The Joe Walker Podcast - The Price Of Uncertainty - Chris Joye

Episode Date: March 26, 2020

Chris Joye is Founder and Co-Chief Investments Officer at Coolabah Capital Investments. He is also a Contributing Editor with The...See omnystudio.com/listener for privacy information.

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where you'll get 25% off an annual subscription and you get to try Blinkist premium free for seven days. That's www.blinkist.com slash swagman. Try it out. Make the most of your lockdown. You're listening to the Jolly Swagman podcast. Here's your host, Joe Walker. Hello there, ladies and gentlemen, boys and girls, swagmen and swagettes. Welcome back to the show. As always, it is great to have you back. This episode of the podcast was recorded on Tuesday, the 24th of March in Sydney, Australia.

Our guest is Christopher Joy. Chris is a fixed income manager with Coolabar Capital Investments. He's a managing editor of the Australian Financial Review, and he's a well-known financial economist. Chris is a former guest of the podcast. He joined us in early 2019 for Housing Bubble Week, where we sent him to worldwide fame. He's previously worked for the Reserve Bank of Australia, for Goldman Sachs, but I don't need to read out his whole CV because it'll come out throughout the conversation. In the conversation, we reflect on the financial and economic pandemonium of the last several weeks, and we try to peer over the

horizon, discussing some scenarios that might play out over the next year, geopolitically, economically, and financially. This is a fun and discursive chat, and I hope you enjoy it as much as I did. Without much further ado, Chris Joy. Chris, welcome back to the show. Mate, thank you for having me on the World's Best Podcast. Thank you. It's a very turbulent time. I don't have a clear agenda for this conversation, but I think we're just going to have a chat. There's a lot to chat about. Obviously, the pandemic that's unfolding around us, I think I sent you a screenshot of a message I sent some of my family back in late January. I believe it was the 26th of January.

Were you talking yourself up, mate? I've learned from the best. But I mean, I was concerned about this a couple of months ago. I don't think I could have foreseen it getting this out of control. You're well known for predicting most things. Did you see this coming? No. Yeah, we had a, as with most things, we were very data dependent. So in January, in my own portfolios,

I sold $500 million worth of bonds. I lifted, which is a net sold, which is a fairly kind of significant de-risking. We de-levered any levered portfolios and we lifted our average credit rating to our highest level ever, which was AA minus. We tend to focus on complex capital structures and something called complexity premium, which is kind of pricing complex assets. And I tend to prefer kind of monopolies, oligopolies and government guaranteed or implicitly guaranteed businesses. And we definitely have a bias towards financials over corporates. So most of our portfolio is financials but um i did have a few corporate bonds in january like uh from memory a coles

senior bond a walworth senior bond and a seek senior bond i sold them all i thought this would be very negative for corporates uh that didn't have the protection of being um a systematically important bank with government guaranteed deposits so we completely shared all corporate risk um But I can tell you right now, I remember reading your text message, as in you obviously shared that with me. I didn't have high conviction. Either way, we were data dependent, as I mentioned. I think everyone who was half smart had a sense of unease that the equity market was completely ignoring this.

And I thought that was odd. And, you know, I'm very respectful of particularly, you know, liquid market price action. And I was kind of – we were asking ourselves a lot internally, why is the equity market ignoring this? And, you know, is it the preponderance of passive money? So price inefficient money where it's price agnostic. But, you know, the U.S. equity market has a lot of information content as well. So that was creating definitely a sense of unease and conflicting perspectives.

As we moved into February, we started building real-time tracking systems which have direct API links into different data sets and basically track global infection rates country by country, every country in the world, every 15 minutes, and sort of tracking infection and fatality rates. And we set up a decision-making tree where we basically said, it looks like China's contained this, but we don't trust the Chinese data. However, we now have two new outbreaks, clear outbreaks,

in South Korea and Italy. This was in sort of mid-February. And our proposition was that if they fail to contain, that this thing would, on the balance of probabilities, go global. And at that point in time, we would have a massive regime change in financial markets. And that became clear, I think, in the back end of February, that it was going to be a global pandemic from the data in South Korea and Italy, and then just the propagation of infections in contiguous countries, particularly around Italy. We saw the disease spreading everywhere.

And basically, at that point in time, I was absolutely convinced, this is around the 25th of February, probably a bit earlier, actually, about the 23rd of February, that we were going to have a global market failure across all asset classes, the likes of which we had never really seen before, because markets have never really had to price pandemic risk. Why do you think investors were so slow to react initially? I think it's that point that you have a situation where investors and I think markets are reasonably good at handicapping probabilities around human events. And this is something I argued to the RBA, the Prime Minister, the Treasurer, and other agencies, APRA, in late February, that we're

dealing with something we've never dealt with before. I mean, Phil Lowe said this recently following the announcement of his QE program. And, you know, one of my sparring partners, shout out to all the sparring partners out there listening, I know I've got lots of lovers and no haters, but one of my sparring partners or attempted sparring partner was Stephen Grenville, the former deputy governor of the RBI, who recently wrote me a love letter in the AFR.

And he kind of was, you know, poo-pooing everything I said, even though events have subsequently absolutely 100% vindicated what I was saying. But at that time, he was saying that, oh, we have seen this before. We saw the Spanish flu and we had SARS. And it's like, dude, the Spanish flu was in 1918. Modern financial markets, fully globally integrated financial markets that are digitized with real-time information have never seen a global pandemic like this. And that's what Lowe reiterated in his press the other day. And so I think that markets, frankly, just couldn't cope and couldn't price it. There are lots of guys out there who would say,

oh, I knew this was going to happen in January and maybe they're a lot smarter than me. I felt that this needed to be data-driven and data-led and I think that in mid-February we had a sense that this was going to be a global phenomenon. But there's lots of just dealing with the reproduction rates, the R0s and the mitigation measures and there were lots of counterfactuals so yes we had first we had containment in china then you had clear containment at that in february a

clear containment in hong kong and singapore and taiwan and um to a greater or lesser extent in japan so you had containment in in the world's one of the world's most populous countries and then containment ostensibly in all these other contiguous countries. Now there's now reasons to believe that there were potentially cultural and idiosyncratic factors that they were countries that had dealt with SARS before, were very well prepared, took assertive action early on. But I don't think there was necessarily a convincing case that this had to go global at that point in time,

given you had containment. The interesting thing, with the benefit of hindsight, is if the Chinese had taken a much more assertive approach to containment in Wuhan in December, and I think more importantly if China had been much more transparent about human-to-human transmission, which they really knew about in December. And I think more importantly, China had been much more transparent about human-to-human transmission, which they really knew about in December. I mean, they took fairly,

I think they closed down Wuhan on the 23rd of January, formally, like they quarantined Wuhan and Hubei. But, yeah, I mean, it's clear containment works. And it's also clear that once you get the r0 below one you basically kill the virus because it doesn't transmit um and i think that there's a reasonable case that there was a period of time that we had to control the virus um and it was highly uncertain as to whether um you know the different policy measures and the so-called reaction functions that were employed by different nations like you know they it worked in singapore worked

in taiwan definitely worked in Taiwan, definitely worked in Hong Kong amazingly, right, given its physical linkages to China. And it seemed to work in Japan, but then obviously the – I think we were very unlucky with Chinese New Year. I mean, I think Northern Italy, you know, the intelligence suggests that there are big leather factories in Northern Italy that are owned by the Chinese that are populated by tens of thousands of Wuhunese workers. intelligence suggests that you know there are big leather factories in northern italy that

are owned by the chinese that are populated by tens of thousands of wuhunese workers and so the mobility between northern italy and china really um you know created this new uncontained outbreak and then the the the idiosyncrasy idiosyncrasies of italy where you've got an average population age of 47 you've got a cultural practice where everyone kisses each other on each cheek. You know, it's a little bit like South Korea was unlucky insofar as, you know, you had this crazy cult with 200,000 members who refused to deal with government agencies. A whole bunch of them were infected.

And even the testing regime that the South Koreans put in place for the cult, the government and, you know and doctors were not treating them. It was the cult. They did a deal with the cult, so the cult tested itself. There's a couple of other possible amplifying factors in Italy, a high proportion of smokers. Yes, exactly. And in China.

Yes, and another cultural factor. I'm not so sure about this one, but the amount of contact between grandkids and their grandparents. Yeah, I think that's exactly right. I think the smoking's important. I think we've all heard the statistic quoted that 99% of the deaths in Italy have been from people who have one, two or three prior medical ailments.

So, yeah, I mean'm i just believe in the data and you know i again there might have been if you're an expert in infectious diseases um probably you had good prize or if you're a guy that had spent a lot of time with global experts in infectious infectious diseases in um january maybe you had you know strong prize that this would go global um but i guess you know it at the end of the day it's a one in 100 year event um but we had a sense definitely in february that that um in mid-february that would go global but most importantly for us that we would have a breakdown in global financial market liquidity the likes of which we've never seen before and And that's a function of the fact, to answer your kind of earlier question, that's a function of the fact that markets can handicap human events and human probabilities.

So I think markets are pretty good at pricing trade war risk, Brexit risk, Grexit risk, you know, Eurozone, sovereign crises, subprime lending risks lending risks tech you know bubble risks eventually right um but trying to price a global pathogenic pandemic you know a novel coronavirus a virus we've never seen before um that scarily originated 900 feet from a level four bio potentially weapons lab right what's your subjective probability that the virus originated from that lab rather than from the bats or the wet market 50 50 yeah wow that's pretty high well i mean they were advertising publicly for uh postdoc researchers in coronaviruses and their transmission from bats and we still haven't found patient zero yeah they don't exist and patient zero apparently

according to one study i saw didn't actually attend the wet market so and then we have obviously the two chinese scientists that were apprehended leaving with i think coronaviruses from a canadian biofacility so they're looking to appropriate them but yeah i think this is unfortunately probably either legitimate medical research or military research gone wrong i think the balance probability is 50 50 i think that you know there has been and i'm not an expert on this but there's been research published that there are mutations in the coronavirus that make it very different to other coronaviruses and relate to its infectious capacity that i think derived from hiv um so i'm quite enjoying it's a little spooky but it's interesting how this is now morphing into a geopolitical kind of set of frictions where trump is taking

taken to i mean originally everyone called it the Wuhan virus. So this is a pretty good montage that Trump's tweeted out of like all the center-left US media outlets who in January were referring to this as the Chinese virus or the Wuhan virus. And then when Trump started using the same language, he's been accused of being xenophobic. But it's clear that this is really going to amplify geopolitical tensions between the two superpowers and i also think this will deal an irreversible

blow to both uh xi's um domestic constituency it doesn't mean he's gone but i think it definitely deals a significant blow to his control and constituency and also China's claims to global geopolitical credibility. And then finally on an economic level, I mean everyone is talking about the fact that we need supply chain diversity and the decoupling that we're getting. The trade war was obviously about decoupling the china u.s supply chains because you know economic risk and uh national security risk had become indivisible so the u.s the hawks in washington were hell-bent on shifting supply chains out

of china and this is just going to accelerate that um i don't agree with andrew chilton's op-ed he's probably changed his view um that it was just a supply shock? Yeah, that's complete bullshit. I like Andrew a lot. That's probably obsolete by now. I'm sure he agrees it's a simultaneous supply and demand shock. I can't represent his views. I wouldn't want to speak on his behalf. But all I know is what he's put in the public domain, I guess. But Andrew's a super smart guy, was a really, really close friend of mine.

But yeah, the idea that this was fiscal policy and monetary policy can't do anything about this because it was just a supply chain shock was obviously intellectually redundant the day that was published. I mean, the supply chain shock was clearly a very short-term, reversible issue. We track live traffic congestion data across all the major chinese cities and they're pretty much back online so you know people say electricity production in the factories is being artificially inflated but you can't lie about the cars on the road

and we're seeing during the work week shenzhen tianjin beijing they're basically at or above 2019 average congestion levels on the weekends it's interesting in beijing um you know it's clear that people are not out on the weekends nearly as much as they used to be but again in the industrial cities like shenzhen um they are uh weekend levels are kind of almost back to normal so i think china's back to work and chinese supply chains will be fully back online within a month so i was never particularly concerned about that. I think the real concern, which is what I argued to the RBA and the Prime Minister and the Treasury in February, is this is not just about a supply chain shock. This is about a completely unprecedented global synchronous demand shock.

And the problem is, and actually I wrote this in some analysis that I sent to them, that the issue is the politically rational, sorry, the socially and economically rational solution was probably always some form of mitigation. So maybe there's a very short-term containment followed by mitigation, depending on the, you know, the trade-offs between, you know, the, I guess, human costs and the economic costs that you want to make. But definitely there's a case that the Chinese went to mitigation quite quickly, subject to the question of whether their mass use of chloroquine has actually really helped them

more or less eliminate fatality rates, which we'll talk about later. But if you took the view that it was politically unacceptable to move to mitigation, and wiping out a big swathe of your elderly population was going to force you politically into potentially a suboptimal strategy of extreme containment, then that was kind of, as I said at the time, economic suicide. And what that necessitated was really assertive, really rapid and more or less unrestricted fiscal and monetary policy support to provide a bridge. I actually came up with that term in letters to the RBA

and they subsequently adopted the language. But this idea that we had a time gap, an air gap, however you want to describe it, between now and when vaccines are available, which will be in about 12 months. I was speaking to Professor Michael Good, who's working on a coronavirus vaccine, two nights ago. And he said, you know, there's 20 to 30 vaccines in the works. There'll definitely be one available within 12 months and they will work.

So they're very confident the vaccines will work. What's the probability we could get one sooner? I think high. Just park that thought for one sec though. But my point to the RBA and the government was you've got this big time gap and fiscal monetary policy need to create a bridge between now and that future point of stability because markets can't cope. Markets can't price the risk of a global pathogen, destroying global economic activity, and markets will fail. So you'll just get extreme illiquidity in bond and equity markets. Governments will fail, banks will fail, unless you do something really, really quick. Unfortunately, they didn't heed that advice initially. I think they thought

I was being alarmist, but three weeks of pretty crazy market price action bent governments to the market's will, and we now have unrestricted liquidity and QE support. I think on the probability of an early vaccine, I have a hypothesis that I think Xi will want to kind of position himself as the saviour of the world. So I think the Chinese will test and produce a cheap vaccine relatively quickly. They also don't have necessarily the same ethical hurdles that other nation states face. So whether that'll be FDA approved, open question. But I think you'll see vaccines quickly, like within six to nine months would be,

if I was to bet on it, I'd say at least within nine months. Having said that, like full FDA approved and Australian sort of approved vaccines are probably, I think a reasonable case is 12 months. I want to come back to something you mentioned earlier in the conversation about the domestic consequences politically for Xi. There's a counter argument to say that he'll actually do quite well out of this domestically because it illustrates the strength and the effectiveness of the Chinese system in contradistinction to places like Italy, potentially the US. Yeah, I mean, I think that's a credible argument.

I think that's a credible argument. I think, I guess, so that's one perspective. Another perspective is, you know, the Richard McGregor line. McGregor has written recently a book for the Lowy Institute on President Xi and his rising, the rising sort of wave of enemies that he's created within China because he has systematically dislocated so many of his adversaries that there's tremendous latent antipathy towards she

and it really just requires a catalyzing event to galvanize all of that animus potentially to remove she so that that's maybe I haven't done justice to his thesis, but that was kind of what I got away from or I took away from his book. So my view would be, from what I've read, that mainstream China feels that the government censored a lot of the early information regarding the outbreak in December and in January. And that censorship, which is a sine qua non for CCP security and stability, so that societal control has proven itself to be an inherent point of fragility for China. And then that then required extreme measures to contain and control an outbreak that should have been controlled

through more open and transparent processes. And we know that the doctors that were the whistleblowers have been lionised by the Chinese community, if you believe, some of the media reporting on that so i think that um yeah my view would be that his constituency and legitimacy in china is undermined by this i do think that they'll spin it and they are aggressively spinning that their reaction function has been much more effective and successful than anyone else in the world, say, for South Korea, but also anyone who looks at that data. I mean, those curves are clearly

doctored. So I think the credibility of the containment is open to question. And I think my view is China's just moved to mitigation. And they have a medical mitigant in the form of chloroquine, which seems to be very effective, and hydroxychloroquine. I think it's interesting they're not promoting that. So rather than saying we've got medical mitigants that really radically reduce the probability of dying from the disease, what they're really promoting is, oh, we've contained this and it's eliminated. There are no new infections.

There are no new deaths. It's actually actually all imported i think that's probably bs i think they've got good mitigants in place and they've got good um social distancing measures in place like if you're in a lift in beijing you've got to stand you can only four people will lift lift and you've got to stand in certain positions within the lift at a certain distance from one another likewise in restaurants you're not seeing again in the beijing traffic data you know much movement on weekends so there's still a kind of quasi lockdown on public gatherings and activities he still hasn't held his whatever it is like the national popular conference that is the gathering of the key ccp members that is meant to be a signal that you know life is back to normal she did personally visit wuhan which was meant to be a signal that life is back to normal. She did personally visit Wuhan,

which was meant to be another signal that life was back to normal. And then I think the key point is that China's you know, tenure and constituency in the broader world has been, I think, irreversibly undermined. I mean, I think the rest of the world's attitude towards China has fundamentally shifted. And it all comes back to the CCP's visceral need to control information flows and to produce propaganda. I mean, the Americans have clearly been really upset that Xi and the CCP have been pushing this message of late that it was a US virus. And so Trump's just doubled down. So in every single press conference, every single day,

he starts out by saying, you know, the Chinese virus. And so they're now calling it the Chinese virus. They weren't. They were calling it the coronavirus. And this is where the classic Xi, he always overreaches, right? So a stupid strategy of trying to kind of pretend that it didn't originate in wuhan really forces the rest of the world to take an even more assertive countermeasure which is actually the whole

world now refers to it as the chinese virus or at least you know more aggressive nation states will what's the evidence they're using hydroxychloroquine at scale? Well, I've seen evidence that the standing instructions for doctors in China for treating the disease, whether it's a mild form of coronavirus or an acute form of coronavirus, is the application of chloroquine phosphate. Now, for those listeners, and probably quite a few of you who don't know what we're talking about, just by way of of explanation chloroquine is a 40 year old drug that is used to treat malaria um now uh so it's available everywhere in the world it's cheap it's not patentable uh it can be mass market uh produced um and it's quite effective against

malaria uh the problem with chloroquine one claimed criticism of chloroquine is that if the dosage is too high, it can be quite dangerous. So there's this report about how a Wuhu and Ease chick took like shitloads of chloroquine and had big problems, was admitted to emergency. Hydroxychloroquine is a synthetic derivative of chloroquine, which is much, much safer. And in vitro, which means in a test tube, when they put the virus, the coronavirus, in with chloroquine and hydroxychloroquine, they both kill the virus in vitro. Hydroxychloroquine, I think, is even more effective than chloroquine.

And that's actually, that research was originally produced in China, I think in February or March. And so, yeah, my understanding is standard medical instructions in china are to treat it with and you know antiviral sorry respiratory antibiotics in combination with chloric and phosphate um and i've seen sort of photographs of those standing instructions so i believe it's you know um being used on a widespread basis in China. Certainly it's public that the Chinese have, I think, up to seven to ten clinical trials of hydroxychloroquine running live. As they do, they've got some trials of the Gilead science drug Remdesivir,

which is a different approach but also appears to kill the virus. It also appears to be very effective. They use Remdesivir on 14 US patients who came off the Diamond Princess and the US doctors who treated them were blown away. They said that basically all 14 were on the deathbed. Average age was 75 and all 14 survived. Half had made a full recovery. There's also the French are using hydroxychloroquine in some of their hospitals and

one of the world's leading infectious disease experts has published a small paper on a clinical trial in France of about 40 patients 26 of whom use hydroxychloroquine and the results looked spectacular he's a very very respected infectious disease authority and he said it was very, very compelling, the evidence. And then in a paper that we've written on this, which is available on Livewire or on my LinkedIn page or at our coolaboutcapital.com website, and this paper's about forecasting the peak in US

and Australian COVID-19 infection rates. In that paper, I've got links to a video interview with him and also links to a physician in one of the New York hospitals where they've treated 100 patients with hydroxychloroquine and he claims they've had spectacular success. None of them have died. So we only get the results. It's FDA. The drugs, the other thing about chloroquine

and hydroxychloroquine is their existing drugs so hydroxychloroquine is used to treat autoimmune disease lupus um and rheumatoid arthritis it's cheap it's publicly available they've got stockpiles of it they haven't got enough to treat the world but they're all the big pharma companies are massively increasing production um and i as i it, the FDA has approved for compassionate use. Hospitals can apply it for all patients. You just can't get it, I don't think, yet off the shelf for COVID-19. So it looks promising, although so far all the trials, or at least the French one and the American one,

are very small and non-randomized. Correct, yeah. Non-randomized, small. But what I would say is that there's a big US trial, I think, with 1,500 patients that's running live right now with hydroxychloroquine. And as I mentioned, there's seven to ten Chinese trials. And I believe, so Trump about, so had a prior uh a couple of weeks ago that because this is a potential game changer right if we get a an antiviral that kills the virus

um then potentially you just go to mitigation as in no containment you let people get infected and if they're really sick they have some hydroxychloroquine with the an antibiotic called z-pack and it's all good right now what they can't fix i understand is if you if they don't know you've got coronavirus or covid19 which is the disease caused by the virus if they don't know you have it and you get really really ill and it destroys your lungs um there's a certain point i think after 14 days where i think uh hydroxychloroquine won't be as effective. So they've got to get it relatively early. Although there are reports coming out of U.S. media just in the last 24 hours of guys who have been on their deathbed who have been kind of had a miraculous recovery following using the drug.

What were we talking about? Rabbiting on on we were talking about hydroxychloroquine oh so I had a theory so so the theory was the theory was

well why aren't we hearing about this this is actually really important oh yeah yeah so you know

we knew about this a few weeks ago and why weren't we hearing like nation state leaders talk about this and I was kind of gaming through this thinking well this is weird you've got a couple of drugs one which is publicly

available two which are publicly available which could kill the disease so why wouldn't you just come out and say dudes we've got a solution don't panic don't freak out so there's a few explanations one doing so would create a huge run on the drug trump did so last week and it has created a huge run on the drug you can't get it now in pharmacies in the US or Australia. So people who have lupus or autoimmune disease, they can't get it. Or malaria, can't get it. So that's probably one sensible reason. A second sensible reason is you need to ramp up production capacity. And that's still probably, I think, one, maybe two months away from being able to, for example, fully treat a

mass market infection in the US. I think they have existing stockpiles to treat about one and a half million patients in the US, which sounds like a pretty big number. But if you think like, you know, 60% of the population is going to be infected, you're going to need a lot more. So what that then tells you is actually you still need containment. You still need to flatten the curve. You still need to reduce the R0 from 2 to 3 to hopefully below 1. And then whilst you're simultaneously ramping up production capacity, you can, over time, you elongate that curve and you can treat sick patients

with sufficient quantities of hydroxychloroquine. Another explanation is that if you come out if scomo came out and said or let's say scomo came out and said we have a cure pubs and clubs stay open party like it's 1999 all that's going to happen is the arnold's going to go through the roof right so in a way paradoxically telling people and giving them the certainty of a cure is actually going to massively amplify the problem. So you can't talk about a cure in a way, right? You kind of got to stealthily roll it out and contain if you want to avoid mass infection. I think Trump is different, though.

So the UK, about a week ago, banned exports of hydroxychloroquine to other countries. Trump, the calculus is very different, I think, for him vis-à-vis other nation states. Trump is petrified about the share market cratering. He's got a November 2020 election. A very smart investor of mine who I'll call the Jedi said to me that the best thing in the world, the most important asset the world has going for it in this crisis

is Donald Trump. Because if there's one guy that can find a silver bullet and who's motivated to find a silver bullet, it's Trump. Now, I believe Trump and the FDA and the White House have access to all the real-time information on the clinical trials. There's no reason why they wouldn't. So the real-time 1,500-person trial in the US and the real-time Chinese trials. So I think what happened last week is they've got really good data and

trump held a press conference i think on thursday last week with the head of the fda maybe it's friday morning our time and the head of the fda and the head of the fda was kind of egging him along i mean he was pulling him back slightly so trump Trump said, we've got a solution. It's FDA approved. It's going to be available immediately. This drug works. Head of FDA said, yep, it looks very encouraging. Yes, it's exciting. We don't actually have it FDA approved for pharmacy use. We have it FDA approved for compassionate use, right?

But we're hoping to get kind of public use approved soon. There's no safety issues with the drug, right, because it's already used for lots of other things. It's just whether it has efficacy against COVID-19. And then Fucci, his doctor who's come out, and he's undercut him a bit more aggressively. I don't know. I think he's been – personally, I think the other doctor

is being a bit of a smartass. He's kind of pulling back on Trump a bit more aggressively. This is the one time in his life when the entire world is listening to what he's saying. So you often see this with central bankers. Like, why on earth would Powell get up there, cut rates 50 basis points in early March, and then say, I'm not going to do QE? When it was obvious to us in late February they were going to be forced to do unrestricted, unprecedented QE.

He says that, he blows up markets. Why on earth does Christine Lagarde get up there, the president of the ECB, start a little bit of QE and then go out and say we're not here to put a lid on the spreads on government bonds or corporate bonds? She just blew up her bond markets instantaneously and within 24 hours had to apologize and the ecb had to issue a statement contradicting what she'd said and and basically stating the ecb's mission is absolutely to control spreads and borrowing costs so smart people make these mistakes and i think what's happening right now is i actually think trump's right but his doctors sort of you know just trying to the other thing is actually the doctor could be playing that longer game

where he's saying to himself, I don't want to rev up community expectations. There's a solution here. Because everyone in America is going to say, fuck staying in the house. You know, again, we're going to party and there's no problem because it's a drug. But the truth is, if the whole American population gets infected, there won't be a drug, as in there's not enough of it yet. Yeah.

Assume that hydroxychloroquine is the solution, and I have no judgment on that, population gets infected there won't be a drug as in there's not enough of it yet yeah assume that hydroxychloroquine is the solution and i have no judgment on that but assume that it is how long would it take for the trial to finish how long would it take until the authorities are confident that we have enough evidence that it's safe that it works and that we can then scale up production i think the trials are expected to be completed in apr. Okay. Yeah, and Remdesivir, which is intravenously applied and is not as simple a solution as hydroxychloroquine, which is meant to be as effective, if not more effective. It's phase three trials.

It's running phase two trials in the US and phase three trials in China. They will be finished in April. So the Chinese government's actually issued a media release saying we're going to release the results on, I think, the 28th of April. And I expect the hydroxychloroquine trials will be finished in April as well. I think that's the base case. Production's already been ramped up. I think you'll see within a couple of weeks an FDA approval.

So I think this will be approved fast. But it doesn't kind of I think the medical advisors and the policy advisors are sort of saying hey let's not talk this up now because it's going to cut against the grain of containing it it's like the problem we have in Australia you know everyone's romping on the beach at Bondi you know pretending like nothing's happening and you've just got a horde of super spreaders that are merging. Whereas we want to get the R0 down. We want to get that.

You want to flatten that curve and then roll out hydroxychloroquine and remdesivir and other antiviral solutions over the next few months and just deal with it that way. Yeah. So let's try and peer into the future a little bit. Maybe we can limit the scope to Australia and the US just for convenience. Probably the two most important countries for our listeners um the first thing i want to stress is that you know the strike rate of the virus the r naught the fatality rate none of these metrics exist in a vacuum they're not set in stone they're affected by the government's countermeasures you know we could we could turn the r naught to zero today we just told everyone to sit in their rooms indefinitely.

Obviously, that's implausible in practice. But what happens from here totally depends on the decisions of governments and, to an extent, individuals. The second thing is I think it's fair to say that in the absence of a hard lockdown, you're not going to get the R0 below one. It's definitely going to help the R0 below one. You probably, well, it's definitely going to help if you tell people to socially distance and if people actually practice socially distancing, if you ban large events, if you implement other countermeasures like Australia's done, but it's probably not enough to get the R0 below one unless you go

full lockdown. So given those two realities realities what do you see for the spread of the virus in australia in the united states in the coming months like do you think we just continue with exponential growth or do you think scoma is going to step up announce a hard lockdown will trump do the same well i think um a few things going for us are, firstly, the fatality rate is pretty low. It's not like SARS at 9% or MERS at 36% or Ebola at 50%. So thank heavens this wasn't like a really, really deadly virus. And we know that the fatality rate is heavily skewed to people with existing conditions and the elderly um i think that like one of the things that's interesting for me that i've been thinking about is that and this was giving me pause in

january and february is that we are also dealing with a pandemic um with social infrastructure that has never existed before so we've got real-time information transmission yeah or using digital devices. So to put in place social distancing in 2020, it's much easier than any other point in human history. And so that suggests that we should have much greater control over transmission rates. On the other hand, counterbalance against that, you've got more travel mobility. I think that we've published a paper yesterday

that tries to, at a very high level, a fairly simplistic level, think through some of these problems in terms of forecasting the path of the infection rates. And what we have done is we've taken data from all around the world and we've looked at the efficacy of containment strategies in different jurisdictions so actually the most effective containment

strategy we've ever seen is not china it's south korea followed by china and then we're seeing signs of containment now clearly in italy so the there's been a big deceleration in infection rates in italy and what we've done is for the US and for Australia, we've built a statistical forecasting model that basically tries to anticipate when we'll get that peak infection rate based on the experience of different countries. And what we do is we effectively discount the efficacy of containment. So for example memory i don't have it in front of me um but if we take um 50 percent of the containment intensity that we saw in uh south korea so we're not going to be as 100 as good as south korea but nor 75 as good as south korea but maybe we're half as good as South Korea. We have peak infection in the US and in Australia in sort of early April,

and it should be clear that the infection rate is slowing down by mid-April. And we look at a whole range of scenarios, so 25% South Korea, 50, 75, 100. Then we look at 25, 50, 75, 100 of Italy and likewise of China. So I think we'll see, our view is we'll see infection rates peak

in Australia and the US in April and then start declining, which for us is important because not only are we seeing the risk of second waves, I think people are now learning that one long-term change is this is going to be a huge reduction in global travel and I think borders are going to be a huge reduction in global travel. And I think borders are going to become incredibly non-porous for quite a long time. So once you've contained it within your borders,

I think people are going to be much tougher about international flows and much more aggressive surveillance of human trafficking or human trafficking, or human traffic, I should say. The Singaporeans have done this very well. So my sister and brother live in Singapore, and they said that when they went through the airport, there were full body scans scanning their temperature right throughout their body.

And pretty much all the additional cases that we've seen in Hong Kong and Singapore where they had very effective initial containment have come from imports. So I'm pretty positive that containment is possible, and I think we'll see for financial markets, they're a really big deal. Markets are focused on a few different things. The first is in terms of regime changes.

The first is when do terms of regime changes the first is when do we see containment in the u.s the world's largest economy and when do we see that infection curve really falling sharply and the death rate falling sharply we think that's going to happen in roughly mid-april um so a few weeks from now the second thing is when do we get a u.s fiscal policy response it's pretty amazing to think that it is the 24th of March. This thing has been on an exponential growth curve since early February in the US. We've had completely unprecedented monetary policy actions from the Fed, the ECB, the Bank of England, the RBA, the Bank of New Zealand, the likes of which we've never seen before. We did predict this in late February that

we needed this. The error I made was I thought it was really obvious that we'd need to go to full spectrum QE and liquidity support straight from the get-go. First week of March was basically my aspiration, and that's what I advised the central banks and governments. Again, I think they thought I was being alarmist, and they needed to be convinced by markets. Well, markets did their thing and blew up. And we saw liquidity vaporize in the government bond market. And we should talk about this later, but government bonds were meant to be

the one really liquid asset that was risk-free. And you couldn't get an offer on US treasuries. You couldn't get a bid on German bonds. And that risk-free and you couldn't get an offer on US Treasuries, you couldn't get a bid on German bunds, and that risk-free rate completely broke down. The Aussie government bond market completely broke down. So anyway, they were forced into action. And that was a highly imperfect process that really roiled markets. It's taken the central banks basically four weeks

to really get their ass into gear, but we're there now. They've just opened the bazookas up and they're all having their own draggy moments. It's whatever it takes. Fiscal policy, on the other hand, has been more slow-moving. And I think, you know, current New Zealand stimulus is kind of sized at 5% to 6% of GDP, and we're seeing around the rest of the world

slowly nation-states move to provide fiscal stimulus, which is is really really important in this case to offset the demand shock and but in the US we still have no fiscal policy stimulus and this is what's freaking out markets because originally in early March Trump was talking about a two and a half billion dollar stimulus it's a 22 trillion dollar economy right then he went to eight and a half billion then he went to 50 billion 100 billion last week uh kudlow was talking about uh a 400 billion dollar stimulus in u.s dollar terms then 800 billion dollars then a trillion then 1.2 trillion now we're talking about 2 trillion we always knew it needed to be one to two trillion but it's fucking amazing how long these idiots have taken and meanwhile like people are dropping like flies in terms of jobs in the u.s um you know california and new

york is shut down so markets have been having conniptions about the fact that there is a complete fiscal policy lacuna in the u.s it doesn't exist right now so we needed asap and i think once fiscal policy is plugged in then you'll have montry policy um i think you'll see more of all of the above so they'll keep on scaling up and the question was like how does this play out I think I think that if so regime change number one for us was monetary policy and under security we've got that regime change number two was fiscal policy we're starting to get there but we still haven't got the US response regime number three for us is the

antivirals so So we need like, you know, wholesale availability of cheap antivirals that actually kill the virus. And if we get that, I think we have a really deep short term depression. I think we have a very sharp increase in jobless rates, as casualised labour is nuked temporarily, but it should only be for about a month, right? You have a hard lockdown for about a month uh you get the r0 down you get the antivirals in and most importantly you're fundamentally changing social behaviors i mean it's quite profound like you and i when we walked in here we bowed to each other we bow respectfully uh no shaking of hands we're at a diagonal distance um you're wearing a mask i'm wearing a uh twin valve uh gas mask and no that's just a

joke guys but but i think there's going to be permanent changes in behaviors for quite a long time so i think that we've got to be more like the asian countries yeah i think i think that the problem in terms of i think there'll be a sharp recovery i think so i think uh you know a sharp two-quarter one to two-quarter depression, particularly as it continues to detonate around the world, you get different outbreaks. So China, South Korea, Italy, Spain, France, the UK, now the US. So you're going to have, like the US will be severely impaired for at least two months, I would say.

And then I think we're kind of back to normal, a new normal, an adjusted normal. So, you know, tourism and travel is going to be really badly affected until vaccines are available. But then there's always substitution. So, okay, you and I are not traveling to Bali. You probably go to Bali. I prefer the Maldives.

That's a joke, guys. But instead of going to Bali, you'll be hitting probably, if I could speculate, Coffs Harbour maybe, and I'll be going to Palm Beach to the wankers on fucking Twitter that would bang me up. I'm not a schoolie. Banging me up about going to Palm Beach. But seriously, my sister runs Travel in Asia for Google,

and she says they're seeing a huge increase in staycations so domestic travel and that'll provide significant substitution because actually australia has more people that travel overseas that come to us each year right so there's a lot of substitution there um you know iron ore and coal have held up well in terms of commodity prices. Yes, restaurants, cafes, and entertainment are going to be very badly hit. I think restaurants and cafes for a month or two, but then they'll come back online. I mean, we do have massive unprecedented fiscal stimulus coming down the pike, which will have an impact one way or another. So I think there'll be a bounce back. Whether we recover the lost output i'm not entirely sure well yeah i want to stress one thing in regards to that whether we do have a sharp rebound is predicated on a hard lockdown now as soon as possible because if it is a rolling partial lockdown we risk organizational decay

hysteresis and we if it drags out we we can't we lose the option to return to square one yeah i agree with that so so i think you agree with me that the us and australia ought to implement hard lockdowns now like boris johnson's just announced yeah as we're recording this but what do you think what's your subjective probability that A, Trump and B, Scoma will do that? I think it's driven by, well, I think we've seen hard lockdowns. Firstly, you know, in countries unlike the UK and, you know, countries with a federated structure, their decisions often are taken away from the leader. So, you know, New York and California are in hard lockdowns.

Sydney and Melbourne, I think,ia are in hard lockdowns yeah sydney and melbourne i think are basically in hard lockdowns i mean all but essential services um and uh you know most school children i think are homeschooling so i think we're actually already in de facto hard lockdowns in sydney and melbourne that that accounts for 60 of the metro population nationally so that's a pretty big swag of... Although I wouldn't describe it as a full hard lockdown. There are certain things that are still operating, like public transport. True. Yeah, true.

But you're right, it is pretty extreme. Yeah, I think it's pretty extreme. And I think the most important thing about whether it's a lockdown or a hard lockdown is it's the messaging and the signalling that this is a a very very very significant um you know health event and in the reality is we all have parents who are in their 60s 70s and 80s who have high probabilities of passing you know sorry um you know uh have a much higher probability of passing away like if you're over the age of we all know the stats you're over

the age of 80 it's kind of circa 15 you feel over the age of 80, it's kind of circa 15%. If you're over the age of 70, it's circa, you know, eight to nine percent. So these are big numbers. My mum, for example, completely quarantined. My dad, completely quarantined. So I think you've also got some bifurcation in the types of lockdowns. I think you're seeing right now in Australia, hard lockdowns of elderly populations and kind of, I guess, a more porous lockdown of the normal populations. But I agree with you, a hard lockdown, short and sharp, make it firm and then, yeah, you mitigate the long-term adverse consequences. We spoke on the phone over the weekend

and we were kind of speculating as to why we haven't seen this in Australia yet, particularly in regards to to schools um obviously we don't know but but one theory i had was that scomow and jay fry and the cabinet are kind of waiting until the school holidays um do you do you have any insight into why we haven't arrived i haven't spoken to them about schools it's a good question i mean you're just amongst the tuck shop you know mothers, they're speculating the same thing, that they're waiting for the holidays and then they're going to extend the holidays. Yeah, yeah.

It's what we've heard. But that's not based on any inside information. That's just, you know, street side scuttlebutt. I think also, you know, the schools for critical essential workers in the health system are, you know, the schools for critical essential workers in the health system are, you know, potentially important, enabling optionality. But, you know, maybe there are other alternatives. So, yeah, I think, I mean, I actually think the schools are already in, I actually don't know many parents at all who have their kids at school. Like my son's not at school right now.

He's homeschooling. All of our friends children are homeschooling so i think this idea they're like our school is technically open yeah but they've actually now moved to google classrooms so they're all doing and my son's eight um actually one of the really interesting silver linings of this whole experience has been spending more time with the family, being able to play, pick up basketball. I'm a very lithe, lithe character, and watching that 80-kilo Wolverine dancing like the devil in the palm of the hand across the basketball court against my fearless eight-year-old son has been pretty good fun.

But no, but seriously, spending time with, like being able to every day, because I'm also working remotely, have that time with family has been fantastic. But yeah, I don't think it's quite as black and white and binary as some people suggest. I think schools are broadly in lockdown. Yeah, last I heard it was like 25 to 30% of parents had taken their kids out, but I assume that's increased.

Yeah, I've probably got selection bias, like eastern suburbs of Sydney, affluent area. But I don't know any of my friends who are not homeschooling. Yeah. So, mate, I know you're not, you know, you don't characterize yourself as an expert on the question of the Australian economy at the moment. You know, I knew it's in particular on the markets, but I still just want to get your opinion um with that caveat assuming we have a short sharp depression do you have an optimistic outlook for the aussie economy um yeah i i think that we're going to see a speculative melt up i think i think the there'll be two phases to the

recovery i think the first phase will be quite sharp as in you're going from zero to one in terms of you know there are no cafes pubs restaurants gyms working and then one day they will all start working so you're going to have a big non-linear change in activity i think that um thereafter you're going to have a few drags on growth. One drag on growth will be the fact that there will be a high debt burden in the SME community. We will have to pay back that debt. So that will be a drag on growth. A second drag on growth will be, I think, which is an interesting kind of second-order one,

just much higher risk aversion. I think people, you know, this has been a shock to the system. They've seen their super balances smashed, equities down 40%. House prices will probably soften up in the period ahead. We'll talk about that in a moment. So you've got, we saw the consumer confidence data today, like a massive fall in consumer confidence. You know, you're going to have vast cohorts of Australians

who have never experienced unemployment, who have never not been able to pay the rent, who have never queued for the dole, suddenly going through that experience. And that's going to, I think, going to be a pretty, that's going to leave an indelible mark on their mind. Well, we're recording this in Bondi Junction and yesterday there were lines around the block

stretching around the corner at the Bondi Junction, and yesterday there were lines around the block, stretching around the corner at the Bondi Junction Centrelink. Yeah. Just extraordinary scenes. So I think that you'll get a big increase in risk aversion, as we saw post-GFC. And so that'll tax consumption. It'll also tax business investment, as in Dullit.

And then I think you'll just see some permanently damaged industries again tourism travel large venue entertainment that'll fade over time but I think that you'll get a short sharp bouncing growth followed by more sluggish growth I mean I'm pretty sanguine I have been sanguine on the Aussie economy for as long as I can remember. You know, when everyone thought we were going to blow up in 2015, 16, I thought we'd be fine. Likewise, 11, 12. And I'm pretty sanguine on the outlook. I mean, the reality is that China is going to have to do a lot of stimulation

and iron ore prices, coal prices have remained firm um the aussie dollar is much much lower than it will be so that will assist in terms of driving export revenues it'll also have a big impact on import competing industries uh so it'll support domestic services domestic manufacturing um and i think you're going to see the resi housing cycle bounce back real strong support domestic services, domestic manufacturing. And I think you're going to see the resi housing cycle bounce back real strong because resi is that one asset that, you know, bricks and mortar, I mean, it's still rising according to the daily just, but according to the daily hedonic core logic indices that are reported and tracked by the RBA

and the main sort of benchmark for house price movements in Australia I did have a hand in I know these haters out there hate it when I said I had a hand in developing those indices but yeah I was a co-inventor on the pattern sorry guys um but but I think um I think that once we get through this I think you'll see a big increase in unemployment you know through the casualized labor force but equally I think you'll see a big drop but I think that once we get through this, I think you'll see a big increase in unemployment through the casualised labour force. But equally, I think you'll see a big drop. But I think the risk is hysteresis, as you mentioned, which for those who don't want to sound like wanky smart boffins, just means some structural unemployment that becomes a permanent part of the system. So once you become unemployed and you lose skill sets or those particular jobs permanently disappear,

it's hard to reintegrate yourself into the labour force. So I think that will kind of manifest in some sort of way. But also substitution I think is going to be really interesting because even within services, okay, cafes, pubs, restaurants are hit, but then they're doing takeout. You're getting an enormous amount of consumption of door-to-door delivery services, a lot of online services. So, you know, you may not be going to the pub and spending money on brewskis, but you may be buying alcohol from your liquor store and going home,

having some friends over and having a smaller sort of gathering where you're spending just as much money. Yeah, so I think the Aussie housing market will bounce back particularly strongly because we've had two RBA rate cuts within a month. 25 of that was passed on. And, you know, it's the one asset class that looks like it's performed. You know, equ Equity has been smashed. Government bonds, Aussie AAA-rated government bonds

fell at 1.4% in the month. There was this view, which I've sort of questioned for years, within the investments world and the superannuation fund world, there's this view that government bonds and bonds generally are a great hedge for falls in equity values. And that's on the basis of this idea that if you have a fixed rate bond, its price falls when interest rates rise, and if you have a fixed rate bond, its price will rise when outside interest rates fall. And so therefore, if equities are falling because the economy is going into recession,

the view is that interest rates will fall and bond prices will rise, and that's a hedge. The problem with that is it doesn't really work well in inflation. It works well in disinflationary shocks like we saw, or deflationary shocks like we saw in the GFC. But if you look at the last 100 years of data, there's actually been a positive correlation between bond prices and equity prices. And that's because in inflationary periods, what we tend to see is interest rates increase, equities go down, bond prices go down. And that's, I think, one of the big economic regime stories and narratives to come out of this crisis is, and this is fascinating for me, one is this complete vaporization in the liquidity

of markets that people pretended were perfectly liquid like government bonds no one believes that right now because those markets became completely illiquid normally it'd be the corporate bond market that becomes a liquid or the high yield market that becomes a liquid but those markets yeah they became a liquid but as did the government bond market and then this idea that we first articulated and i think we were the first to articulate it in february that you can get market failures from these extreme information asymmetries that just create these uh contagions um these economic contagions the the second learning from the crisis is that government bonds and bonds generally have been a terrible hedge for equity risk. So what's happened is a few things. Markets are starting to figure out that this unprecedented wave of fiscal stimulus

is going to have to be funded by governments issuing debt. And you're going to get this tsunami of government debt. So a supply shock. And as those, generally speaking, when you get a supply shock, the required returns will increase and prices will fall. So investors around the world, like myself, will demand higher interest rates to hold government debt. You could also argue, which is another hypothesis of ours,

that because of the newfound illiquidity risk in government bonds, you'd also require an additional risk premium. And then finally, this is likely to be quite inefficient spending and you're likely to get a bit of an inflationary pulse building. So as we continue to cut and crush those output gaps and as labour supply diminishes over time, you could find ourselves,

or one could find oneself in a situation where we have yield curve steepening because there's just been this massive increase in in the stock of government debt outstanding at the same time as questions start to emerge about the capacity of governments to repay that debt so you start getting credit risk priced into sovereign or government bonds and then that could ultimately i think will be met with some mmT-style solution where basically the central bank prints the trillion-dollar coin,

hands it over to the Treasury, Treasury repays the debt, and you just basically have the central bank printing money to finance government spending, which could ultimately be very inflationary. So I think that's an interesting second order or third order consequence of the viral contagion, the pandemic, that does this actually accelerate us to that end game where we get much higher levels of money printing and inflation.

And also remember that every time they roll out QE as a solution from their toolkit, it becomes more and more conventional, not unconventional. People like to talk about QE as being – which is just money printing and buying assets. So this is a central bank buying stuff. And people need to understand, for those who don't understand, that when a central bank does QE, let's look at the Fed. The Fed started off by buying government bonds. Then it announced it was going to buy mortgage-back Fed started off by buying government bonds. Then it announced it was going to buy mortgage-backed securities issued by private lenders. Then it announced it was going

to lend directly to companies. Then it announced it was going to lend directly to investment banks. Then it announced it was going to buy corporate bonds in the secondary market. Then it announced it was going to buy corporate bonds in the primary market. And then it's also announced that there's no limit or end to what it will do. In overnight the fed announced it could buy up to 20 of any fixed income etf an exchange traded fund i happen to run an exchange traded etf uh and uh i would love the fed to come and buy our etf but unfortunately we don't have the fed uh in australia right now but so really what they're doing is they're artificially bidding up the price of privately traded assets just you know to manage market prices and to provide some semblance of stability or the perception perception of stability but ultimately you have central banks massively

interfering with that that pricing process and the um and they're trying to prevent the creative destruction uh that capitalism would otherwise impose so they're trying to prevent the bad businesses from failing and the good businesses from rising up in their stead. So I think that's really, really interesting that actually medium term this could be one big motherfucking inflation shock. Are there any categories of businesses you think they'll allow to fail? Yeah, I have a view on this that I think I might have mentioned, which was offline. But I think that it's very interesting to think about

how the winners and losers from all of this intervention, fiscal policy intervention and monetary policy intervention. The monetary policy intervention has been focused on really central banks protecting government bond markets and bank bond markets, and to a lesser extent, corporate bond markets. But really, they're just protecting governments and government bond liquidity, systematically important bank liquidity, and specifically, they want to keep funding costs for banks very low so that those banks can then pass on those funding costs or the funding cost savings to borrowers so here in Australia you know we've seen the credit spreads on the major banks bonds go nuts so to give you some

hard numbers you know CBA in January used to pay 0.78% per annum above bank bills, which is a proxy for the cash rate, to borrow five-year money via issuing senior bonds. Before the RBA intervened last week, they were probably paying about 2% over bank bills. So basically their funding costs had increased by about 1.2%, probably more, maybe 1.3%. So 130 basis point increase in their funding costs had increased by about 1.2%, probably more, maybe 1.3%, so 130 basis point increase in their funding costs. Now, they can eat that, so they can absorb it,

but the problem is that the bank's returns on equity have fallen dramatically. So the four major banks used to produce returns on equity that were between 16% and 18% per annum in or around 2014, 2015. But because people like me argued that they were carrying too much leverage and they needed to be radically delevered, CBA was 21 times levered in 2007. Today it's only eight times levered.

And when you deleverage a business, you reduce its returns. And so their ROEs have gone from 16% to 18% to, depending on the bank, about 10%. And their cost of equity is not much below that. In fact, the markets now think ANZ, for example, is producing an ROE that's below its cost of equity, which is why ANZ is trading at 0.7 times book value. Long story short, the banks actually can't eat much more margin compression. So what that would mean is they'd have to increase borrowing rates.

And we actually saw this in the US. So after the Fed cut initially 50 bps in March, we actually saw the cost of providing home loans in the US jump substantially. So lenders were actually increasing interest rates on home loans in the US, not reducing them. And that's why the Fed came out and bought RMBS. So the Fed has committed to buy an initial, a minimum of US 200 billion of RMBS. I came up with a similar idea, I know the haters are committed to buy an initial, a minimum of US 200 billion of RMBS. I came up with a similar idea, I know the haters are going to be cringing right now, for the Australian government to do something along the same lines in 2008

and Treasury through the AOFM bought 15 billion of RMBS and made billions of profits for taxpayers because when the Aussie government buys residential mortgage-backed securities, its cost of borrowing for three-year money for the taxpayer is about 0.25%, but the RMBS is paying us interest as taxpayers of 1.5% to 2%, so we have this huge interest rate arbitrage.

So it's very profitable. And then it saves the liquidity of that market, it saves the small banks, and it makes you rely on RMBS funding. So to answer your question, phase one of the policy response has been been to protect governments and systematically important institutions and then and that's monetary policy phase two has been to support basically middle australia main street and smes i think mainly um which account for a big chunk of the labour force, through fiscal policy.

So fiscal policy has really been directed at, I think, small business and workers. You have sitting between SMEs and large, systematically important institutions, what you might call the mid-market. So these are companies that are making more than $50 million a year systematically important institutions, what you might call the mid-market. So these are companies that are making more than $50 million a year in revenue but are not too big to fail. And the problem for those businesses, Joe, is that the risk is they're left to die on the vine.

So the major banks are never going to fail. Qantas isn't going to fail. And if you look at what the Fed's doing, the Fed's buying all investment-grade bond issuers. So if you're a big company and you issue what are called investment-grade bonds, which means they're highly rated bonds, then you're fine because the Fed's buying your bonds. And then the US Treasury, through its $2 trillion stimulus,

will kind of bail out SMEs andes and workers as scomo's done here but you know the the mid-caps and the mid-sized businesses who are frankly probably subprime borrowers and by that i mean they're either tapping the high yield bond market they're tapping the leveraged loan market um uh because they can't get a loan from a bank or they can't get a loan on the same terms from a bank, I think you'll see lots of bankruptcies in that sector. So I think the concern is that, you know, investors who are targeting global high yield,

I think it's going to be very, very tough for them. I think you'll see lots of bankruptcies, particularly when you've got, you know, this perfect storm of global market liquidity shocks, global market supply chain shocks, global market supply chain shocks, global market demand side shocks, and then a global oil price shock. So I think mid cap companies are going to suffer an enormous amount of disruption. But nobody really cares about them because they're not too big to fail and they're not too small to matter. There's not a big voting base in that mid-cup segment. That's why I think the equity market rebound is going to be very disjointed.

I think equity beta will perform well. You know, equities are bouncing today because people are hoping that Trump will do this deal with the Democrats on his $2 trillion stimulus. But I think you'll get a bit of a bounce. But I think there's going to be permanent brain damage in the mind of the market from the extreme volatility, you know, and the extreme illiquidity that we've observed.

I think that you also get a lot of heterogeneity within markets. There'll be winners and losers. Afterpay is probably a loser. You know, Virgin is clearly a loser, but, you know, Uber Eats is a winner, and Uber Eats is a winner, and Menialog is a winner, LogMeIn is a winner, Zoom conferencing is a winner, those sorts of things. I think within bond markets, which is my wheelhouse,

I think corporate bonds are going to have permanent damage and ongoing problems, particularly that high-yield market, which isn't too big to fail or too small to survive. I'm sorry, too small to matter. So I prefer government-guaranteed bank-issued bonds, which is where most of our assets are, or AAA-rated asset bank bonds that governments are buying. That kind of makes sense.

I want to come back to the aussie housing market for a moment so we spoke about the optimistic case which is predicated on a hard lockdown by skoma asap let's riff for a little bit on the the pessimistic case so assume that we have 15 unemployment or higher or higher for two or more quarters. I'm selecting those numbers somewhat arbitrarily. What happens to the Aussie housing market in the context of a rolling, drawn-out lockdown? I might reframe the question just to first deal with the case that, let's just say we have a really bad recession that is 91- style yeah with higher household debt um and let's say for whatever reason we get unlucky like we've got a bit of bad luck with the oil price shock it's not

bad luck necessarily uh for um net consumers of oil because it can be economically stimulatory but let's assume i don't know china blows up i think my position has consistently been that if we have a deep protracted recession um that it's reasonable to think that aussie house prices could easily fall um you know 20 to 40 percent somewhere in that spectrum easy and fast um we would need to see i think i, I mean, my base case, so I think that scenario will one day absolutely materialise at some point in some cycle. My base case historically had always been that you have low rates for long, that fuels eventually wage pressures,

which eventually bleeds into consumer price pressures. We've seen this in the US. If you look at a chart of US wages, they peak at about 3.6% pre-GFC. They drop down very sharply post-GFC. And then since 2012, there's been a trend increase in US wages up to a peak of 3.4% in February 19. They dropped a little bit in 19, but I think they'll come back notwithstanding the current shock. So if we abstract away from that shock and we think about a world in which we get a lot of – so actually one of the –

the state of nature I was talking about earlier where we actually get an inflation shock care of – actually, let me think about this. I'm kind of jumping around. One way of thinking about it, I'm trying to kind of conceive of my worst-case scenario. So my worst-case scenario is this. Let's assume this is a temporary shock, which it should be. Vaccines coming in 12 months, post-vaccines,

we should all be pretty much okay. However, we're left with massive residual fiscal and monetary policy stimulus. This is the scenario that I think is likely. This is, it's kind of, it's my positive case short-term, worst-case long-term. that I think is likely. It's kind of my positive case short term, worst case long term. So we've got way too much QE and way too much fiscal stimulus in the system.

And you have the mother of all speculative melt-ups and a huge rebound in activity, albeit with some of the drags we discussed, high household debt, initially high risk aversion, but that kind of rebound will start fitting in on itself. If central banks start trying to normalize interest rates um and if that inflation cycle is not checked and it starts to in turn bleed into inflation expectations and then inflation expectations become um unanchored and we start to get higher and more volatile inflation which is i think what we will

get particularly because i think that the central banks will say don't worry about the high inflation because we've undershot our target for 10 years so we can tolerate periods of higher inflation we can look through it they start moving their targets whatever i think eventually you get this existential battle between markets wanting to price in much higher interest rates and central banks wanting to look through the inflation and wanting to keep interest rates lower. But at some point, I think the central bank is going to say we need higher interest rates. And at that point in time, I think we get a 1991 redux where we kind of get the recession we had to have. It's kind of, I think, a conventional capitalist recession where the central policymakers say we need to increase the cost of capital

materially. The policymakers are eventually convinced they need to normalise the cost of capital, notwithstanding, I think it's a two-step forward, one-step back process. So inflation rises, they say ignore it. Markets start getting worried, they say ignore it. Eventually they start paying attention. Then they start increasing interest rates. They aren't keeping a grip on inflation. And at some point, they do genuinely normalize

the cost of capital. And I think it's at that point that we get a 20% to 40% drawdown in Aussie housing. Because Aussie housing is fundamentally mispriced at anything that looks like a normal cost of capital. Put differently, Aussie housing has to fall 20 to 40 percent if mortgage rates are going to increase by you know pick a number but you know 200 to 400 basis points right so that day will come I think eventually another scenario is um and sorry and for that scenario to play out you know the policymakers have to have the courage of their convictions because they kind of this needs to be effectively we're going on a zombie killing rampage. We're going to kill all the bad businesses.

Let asset prices reset and we can live with that because that's welfare enhancing for everybody. Another scenario is your scenario, which is not my base case, but let's say they don't do containment well we get rolling outbreaks um and which means we'll get more and more stimulus um but we get um you know really impaired incomes really high unemployment and for some reason we struggle to bring down that unemployment rate quickly i think in that scenario i mean it depends on a whole range of different parameters, but I think in that scenario, house prices could easily fall 10% easy.

I mean, it depends on how high unemployment goes and how much that sort of really erodes the earnings to investment properties and the imputed rents to owner-occupied properties but you know we've hit the effective lower bound and the cash rate at 0.25 the user cost of housing is very low and yeah i mean we can reduce further long-term government bond yields there's probably some additional pass-through from banks that can be done.

But the reality is for housing, we're running out of monetary policy stimulus. So the only bailout for housing is you do housing QE, you start buying houses. I don't see the RBA doing that. So I definitely think you could have a period of no growth for a very, very long time. So you could have no growth for you know five years we saw that in sydney between 2004 and um 2008 so circa 2004 2007 so you could

have a period of no growth or weak negative growth that cumulatively adds up to a big number you could have a faster reduction in prices where prices fall 10%. My base case right now for what I see is that I think that the current boom slows right down. I think house price growth more or less stops for the next few months. I think it's possible we could see prices fall about 5%. And that's predicated on the assumption that containment works and we get a relatively, you know, within two or three months, we're back to normal, China style. You know, subject to the riders we talked about earlier,

some permanently affected industries. But I think, you know, a circa 5% drop in Aussie house prices in the short term, which would then be followed by a really significant bounce. Because I think I remain of the view that we're going to get a sort of 25% to 30% increase in house prices this cycle. We've had about 11% so far. So I would still be looking for substantial house price inflation.

Even with a sharp increase in unemployment, because a lot of that unemployment will be casualised, non-owning, they're not home buyers um but also i think it'll be temporary yeah i think if this is managed well yeah the unemployment rate could go sky high but i think it could come back real fast if it's managed well if it's managed well yeah yeah it's a weird old housing bubble the aussie one why is that a lot of the other housing bubbles historically have ended endogenously. Like they've kind of hit the ceiling and then crashed. So the classic symptom of a credit boom gone bad is the last person you lend to is the first person to default.

That was certainly true of the US housing bubble. I think then there was probably a transmission mechanism via confidence to the Irish and the Spanish ones. But prior to the housing bubbles of the 2000s, they followed that general pattern of a credit boom gone bad. Whereas in Australia, it's like we've just been towing the line for decades and the cycles have been managed by regulators quite adroitly.

I think the... My own view is that... So, firstly, in the US, it was a credit-fueled bubble where there'd been obviously... It's like a classic speculative bubble. Correct, yeah. Demonstrable deterioration in lending standards. House prices in the US rolled over in 2006.

Subprime arrears rates were spiking in early 2007. The UK situation was very different. What happened was funding markets shut to a lot of the smaller and very competitive and marginally important lenders like Northern Rock, which were big securitizers. And when the securitization market shut, they stopped lending. And then you got a credit rationing induced correction because you couldn't refinance your loan, therefore, you know, arrears rates popped and then that forced distress selling.

I don't see any real distress selling in this. If my base case is right, we have really sharp retrenchment of activity, a big jump in the jobless rate, but it's relatively temporary. We've got a vaccine in 12 months. We have that certainty. And we've got, you know, three months of very weak activity, but followed by three months of very strong activity, relatively speaking, and relative normality thereafter. I don't think you're going to see banks foreclosing on borrowers. Yeah, arrears will

increase sharply, but that will just mean a longer loan term effectively. So people will just have a longer amortization schedule. And because you won't get forced selling, I don't think you'll see a huge impact on prices. Having said that, like our real-time intelligence in the housing market suggests it has weakened very sharply. I know some of the trolls that try to bully me online on twitter were referring to an afr article that i didn't write about panic buying but i'm not hearing any stories of panic buying our due diligence suggests the exact opposite what i'm hearing is panic selling vendors hitting bids because people are freaking out you know i've i've seen some crazy like people are really

freaking out and that's why the retrenchment in activity right now while we're going through the peak virus is likely to be so sharp. You know, I'm seeing guys ripping money out of banks, guys wanting to go into government bonds. So I think, yeah, you might see prices. And we do have these daily indices where we're literally using data from every sale every single day. So we should see it in the indices.

We've also seen a big drop off in auction clearance rates. So that's dropped quite strikingly. And that's generally very, very stable and secure source of wealth for savers relative to super or equities. And all the negative headlines they're hearing are really about financial markets. It's not about bricks and mortar. So, yeah, I think that what we were talking about, we're talking about 2007, the UK. Yeah, and here in Australia,ia sorry my thesis is this we're quite unusual in australia where 80 normally about 85 of all borrowers are

variable rate which means we have a very very interest rate elastic borrowing community and what that means is that short-term changes in monetary policy have a huge impact on housing and whereas when you got a 30-year fixed rate loan dominating in the US, the cost of capital is much more determined about very long-term interest rate expectations. And so we've seen, even though the RBA denied it and they were totally wrong, that they didn't create the big bubble that we forecast between 2012 and 2017. And then the bursting of that bubble, which we also correctly forecast in June 17, we published our prediction in, I think, April 17. That was really a function of credit rationing and a huge increase in borrowing rates wrought by APRA's macro prudential constraints on lending.

And then we got the 10% bust that we anticipated. And then in April last year, I said, whilst prices were still falling, we'd get a very rapid rebound, a sharp 10% bust that we anticipated. And then in April last year, I said, whilst prices were still falling, we'd get a very rapid rebound, a sharp 10% plus rebound. That's exactly what we got. We were the only analysts in the country that had that view at that time. I'm not fussed about Resi right now.

I don't think there's going to be some cataclysmic correction. I do think it will be interesting to see whether there's any panic. I mean, we haven't really seen a panic in Aussie housing before. And there is, like my real estate agent sources are saying, there's quite a lot of panic.

So maybe that means it could be a little worse than 5%. But I think that once we get through this, my prediction right now would be like peak to trough for the coronavirus would be 0% to 5%, fall in national house prices. And I think you'll see a very, very, very sharp recovery. And we'll get 25% to 30% this cycle. Have your real estate sources differentiated

between investor and owner-occupier panic? No, I asked them about that and also across price distribution and they seem to say it's pretty pervasive but this is a sample size that's very small so it's also, like I was talking to the most successful real estate agent in Australia who does billions of dollars of transactions but he's focused in

probably the $2.5 million to $10 million market which is not necessarily always representative. Is he the really quiet guy who works in like Fort Cluse and he's like really polite, really quiet? No, he's the opposite of that. His name is Alex Phillips who works with Panzer Phillips Donnelly and he's pretty loud and obnoxious.

I really like you, Alex. On the 1% probability case that you're actually listening to an erudite cerebral podcast like this, he's much more flashy. He wouldn't have time for a long podcast, I don't think. But you never know. We'll see. Yeah, so I think Aussie housing is okay, but it'll be soggy. And you get some arrears, but I think the banks will be particularly flexible.

I mean, the reality is lending standards have the austerity of lending standards have increased dramatically since 2014 so I think we're relatively well positioned but it's not something I'm worried about Ozzy has yeah yeah at all not for our MBA it's not for banks I think a bigger concern for banks is just small business arrears and losses and then corporate arrears and losses and I think a bigger concern for banks is just small business arrears and losses and then corporate arrears and losses. I think to your original point, the higher the intensity of the containment, if you keep it short and sharp, then you can move back to normal much more quickly. If we fuck it up and we have rolling multi-month containments,

then that's just going to be a disaster. The other variable at play is if we do have the role in containment and deaths are increasing exponentially we also have like a fear slash community driven lockdown as well yeah i think that's a variable well i think we're getting that right now i i know that like you know i was going to do a renovation yeah and i'm like fuck that yeah i'm sitting on the sidelines yeah and a mate of mine was going to build a house and he's like that i'm sitting on the sidelines so i think all discretionary spend is been zeroed but i think that um i mean we've seen you know south korea went back to normal china's gone back

to normal uh friends of mine who are living in hong kong said when it first came out it was just shut down yeah but then hong kong back got back to normal people were in pubs bars restaurants then when they've had this little influx of the spike in infections imported apparently they've gone back into lockdown again yeah so I think the lesson from those communities is go hard and fast yeah go early it's probably one of the few things that my good friend John Hepton and I agree on. Well, there's an interesting historical contingency there as well, which is I think the West was rendered complacent by the experience of swine flu,

whereas some of the Asian countries were really rattled by SARS and MERS. Yeah, okay. Interesting. I hadn't thought about that. Yeah. Is that what you think? I think so.

Yeah, interesting. Yeah. they were ready for coronavirus yeah yeah 100 yeah 100 i remember um swine flu i was at school at boarding school it was like the best thing that happened to us because there are a few boys in the boarding house got it so we got closed down we we got all we were all sent home all assignments were postponed And that was the extent of the pandemic for me. It's a bit different this time. So, Chris, looking back on the last few months, this is the biggest financial and economic event we've seen in our lifetime so far. You know, we'll all remember where we were when we first heard about the novel coronavirus. What general lessons have you been contemplating in recent days?

Yeah, that's the thing that when I'm not stressed with work is actually one of the most enjoyable things to do is to kind of ruminate on, wow, wow, this is such a historically iconic and unusual period in time we're living through it. And we're also observing really fascinating behaviors so you know last year i spent a lot of time writing about the tsunami of listed investment trusts these are basically funds listed on the asx that was sold by financial advisors to their customers and brokers to their customers really broke stockbrokers not so much financial advisors because the fund manager was paying them in a fees of up to three percent on every dollar they got from their client into these products and you know i said that they were disaster waiting to happen um i wrote endless columns about this particularly

the so-called high yield lits or list investment trusts from companies like kkr newberger burman perpetual metrics and others and these are good managers but my point was because they're it's complex but because they're a closed-end structure which basically means when you put your money in you can't get it ever out and the only way to get it out is to trade your interest on an exchange so you're just trading you've got to find another buyer who's willing and that buyer has to put a price on it and what we saw with equity LITs is they all traded a discount to their net tangible assets they typically traded about a 10% discount about 80% of them but the new tsunami of high

yield LITs from again KKR you know partners group Neuberger Berman Metrix and others managers that retail investors have never really heard of before raised billions and billions of dollars very lucrative money and I said these things in any stress event are going to trade a big discounts be like the equity funds do and sure and i was absolutely vilified like i was personally attacked they employed lobbyists to attack me david gazzard i think his name is one of skomo's mates um and said chris is conflicted you know uh and anyway and these things to that point up until december last year had always traded at nta now mate like you've just seen them blow up so pretty much all of them are trading at 30 to 50 below the investors entry

price so basically investors have dusted half their money on these things. Huge discounts to NTA. And the reason being is they often own loans or high-yield bonds that you can't value, stuff that doesn't trade much in good times and in bad times doesn't trade it at all. So no one believes the NTA. So some would argue that they're rationally exiting at the right price. But mums and dads have had billions of dollars of money torched. So that's one lesson. A broader lesson is just on the value of liquidity and how, as I've mentioned several times during the podcast, how markets can function well in lots of circumstances most of the time, but occasionally you get these financial asteroid strikes where there actually is a role for the state as a liquidity provider of last resort to provide what I call catastrophe insurance. So if there was a global military conflict, we'd have exactly the same problem. If some Martians came from Mars and started blowing up cities,

we'd have the same problem. Like everything, markets would collapse. And then if we have a global pandemic that's fatal, you're going to see the evaporation of liquidity in all markets. And I think that's been a profound lesson. I think the fact that bonds haven't been a good hedge for equities is another important lesson, particularly fixed rate bonds. I think one interesting, probably the most important lesson for me as an investor has been, you know, I guess over time, I'm 43 now, one thing I've kind of figured out is I'm pretty good at solving problems. And that's the way my mind works.

I often, you know, used to think, like over previous cycles, why are certain peers or colleagues so fundamentally negative about everything? And that's because, much like a lawyer, i think their neurology is wide to find problems i see problem solvers and problem seekers right and a lawyer so the legal profession is a classic example if you study law at university it's basically trying to study what all the rules and limitations and restrictions are on you know the way we can conduct our lives and then you advise people on the way we can conduct our lives. And then you advise people on how they're going to run afoul of those laws, and you highlight those problems. So you find that, not only saying there's a huge influx of human capital into the legal profession,

and that's very high quality human capital. So these are often some of the smartest kids in our schools. Very few lawyers transition into becoming successful entrepreneurs. And I think that neurology, the conditioning of that learning experience and that professional experience basically reshapes your mind such that you're very, very instinctively and reflexively good at immediately honing in on vulnerabilities and flaws and fragility, but you're not particularly good.

Your mind isn't wired to then think of the solution. So one thing I figured out a while ago is I'm actually wired to think of solutions. Every time I see a problem, I think of a solution. The problem with that is, so when I went to the RBA, Phil Lowe, Guy DeBell, to Scott Morrison, Josh Fryderberg and all their advisors, and Wayne Buys it App in February over and over and over again, I said to them, hey, unless you do something really quick, this will be a global liquidity crisis

that will be then a global solvency crisis. And it will be the end of the world as we know it. And there's, because this, markets can't price this risk. So you'll get total market failure. And for me, that was blindingly obvious. And when I spoke to my internal colleagues, I was like, we're going to get unrestricted QE

of the like we've never seen before. And it's going to come really quick and it'll be globally coordinated and synchronized and it should be clean but that's not what happened you know again rba cut fed cut no qe power says we're not going to do qe markets blow up uh you know lagarde says that she doesn't want to keep a little on the spruits the markets blow up that the the the lagarde announced 10 billion euros a month of QE two weeks ago. She's had to increase that to 100 billion a month of QE. The Fed's done like nine or 10 different QE programs. So eventually they got the message,

but it's the imperfections in human decisioning, notwithstanding that these are powerful people and they've got awesome responsibility, and notwithstanding, I see the RBA do this a lot, notwithstanding that they've got access to much better information than I do and they've got guys sitting in their organisations who are probably 10 times smarter than I am. Maybe save Gianni LaCava at the RBA

who came slightly behind me in the university medal race because I know he's one of my lovers as well. Shout out to Gianni. I'm only joking, mate. I really, really like you. But I think that when you get those complex organisations, when you get those organisational structures, the decision-making processes can actually start to fail.

You often get committee and consensus-based decision-making, and that can be highly, highly suboptimal. I actually wrote to Phil Lowe the day that he announced his monetary policy decision and i said when you go to your media conference the journalists and the economists are going to want to pin you down they want to they want to secure binary yes no answers on what you will do and what you won't do and i said the reflex i've seen amongst economists economists love to provide artificial precision you know the jobless race is going to do this i'm forecasting that oh i'm never going to show you the standard areas around the forecast because if i did you wouldn't believe them because they're not written

on they're not worth the paper they're written on right um so this this artificial precision in economics and and frankly anyone who's smart you know often tries to uh i think populate uh their communications with artificial granularity so i said to him in this long note if i were you i try and learn from the lessons of your peers you know pow often sounds too smart by half oh we're not going to do qe why would we do qe as you're basically the leader of the free world or equivalently, right, the head of the Fed, the one thing you don't say in the middle of a financial markets crisis is you're not going to do something, right? You always keep all options on the table. And the ECB and the BOE and the RBA all made the same, well, I don't think the RBA made the same mistake because they actually

did learn from their lessons. And it was fascinating when he went to the press conference, as I expected, everyone was like, well, are you going to do this? Are you going to do that? And he just said over and over again, relentlessly, we're going to do whatever it takes. We're going to leave every option on the table. We are not ruling out anything, right? And markets loved it. And all the feedback from the brokers was, wow,

low is a whatever it takes guy. And that's what the market wanted. It doesn't want to see constraints on the central banks. It wants the central banks to be solutions not problems but i think that the fact that it took the world three to four weeks to figure out what we needed in this completely unprecedented crisis that's what i didn't i learned about myself that i had imputed onto the decision making process my own process and i and i was probably overly enamored with my own logic and I didn't allow for enough imperfections in the process.

So that's a real lesson. I've just got one thing, a really searing lesson for me is when trying to game through and anticipate the actions of others and the behaviours of others. So I find it much more, it's interesting. I think sometimes central banks are harder to predict and policy makers and politicians are harder to predict harder to predict because you're dealing with so much idiosyncratic risk at the single person level and that single person like pal or lagarde

or others is capable of kind of errors that you would think it would be incomprehensible i mean the whole world was just like lagarde you're a fucking idiot after she said that she blew up the portuguese greek italian and french government bond markets when she said that. She blew up the Portuguese, Greek, Italian, and French government bond markets when she said, we're not in the business of trying to manage spreads. And the next day they issued this statement saying, we actually are in exactly that business. And then a few days later she apologises. And then she writes an op-ed in the FT a few days after that saying,

we will do whatever it takes and whatever rules that exist that constrain the ECB today, by the way, we can dissolve those rules as well. Because markets want that impression of unlimited support. So, yeah, that's been a lesson. I mean, I think the final lesson and just as important a lesson is, we were sailing through 2019 thinking, we had huge you know trade tensions huge geopolitical rifts we had brexit we had north korea and it felt like i've written before it felt

like we were coming into 2020 and i went on holiday and i was like oh mate you know brexit's resolved trade wars are temporarily resolved maybe we'll just have some time and space and some normality and then you know we start work in january and iran fires 22 ballistic missiles at two u.s bases in iraq and we're on the cusp of a major war between iran and the u.s then we have the biggest bushfires in human human history and now we've had a 100 100 year global pandemic it just doesn't stop it's fucking unbelievable. And I'm not sure why that is, like whether life is always like that or whether there's certainly evidence that financial market volatility has,

like financial market shocks, the frequency of financial market shocks is increasing. And I think that's a function of the fact of two things. You've got much more leverage in the system than we've ever had before, so you'd expect more volatility in equity. By definition, that's tautological. And then the second point I'd say is, I think the other thing that's kind of tautological is if markets were freely functioning pre-2007,

relatively speaking, and there wasn't much intervention, and then you layer on top of that this new regime where markets are subject to massive disruption and intervention by central bank actions. Well, that's just going to create a lot more uncertainty and volatility. And that probably explains why. It's kind of the paradox of inflation targeting. Inflation targeting is meant to give us price stability,

but actually what it feeds us is financial instability, as in rates held too low for too long and then you get a uh you know a leverage uh driven speculative bubble that you have to unwind through high rates but then they don't have the appetite for high rates so you end up you know battling out those bad businesses we still haven't got the hang of money and banking in the west have we no that's interesting as well yeah i've um i've recently been reading a new book by john k and mervyn king called radical uncertainty they talk about frank knight's famous distinction between risk and uncertainty uh which the economics profession kind of forgot for a long time in the post-war period.

But uncertainty, or what King and Kay call radical uncertainty, is where you don't know what all the possible outcomes of the future are, and or you can't attach a probability distribution. And that's kind of the world we live in. I think Guy DeBell or Lucy Ellis gave a speech a few years ago on 90 and uncertainty. Okay. Yeah, yeah, definitely. I'll check it out. Yeah, where he or she, I thought it was Guy, was really kind of stressing the fact that, you know, there's measurable volatility and there's non-measurable and knowable uncertainty. uncertainty and yeah I mean our wheelhouse in my business is pricing assets and finding

situations where we think those assets will mean revert back to some fundamental anchor that is representative of fair value and the problem of course in situations like this is that your confidence around that estimate of fair value gets thrown out the window and markets don't give a rat's ass about fundamentals they throw the baby out with the bathwater and and so it can get quite complicated but equally in situations like this if you maintain your conviction in your own internal estimates of those fair values you get tremendous opportunities I mean there's no doubt that the asset prices we're seeing in for example bank credit are the best investment opportunities we've seen in a lifetime so it's a bit painful right now

but I think when spreads mean revert normalize as they have done after every shock you're gonna get incredible returns over the next 12 months 12 to 18 months but um yeah it's a it's a big lesson and we need to kind of continue i think dwelling on what are the lessons one of the things that you know has been great about my team in my business is we were talking about this the other night is i mean this has been a supremely stressful period, but the team's been extremely cohesive. And it's a really good team. Like I've got 23 guys, 11 analysts, four portfolio managers,

a bunch of PhDs, and they're all really smart dudes, but there's no ego. And it's a very cerebral environment. People who come into our office always say, I can't believe how quiet it is. It's like a church. It's like a library. And, you know, it's a very kind of, I feel,

we're a very honest, intellectually egalitarian environment searching for the truth, just because the truth is what is the right price. And you just try and find, you try and answer that question as best you can which kind of also brings us to another topic of why you so boastful you've done it you've done a little bit of that today a little bit of talking your book a little bit of talking up the predictions but I think you've counterbalanced it with you made

you open up you open up in the very first minute with telling us how you predicted this in January. You even sent me the text message to prove it. I wanted to get the first boast in in a conversation with Chris Joy. Yeah, so it's funny. I always ask this question of people who work with me. You know, do you think I'm too arrogant um self-angredizing and every single time i've never had anyone who says yes um they because i think there's i guess a private me that people see and

there's a public me that people see uh and the private me is i'd like to think i'm pretty intellectually agile like i'm constantly changing my mind and we're constantly getting new information synthesizing it and just searching for that truth what's the right price what's the right price and we have over 30 internal quant models we use to value assets and um and you know you may have a view one day but new information arrives and proves that view wrong and you have to shift that's our fiduciary responsibility um i've been writing newspaper columns i reckon for the best part of almost 20 years and one of the things that i noticed over time was that when i'd express a view um in one column and then i might have been writing for another newspaper and i'd express the same view uh and then a year later i running for another newspaper and i'd express the same view

and then a year later i'd express another view but people would constantly come up to me and say oh you're really uh you know to give you some examples um you're you're the world's biggest bank basher you know you're the bank hater or you're the hybrid hater. You hate hybrids because you describe them as, you know, incredibly complex securities. Or you're really bearish on housing. You're the housing bear. And I'm like, no. So every one of those questions, which to anyone listening today

might sound surprising, you know, for the best part of 10 years, I was running a campaign against the banks to get them to deleverage their balance sheet. I wrote the terms of reference for the Financial System Inquiry for Joe Hockey with David Murray in 2010, and the 2014 inquiry did deleverage the banking system. And all through and since the GFC, I've talked about the need to price or mitigate implicit taxpayer subsidies of the system.

You know, between 2017 and 2019, I was extreme. In 2017, I was the most negative public analyst on Aussie housing. I said house prices are going to fall 10%. No one else had that view at the start of 2017. House prices were still rising. But then, of course, you know, between 2012 and 2017, I'd been very bullish. In the context of hybrids, in 2014, when hybrid spreads were at their

post-GFC tights, I wrote countless articles saying i thought these assets were way too expensive we had no exposures in our portfolios but when spreads blew from you know 200 over to 600 over in february 16 i was like this is a great opportunity uh and so i started writing hey you know we like hybrids uh do i think retail investors should invest in hybrids? No. I think they're far too complex to price, but frankly, I would say that they're easier to price than direct equities. The most complex asset with the most uncertain cash flows is any direct equity where you have a tech stock or a small cap or a mid cap or even a bank. You've got a multiplicity of variables impacting those future cash flows. With hybrids, which sit one level up in the capital structure, you've got a predetermined income stream that's set,

and then you've got just some risks, some finite, basically three or four events that could risk those cash flows. Very different to pricing CBAs' future cash flows, which are impacted on by an almost limitless number of variables. So that's a kind of long-winded way of saying that I kind of changed my tact a few years ago where i said fuck trying to constantly say to people i said this and i said

that because that's what i was having to do i kind of just started when i write my articles trying to provide a chronology of what i'd said and then actually hyperlinking back to when i'd said it so there was no disputing it um but it has created this effect where I'm writing saying, hey, we said in 2017 that S&P would be forced to upgrade Australia's economic risk score, which meant that the risk weights in S&P's model of Australian banks would change, which would result in S&P upgrading their risk-adjusted capital ratio for the big banks, which would then result in our forecast of S&P upgrading

their standalone credit profile from A- to A, which then in turn would result in S&P upgrading major bank hybrids from BBB- to BBB-. And I just do that to provide that cohesive narrative around where we were in the past and where we are in the present and where we think we're going in the future but people find it a little bit um self-referential i actually think the value outweighs the costs um you know i don't yeah i don't think i'm particularly arrogant i think i have high conviction views but i think i changed my views also um i mean even in our discussion on housing today i don't i don't have a super high conviction view about what's going to happen

in the short term. I have a high conviction view that if we have a reasonable recovery, that this cycle will continue and house prices will increase by 20% to 30% in this cycle. We've already got 11 percentage points of that growth. But, you know, I think it's very complicated in the next three to six months. And so I'm happy to say 0 zero to 5% is a reasonable range.

But it could be 10%. But that would be my best guess. So, yeah, I don't think I'm arrogant. I don't think I'm boastful. One thing commercially, I run a business, an investment business, and I will say that, you know, when we get forecasts right, we let our clients know. When we get them wrong, we also explain why we got them wrong.

And I get really good feedback from, I'd say, 90% of readers who absolutely love the approach. They really like the fact that, you know, I'm very clear and transparent about what we've said in the past and what we think in the present. I think there's this small minority of haters who are probably peers who probably work as traders um who are probably a little bit not happy that i'm doing what i'm doing and that i've got my platform i sometimes hear about peers who complain about the fact that chris joy has a column in a newspaper and that's his platform. Well, you know, I've been writing for 20 years in newspapers.

It's not like somebody's gifted that opportunity to me. I've earned that over 20 years and I'm the AFR's, probably the AFR's most read columnist on a column by column basis. And there's a very large readership base that values those insights. And also, the other thing is I've publicly engaged in big policy debates for most of my life. You know, I was bashing. Another classic one is, oh, Chris, you're right up ScoMo's ass. So when the listed investment company guys were trying to smash me

about criticising the high-yield junk bond, the leveraged junk bond LITs that I thought were going to blow up and which have blown up. They paid a guy to write an article for Livewire that basically said, oh, Chris has brought up ScoMo's arse and no wonder he's flawed because ScoMo's flawed. Personal attacks like that. Let's just be clear. Some people think I'm a Liberal Party lackey.

I was smashing the Liberal Party over the LIT policies, absolutely smashing. I was going to war with Josh Frydenberg. In 2014, I went to war with Matthias Korman over the Coalition's attempts to wind back the consumer protections in the financial advice laws, like waged an unremitting war, and we won that war, as I think we'll win the LRC war.

So, you know, I just pick my battles based on the arguments. I mean, as you know, you used to work for Andrew Lee. Andrew Lee is a good friend of mine. I constantly plug Andrew because I think he's, you know, probably the smartest politician in parliament and a super human being, like just a wonderful guy. And most importantly, he's there for the right reasons. He actually wants to make a fucking difference to policy.

He could be making a bucket load elsewhere in the private sector. Bucket load. He could be working for Boston Consulting, killing it. Absolutely killing it. Making millions of dollars a year. And he's a national treasure, Anjali. So I think that, yes, I have commercial interests, but I always argue what I believe in.

Well, in the spirit of intellectual humility and 90 and uncertainty, you have the mic just to counterbalance your time stamping of your track record. Is there ever a time you've got a big call really wrong you can tell us about? Yeah. I can think of lots. So, I mean, the most obvious one is what happened in March. So, I mean, I thought we would get QE in like unrestricted, synchronised global QE in the first week of March.

I was convinced that was the obvious thing to do and I was totally wrong. It took three weeks and between the start of March and when we got it, markets went into absolute freefall. So if I'd put more aggressive hedges on, credit hedges, I would have made more money over those few weeks. But because I thought the policymakers would embrace what I understood,

which they did, it just took them three weeks. In fact, they've embraced it even more aggressively than i could have hoped for so which is great for credit and spreads have started ripping in um but that's that's one obvious example um what are other examples um i in 20 early 2018 we exited all our rms about 400400 million worth of bonds, and I was convinced that because house prices were falling and rears were rising, that RMBS spreads would have to increase because by definition, default rates were increasing on home loans and the losses were higher and higher and higher.

And so investors should rationally have demanded more of a risk premium for those assets. That view did eventually play out, but there were six months where the inertia of investors really gripped hard and RMBS actually performed well, really well. But by the second half of 2018 and certainly early 2019, RMBS was the worst performing asset

um in our in our uh sort of sector and and so we were wrong early uh right in the end um another example is um and these a policy for the banks last year, in July last year, that would basically force them to have to issue like hundreds of, you know, potentially over $100 billion of bail-inable subordinated bonds. So these are quite risky bonds that can be bailed in to equity by APRA whenever APRA wants, if they declare something called a non-viability event.

And I traded these bonds forever, understood the market intimately, understood the liquidity of the market. And all expert participants like myself were of the view that once this policy came out, the spreads on these bonds would go through the roof. They'd go absolutely crazy. And that the supply tsunami that came down from the banks

where they were issuing like 15 to 20 billion of this stuff a year would just push spreads wider and wider and wider. So we had no exposure. And what actually happened, and this is a behavioural explanation. I'm not exactly sure what it was. You may know. But basically these were high-yielding bonds. In any stress event, they got no liquidity.

And in stress events, they tend to behave badly, as in perform poorly. And yet when APRA announced the policy spreads did move initially about 20 basis points wider but then it was like the supply beget demand so the banks started issuing vast quantities of this stuff all around the world and the spreads just got they actually performed so rather than spreads going wider from that supply shock spreads credit spreads came in tighter and these uh tier two subordinated bonds were one of the best performing asset classes of 2019, notwithstanding you had unprecedented supply.

And that was, I think, a function of the environment where you had very low interest rates and people were looking for an asset that satisfied their search for yield dynamics or needs. However, what has happened, as i expected uh when the shit hit the fan which was in you know february march this year those bonds have absolutely been destroyed so spreads have gone from 165 over to 350 to 400 over and they've been obliterated and most importantly there's been zero liquidity so so again, we were wrong for a period of time. And we traded them.

We would buy and sell them, but not in super large quantities because I felt that they were a very, very risky proposition in any stress scenario. But what I thought would have played out perhaps earlier, it took the coronavirus for us to see the whites of the eyes of that instrument and for fundamentals and fundamental risks to reassert themselves. Another thing that we haven't, one thing we've been getting much better at, when I started in this business, I started in running an asset-backed securities business in 2004

and we built this business in 2011. And I've always run teams of quants and I've always had lots of really, really crazy smart people around me. And the problem with that is there's a tendency to kind of sit in the ivory tower and be convinced by the models and assets cheap where there are often omitted variables from the models that are hard to quantify that really impact price.

And we call those technicals. So there are technical influences. Some of them can be quantified, some of them can't. But it could be like, you know, APRA changes a regulation that suddenly means banks can't hold these bonds or it's much more expensive to hold those bonds. Or it could be that they change regulation that it's much more expensive to hold those bonds. Or it could be that they change regulation that makes it much more attractive to hold those bonds.

All that sort of stuff impacts price. And it could be that PIMCO has come out and said, PIMCO came out in October 2018 and said, Aussie housing crash is going to continue for another two years. Major banks will be downgraded from AA- to A+. And that created a very negative sentiment in the market in relation to those bonds. We thought they were dirt cheap.

I thought the housing correction was about to finish. I said that a few months later in April. I thought the major bank senior bonds would be upgraded to AA-. They were AA-. I thought they'd be upgraded to AA- stable. And that's basically what happened but there was a period there where the the market technical where pimco was giving interviews globally saying major bank senior bonds suck oh and by the way we've sold all of our major bank senior bonds and the housing correction is going to continue you know to 20 um this was late 2018, so I guess through to 2020, 2021,

and they'll be downgraded. And the opposite of all those things occurred, but maybe my timing could have been better if we'd waited to strap on those securities a couple of months later to coincide better with the rebound in the housing market. So you can can be wrong. Mate, it can happen. I've got a final question before we wrap.

Referring back to former Deputy RBA Governor Stephen Grenville's article, on the question of liquidity, he distinguished between three different types of liquidity. And he said that it was the central bank's role to ensure base money, but ensuring that securities don't sell at a discount is arguably not the proper role of the central bank. What did you make of that argument? Well, again, my sparring partner, Stephen Grenville, I don't think he understood my argument. And I kind of generally agree with some of the things he said, but let's just unpack it. Firstly, he was responding to something I'd written in the AFR.

So what did I say? What I said was that the central bank's role is to vouchsafe or guarantee the liquidity of the financial system, which basically means banks. Banks run asset liability mismatches. They borrow short from depositors, so you give them an at-call savings savings account and then they lend your money out as a 30-year home loan and the first and foremost role of all central banks is to guarantee what is called you know banking or financial system liquidity and they do that through a bunch of different mechanisms we have a government guaranteed deposits the central bank stands ready to lend to any bank that has a liquidity shock, and they'll lend them an unlimited amount of money at a very, very cheap rate.

And Jay Powell, when he finally got the message, not after his first cut, but following his second cut to zero, and when he finally belatedly launched his multifaceted QE program, he was waxing lyrical and banging on about this exact point. He said, central banks, their key mission is to be a liquidity provider of last resort. So what I was seeing when I wrote my article was that liquidity was evaporating in government bond markets and in core bank funding markets. And that's kind of all I was interested in. Grenville erroneously and incorrectly thought that the government bond market was perfectly liquid and the equities market was perfectly liquid. So that's what he said. His exact quote

was, government bonds are in such high demand because they have such, you can see that through the fact that the yields are so low, right? So people have bid up the price and they'd bid the yield down. But actually, he was totally wrong. And unwittingly, Phil Lowe, the current governor, made the point for me when he came out and said last week the liquidity in the Aussie government bond market had become highly impaired, and that's why the RBA had to inject liquidity through buying government bonds.

Jerome Powell did exactly the same thing. He said the liquidity in the US treasury market, what is meant to be the most risk-free market of them all and liquid market of them all, the liquidity in that market had also become quite impaired. The market had shut down at various points in time in the last few weeks and hit circuit breakers. Bids and offers had evaporated. We saw similar things in one of the last few weeks and hit circuit breakers bids and offers had evaporated

we saw similar things in um one of the global bellwethers something called the uh s&p 500 futures contract or the e-mini that bid and offer side liquidity had started to disappear and i remember relaying grenville's comments to a trader in europe and he said yeah show me a bid in german bonds because every time i try and sell them, the bid disappears basically. So liquidity had vaporised because of that information asymmetry problem. Participants just did not have a price to risk, so they're withdrawing from participating. So Greenville would agree with my core proposition that the RBA should vouch for the liquidity of the government bond market,

the market for the risk-free rate, and also absolutely the RBA should vouch for the liquidity of the government bond market, the market for the risk-free rate, and also absolutely the RBA should guarantee the liquidity of the banking system and the financial system. They did that during the GFC. So people think that the RBA didn't do QE in the GFC. According to its own account, they did. They lent to all the banks in terms of up to 12 months, and they expanded their balance sheet by 50%. So the RBA became the key funder of the banking system because the banks couldn't get money in funding markets, wholesale markets.

The same was true over recent weeks. Wholesale markets for bank paper had shut down. You could not issue debt. If you found a bid, it would be a small bid, and it would be at a crazy price. So that's why everything I proposed to the RBA and the government, they did. I basically said, you need to go to term repo, which is basically short-term loans to banks of up to 12 months, and they're doing that now.

Secondly, I suggested that they emulate the Bank of England model and offer banks three to four year funding at cheap rates, which is what they're doing now. So they're providing a minimum of $90 billion of funding at a cost of 0.25%. Thirdly, I recommended that the Treasury roll out the idea I developed during the GFC, ironically with Andrew Charlton, or at least he was the conduit, to get the government and Treasury to invest directly into RMBS. So these are AAA-rated asset-backed bonds

that are issued by banks and non-banks. And they've done that. They're investing $15 billion into that program. Now, I proposed all those ideas publicly in a column a week before they announced those programs. And so my key proposition was simply there was a huge liquidity crisis. If we didn't move quickly, it would become a solvency crisis. And the central bank and treasury needed to cauterize that problem

i think what too smart by half grenville was thinking was that i wanted like i heard some dudes say and maybe it's some of the trolls on twitter who are criminally bullying people i would just remind any listeners that there's a five-year jail term for trolls on Twitter or for social media bullying and a $500,000 fine. Just one second. I'm going to take a call. Yeah, I'll be one second. I'll be one second.

Okay, okay. Recut, blah, blah. Okay. So I think what Grenville was saying was he wanted perhaps the RBA to – like I was suggesting the RBA should buy hybrids or something. It's ridiculous. Hybrids are a tiny percentage of our portfolios, and I've never suggested such.

What I wanted the RBA to do was guarantee the liquidity of the government bond market and also the banking system, and that's all I was interested in doing, and that is absolutely standard fare for central banks. Chris Joy, good to see you again jolly swagman thank you for having me on the show this is the world's greatest podcast and um listen hopefully you've got a better insight into uh the mind of wolverine you're a lot you're a lot chubby wolverine some people like to call me

no good to see you you're very calm and contemplative today yeah and uh it was a brave decision to record during the pandemic 100 thank you so much for listening i hope you enjoyed that conversation as much as i did for links and show notes for everything we discussed you can find those on my website, www.josephnoelwalker.com. That's my full name, J-O-S-E-P-H-N-O-E-L-W-A-L-K-E-R.com. You can also find me on Twitter. My handle is at josephnwalker. Until next time, thank you for listening and be well. Ciao.