The MoneyWeek Podcast: nuggets of positivity in an extended bear market

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Merryn Somerset Webb: Hello and welcome to the MoneyWeek Magazine Podcast. I am Merryn Somerset Webb, Editor-in-Chief of the magazine. With me today is John Stepek, our Executive Editor. It's been a while since John and I did a podcast together and we thought you’d be clamouring for it, so here we are. Hi, John.

John Stepek: Hi, Merryn. Lucky listeners.

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Merryn: I know, all their dreams come true at once. Actually, particularly, their dreams are going to come true today because we’re going to talk about house prices. In fact, before we even start talking about house prices, I want to read you a headline in The Times. It's not that I'm reading the newspaper while we’re chatting, it's just [overtalking] this morning. It says I invested in crypto in the early days and bought my dream home with Bitcoin. Isn't that great?

John: That is. It's nice to know that someone got something out of it.

Merryn: Yes, it is. Every day I would wake up and I've made another £100,000 overnight. I am so jealous. I now have £350,000 in my bank account. I'd seen a four bedroom, semi-detached house with a garden and driveway near Worthington in West Sussex on sale for £400,000. And so, he just bought it. Long process, by the way, because he had to prove where he got the money to buy the Bitcoins in the first place. His mum wrote a letter, shame, she’d lent him the money. Then he had to pay the capital gains on his Bitcoin profits and then handed over the cash, and that what was. £50,000 mortgage.

John: That’s fascinating because that’s everything in there. This person managed to have the wherewithal to not keeping holding on, even though it kept going up, so that was good. They managed to get an offramp from Bitcoin, which is always a bit tricky. They managed to manoeuvre through the anti-money laundering rakes that, clearly, would be a nightmare if you're trying say where you got 300 grand from. It sounds like, I'm assuming, he’s quite young. Is this a 20-something or…?

Merryn: Hang on. No, he’s 32. Hang on, this is the good bit, there are so many good bits in here, I love this article. He refused to give his name for fear of crypto muggings.

John: What’s a crypto mugging? Is that online mugging?

Merryn: Yes, someone will go online and steal his Bitcoin. By the way, listeners, if anyone can find a way to steal my Bitcoin, that would be great because I don’t have any of the passcodes. I can't get to my own Bitcoin, so if someone can find a way to steal it, at least it would have some utility to somebody and maybe you could give me some of it back, that would be great. Let me know.

Anyway, so he’s got his house, this is fantastic. But here’s yet another interesting bit. I'm now waiting for Bitcoin prices to hit a low of $15,500, then I will start buying Bitcoins again. I believe one Bitcoin will be worth about $150,000 by 2025, so the plan is to reinvest and hold until then. I'm speaking to asset managers in London to get them to take custody of five Bitcoins for my son when he’s older. He’ll get one when he’s 18, one when he’s 21, etc. Hopefully, if my prediction proves correct, he’ll be able to buy any property he wants, anywhere in the world.

I love this guy. I wish he wasn't keeping his name secret for fear of crypto muggins because it would be great to have him on the podcast and talk through this, what we now call a journey, with him. I'd love to hear. You say how difficult it is to get the money out, how difficult it is to get through all the money laundering stuff, etc. And he’s achieved all that. He’d be fascinating to talk to.

John: Yes, that would be really interesting. I’d also like to know why he’s so specific. I'm sure it has something to do charting, but why 15,500? Everyone keeps talking about how 20,000 was the line in the sand. And it's gone below that.

Merryn: Here we are, we’ve now backed ourselves into a corner with this conversation, which I did not intend to do. We’re talking about crypto, which wasn’t the plan. Here’s a question for you, John. In five years, will the average house price be higher or lower than the price of ten Bitcoin?

John: Help me do some mental arithmetic now. Wait a minute, it's already… That’s interesting because it's roughly the same price now.

Merryn: Yes, I know. I just plucked that straight out of my head. No advanced maths, nothing.

John: If I was forced to choose, which I clearly am, then it’d be houses. I'm still of the school of thought that Bitcoin is worth something, but I just don’t know what. I think a lot of the other crypto stuff is pure Ponzi scheme nonsense, but I think that Bitcoin itself probably has a value.

Merryn: Stop there. Why do you think? I'm in trouble with the crypto people, by the way, for my interview with Dylan Grice last week, or was it the week before? When I said I couldn’t find a valuable use case for Bitcoin at all.

John: I did notice that you were getting some flack.

Merryn: I was.

John: For open-minded libertarian people, they’re not very open-minded.

Merryn: I know. I did say to one guy who said to me, have you read this, have you read that? And, rather amusingly, one of the main things was, have you read When Money Dies? Yes, I kind of have. I did reply, saying maybe, just maybe, I'm not a badly-read idiot. Maybe we just disagree, we have a different opinion on this, and that’s okay. But maybe it's not okay.

Anyway, you say you think that Bitcoin has some value. Now, I accept Dylan’s idea that the value may be in the ability of cryptocurrencies, in various ways to provide us with the financial privacy we can't get or are never going to get elsewhere again. What’s your use case?

John: It's not too different from Dylan’s. My thought has always been, and one of the things that you notice price spikes is when something like Venezuela happens, or Argentina. I can see why, if I was living in a dodgy regime and I wanted to move money across the border, Bitcoin would then potentially be quite a useful thing because it's easier than smuggling a lot of gold coins out in your car’s tyres, or whatever.

But to me, that’s the primary use case and, from that point of view, it's also got the money laundering, criminal money movement. That thing where you don’t necessarily mind or you're willing to take the hit if, perhaps, the money’s worth 20% less than it was when it originated. Because all you really care about is getting a large sum of money from A to B. But that is it, it's that whole digital bearer instrument thing. But that can be undermined.

Sorry, I know this is going on about Bitcoin. I was reading an interesting article in some science mag the other day about how they’ve effectively managed to trace back to the early days of Bitcoin. And there was roughly 64 accounts that originated, the founding members of Bitcoin. If you were able to identify those 64, you could almost certainly, essentially, just deanonymize almost every single transaction that’s ever happened on the blockchain. There's that thing of actually, is it private as it…?

Merryn: That takes that away completely now. God, I want to know who those 64 accounts belong to.

John: Yes, exactly. Not saying it’d be easy to do that, but it's that thing where there's always a path to break a code. Even if it's not a quantum computer, if you can trace the network and you can have a good guess who each node in the network is. You can probably plug an awful lot of those gaps if you're curious enough and interested enough, just by looking at the way the money has flowed, rather than anything else. I think that’s the other thing, what we might find is that now that the bubble has burst and there's quite a lot of scepticism creeping in and you're seeing a lot of the full-one bezel is coming to light.

We might also find that there's concealed vulnerabilities or things that we didn't realise or we’re willing to sweep under the carpet during the good times. That’s the other reason I'm slightly concerned. Perhaps it's got a use case if it works the way it's been said to work, but I think there’s a chance that actually even that isn't a thing.

Merryn: Let’s move on to what we were going to talk about, which is property. Now the thing, of course, that Bitcoin and houses have in common is that they are both incredibly interest rate sensitive. If we think of Bitcoin as the ultimate semi-worthless long duration asset. And I only put in semi-worthless to upset the people on Twitter. I was going to go worthless, just to see how much aggro I can cause.

I suspect that true believers in cryptocurrency were not aware that it was incredibly interest rate sensitive. And, of course, true believers in property, always goes up forever and the supply/demand, etc., they don’t believe that property is interest rate sensitive, do they?

John: No, it's always about the physical supply and demand. I get why some people get frustrated about this because there are a lot of issues with supply and demand, more specifically, planning and not being able to get the sort of properties you want where you want them. There's lots of… The fact that property’s prices are interest rate sensitive doesn’t mean that the property market works.

But it is clearly the thing that drives property prices because you just need to look at what’s happened to every single market in the world, pretty much, over the last 20 years. To see that what drives prices higher is, fundamentally, falling interest rates and the amount of money, the amount of credit, that can be used to buy a house. It's very straightforward. The tricky thing is that with interest rates going up now, that implies that property prices are set to go down.

Merryn: Can it really be that simple?

John: The one tricky thing is the role of inflation. Because property, in and of itself, if you bought properties with cash then you’d probably be comfortable saying that that’s an inflation linked asset. But it's the role of the debt that makes it the tricky thing because at the end of the day… Also, the other issue is valuations.

Merryn: The loan-to-value ratio.

John: Yes, the salary multiple you have to pay for a house now is off the charts again. It's back up at levels we haven’t seen since before the last crash in 2008. I think they’re have to believe, certainly, that rising interest rates aren’t going to put a dent in house prices. I think the tricky thing is, are they just going to cool down or is there going to be a crash?

Merryn: Things that are slightly different in the UK to how they used to be, aren’t they? It used to be that almost everybody was on a standard variable rate, on an SVR, but now about 80% of mortgages are on some kind of fix. Maybe not five years, maybe not ten years, but two years. Even if interest rates continue to go up, which obviously they will, we will get a lag, at least. It may be that we do have a proper crash, but one rather suspects it’ll be more delayed than it would be otherwise.

John: One thing that’s interesting to watch just now is other markets, where interest rates are obviously rising as well. Canada and Australia are two classic ones because their housing markets have been even more ballistic than ours. Obviously Australia hasn’t really had a recession for a ridiculous length of time because, even during 2008, they got bailed out fast by China. There hasn’t really been an interruption there. In both of those countries house prices have started to fall now, but again, their variable rate mortgages are still quite a big thing.

So, you've instantly got a certain level, actually, probably get people suddenly unable to afford to pay the mortgages. You get actual distress selling there. Whereas here, in the absence of a proper, full-blown recession and lots of people losing their jobs, it's harder to see that happen. Or certainly, happening as quickly as it has over there.

Merryn: But also, it feels like there's a reasonable chance that real wages will go up. If real wages go up, or even if nominal wages go up significantly, it doesn’t necessarily have to be real, then that changes that income to house price value ratio.

John: Yes, that would be ideal. Obviously the flipside of that is the corporate profit margins get squeezed, so it's maybe not ideal for shareholders. But if we want a happy ending in this particular part of the economic cycle, then rise in real wages are the way that we get it. These people can hope that maybe central banks can somehow engineer a soft landing without putting interest rates up very much further. Then we go back to the secular stagnation model. I don’t think that’s possible, I think that’s done now. Either the share of the spoils when your labour goes up and then we can rebuild an improved economy from there, or we do end with a massive recession, which would be much more unpleasant than the alternative.

Merryn: It does feel at the moment, doesn’t it, that it's going to be corporate margins that get squeezed?

John: Yes. I think what people underestimate, and it's interesting, because actually the Bank for International Settlements, which is the Central Bank’s central bank, was doing a big report about inflation this week. One of the key points that they made, that I think is a good point and we need to remember, is that once inflation gets to a certain level, the way that things work changes, the feedback loops you get change.

When inflation’s low it self-corrects a lot more easily. But once it gets above a certain level, I think 5% is one figure that I've seen, the relationships start to change. A lot of that’s to do with the psychology changing because people’s behaviour changes, because they’re anticipating more inflation in the future, as opposed to a drop in inflation. I don’t think the market’s really got a handle on that yet. There are still a lot of people who are hoping that this is basically still transitory, it may go on for a long time.

But we’re about to see a lot of computer chips hit the market, for example, so they think that’s a good sign. Freight prices are coming down from their COVID highs. But all of that, of course that’s going to happen. A lot of stuff has been held [?] up, specifically because of COVID, but that doesn’t mean that inflation isn't now a problem.

Merryn: Because it's already embedded. You can make this argument about oil prices as well, energy prices, that the same amount of oil still exists, it's still meandering around the place. It's just being bought by different people in different places. Once all that shakes out, the oil price will fall again and this whole thing is over, we’re back to normal. You can make all these arguments, they’re quite easy to make, but the point that I think you're making, that I agree with, is that people’s mindset has already changed. It's already too late. People are going to insist on 5%, 6%, 7% pay rises and people are already adjusting their behaviour in the expectation that the prices will go up, so it's too late.

John: You look at the strike action that we’re getting prepped for over the next year. There isn't a public sector group of workers out there who aren’t planning to go on strike at the moment. I think there’s an incredible amount of complacency in the market. I think that people have sat there and said, yes, okay, inflation’s happened and it's gone on for longer, but everyone keeps expecting it to peak. Again, of course it has to peak at some point, it can't keep going up at the current rate that it has done because that’s just maths.

Eventually prices are going to be lower or not going up as fast as they were last year and that’s going to have an impact on CPI. But that’s not the point. If we go back to a world where suddenly 3 or 4% inflation is the norm, rather than 1.5%, that’s just a massive shift for investors and for everyone’s portfolio. I still think there’s a huge amount of complacency out there. It’ll be interesting to see what happens.

Merryn: I think there's a lot of complacency in the stock market, as well. It's interesting because, so far, particularly UK investors, there's been this global bear market and global stocks as a whole, depends which index you look at, but 15, 20%, etc. But if you're a UK investor, you've had a reasonable amount of your money in the UK market, maybe you've only lost 10%, 11%. And it doesn’t feel that bad because that’s all froth from the last couple of years anyway. If you're not the kind of person who looks at your account all the time, you might not even know that you lost money.

There isn't significant stock market pain for people. They go, there was a stock market crash, that’s it, it's over, that didn't really hurt. I think they’re going to be surprised as margins begin to fall. Whether we have a recession or not, we certainly have this ongoing downturn. Margins begin to fall, valuations still look expensive, prices come off more. And this drags on, it doesn’t just stop here.

John: That’s a really good point, about the bear market because, you're right, with a bear market and US stocks, particularly, because they’re obviously the headline ones. Really, no one seems that phased by it. I think it must be the least dramatic bear market that I've seen in the time that I've been writing about stocks. By this point you would usually have people say bloodbath on Wall Street, all that sort of stuff. But equally, nothing appears to have broken yet, outside of the crypto space, which nobody cares about because it's not systemic. I think that’s the other reason why you're absolutely right, there’s complacency. Because so far, it doesn’t actually feel that bad, but that also implies that there's still probably a lot more to go.

Merryn: Or it may just show that investors en masse are more rational than people give them credit for, in that investors en masse, retail investors, they look at it and they go, well, everything I've made over the last couple of years, not like I deserved that. Pure fluff. And now it's gone and I'm back where I was two years ago and that’s good enough for me. That seems like a perfectly reasonable reaction for, say, a 55 year old saver in the UK, to have to what’s happened.

John: I think they’d be in the UK, but depends on what they’ve been invested in. If you've actually been sitting in… The great example is Cathie Wood’s ETF. You've watched your money go up six- to ten-fold times and now you've watched it drop right back down. You're not going to have that equanimity. I don’t think that would be a rational reaction, either, if I'm honest.

Merryn: Also, if you've had all your money invested in nothing but Baillie Gifford investment trusts, or something, you’d be feeling a little tense right now. But not very many people are invested like that. Look at our MoneyWeek Investment Trust portfolio, which I haven’t done the numbers on recently, and I'm sure is complete carnage because it's got mortgage in it. But, nonetheless, I'm guessing I will look at it later, but it will probably have mildly outperformed the market, regardless of that, over a ten-year period. It massively outperformed because Scottish mortgage went up, up, up and down, down, down. But the others, personal assets, etc., have balanced that out to a degree, so there won't be massive outperformance in it. But it’ll be fine and overall it’ll be down probably 10, 15% from the peak.

John: You know what will be more interesting, though? Just talking about portfolios. This has been a terrible first half for bonds, as well. A lot of people, the sort of people you're talking about, the people who won't be looking at their portfolio very often until they sit down with their financial advisor once or twice a year to have a chat about it. Of course, the 60/40 has been the best type of portfolio you own for X number of years now. Suddenly they’re going to get headway, your equities crashed and your bonds crashed, as well.

There's going to be some interesting conversation, I think, that people are not accustomed to having. It’ll be interesting to see, once that starts to feed through and people start to think, oh my God, my pension’s worth much less than I expected, how that starts to affect people’s behaviour.

Merryn: Also, there's the private equity shoe to drop, isn't there?

John: Yes. That’s going to be interesting.

Merryn: That just gives you the giggles. Even talking about it makes you start giggling.

John: Private equity always outperforms. Yes, that’s because you never put a price on it. Whenever you have to value this stuff, they say no, sorry, we'll hold on. Well, you can't hold onto it if it goes bankrupt because it wasn’t worth anything in the first place.

MS And you can't hold on to it and pretend that the growth you overpaid for in this private equity portfolio is still valued in the same way as it was a year ago. You have to take your queue from the public markets to revalue this stuff. I know funds are beginning to do this, but it's going to give people quite a shock, I think.

John: The other thing that’s interesting there is, again, that whole sector is in a proper recession now. The number of companies that have been laying people off and hiring’s entirely dried up. You can any time you go on, you look around the venture capital Twitter, it's all people talking about battening down the hatches and the winter time and all the rest of it. Again, I'd be curious to see how that feeds through in the wider economy. How much does this sector matter? How big an employer is it?

Because that’s the other thing, we’re okay for as long as demand for labour is still higher than the supply, but employment’s a lagging indicator. When you start to notice that toning down, then chances are that’s already probably in a recession. It's hard to feel bullish right now. The roaring 20s, I think there’s still a chance that that could be saved, but the only way that’s going to happen is through actual rise in real wages.

Merryn: It may be if there is a roaring 20s, it's not a roaring 20s that particularly good for the stock market. We've talked about this before, in the 1970s there were parts of the economy that were in great shape and people who hung on to those jobs all the way through, saw rising real wages and had a very happy decade. It was investors and the unemployed who had a horrible decade. There's no reason to think that the elements of the roaring 20s that we’ve talked about before, can't coexist with a long-term bear market, because they can.

John: Yes, this is true. It's a slightly cheerless roaring 20s.

Merryn: Cheerless for people who rely on their investments, not cheerless for people who rely on earned income.

John: That’s true. As long as you've got a job, that’s the main thing.

Merryn: The problem now, of course, is that most people are both, which they weren’t in the 1970s. Almost everybody, they rely on their earned income, but they are saving into stock markets and, so, they’re reliant on that as well. Great for the young, by the way, if they’re finally able to buy something that isn't horribly overpriced and that’s equities, that’s great. There hasn’t been much about for the 20-, 30-somethings over the last couple of decades, but if now they can get higher wages, buy cheaper houses, one day, honest, it's coming. And feed their money into the market, which most of them don’t even know they're doing, but they are doing, and buy equities at cheaper prices as well.

When they turn into their 50s, they might certainly have a similar experience to the last generation, who reached their 50s and went, oh wow, look at this, I've got a great house, I've got money in the market, got a good retirement ahead of me, have a nice career. Wouldn’t that be great?

John: That would be great. And, even better, whenever they retire interest rates will have gone back up again, so they’ll buy annuities and get a great retirement income from it

Merryn: Oh, to be young. As we are now suddenly on an optimistic note, I think we’re going to have to stop, before you start getting depressed again.

John: Good idea.

Merryn: This stops here. John, thanks so much. I think there were some nuggets of positivity to pull out of that. Please do read the magazine this week, there are nuggets of positivity in there, I think, aren’t there, John, some nuggets of positivity?

John: Yes, I'm sure we let some of the other writers put pen to paper this week and say something happy.

Merryn: Good. If you enjoyed the positivity on the podcast today, please do leave us a review on your podcast provider of choice, that’s how we get the great guests in. Great guest next week, by the way. Otherwise, you know where to find us, moneyweek.com, where you can sign up for John’s brilliant newsletter, Money Morning, and you can follow us on social media @MoneyWeek. Thank you very much.