Christopher Joye: No margin for error for risk junkies craving rate cuts

Hi there, and welcome back to another episode of The Rules of Investing, a podcast that gets inside the minds of leading investors, economists, and industry experts, and it's brought to you by LiveWire Markets. I'm James Marlay, and in the last episode, we heard from Ben Clark, fresh off the back of a trip to the US that turned him from AI skeptic to a fully converted diehard.

My guest today is also joining us fresh off the trip to the US, but his interests and and expertise lie in the machinations of central banks, pricing and bond markets, and what these mean for other asset classes. Many of you will be familiar with Christopher Joy, who is Portfolio Manager and Chief Investment Officer at Koolabar Capital Investments.

Koolabar manages in excess of $10 billion of assets on behalf of institutional and retail investors across the firm's suite of fixed income portfolios.

Chris is also a regular columnist in the AFR, where he publishes the firm's research on topics ranging from the inflation outlook, the trajectory of interest rates, and to Australia's favourite hobby, house price predictions. In our session today, we'll cover insights from Chris's recent trip to the US, some of the risks that are bubbling away in the background, and of course, we'll touch on the resurgent property market here in Australia.

If you're an Apple podcast or Spotify user, don't forget to subscribe to the podcast so that you don't miss an episode. Or if you're a LiveWire subscriber, hit the follow button at the bottom of the wire to be notified when new episodes are available. available. If you're not a Livewire subscriber yet, we'd love to have you on board. Just head on over to livewiremarkets.com. It's free, easy to register, and you'll get access to insights from the leading investment minds in the country.

With that, Chris, I'd like to welcome you to the podcast. Great to see you. Thanks, mate, for having me back. I think the last time we did a podcast, it was great fun, and I'm thrilled to be able to engage with your audience and talk through some ideas. Well, we're going to start big picture from your US trip, and we'll come back to the local economy. Before we do that, I'm interested to know, you are a prolific writer.

Your column in AFR is well-followed, published on LinkedIn. You share a lot of the research that you generate internally at Coulibar. What's the motivation for that for you?

Oh, mate, it's a bit of a long story. I've been writing for newspapers since I was about 23 area. I'm 47 now. I've always loved writing. I find it's a good part of the process being forced into the discipline of articulating your view of the world, And then you get held to account, and that becomes a mark to mark for your perspectives at that particular juncture. And people will go back through time and try and assess what you said and whether it came to pass.

So it's a very, I think, intellectually honest process, putting down in black and white what you think of the world, what your ideas are. We, as you say, disseminate at Coolbar a lot of our research. So often I'll reference the research produced by our 16 analysts across the business. But it's also great fun just engaging with the world historically. I've written on national security, politics, cybersecurity, technology. The AFR is a terrific platform. LiveWire is an amazing platform.

It is sometimes a little bit hard doing it weekly. Sometimes I just get jammed with meetings. And I typically only have max an hour or two to write the column. And it's about 1,300 words. So it's not a trivial task. asked. Nobody writes for me. I'm often asked, does someone show to write the comments? Never happened. Never will happen. But I love it. It's just part of my process, and I guess it's who I am. And you're not fearful of putting your views out there and being wrong?

No. Happy to be proven wrong. I am fearful of the consequences. So one of the reasons I stopped writing about national security was I had broken some big global stories about allegations that Huawei was spying for China. And I interviewed the head of the CIA. I interviewed the head of National Security Agency. I interviewed the head of ASIO here in Australia, the head of our electronic eavesdropping arm known as the Australian Signals Directorate.

And I kind of felt like there was potentially going to be a bit of blowback over time. The Chinese Ministry for State Security, the equivalent of the CIA, actually approached our Beijing Bureau Chief of the Financial Review, Angus Grigg, and basically offered to pay him money to get an inside running on every kind of national security story I was writing. At that time. And so I thought, listen, I'm a fund manager and I paid to run money.

I need to have an unalloyed, unambiguous focus on running the money. And that was a bit of a distraction, albeit geopolitics have been very important to our investment process. You might remember we produced something called the War Laboratory or the War Lab. You can see it at predictingwar.com where we use AI to basically put an empirical probability on the likelihood of true military military conflicts, so kinetic conflicts coming to pass based on 200 years of conflict data.

And so the AFR has been an important clearinghouse for ideas. The ideas themselves have become more focused and telescoped over the years because of, you know, I can't really write about politics anymore. I've got a lot of clients that probably not thrilled about me, you know, not that I'm politically partisan, but they're not thrilled about me engaging in politics. So I try and just just focus a little bit more on fixed income markets.

And that, I think, makes the common a little bit more anodyne these days, but it's great fun.

Well, as I mentioned, you've just been to the US, a raging economy, it seems, from the outside at the moment. What were some of the key observations that you took from that trip? Yeah, it was fascinating. I mean, we're one of the biggest traders of credit globally. So we're trading about $700 million a day, bonds every day, traded about $44 billion of bonds in the last three months, about $133 billion last year. So we trade with more than 80 banks globally, and we have lots of counterparties

in the U.S. And it was fascinating. I learned so much. I met with all of our trading counterparties. I met with George Soros' family office, who runs 20, 30 billion U.S., and it was really interesting getting the pulse of the street, as we refer to it. Observations would be, firstly, I really feel like there's a lot of cognitive dissonance between what the economy is telling us and what asset prices are doing, equities are,

all-time highs, Bitcoin at all-time highs. You've got credit spreads which have compressed tight levels. But on the other hand, we've got clearly evidence suggesting that there's a re-acceleration in US inflation and indeed here in Australia, Aussie inflation, which the market's sort of ignoring. Bond yields have kicked up. So we've seen US 10-year government bond yields pop from 3.8% to, in the last couple of days, as high as 4.47%.

But I think there's a lot of of ebullience, a lot of complacency on the street. People just think things are going to straight line in a linear sense from current prices. I don't see many people talking about big corrections, big dislocations. In our land, fixed income, there's a lot of talk of the difference between the yield buyers and spread buyers.

The yield buyers just focus on the fact that, if I was to use a local example, a hybrid's paying a 6.5% yield, which is attractive, or 6.5% to 7% yield. But the spread on a hybrid is really unattractive. It's only 235 basis points above above the cash proxy, normally it's $325 to $350 above the cash proxy. If I look at US high yields paying about $300 over US treasuries, normally for single B-rated high yield bonds or junk bonds, normally those junk bonds pay you about $550 over US treasuries.

The rub is that in a default cycle, they normally pay you about $1,000 over US treasuries. So how do you reconcile those two things? And one of the ways you can reconcile it is, well, the overall yield on high yield is attractive because cash rates have gone from 0% to 5.25% and 5.5% in the case of the Fed's policy rate. So yeah, complacency, cognitive dissonance. And then interestingly, for my asset class, there's been an explosion in hedge fund pods and specifically credit pods.

These are guys who are trading bank bonds, corporate bonds, insurer bonds. And it's really interesting because I was told that Millennium has eight credit pods. Rishan has eight credit pods, Citadel has three to four credit pods. But the fascinating thing is every trader on the street said they're all ex-street traders and they've all got the same positions. We would speak to traders and they would say, I get hit by one pod, I get hit by 12 pods.

They're all talking to each other. They're loosely colluding. And I don't think anyone thinks they really have any edge. They're just X street traders. They don't have any analytical advantages. And to our mind, well, they have become like a second street. So you've got the banks that are the market makers in bonds, and now you have this second street, which is scores of credit hedge fund pods that are comprised of X street traders that are providing a lot more liquidity.

So some of the biggest US banks, the hedge fund pods are about half of their trading volumes these days. But it's all one-sided. They've all got the same positions, the same positions as the street. And obviously, in any massive dislocation, they're all going to be rushing for a small exit at the same time. So we're going to see price moves could be heavily exaggerated and amplified by this new injection of liquidity.

So I thought that was interesting. I also heard that the returns on these hedge fund credit pods have been really poor over the last 12 months. They did well in 2020, but they've done poorly in the last year. And actually some are starting to be shut down. In our hedge fund strategies, like our long-short credit fund, pre-fees has done about 18% in the last 12 months, after-fees, sort of mid-teens.

And that's the Aussie dollar unit class, the US dollar unit class, I think has done about 15% net of fees. So returns have been strong, and I think there's been a ton of opportunity, and there is still a lot of opportunity. That's a new development that is relatively nice, insofar as it's emerged in recent years. but it's kind of changing our asset class.

You talk there about these ebullient conditions, a risk on environment. What we've seen more recently is that pricing of interest rate cuts in the US is rapidly being wound back. Everyone was expecting there to be four rate cuts sooner rather than later. It's now the quantum of rate cuts and the timing of those rate cuts is looking to be wound back, yet the market seems to be taking it stride. How do you rationalize those two things?

Well, our views haven't changed. In late 2021, our Taylor rule models were saying we prepared presentations in December 21 when the cash rate was 0.1% and US 10 years were at 1%. Our modeling was suggesting the Fed needed to get to 5% to 6%. We have those presentations showing that. And no one in the world was saying that at that point in time. The peak in the Fed's cash rate in late 21 that was forecast for 22, 23 was like around 1%. So they thought they'd lift it off near zero to a circle one.

No one was thinking they'd go to five to six. And obviously, they're at five and a quarter, five and a half right now. And our modeling for the Aussie cash rate pointed to a four to five percent cash rate. And I actually myself thought that both those conclusions seemed very extraneous. It seemed like getting to five to six percent and four to five percent in the US and Australia would have pretty cataclysmic consequences for the economy.

The thing that I think everyone missed was the emergence of these huge cash savings buffers. So in the US, the buffer was about 9% of nominal GDP worth about two years of extra economic growth. And they were spent over 22, 23. Households spent those cash buffers that were accumulated because we ran massive fiscal deficits, gave away a lot of cash. Households saved because they were forced to due to lockdowns.

And that's what has really supported the global economy and the US economy in particular over 22, 23. And that's what's given us this sense that, oh, we don't have to have a recession. We've had a soft landing. The risk junkies are all talking about, Hey, no recession, look at the soft landing. But the cycle's not over. New Zealand's just had 12 months of negative GDP growth. They're in recession. The UK's had 12 months of negative GDP growth.

We've had really poor economic growth data out of Japan, and we are definitely seeing cracks appear. US bankruptcies last year were the highest since 2010, despite, as you said, the raging economy. Global corporate defaults, already in the first three months of this year, the worst since 2009 in the GFC. So coming back to your question, our forecast and modeling were all implying that this would be a protracted multi-year inflation cycle.

And it wasn't just goods prices. It was about services or demand side inflation. So supply side inflation really pertains to goods prices. We shut down supply chains. Goods prices went up about 12% on a trend annualized basis, and then they've come down. So in the US now we have goods deflation. So goods prices are falling. So inflation is negative. And we also have that here in Australia.

And that is what has pulled down poor inflation from the sevens and eights all the way down to now in the US, depending on how you measure it, three and a half to four and a half. The Fed affected a dovish pivot late last year, right? On the basis of these goods prices falling. But our argument was, well, that's a temporary effect. It's a level effect. It's not a growth effect.

It's like a peak through a python. Because once the supply chain's normalized, goods prices can't continuously fall to zero, right? At some point, they have to stabilize. And then if you've got strong services or demand side inflation, which is being driven by completely different factors, namely a 3.8% unemployment rate in the US or a 3.7% unemployment rate here in Australia, very strong wage growth of 4% to 5%, Very poor labor productivity.

And most businesses are services businesses, and their biggest cost is people. And the cost of people has been increasing very rapidly. We're also seeing a political narrative around re-regulation of labor markets, the right to disconnect, the right to not work. Here in Australia, we're staring down the barrel of a big minimum wage increase that's around the corner. Last year, they increased the minimum wage by 8.6%, and they increased award

wages by 5.75%. That affects on our numbers about 25% to 30% of all workers. Because we're going to have another one of those changes looming. And basically, the federal government's arguing for, on our numbers, a minimum 4% increase in the minimum wage, which would be potentially very inflationary.

So the bottom line is that, to answer your question directly, in January of this year, markets were pricing 175 basis points of cuts from the Fed, and they were expecting the Fed to start cutting in March. We called bullshit on that. We were like, there's just no chance. We've got strong services inflation. The goods deflation will dissipate at some point, and then you're going to get a research as inflation.

And lo and behold, that's exactly what we've had. Last three CPI prints in the US and we get another one in the next 24 hours. The last three CPI prints have all been big upside surprises. We have seen massive re-acceleration in core US inflation. So to give you the numbers off the top of my head, core PCE inflation in the US, which is the Fed's preferred measure, has jumped from about 2% on a monthly annualized trend basis This is to about 3.5%.

Now, the Fed's targeting 2%, and they're currently running at 3.5%. So that's a big problem. The move down to 2% is what gave us the WP. It's what gave us the 175 basis points of cuts expected for this year. It also pushed the US 10-year yield down to 3.8%. Now it's back at 4.4%. On the core CPI measure, inflation has jumped from a low last year, about 3%. Up to about 4.5%. Now, this is all being driven by our kind of thesis, services inflation.

So US services inflation has re-accelerated to about 6.3% annualized, or if you exclude rents, about 6.5% annualized. So service inflation running about 6% to 7%. Pre-pandemic, it was running about 3%. So to get inflation back to 2%, you really need to get services inflation back down to circa 3%. And we're sitting at 6s and 7s. Here in Australia, we're sitting at 5 to 6.

So we have this real services inflation problem, which is arguably precipitating a bit of a wage price spiral because it's keeping overall inflation high. And inflation has been artificially dragged down by the goods deflation, but that's a temporary effect. So really, there's no basis for the Fed to cut right now. The Fed desperately wants to cut.

And the reason they want to cut is because they want to start cutting well before the 5 November US election, because they don't want to be seen to be politically interfering with that process. six. But the problem, James, that I fear they're going to make, or the mistake I think they're going to make, is they're going to over-invest themselves in one of these intellectual narratives or paradigms that Central makes a fond of fabricating.

So the classic is, feel low, I'm not going to cut rates until 24. Don't worry, go and borrow. Binge on debt because the cash rate's going to stay at 0% all the way to 2024. We're on 24 and the cash rate's at 4.35%. And so whenever they make these long-term forecasts, they end up often blowing up in their faces. And my concern is we're going to get a re-acceleration inflation that provides no basis for cutting the end of cut rates in June because they desperately want to cut rates in June.

But we'll see that this potentially only reinforces the inflationary pressures.

And if I could add, and this is crucial, and I think quite a few people have noticed this, that the whole Delvish pivot has propagated a massive equity and risk rally because everyone's like, okay, hiking site was over, next move is down, we're off to the races. And you see it anecdotally in survey data. Consumers think big rate cuts are coming in the US, in Australia. All the risk junkies, the commercial real estate guys, VCPE, equities.

They're all desperately in need of big rate cuts this year to be bailed out of otherwise unsustainable positions. So this is the cognitive dissonance I'm talking about. And what are some of the implications across asset prices? So you've talked about this big run-up in equities. People seem to be buying into it, getting a full head of steam. Do you think there's a catalyst that would precipitate a bigger fall there? You've had the yield curve in fixed income markets has been inverted.

No one seems to be paying attention to it, it hasn't called it correctly.

What are some of the implications for the big asset class pricing? So the interesting thing is I like to work in scenarios where we're right and wrong. So scenario one is like we get sticky services inflation and either the Fed doesn't cut and possibly hikes again or cuts are deferred for a long time and you're stuck with this higher cost of capital. Concernedly, what we know is that the pressure is building, that boiling frog dynamic.

So as I mentioned, corporate defaults for the first few months of this year, worse is the GFC, bankruptcy bankruptcies in the u.s worse since 2010 aussie insolvencies worse since 2015 worse than basically a decade and they're heading in one direction if you open up private debt portfolios it's mayhem but it's only gonna get worse those are those guys all need to be bowed out by massive cost of capital reductions you've got a big wall of high yield

or bond maturities next year in the year after they're all hoping that they can refinance those bonds at low interest rates care of cuts. So that's the context. If we're wrong, however, let's assume that we get the so-called immaculate disinflation.

Let's assume inflation zooms back to 2%. Then what we face is a really interesting situation because the central banks run these neutral rate models where they're basically trying to figure out what's the right rate to assert itself over the course of the business cycle, through the cycle, steady state. And that neutral rate model basically wants to see inflation at 2%, low unemployment, trend growth. Well, right now the US has high inflation, low unemployment, and trend plus growth.

If I'm wrong and inflation isn't persistently problematic and it zooms back down to 2%, well, you're going to have all three criteria satisfied. You're going to have 2% inflation, low unemployment, trend plus growth. And so that in turn implies that there's not much scope at all for the Fed to cut rates. Their neutral is actually very close to where where they are right now. Ironically, here in Australia, not many people understand this, but we're at 4.35%.

Which is weird because normally the Aussie cash rate is kept 150 basis points above the US rate. But the RBA has been really politically compromised, I think, and has become very dubbish. And it's really gambling on the idea that the rest of the world keep rates high and basically apply a tight monetary policy that will do the heavy lifting for the RBA. Because the RBA's estimate of neutral, which matches Coolabar's estimate,

is just 3.8%. So the RBA's got their their cash rate only a bit above neutral, which implies it's not very restrictive. And if you look at the Aussie data, 3.7% unemployment, strong wage growth, okay, overall economic growth, we've got booming population growth, house prices are surging.

There's not many signs that the economy in aggregate, notwithstanding the tails I refer to, there's tons in the non-bank lenders, the risky, the zombie companies, the commercial property owners, the resi developers, they're all cactus, right? But for most of us who are not those folks, the economy is actually really quite healthy and resilient. So I think the consequences, either way, you kind of land in a scenario where you're left with high for long.

Because what I'm trying to say here is if we get rapid disinflation to 2% and the Fed's happy, they're not going to cut rates by much. The last time they engineered it, or in fact, the only time they've engineered a soft landing since World War II, this is the Fed, was in 1995. They only cut by 75 basis points. And it also feels that there's a risk that history could be repeating itself a little bit with this dovish pivot because they've really invested themselves in the dovish pivot.

There's a lot of Fed rhetoric right now that is trying to rationalize a June cut before the election. But we saw in the 1970s that they cut rates too fast and too early. And what actually happened was inflation reaccelerated, which left the Fed having to lift rates into double-digit territory. And I know that Jamie Dimon, in his annual letter, I think, recently said that JP Morgan are modeling two key stress tests, one where interest rates go to 8% and another where they go to 2%.

Now, the 2% scenario would be a big disinflationary shock. It could be some sort of external category. In any external crisis, rates tended to have trended towards zero. But the 8% scenario is interesting, which is kind of like the persistent inflation problem. So I think in summary what I'm saying is I don't see positive outcomes, ramifications for asset prices in either contingency.

If we get immaculate disinflation, we're left with a high cost of capital, which is bad for risky borrowers, and I think bad for the pricing of risky assets like equities, commercial real estate, VCPE, private debt, HIO. If on the other hand, we get the salary that we're advocating, which is persistent services inflation, keeping costs high and giving us a much tougher cycle than we expect, and the markets are pricing.

So as you know, we've gone from 175 basis points of cuts this year to just 75, and we've gone from pricing March, now they're saying June, but June's like a 50-50 proposition. And we're recording this one day before we get the next batch of US inflation data, which will be crucial. And we could see, if we get a few more strong inflation prints, we could see total capitulation in equity pricing and risk pricing.

But thus far, equities and risk have buried their head in the sand, and they've basically said, okay, we're going to ignore all these upside surprises to inflation, even though folks like Kulabar had anticipated that this would happen. And the Fed's also trying to ignore it. I mean, one of the things the Fed's doing is it's arguing that there might be some residual quote-unquote seasonality that's biasing up with some of the US inflation data. Only time will tell.

We have a sense that one contingency is more likely than the other, but we think both contingencies could be problematic for risk. risk. Just before we move on to a couple of the other risks, I wanted to talk about, you've touched on a few of the points already, but do you think there's a chance that the Fed doesn't cut? They seem to have talked themselves into this position where everyone's almost factored in a 100% chance of there being at least a rate cut between now and

the election. Do you think there's a chance that they're not able to? Yeah. The funny thing about central banks is is they kind of yo-yo between the vainglorious and supercilious construction of these grand intellectual narratives. You know, we're in a low for longer world, high for longer world. You know, the yield curve target in the RBA case, which they were sensationally forced to dump more or less in between meetings.

You know, the productivity miracle and potentially the death of the business cycle that Bernanke used to talk about. And I think that... The Fed is ultimately going to be data dependent. So they yo-yo between the narrative and the data. And right now, I think the data is pulling them towards pragmatic reality, which is, hey, there may not be a case of cutting here and we may have to, neutral may be higher than we thought it was. We run four different neutral models that the Fed uses.

And we have neutral having increased from, say, 2.5% where the Fed thinks it is currently, what they say, 2.6% up into 3.5% to 4% territory. territory. And if the economy isn't responding, if we're not getting an increase in unemployment, if we're not getting a deceleration in wage growth, and we're not getting sustainable inflation around 2%, then they're going to have to lift rates further.

So I think that there is absolutely a chance that the Fed doesn't hike, sorry, doesn't cut, and either keeps rates at these levels for longer or contemplates hiking again.

And I think ultimately they're going to be data-driven, because you've got to remember, on the subject of these grand, delinquent intellectual interfaces, emphasis this is exactly what happened in 2021 like in 2021 they told us inflation is transitory and not a problem it's all temporary or ephemeral and so they told told us that this transitory inflation would pass and they wouldn't need to lift rates aggressively but of course they were stopped out of that position and compelled

to lift rates to levels that we haven't seen for decades so i think the data will ultimately be deterministic and decisive apropos you know their decisioning but right now we're in this twilight zone where they would love to stick to the dovish pivot pivot narrative, start chiseling rates lower each year, have a normal glide path heading into the US election. They're probably fearful about what a US election means for inflation,

frankly, and what it means for their livelihoods in the case of the Fed. But Paris is. The core CPIs and core PCEs are strong, then they're going to be potentially forced to sit on the sidelines. Well, it's moved through to a couple of the other big events that happened this year. We have a US election, 5th of November. Do you think that's a risk that people need to think about? I mean, Trump's not the wild card that he was the first time he got elected.

And even if you knew the outcome, the response in markets probably wasn't what most people were expecting it to be. Do you think that it's a big risk on the horizon for people to consider, or do you not spend too much time thinking about it? We do a lot of macro modelling, a lot of macro forecasting, so quantitative analysis.

So even though our typical holding period is measured in days in the bond market trading 700 million a day, often only holding for a few days in a given position and we're hyperactive and we're like this big quantitative market maker, what we find is that macro forecasting is really important for trying to predict regime changes. So we have 80 proprietary bond pricing models and we typically use 20 to 30

models to price any given bond. But we find that the macro can result in markets throwing the baby out with the bathwater episodically. So every few years, like late 21, we sold all of our credit, all our bank bonds, all our corporate bonds, all our insurance bonds, because basically we felt that interest rates were going much higher than markets were pricing. The credit spreads were going to move explosively wider and that the value of those bonds would decline.

And so we got completely out of our own asset class. We actually went net short. And then at the time, we existed at about $10 billion in positions. And then in June 22, when spreads moved explosively wider, we jumped back in and bought about $10 billion in credit. As those entry points have improved dramatically. The history of Trump suggests that he's a volatility amplification device. So he's just a constant source of inflation.

No-no-no's, no-no-no's, no-no-no's, and he's highly capricious, highly mercurial. We are focused on him because he's one of those external shocks that could result in markets trying to baby out with the bathwater, and crucially, the model's not working. So what we find is the quantitative techniques we use to price bonds, if there's an instant dislocation, they may not work for a period of time. They always work.

Our assets always mean revert because we're dealing with A to AA rate of bonds that are very very safe and inherently mean reverting and very liquid and super liquid like as i mentioned we're trading you know 700 million dollars a day we often turn over our portfolios 25 times a year but between late 21 and early 22 you know the models were not necessarily going to give you good signals about the cross-sectional mispricings it was really about the

time series and longitudinal analysis about you know where are these assets in a historical context and so for us macro forecasting, James, is key to trying to understand the probability of these big external shifts. So we're doing a lot of work on Trump. And my quick thumbnail sketch on Trump would be, he's all the things I described.

One, two, he's campaigning on the basis of slashing immigration and de facto kind of shutting borders to many folks, which is only going to put a lot of upward pressure on wage guys. So the US labor cost problem is likely to be amplified by his immigration immigration policies because that immigration is providing a lot of labour supply that's otherwise attenuating wage pressures. So that's bad for inflation is border policies.

And then secondly, he's campaigning on slapping tariffs on Chinese imports, which is going to be highly inflationary. And then thirdly, our intelligence suggests that the folks he's surrounding himself with, his advisors this time around are even more lupia than the guys he had in place last time around. But ultimately, he's a capitalist and you hope he's a rational actor. So I think we don't know what's going to happen, but we're worried about it and we think it could be an opportunity.

So we actually would like to see more volatility and more dislocations. And so we're definitely doing a lot of diligence to understand the probability distribution around trial and I definitely 100% think that this is something that investors should be focused on.

And have you done work on the probability of him winning the US election? We've done some work. I mean, a lot of the betting markets have him winning the election, but it's difficult to know because some of those betting markets have been wrong and the survey data you get these days because- The polling data is often unreliable. Well, correct. People don't use landlines anymore. So it's difficult to decipher. But yeah, we're kind of gaming for both contingencies

and trying to understand what the world looks like in a Biden and Trump world. Yeah.

You mentioned a few times in this interview today already, but at LiveWire Live in late 2023, your prediction as part of your session was that we're about to see the biggest corporate default cycle since the 1991 recession in the GFC. Could you give us a bit of an update date on that prediction that you made and what some of the implications that people need to think through are. Yeah, James, wow, you're really trying to pin me down on those.

It's always a mistake going to those live wire events and putting bold calls out. But that one, it looks like it's traveling pretty well. So yeah, basically, US bankruptcies last year were since 2010, corporate defaults this year were since 2009. Much really rides for that forecast on what happens with rates this year. year. If we get high for long guns, there's just so many borrowers who are just not in a position to service their debts.

And you've had an explosion in, we'll talk about this later perhaps, but in things like private credit and those guys. I've never seen a default cycle. We actually haven't had a proper default cycle here in Australia since 1991. There are a lot of people in pain. There are a minority of people.

Most people are doing absolutely fine, partly because in Waukastan, or just taking a step back, we did see, and this is obviously very sad, that in many non-democratic authoritarian countries like Iran, North Korea, China, and Victoria, extreme lockdowns. But we saw really extreme lockdowns in Australia. If you look at the cash buffers that built up, the US buffer was about 9% of GDP, three years of growth.

In Europe, it was about, from memory, about 5% or 6% of GDP, about one few years of growth. In Australia, our buffers were worth 13% of GDP, about three years of growth, and we've only spent about a third to half of the excess savings.

There's a lot of excess savings that still exist in Australia. in the US and Europe their excess savings buffers have been exhausted and that's why I think a stagflationary future is kind of very likely for the global economy that's what you have in New Zealand which is a canary in the coal mine the New Zealanders were raising rates before most in October 21 they started we didn't start here in Australia till May 22 and in New Zealand

as I mentioned you've had 12 months of negative GDP growth so they're basically in recession but you've still got very high inflation high service inflation actually still high goods inflation you're very strong wage growth even though the unemployment rate has increased from about that 3.2% to 4.2%. So you've got a recession in New Zealand, but you still have this stagflation.

And it's going to be super interesting to see how they beat that out of the system, because really what you need is a big recession. But coming to your question about our prediction for the worst default cycle since the GFC, I think we're more or less in line or tracking close to that expectation.

If we get immaculate disinflation and the Fed cuts aggressively, progressively or at least cuts a little to their new estimate of neutral, and then potentially some of those borrowers will be bailed out. But I'm pretty comfortable that you don't want to have any cyclically sensitive risk in your portfolio.

You don't want to be exposed to those businesses, which you find in a lot of growth equity portfolios and a lot of VCPE and a lot of high yield and a lot of private debt, those businesses that predicated their finances on the presumption of perpetually cheap money, that believe fill low, that rates would stay low for years and years years and years and really can't survive in a high cost of capital environment.

And that high cost of capital, and this is what creative destruction in capitalism is all about, that high cost of capital is actually meant to crash weaker businesses and push them out of the system like a bushfire, cathartically rushing through a national park. And so kill off the weak businesses and allow more productive and vibrant concerns to rise up in their stead and get that capital and labor that was in that zombie

company reallocated to those people and that money. to much more productive businesses. So I'm super negative of those spaces. And so you've mentioned it a few times, you have some concerns about the private debt space and the private credit space. It's been a burgeoning asset class and a lot of interests, a lot of new operators entering the market, talking about here locally, the pullback that the big four banks have had.

You've mentioned it a couple of times already that you have some concerns around that space. Explain that to me. Those businesses have, as you said, had explosive growth.

You've got to remember private credit did not exist in Australia in the GFC as recently as like 2008, but none of those funds were around. So none of these funds have been through a default cycle. In the GFC, our unemployment rate peaked in the high fives. We didn't have two quarters of negative GDP growth. The last real recession in Australia was the 91 recession where unemployment went to 11% and ANC and Westpac almost went under. Why?

Because of their exposures to commercial real estate and renzi developers. Developers, you say they argue that banks are pulling back, but that's obviously not entirely true in the sense that banks are desperate to lend. Banks want to grow their balance sheets. Banks are all falling over themselves to lend to businesses.

So there's absolutely no shortage of finance available for good borrowers. They can get loans from banks and meet their serviceability standards. What we are seeing is that there's a swathe of borrowers out there that don't have out for the capacity to get a loan from a bank because they're subprime. So after the GFC, regulators did go to the banks and say, hey, you've been lending money to people who can't afford to repay those loans. You've got to stop.

But if you can afford to repay the loan, the bank will lend to you. So these are prime borrowers that actually are very risky propositions. And lo and behold, if you open up private debt portfolios in Australia, you'll find a lot of Australia, it's like the Genesis Healthcare loans that were completely wiped out, a lot of healthcare, I think, exposures have caused a lot of mayhem. But the biggest drive is actually commercial property and resi developers and construction loans.

And one thing that the banking regulator APRA has documented over 100 plus years is that that the biggest killers of banks and therefore lenders is commercial real estate and real estate developers. Now, what's unusual about the Australian private, and it's many unusual things, but one unusual facet of the Australian private debt industry is that if you go to the US and go to Europe and you open up a private credit fund, you'll see very little real estate.

It's all diversified across industry sectors, big diversified portfolios. In Australia, almost every private credit fund is a real estate debt fund. And now they're creating real estate equity funds. I wonder why. Why? Because their loans have gone to default and they've ended up with real estate equity and they want to flip that to the real estate equity funds. So it's quite amazing getting real estate equity funds popping up alongside real estate debt funds.

And these are sectors that are clearly not sustainable. And I think that it's very few players, aside from the likes of Metrix. Metrix, obviously, 500 pound griller, 125 staff. Lockie, the guy that runs that business, he's clearly a bit of a beast. But these shops are normally two men and a dog. They've got no resources.

Really few skills sometimes they've got no skills they've never even worked in the sector they've just decided to make subprime loans to their mates I actually had a client ring me last night and he goes, oh mate, I've got this resi developer in Western Sydney they're offering me 18%, And I'm like, and this guy's smart. And he's like, what do you think? And I said, well, so where do you sit?

Is it a senior line? He goes, yeah, it's senior. I said, so what, you're not subordinated to anyone? He goes, oh, well, we're subordinated. The bank did. I'm like, well, what do you think the bank's going to do when the borrower defaults? It's all over Red Road. So you're basically providing equity. And Western Sydney is kind of ground zero for mortgage stress, high property prices, high interest rates. The risk is they go high because the RBA is forced to raise again.

And the risk is that there's a slowdown in population growth and the overall economy starts to kind of stagnate.

So I think private credit is completely illiquid. I think there are very good managers, but there's also a lot of most are, I think, not going to survive the cycle. I think people need to understand what they're buying. One of the problems in private debt is we haven't seen the credit spreads on private debt portfolios match the moves in credit spreads in liquid asset classes.

And, you know, it used to be the case you could get 6%, 7%, 8% in private debt, and that looked really attractive when the cash rate was at zero and term deposits were paying 0.5%, and a high-grade credit fund might have been paying 2% or 3%. But now, you know, our floating rate high-yield fund has a yield of 8.3%. That's A-rated, A-plus rated, in fact, Aussie bank bonds. Two-thirds senior, one-third T2, we do some gearing.

But if you can get 8% to 9% on Aussie bank bonds with very little default risk and liquidity risk, that creates a high hurdle for riskier asset classes that do have default risk, that have no liquidity. So you'd really want double-digit returns and then you'd want to interrogate the underlying assets. So I think private credit has a role to play in portfolios. I think right now, given we're in the midst of the worst default cycle since the GFC and it's only likely to get a lot worse.

Personally, I think I'd be sitting on the sidelines and looking at an opportunity to re-enter the sector on new assets at some point over the next 12 to 24 months. But we've heard war stories of about a dozen Aussie private credit funds that have got liquidity crises because people are pulling money and borrowers are not repaying loans, and they've been looking for emergency liquidity from family offices who have been gearing the private credit funds up to allow them to make redemptions.

So I think it is amazing and breathtaking how many of these shops have opened up. And that in and of itself is a signal. There's no barriers to entry. It's dead easy for Joe Bloggs to open up a private debt fund and start making mezzanine support and outlines to risky and racy developers who desperately need a cash because the banks prudently won't lend. Now, the cynic or the skeptic would say, you're talking your own book. These are competitive firms. What's the response to that?

We're really different asset classes. is our portfolio is A to double A rated liquid portfolios, which we turn over 25 times a year. We don't really come up against private credit funds, to be honest, most of the time, because I'm allocated out of high-grade fixed income. They're allocated out of high-yield or private debt or alternatives.

We do have some products that cross over, like that floating rate high-yield fund that's yielding 8% to 9%, and it's probably done about 11.5% after fees over the last 12 months. But we're not running private debt. It's kind of like saying an equity manager competes with a REIT manager. Maybe they have similar type of returns, but we're in different asset classes. They're in liquid lines. We're in highly liquid lines, which we only hold for a few days.

We're getting out returns from mispricings and alpha using those 80 models to try and get price appreciation on top of yield. They're just chasing yield, which is a pure proxy for risk. But I want to stress, I think private debt has role to play in portfolios. I'm not sure that in the middle of a default cycle is the best when things haven't properly repriced is the best time to allocate. And I do think that there are very good managers that we've mentioned already that have amazing resources.

Yeah. And skills and capability. I saw some research. So I'm going to bring it back to the Australian market, have a quick chat here before we get into some of our regular questions. But I saw some research from Roy Morgan showing that inflation expectations have risen for four consecutive weeks. weeks. Do you think the RBA is losing control of the inflation fight here a little bit?

I think that they're losing a lot of credibility because nobody understands, I can give you some pretty powerful anecdotes, nobody understands why Australia's cash rate's at 4.35% when normally it would be 1.5% above the US Fed fund rate. So the Fed fund rate is currently called roughly five and a half. So that would imply our cash rate shouldn't be in the sixes and sevens, right?

So that's problem one. Problem two is the R-Bet publishes the macroeconomic models that it uses to determine what the right cash rate is and we run those models. And those models imply that the RBA should be at five or higher. And then number three is Jonathan Kearns was head of economic analysis at the RBA up until recently. I think he was there for 28 years. He just recently, last year, spun out. He's now chief economist at Challenger.

And he's written on Livewire, I think, like what we've written, which is that if you run the RBA's macro models, they should be at five. There's just no reason for them to be at 4.35. So they're devilishly trying to preserve these employment gains. And we've got this re-acceleration in the Aussie inflation data as well.

And I think that the more you see inflation entrenched at high 3%, 4%, 5% rates, the more likely that you'll get this upward drift in expectations and that will feed back into the wage price setting process. And we're seeing this with these minimum wage and award wage determinations where the government's saying that workers can't go back in real terms, so therefore they need a full inflation adjustment.

So the government's arguing for 4%, but the RBA is saying, because our labor productivity is so poor, 4% wage growth each year does not give us 2.5% inflation. Right now, it gives us about 3.5% inflation. So the RBA can't hit its inflation target right now with 4% inflation growth. And to get inflation back to target in 2025-2026, the RBA has had to make these heroic assumptions about productivity growth. And basically it's assuming a massive increase in productivity.

Which we haven't currently got, and to a level that is actually sustained at thresholds significantly above the pre-pandemic trend. So I think the RBA, you know, listen, it's rolling the dice. They may get away with it. None of us know. We could get the immaculate disaffirmation, but I think there's a real risk that the RBA blows itself up again with these silly games that they play with these intellectual narratives, the current narrative being that, oh, we're fine.

We're just going to hope the rest of the world does the heavy lifting, and we want to look at the dual targets in our mandate, which are price stability or the inflation target, 2.5%, and full employment. We've got full employment right now, and we don't want to lose full employment. I think there's also a risk they were politically compromised because Michelle Bullock was not expected to be the appointed governor.

It was expected that Chalmers, our treasurer, would appoint an external candidate. And at the last minute, Bullock got the job. Chalmers obviously wouldn't have appointed someone he thought was going to go crazy on raising rates. And she's been pretty dovish to date. But I think ultimately, again, think of that yo-yo or oscillation between the fictitious intellectual paradigm or narrative that they're trying to propagate and the data.

Ultimately, they're going to mean revert to the data. Every single time the central bank is going to be forced to respond to the data, it's just a question of how long they can divorce themselves from the data. Property, it had a fall and it's been a strong bounce back. I think it caught people by surprise. price. What's your take on what's taking place in the Australian residential property market at the moment, particularly in the major cities?

Yes. Just for the record, in October 21 in Livewire, we were the only public analysts that had a view that house prices would fall based on our view that the RBA would lift the cash rate. Our internal modeling had the cash rate going to 425, where it obviously got to 435. That 425 cash rate in our models, we use the RBA's model of house prices, the Tulip Saunders model. Okay. Saunders-Chulip model had a 15% nominal correction in national house prices as a minimum. We offered a 15% to 25% range.

According to the daily CoreLogic house pricing index data that Donnie Kinsey said, I was a kind of venture on the patent applications, house prices fell 10% beat to trough. And then since, so that's between May 22 and February 23, they have subsequently recovered all those losses, appreciated further. So we expected a 15% plus drawdown. We got 10. That was the second biggest fall in 40 years of data.

Inflation adjusted, house prices did fall 15%. But we were surprised by the fact that they didn't fall further, a little bit further, and we were surprised that we got the rebound we got. I think Louis Christopher actually caught it pretty well, the 2023 bounce. And I think what we underestimated was we expected a massive increase in immigration once the borders opened, and we forecast that. that. We didn't perhaps expect the ferocious nature of that population growth.

We're running basically world-beating population growth. And also the composition of the population growth was probably more well-heeled than we had anticipated. A lot of people coming to Australia, bringing a lot of money to Australia. Just anecdotally, in the eastern suburbs of Sydney, you're seeing 1,000 square meter lots with a 600 square meter homeowner sell for $40 million.

I mean, it's just ridiculous. And when you speak to agents, they'll tell you that it's Chinese buyers and Vietnamese buyers. Apparently, a lot of Vietnamese money is coming to the country because when the supply chain shifted from China to Vietnam, they made out a lot of mandates. So I think you're seeing a lot of foreign money come into the country. And as to the outlook, so we expected the drawdown. The drawdown wasn't as big as we got.

Or sorry, the drawdown that we thought we'd get was larger than what we ultimately saw, and we were surprised by the bounce. As to where from here, we haven't published any hard views, and I'm kind of liable to express any, other than I do think there are pockets of opportunity in Aussie Resi from an investment perspective. You know, I like the Sunshine Coast, and we bought a place on Pridgian Beach,

and the Noose is crazy expensive, but south of Noose, you've got the 2032 Brisbane Olympics. big. The Queenslanders are interesting. They own all their own infrastructure. So the state owns the infrastructure. They didn't privatise anything. And the infrastructure is very high quality and they're building a tonne of it. And property is very cheap south of Noosa. So that Sunshine Coast is attractive. I think Perth is also very cheap. I was tempted to buy property in Perth.

And then you get these kind of little enclaves in the well-heeled sectors of Sydney, like Bilby Hill, where I own, where prices have got crazy because of just the proximity to Dubai, the city. And the amenities, you've got two schools, Cranbrook and Scott's on Victoria Road, Bellevue. You've got access to the train station and Bondi Junction. So I think there are tons of opportunities because there's no doubt there's a lot of momentum.

I saw a place, a cabaret on the beach there that they were marketing for $12 million, it's now $14. I'm sure there are many anecdotes that others have. So I think there's opportunities. I think the population growth will stay strong. Australia's always run broadly amongst the strongest population growth in the OECD, where immigrant country, a third of us weren't born here. One in two Aussies have a foreign parent, and I don't think that's going to change.

Immigration is massively powerful for productivity, and I'm actually quite bullish on the Aussie economy overall. But all those roads lead to higher interest rates, and the house price action can't be comforting to the RBA. Chris, in your property, you've been loath to give too many predictions. In the fixed income market, do you like duration at the moment or do you prefer to be at the shorter end or do you like taking on some duration?

Because we've talked about what is quite an uncertain and dynamic outlook for interest rates. So, I mean, that obviously poses a challenge for someone like you that plays within those markets. Yeah, we've advocated floating rate, particularly since late 21. one. And then when US 10-year bond yields started piercing 4%, we've advocated averaging into duration between a 4% and a 5% US 10-year bond yield. Right now, we're at 4.4% area. We've got this crucial inflation data in the next 24 hours.

If it's ugly, we could see yields push back towards 5%. But I think, yeah, duration right now makes sense. In my portfolios, I'm probably 75% floating and so zero duration and 25% fixed or long duration. But I think you could rationalize here and now with where current yields are, particularly if they creep up into the north of 4.5%, you could easily go 50-50 fixed floating. So half your portfolio long duration, half your portfolio zero duration.

Obviously, I'd stress this is not personal financial advice. This is just me talking to myself about what I would be hypothetically doing in my own PA book. book, but duration is so much more attractive than it's ever been.

Obviously, 10-year bond yields in 2021 at 1% duration was hands down attractive, but at 10-year yields of 4.5%, that's basically the same yield you're getting on A-grade office property, or that's a better yield than you're getting on an investment property in resi before any transaction costs you have to incur and other depreciation costs in resi. So I think duration has some pretty attractive insurance properties.

Self-plug, we do run Australia's best performing long long-duration strategy, the Active Composite Bond Fund. Its ETF ticker is FIXD. Last 12 months after fees, it returned 6.35%, I believe. The index did just 1.35%. We did about 5% above the index net of fees. And to the best of my knowledge, we beat every long-duration manager in Australia over one year, three year, five years, and since inception in March 17.

So I think I invest in FIXD. Obviously, this is not personal advice, and you should go and speak to an advisor about what you you want to do with your own portfolio. All right. Well, Chris, I'm conscious we've gone a little bit over time, but I do have three questions I'd like to finish up on. So if you're happy to stick with me, I'll get through our regular questions. What do you think investors are overlooking or getting wrong about markets today?

Yeah, I just think it's this dichotomy between what the economy is suggesting needs to happen with interest rates and what markets are pricing will happen with interest rates. You see it very clearly. We run, as I mentioned, the Taylor rule that basically tells us where US rates should go. And then we map against that where markets are saying US rates will go. And there's a big gap. The same is true here in Australia.

Our modeling of the Aussie cash rate implies the rate to go up, not down. So I think. We're going to get a hell of a lot of super important information on US inflation and wages and unemployment. I mean, we had very strong payroll data last week before we recorded this. It blew the market estimates out of the water. But if this strong data keeps on coming through, hold on to your motherfucking hats because the world is not priced for this risk. Make no freaking mistake.

There is no margin for error in listed equities. There's no margin for error in venture capital, private equity, zero in crypto, in commercial real estate, nothing. In resi development stock, in high yield junk bonds and private credit. So all these guys are priced for perfection. They're all assuming we're going to get a big reduction in interest rates that cost of capital relief, which is going to in turn radically reduce repayments and bail them out of their zombie graves.

But if we get persistent, prolonged, protracted, elongated core inflation, then we're going to have a huge amount of strife and I think another regime change. age. So that's what we're, in my AFR column this year, every single column I'm talking about services inflation. In fact, I pretty much talked about it in every column for the last two years.

And all anyone's talking about right now is services inflation, but it's still not, I think, front and center because the Fed's trying to diss the data saying, oh, we can still cut in June and everyone's trying to rationalize the W-ish pivot. But asset prices, I think these days, particularly J-June, what I mean by that is I feel like with with the amount of passive money and ETF flows and the amount of retail money. And then also the amount of momentum-based algorithmic money in equities,

you get a lot of exuberance. So a lot of extreme exuberance. There's not really paying attention to the data. I'll tell you something interesting. Between late 21 and early 22, we noticed these really weird disconnects between data releases and market reactions. So we'd see bad inflation data come out and equities would rally. And we'd see a strong payroll sprint and the unemployment rate falling and equities would rally. And we're like, dudes, this is early 22.

We're like, dudes, what's going on here? This is going to mean hikes. Hikes are terrible for risk. But for about six months there, the equity markets couldn't price the economic data correctly. And I said to my team recently, I think I'm seeing the same regime, the same heuristic once again apply itself, where it feels like the price action in risk is really insensitive to and ignorant of the signals in the economic data noise that we're seeing very clearly.

Chris, can you share a lesson from a big win or a big loss? Tell us what happened and what was the lesson. Yeah, easy. I'll start with a big loss. It wasn't a big loss, but we had these wonderful macro models in late 21, as I mentioned, where we sold all of our credit. And we're a credit manager. We had no credit. We actually went net short credit. I think I had more than $12 billion of investment-grade credit shorts across various portfolios. The world's greatest call was fantastic.

And credit spreads went about 150 basis points. Why does it tick that box? And we hid in infrastructure hedged sovereign bonds, but we hedged the bonds with futures. We had this idea that banks would be forced to buy about 300 to 500 billion of these bonds. Everyone said we were wrong at the time. Since that time, the banks have done exactly that. And everyone agrees we were wrong. We found a liquidity hole on bank balance sheets in 2021.

And we were basically, I went and saw Matt Common, the CEO of CBA about this. I went and saw all the bank treasurers and I said, you've got this massive liquidity hole. You have to buy 300 to 500 billion government bonds. They all agree with this today. But at the time, they were kind of trying to push back and none of the market knew anything about it.

In the same way that, again, I'll say this sounds too self-referential, but like last week, S&P upgraded all the banks' T2 bond ratings and hybrid ratings. We had written in a live wire in November 2023, we thought this would happen. We were the only analysts or investors globally that were aware of this. S&P said no one else on the planet had asked them the question on the subject, and it happened last week. So anyway, I was thinking we'd done all the right things.

We got out of risk. We were short credit, late 21, and we're hiding in sovereign bonds. and those sovereign bonds were going to be in high demand, but we hedged them with futures. If we'd hedged them with swaps, this is an inside belt way and most people won't understand the difference, but if we'd hedged them with swaps, the spread on the sovereign bonds to swaps would have compressed 40 basis points.

We hedged them with futures, the spread on the sovereign bonds to futures went 50 basis points wider. So it was better than being in credit, but because we got the hedge wrong, we didn't get the monster returns that we would have otherwise got. And that was partly because the RBA blew up the swaps market when they dropped the yield curve target in late 2021 and swap spreads went crazy. And the lesson for that process was we could have hedged with swaps or futures.

We'd not historically use futures because, sorry, swaps because futures were cheaper and more liquid, but they were an approximate hedge. They weren't a perfect hedge. The swaps were a perfect hedge. And had we hedged with swaps, we would have been probably the best performing fixed income manager in the world over the 12 months of June 22.

Because we got all the shorts right we got the asset class we got the idea right but we got the hedge wrong and so the lesson in that story is you want to be very very precise and so these days we're incredibly anal and and precise on all our interest rate hedging and we don't leave any residual risk so that's one thing we got wrong the thing we got right that was i think interesting was a good story in march 2023 credit swips credit swiss is about to collapse and

a lot of the aussie credit funds They were loaded to the gills with Credit Suisse hybrids. And unfortunately, all these hybrids were wiped out. So they were zeroed. Our analysts had put a blanket ban on any long exposure to Credit Suisse in May 21. So we weren't interested in going long Credit Suisse. In fact, we were short selling Credit Suisse senior bonds in 2022. But at the time of their collapse in 2023, UBS were the obvious merger partner.

And they were forced by the Swiss regulator, Finma, into a shotgun marriage over a weekend. But when the market woke up on Monday and UBS announced that they bought Credit Suisse, Swiss, the market says, this is going to be a disaster. So everyone was shorting UBS equity bonds. Their share price fell 16%, and their senior bond spreads went from 150 on the bonds to 310 on the bonds.

Our analysis was the complete opposite. Our analysis was UBS is buying Credit Suisse for 3 billion Swiss francs, when it's probably worth about 33 billion. So we thought they got it 30 billion cheap. They subsequently announced they got it 37 billion cheap. Plus the Swiss government was giving them a 9 billion Austin Demony, and the Swiss central bank was giving them 150 billion of cheap loans. And then finally, they were taking out they didn't want to bet it,

right? So they were becoming like a monopoly systematically important bank in Switzerland. So on that day, I rang up one of my pension fund clients. We shared them with the research, and they said, yeah, we're in. And we bought about a billion dollars of UBS senior bonds that day at 300-plus overborders. And that spread has since come in 150 basis points. We've made massive money on that trade, and it's a good example of what we do.

We're massively contrary and counter-cyclical, and we tend to have very different positions to what the rest of the world has. Final question, Chris. If you had to pick an asset class to buy and hold for the next five years, say markets were going to shut, you had to pick an asset class to buy and hold for the next five years, what would it be and why would you hold it?

Yeah, what I like is government guaranteed banks, they're too big to fail, they have government guaranteed deposits and implicitly guaranteed bonds. So if you take the senior bonds issued by, say, the four major banks and you gear them up 70%, 80%. You can earn a 7% to 8% per annum return, which you can hold to the maturity of those five-year bonds. That is really, in my personal opinion, an exposure that has relatively low risk.

So you've got senior bonds that are implicitly government guaranteed, double-a-march rated from ANZ to CBA, NAB and Westpac, paying you 7% to 8% per annum, that are very liquid, that have no default risk, unless you think one of those banks is going bust. You can trade hundreds of millions of dollars a day, and you're basically locking in a 7% to 8% yield that's super attractive. That, for me, is a pretty good trade in a world where all asset classes are expensive.

Housing looks expensive. Equities looks expensive. Commercial real estate looks expensive. And all the other assets, private debt, high yield, VCPE. Financial spreads, because we still have a bit of an echo of the Credit Suisse collapse in our memories, Aussie Bank senior bond spreads are actually still cheap. So hybrids are not cheap. Hybrids are trading at $235 over bank bills, and normally they trade at $325 to $350 over bank bills.

So bank hybrids are not cheap, but bank senior bonds are cheap, which is interesting. And then if you can leverage them and get 7% to 8% returns more or less banked, then I think that's pretty attractive. Now, if the spreads go tighter, so if they go from being cheap to normally valued or even expensive, which I think they will do, then you're going to get an additional capital gain on top of that yield.

So your total return is going to be much higher. So in our floating rate high yield fund, the yield over the last year has been about 8%, 8.5%. The total return pre-fee has been 12.5% because of the alpha from finding cheap bank bonds that normalize or may revert and provide some price appreciation. So that's what I would do. And I'd probably do half-fixed, half-floating. So a bit of a pun on duration for the next five years. So if rates get cut, the floating rate notes, their rates will fall.

But if you punt on duration and load duration of the portfolio, then I think it's highly diversifying in the event that at some point central banks do lower rates. Yeah. Well, Chris, thanks so much for taking the time to speak with us today. Really enjoyed hearing a bit about the views on what's quite a dynamic space with the interest rate and inflation settings, and also hearing a bit about what you've been doing with the portfolios at Coolbar Capital.

James, man, it's been a great privilege. What you're doing at Livewire is absolutely incredible. Well, you guys have been market leaders, not in Australia, but globally, hyper-innovative. And to be a clearinghouse for the best minds in the business every day, all day, I'm obsessed with Livewire. I read it nonstop. I've got the feet on my phone. I've actually got a Livewire dedicated screen in my toilet so I can see the Livewire feeds. That's no joke.

That's no joke. So I always want to be connected. And it's just not me that obviously publishes on Livewire. I haven't published as much of late. I do actually have other contractual commitments to the financial review, but my chief macro strategist, Kieran Davies, publishes all the time on Livewire, very short, punchy, parsimonious pieces. A little bit doer, like can be a bit dry.

He's also a pretty doer, to be frank. KD is not necessarily the most charismatic character, but he's an absolute beast and definitely the best macro economist in this country, in my not-so-humble opinion. So have a look for Kieran Davies on Livewire. Otherwise, you can find Twitter at CJOY or LinkedIn, and we'll continue punching out as much as we can as a public good and also to educate our clients.

Well, thanks, Chris. And to all of you listeners out there, thank you very much for tuning in to today's podcast. I hope you enjoyed it. Remember, hit the subscribe button on your podcast platform of choice so you don't miss anything. Music.