Recorded: April 15, 2020
INTERVIEW TRANSCRIPT (EDITED)
Albert Lu: Welcome to The Power & Market Report. I’m Albert Lu. My guest this morning is Mark Yusko, the founder, CEO and chief investment officer of Morgan Creek Capital Management, which manages close to $2 billion in assets. Mark, thank you very much for joining The Power & Market Report. It’s nice to meet you. Welcome. How are you?
Mark Yusko: Thanks, Albert. It’s great to be with you this morning. Everybody’s doing well here in North Carolina. I hope you guys are doing well in California as well.
AL: We are, considering all. We’re very lucky here. Lots to cover, not a lot of time, so let’s get into it. [The] Dow rebounded nicely this morning; it’s up 600 points. We’re getting some good news on the health front — meaning that this thing is reaching peak. Are you willing to say that we put in the bottom and, if so, do you expect a retest of those levels any time?
MY: You know, I’m actually not. I’m one of the few that’s still in the camp that the worst is yet to come. You know Bob Farrell, the famous Maryland strategist, talked about bear markets. And his rule number 8 of his 10 investing rules was: Every bear market has a sharp down, a reflexive rebound, and then the fundamental downturn. And I think we’re in the middle of this reflexive rebound and people are focused on kind of what’s happening with every little piece of headline. And they’re not really focusing on the big picture, which is, you know, we’re going to have a pretty sharp downdraft in economic activity, already seeing that global trade is collapsing, profits are going to fall dramatically. And I just don’t think you can increase P/E multiples in a world where interest rates are zero and global economic trade and growth are falling. But you know everyone else is doing that right now.
AL: Mark, is it a mistake to focus too much on the exogenous shock that caused this, rather than the fact that we’re in this now and we have to deal with maybe some excesses that built up over the years?
MY: Yeah, look, I think that’s the great insight of all insights, right? Which is, everyone is focused on this shock and they’re saying, oh, it’s going to be temporal and it’s going to go away. And look, I believe it. I believe the virus is a novel coronavirus. I don’t think it’s a bio-weapon. I think it will fade. I think it will disappear over one flu cycle the same way that, you know, other novel coronaviruses, like SARS or MERS, have faded away. So, I do think it will be a short-term shock. But to your point, which is again the great insight, it’s not about the shock. It’s about these epic bubbles that were created by a decade of abusive monetary and fiscal policy globally. And now, the day of reckoning is coming and you can’t displace the entire global economic system. You can’t lock everybody down for months and then expect it to just magically restart perfectly and go back to where you were. And, look, we’ve been conditioned over the past 10 years to buy every dip. And if you did, that worked out, because the Fed had your back. I think this time what we’re going to find is the economic calamity on the other side overwhelms the opportunity for the Fed — through monetary policy or even a little bit of fiscal policy from the governments — to stimulate demand, because you can’t fix a solvency problem with liquidity.
AL: Right. You know, I like the use of the word temporal. So this sort of is a temporal problem, in the sense that there’s going to be a duration to it. And we’re going to have to work our way through it. But to borrow a little bit from the “Star Trek” vernacular, Mark, they want a wormhole to, sort of, bypass this problem that we have. They did it in ’08. They did it, in my opinion, a few times since then, bypassing [it], sidestepping it, cheating in a way. They’re obviously trying to do it again. How many times are they going to be able to do it?
MY: Look, it’s a really important question. And to your point, you know 2015, you know we started to have a normal cyclical recession on that seven-year cycle like we should have. And, you know, first quarter 2016. If you remember, the markets were collapsing down double digits in January, and then magically the first week of February, everything turned around. We had this cyclical rebound and that was because China pumped $4 trillion into the global economy and turned things around. And so that, like you say, is kind of cheating, in the sense that all you’re really doing is pushing out the future day of reckoning by pulling forward economic growth in the form of incentivizing consumption today at the expense of tomorrow.
And now, you look at car sales, for example. Car sales are collapsing globally. Why? Well, because we incent[iviz]ed people to pull those purchases forward by basically giving away free cars, right? No money down, no payments, no interest. Eventually you had to pay. But the real problem was that about 38% of car loans now have negative equity on the day they issue the loan. Think about that. You’re trading in a clunker, you’re financing more than 100% of value of the car and you’re underwater on day one. So it’s just a bad situation. Look, you can do that for some period of time and we’ve been doing it, as you mentioned, for years. And I think that day of reckoning is around the corner. I don’t know if it’s tomorrow because, look, the Fed, the Treasury, or the “Freasury” – like, you know, somebody said the other day, like Frankenstein — they’ve created this boomlet in expectations around the amount of capital that’s going to seep into the economy.
I think the problem is [that] most of that capital is going to go to retire debt, some of it’s going to get saved, not as much of it’s going to get spent, and old habits aren’t going to return right away after people realize, huh, I got by with spending less, I got by with traveling less, I got by with eating out less. So that consumptive boom that we’ve been experiencing for the last couple decades, I think, is going to shift. And whether it’s as big a shift as — remember the Depression-era babies? We had a whole generation [that thought] debt was evil, right? Saving was good and spending was bad. … When I bought my first house, my wife and I were young marrieds, [and] our next-door neighbor was an older couple. They still had the original pots and pans from when they got married 45 years ago. I think we’d only been married about four years and we were already on our third set of pots and pans, because, you know, they’re disposable, right? So I think that shift generationally may occur here and the idea that we’re going to get magically back to that consumption-fueled boom, I think, is a pipe dream.
AL: Yeah, good observation on the auto front. Looks like prices for autos are declining. Stocks are reflecting those declines. I want to talk about the banks now. Back in the last big crisis the Fed and the government bailed these guys out and it looked like it was a gift. But I always thought that maybe they were just fattening them up for Thanksgiving. And I wonder if Thanksgiving is here, because you look at [the] playbook that they’re running. They’re cutting the dividends. Wells Fargo, you know, EPS of 1 cent versus, what, 33. The stocks are down. They seem to be preparing for something bad and I’m wondering. I’ve had guests on here that said, look, this is the standard garden-variety recessionary playbook. This is the smart thing to do — that’s exactly what it looks like on the surface. But I’m wondering if they’re preparing for something more than that. That they’re going to be marched out and asked to do things and they sort of already have, right? To do things that they don’t want to do, that don’t make sense from a, you know, orthodox banking point of view. What do you think the bank’s role is going to be in the continued bailout of pretty much everything now?
MY: Yeah, like, again, lots to unpack there. And again, really, really important in good points. If you go back to, you know, the history of banking and fractional reserve banking, in particular. You know, it all kind of changed at two important points in U.S. history. One was 1913, with the creation of the Fed. Look, the Fed has one job: It’s to enrich the bankers, right? The bankers own the Fed. The big banks and the big banking families around the world, they own the Fed. And that pays a dividend to them. And their job, if you look over history, is to bail out the banks when they’re struggling and to enrich them over time.
The second big change was 1971, when we went off the gold standard and we started this nominal inflation of things, of assets, that I talk about as the dictator playbook, right? If you’re the dictator, you surround yourself with cronies and you get all the assets in the hands of the cronies. And then you devalue the currency. And that’s exactly what happens around the world. If you look at primary dictatorships, that’s what they do. A small number of people own all the assets. They devalue the currency. Those assets appreciate. The poor get really, really poor. The rich get really, really rich — in nominal terms, maybe not in absolute terms.
And I think the same thing’s happening today. If you go back to 2008, as you said, what did they do, right? The banks back to 1994. We got rid of — shoot, I always forget the name of the bill — but we got rid of the famous bill that Clinton did away with. It separated. [The bill was] Glass-Steagall, sorry. It separated investment banking from traditional banking because original banking is guaranteed by the FDIC. And so, these banks got over levered — Lehman, Bear Stearns, Goldman Sachs, Morgan Stanley — and basically they were all done, right? They were all out of business. They were all bankrupt and it was because they had too much leverage for the process of fractional reserve banking.
Fractional reserve banking works at maybe 10, 11, 12 times leveraged — not at 30, 40 times leveraged. So what’d we do? We bailed them out, we put together TARP and TALF and all the alphabet soup. And we bailed out the banks. But we actually didn’t bail out the banks for any other reason than to keep that cabal in charge and [to] keep that dividend stream from the Fed going. Because what does the bank actually do? They borrow from the Fed. They buy Treasuries because the government is overspending and they have to issue Treasuries to fund that spending. And they arbitrage that and levered up 10, 11, 12 times. So last year, JPMorgan had zero losing trading days. Now, trading implies taking risks, so you can’t have zero losing days. Well, they don’t actually trade. They borrow from the Fed at really cheap prices, because, remember, you and I don’t get to borrow at Fed Funds. Only the bank gets to borrow at Fed Funds. So keeping Fed Funds abnormally low for years was just re-liquifying the bank balance sheets. Ah, but here’s the problem: ZIRP — zero interest rate policy — creates zombie banks and ultimately destroys the equity of the banks. Like look at Citi[group]. The stock in theory is like 42 bucks. Oh no, no, no, no, no, no, no. That’s $4.20. They did a reverse ten-to-one split a few years ago to fake everybody out in thinking that the stock’s not down 90-some-odd percent.
[This] goes back. During the crisis, they had to issue so much new stock at one point there were four shares of Citigroup for every man, woman and child on the surface of the planet. So they diluted the old shareholders. They, you know, enriched themselves, the management teams and the Fed — and the Ponzi keeps going. So we’re in this Ponzi-financed period and it’s going to be really tough to get out of it, because the way a Ponzi works is you have to take other people’s new money to pay off the old shareholders.
And if you think about banks, if we look at Japan, Japanese banks for 20 plus years have gone down, right? They’re down about 90-something percent. The same thing’s going to happen to the European banks, to the U.S. banks, because fractional reserve banking system doesn’t work in a low-growth, no growth world, which is where we’re headed because of bad demographics, too much debt and deflation. And those killer Ds — it’s a long answer to your question, I apologize — but it’s a really important question. The killer Ds — bad demographics, too many old people, too much debt, so you can’t have highest rates because you couldn’t service your debt and then deflation, which comes from technology and other things — all of that comes together to mean lower share prices for banks and an inability for them to jump start the growth of the global economy the way it has in the past.
AL: Great answer, Mark. It looks like, as many predicted, that these institutions are just becoming utilities or instruments of the state. Not the businesses that they once were. And they’re suffering. Wells [Fargo] is down 41% this year, [JP]Morgan’s down 30[%], Bank of America also down over 30%. I wonder if part of what the bleak outlook for them is a possibility of negative interest rates, because Powell went out of his way to say, we’re not doing that. Because, in my opinion, he was just afraid the market was going to price that in immediately like it does every other thing we know he’s going to do. What do you think about the possibility of negative interest rates?
MY: It’s a certainty, absolute certainty. And again we know how this movie ends. We’ve seen it before. You know, I’d cue the Vapors song from the 80s; you know, we’re “Turning Japanese.” I really think so. And look, Japan is 11 years ahead of the United States demographically, nine years ahead of Europe demographically. And if you look at everything that happens in Japan, fast forward nine years it happens in Europe, fast forward 11 years it happens in the U.S. So, you know, debt got downgraded, market peaked in 1989 in Japan. Market peaked in 2000 in the U.S. Debt got downgraded in 1996 in Japan, 2007 in the U.S. So the same thing happens 11 years later. And so, negative interest rates came to Japan, right? Remember the Bank of Japan, in 2007, said they were going to end QE, or what they call QQE; they call it Quantitative and Qualitative Easing. They were going to end QQE. At the time, the Bank of Japan owned 26% of GDP in Japan. Today, they are over 100% on their balance sheet. So we said 11 years later, we’re going to end QE. But we’re not. So we’re at 22, 23% of GDP. Okay, Europe two years ago is at 22%; now they’re at 40[%] we’re going to 40. Then we’re going to 80. Then we’re going to 100.
And it’s all about, ultimately, a big debt jubilee, because once you get to 100%, once the Bank of Japan owns 100% of the Japanese government bonds, they can just write them off. And people say, oh, that could never happen; it’ll crash the currency. No, the currency’s been crashing all along while you print new yen. You buy the bonds from the insurance companies and the pension funds. You put them in the Bank of Japan and then, ultimately, you’re going to write them off. Same thing’s going to happen in Europe. Same thing is going to happen in the U.S. But all that does is it leads to more deflation, more negative interest rates. And look where Japan is: they’ve had negative interest rates for, you know, coming up on a decade. Europe has got negative interest rates. And if you plot an inverse of the number of 65-year-olds relative to total population, it tracks interest rates almost perfectly and it’s forecasting negative interest rates in the United States, starting about 18 months from now and lasting for almost a decade.
AL: Mark, I’m seeing a level of desperation at the Fed that I’ve never seen before. And to your point, we have been following the Japanese trajectory. Is it safe to say that the Fed is going to be employing every tool that has a precedent, whether it’s our own history from whatever, 1913, or what’s being done by the Bank of Japan, or what’s been done by the ECB? Is all of that on the table now? How confident can we say that? And would the correct speculative course of action in this case be to sell whatever the Fed is buying and to buy whatever we think or know the Fed is going to have to buy next?
MY: Yeah, now again, [that’s] a great point. The Fed has no choice, right? The Fed has to buy it all and, ultimately, they’re going to continue to buy bonds, and rates will go negative. And so, that means bonds, that everybody’s been predicting the end of the bond bull market for ten years. They’re going to continue to be in a bull market. And long Treasuries have outperformed stocks for 20 years; they’re outperforming again this year. They’ll likely outperform for the next decade. And most people don’t have more long bonds than stocks. They have a lot of stocks. And, you know, the funny thing is everyone’s rejoicing in this, you know, reflexive rebound off the bottom. Stocks are still down double digits for the year. Long bonds are up double digits. So very interesting and kind of tale of the tape when you look at the scoreboard.
So the Fed has to continue to buy assets. You know, they’re going to go down the credit spectrum in the sense that they said they’re going to buy ETFs and now ETFs that hold junk bonds, which, again, is illegal right? It’s against the Federal Reserve Act. And how they’re doing it — which, I think, is horrendous — is they set up a special purpose vehicle with the Treasury. So they’re skirting the law, right? They’re breaking the law. Now, they’re doing it, they think, in the best means possible. But they’re still breaking the law. I should say not the best means, but the best intentions. They have best intentions. But the road to hell is paved with good intentions, so I think we’re at a really precarious point where the cure is worse than the disease right?
Locking down the global economy and shutting down global GDP because of a virus — that, like many other viruses, is going to be seasonal and will disappear after some period of time — doesn’t make any sense. Buying every asset that isn’t tied down and locking it up in Treasury doesn’t make any sense. Bailing out companies that should fail by buying their high-yield bonds, that the market is telling you are worth less than par, doesn’t make sense, right? We need the cleansing of capitalism to work and we got to get away from cronyism and bailouts. And, you know, this idea that we should bail out every industry to save jobs is ludicrous. That’s what we have restructuring laws for. The jobs can be saved. It just means the equity gets wiped out and new owners with new, fresh capital come in and re-liquify the companies. It’s worked every other time. It will work now if we let it.
AL: So just to clarify, Mark, should we be moving out of our long bonds now and into equities, which seems like [an] inevitable item on the menu?
MY: No, absolutely not. I’m definitely of the camp that, you know, sell the freaking rip. You know, the buy-the-dip days are over. Oh, but the last two weeks. Great. If you bought this dip perfectly and you owned nothing before, good for you. I don’t think that’s the case for anybody and I think the average person is down a lot. And the little money they’re putting on the margin isn’t going to fix their portfolio. Whereas if they would have been long Treasuries, they would have done much better. So I think you want to own gold, gold miners, Treasuries, cash, hedge funds, Bitcoin. All the uncorrelated assets are going to dramatically outperform over the next few years.
AL: How far down are you willing to ride the yield on the long bond before you start to get nervous even if [you believe] we go negative?
MY: Yeah, look, we’re going negative. All rates in the developed world will be negative. Full stop, right? They are in most of the developed world already but they will be everywhere and ultimately even China will have negative rates. And so some of the best buys in the world are long bonds in China that still yield about 3%, because when it goes from 3 to 0 you make a lot of money.
AL: How much room do you leave for the fact that there’s something that we’re missing here, that there’s some other trick that they’re going to pull out of their sleeve and then that’s going to send the equity market on another rip for, I don’t know, five years?
MY: Now look, I’m wrong all the time. People say [to me], you say things so forcefully. You know, what if you’re wrong? I’m wrong all the time and it’s changed my mind. So I am absolutely open to the idea that, as I missed 2009, I really didn’t understand in 2009 how the Fed buying bonds would translate into higher stock prices. What I missed was that the banks would give more money to hedge funds to buy stocks. They give more money to individuals to buy stocks. They’ve actually put stocks on the balance sheet, which they weren’t supposed to do. So I missed that. So, you know, the thing about mistakes, right, is that you’re supposed to recognize, admit, learn, forget—RALF. And so I did learn from that experience.
So I look at it this time and I said, okay, the Fed has pulled out not a bazooka but a tank and they’re going to try everything to inflate equity prices. And I think that’s fine. But at the end of the day, equity prices reflect earnings. And in 2009, we were able to reverse the slide in earnings and we had earnings recover pretty dramatically. I don’t think earnings are going up anytime soon. In fact, I think they’re going to go down quite dramatically. And [for] people who think that we’re going to return to new normal, I think you’re going to be disappointed. So until I see signs of economic growth and profit growth, I think that, you know, deflating the bubble one more time is likely to come in that fundamental drawdown in the bear market.
AL: Mark, before I let you go, I want to get your thoughts on some fireworks going on on Twitter. The founder of Social Capital on CNBC made a comment: Chamath Palihapitiya is his name. [He] made a comment that these bailouts are wrong. We should be letting investors — and he pointed out, specified hedge funds, in particular, but just forget about whom — investors should be absorbing this blow. Not regular people and holders of the currency and whatnot. Leon Cooperman took offense to that. I’m sure you’ve seen it. What do you think about this little debate?
MY: Look, I’m totally on Chamath’s side. I mean, it’s absolutely ridiculous to socialize losses. If we don’t allow risk capital to actually be risky, then we pervert capitalism. We pervert the capital asset pricing model, and everything that we believe about investing goes out the window. The way it’s supposed to work is if you want no risk you leave your money in cash or bonds, right? If you want to take some risk, you can take credit risk. You can buy a risky bond, OK? The bond may not pay you back like a high-yield bond. You get paid a couple hundred basis points above risk-free for that. OK, if we take equity risk, we get paid 5% more, 7% above risk-free to take equity risk. That’s why you get paid more, because it’s a contingent claim. You should not get bailed out. And so, this idea that we need to save everyone is silly. There are cyclical threats to every business, and businesses that don’t manage properly — like don’t save for a rainy day, don’t create a rainy day fund, they spend all their money on buybacks and financial engineering to enrich the management teams and pay dividends to Warren Buffett — those equities should be extinguished. And we should start over through restructuring. The bondholders become the new equity holders. The dip financiers become the new bondholders. And everybody moves forward.
That’s the way it’s supposed to work and if you don’t do that, if you socialize loss and you bail out every business just because they made a big campaign contribution to the administration, then you end up with socialism for the rich and capitalism for the poor. The income inequality and wealth inequality gap widens. And if you think about it, we just approved [$]6 trillion with a T — and remember, [$]1 trillion is a dollar a second for 31,710 years. We put 6 trillion dollars of stimulus out there. The average person is getting $1,200. Well, where did the other $58,000 go? That’s [$]6 trillion divided by 330 million [people]. It’s going to the fat cats and the people who contributed to campaign contributions or lobbying — as I like to say, formalized corruption or kleptocracy. So, if we don’t allow the process to work, the whole idea of investing breaks down. And we’re in for a very long, very sad tale of basically cash like returns, and inflation will chew that up and spit you out and you’ll end up with less wealth and less income over time.
AL: Very interesting. Glad to hear that point of view even though it is a rare point of view. We are out of time, Mark. But thank you very much. I want people to know that they can find you at morgancreekcap.com and also on Twitter, where I love to follow you, @MarkYusko. A recent tweet you had about the coronavirus is this move against large gatherings [is] more than just about COVID-19. I can’t wait to get together with you some other time and talk at length about these topics. So, thank you very much for joining me, Mark. I really appreciate it.
MY: Thanks for having me on. I look forward to getting together next time I come see my daughter out in California.