposure, and then buy to the panics. And I’m afraid we’re on the cusp of the mother of all panics, or at least the biggest panic that we’ve had since 2008. If we’re going to be an environment, again, getting back to your analogy, the 1970s, where the market really doesn’t go anywhere for a long period of time and in real terms, it actually goes down. But you could have made really good money in the 1970s if you did sell the rips back then and buy the dips. And I think that’s the kind of scenario we’re in right now.

Rebecca Hotsko (56:41):

That was so great. I think that we will end it here today. But before I let you go, can you let the audience know where they can connect with you, learn more about you and everything that you do?

David Hay (56:55):

We are, my brand name so to speak, is Haymaker. So if you go to haymaker at Substack, you can see us and we do write two free newsletters. So for your listeners that want to get free education, some of it’s very market specific and we actually put out trading recommendations on a regular basis. We have a model portfolio and we also, so that’s on Monday, it’s called Making Hay Mondays. When we do the Haymaker, which is more of a big picture, kind of macro think, type of piece that we put out on Fridays, often with a guest author, many times from our friends at Gavekal. So that’s, again, we really encourage people to subscribe. You act, we can’t do that for you. You have to go there and subscribe, but if you like free, it’s there.

(57:38):

And then as far as the Bubble 3.0, we have, I think by the time this will be sent out to your listeners, we will have a site where you can actually buy the book in hard copy form. Right now you can get the audio book at Awesound, A-W-E-S-O-U-N-D. And the code there for a discount is M-I-N-D-E-S-T- 33. So Rebecca, thank you so much.

Rebecca Hotsko (58:03):

Thank you so much, David. All right. I hope you enjoy today’s episode. Make sure to subscribe to the show on your favorite podcast app, so that you never miss a new episode. And if you’ve been enjoying the podcast, I’d really appreciate it if you left us a rating or review. This really helps support us and it’s the best way to help new people discover the show. And if you haven’t already, be sure to check out our website, theinvestorspodcast.com. There’s a ton of useful educational resources on there, as well as our TIP finance tool, which is a great tool to help you manage your own stock portfolio. And with that, I will see you again next time.

Outro (58:43):

Thank you for listening to TIP. Make sure to subscribe to, we Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin. And every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by the Investor’s Podcaster Network. Written permission must be granted before syndication or rebroadcasting.