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308: Interest Rates, Inflation and Cryptocurrency!

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Buck: Welcome back to the show, everyone. Today, my guest on Wealth Formula Podcast is David Sacco. Now David is a practitioner in residence of finance from the Pompeo College of Business at the University of New Haven, and he has become a nationally recognized expert in investment trends and analysis on the stock market, inflation, cryptocurrency, and Dogecoin. David, welcome to Wealth Formula Podcast. 

David: Thanks, Buck. Thanks for having me. 

Buck: I’m going to have to come back to that Dogecoin part in a minute, but let’s start talking a little bit about the 900 pound gorilla in the room. I think that’s what everybody’s worried about as we record this in the Ides Of March, we are a day away from the Fed’s meeting or announcements. The plan, presumably, is to raise interest rates to address the inflationary environment that we’re in. What do you think the Fed’s best options to combat inflation are right now? 

David: Unfortunately, I don’t think they have too many good options. I’m pretty sure that Powell telegraphed today or yesterday that they’re probably only going to raise rates 25 basis points. I think before the last few weeks there was a possibility that they would go 50. I think if all they were having to deal with right now with the fight against inflation, they probably would raise rates a little bit more quickly. But obviously, the war and the impact that that’s had on the energy and financial markets has created a level of uncertainty that the Fed just doesn’t like to deal with. So I think they’ll go 25, which will help start what they need to do. But ultimately they’ll have to pick up the pace. And I think they’re just a little worried about the uncertainty related to the war right now. 

Buck: And that’s a good point, which is basically that the war it’s got an interesting effect because it’s also increasing the price of energy, and that we’re feeling the effects of that as well, in addition to the inflationary environment that we’re already in. So I guess the idea is there’s volatility in the world, and therefore maybe we shouldn’t be quite as hawkish about this right now as we might be otherwise. 

David: Yeah, I think. But it actually put the Fed in the box. So the way I like to think about it is that demand pre Russian invasion of the Ukraine was sort of like a rubber band that was stretched pretty taut. Right. So demand was creating a lot of pressure. That was creating the price pressure and inflation, the war and the impact on the oil market sort of added to that pressure. Right. So normally to sort of combat rising prices or inflation, you sort of raise interest rates and that sort of puts the brakes on demand. But at the same time, the wars created all these other uncertainties. Right. About what could happen. We saw that in the stock market last week. So the Fed’s task is to sort of top the brakes on the economy without bringing us to a crashing halt, which would have been difficult before the situation that we were in because of the recession related to the pandemic and how we came out of it and made that very difficult to begin with. And the war just exacerbates that. So this is probably the toughest situation that any Fed has faced, I’d say since Volker back in the early 80s. I would even put this 2008 was pretty rough, too. But there wasn’t any debate about what needed to be done. Right. Because it was just a complete meltdown. This one’s a little trickier because the economy is generally doing well. But you got to just resist the urge to slam on the brakes and throw us into a recession. 

Buck: And then I guess that’s the next question is, is it possible really to eliminate inflation without triggering a recession? 

David: Again, we’ll get into the sort of what’s your definition of a recession? Well, the way the Fed reduces inflation is they slow demand. Right. They raise interest rates that slow people’s spending. It makes it better for people to save money now and invest it and then spend it later. So you’re slowing the economy to tame inflation. And the recession is just definitionally slow down by a certain amount for a certain time. Right. So you have to slow the economy, which is sort of what starts a recession. So it will be difficult to not have what I would at least call a relatively large economic slowdown if we’re going to get inflation under control. Because remember, it’s not just a US phenomenon. This is going on globally. Right. Every central bank around the world. Every big monetary authority uses the same playbook, and we are seeing the effects of that. 

Buck: I’m curious, kind of your take on how this affects the equity markets, real estate markets and such, because certainly you would think a slowdown or recession would potentially hurt the markets. But we’ve seen sort of a lack of correlation, particularly during Cobid. What was the biggest recession in history? The stock markets act like it didn’t even happen. What do you think happens there? I know you’re interested in the market trends as well. 

David: So when we see interest rates start to go up, obviously it creates a situation where equities become less attractive to fixed income investments. But interest rates are still so low that that comparison, I don’t think is that valid. I mean, if interest rates were at four, five, six, 7%, then I think maybe we have that conversation. So park that on the equity front for a second. At the same time, the equity markets are forward looking. Your analogy about the pandemic is a good one, right? Because obviously when the pandemic hit and it’s funny, in the same place I was two years ago visiting my son in Charlotte, North Carolina, when the economy shut down and the whole economy turned into a ghost town. Now, about three weeks later or four weeks later, we kind of realized that it probably wasn’t going to be that bad of an economic event. So the markets are sort of looking forward to saying, okay, we’re going to have a recovery. The government is going to throw a lot of money into people’s pockets in the form of direct stimulus. The Fed and other central banks are going to engage in easy monetary policy. All of that really bodes well for a real big economic expansion, which in fact happened. So I think the stock market right now is sort of thinking about, okay, what is happening next? Now, there’s still tons of investable dollars out there. The problem with inflation is that the economy is growing too strongly. Well, on the one hand, that’s a very good thing for the stock market. So I think the stock market is sort of taking the at least uncertain Nevada approach right now, which is assuming that the Fed is going to be able to pull something off without cratering the economy. And then I think that’s why they’re a little bit more sanguine about things going forward. The real estate market is an interesting one because again, when rates go up, you would expect that to put pressure on housing prices because it makes mortgages more expensive. At the same time, what we haven’t seen in 2030 or 40 years, we’ve seen asset inflation, but we haven’t seen price inflation. So when interest rates go up because of inflation, on the one hand, that’s going to retard investment in real estate because of higher interest rates. But on the other hand, the inflation itself sort of helps boost asset prices. So you’ve got things pulling in both directions. And I think the market is still relatively positive right now.

Buck: In terms of commercial real estate. I think the interesting thing is I’m big in the multifamily market myself, and I often get this question about what to do given the possibility or the probability that mortgage rates are going to go up. And in situations like that, I think we also have to put into context the idea that, well, why are they going up? They’re going up because inflation and what does inflation suggest? Certainly for a multifamily investor, that means your rent is going up, too. So you may have a little bit of a hedge there’s. Do you think that’s true? And maybe could you talk about other situations that may have parallel offsetting type situations like that? 

David: Yeah, absolutely. I mean, there’s the rent component and there’s also just the price appreciation of when inflation goes up, all real assets increase in price, whether we’re talking about gold real estate. The other thing that’s happened and this is exacerbated but also started by the pandemic is the shift in mobility right now that we’ve gone through this transformation where people are not tied to a geographic location because of their jobs. We’ve seen this kind of steady growth in real estate prices in a lot of different areas. Right. You can basically take your job now and go work anywhere. That’s sort of a structural change that I think is profound enough that it’s going to eat up a lot of the lower demand that will result from interest rates going up. I think there are plenty of people still out there looking to relocate, maybe away from urban areas or just moving to a different area because they can now move with their job. So that’s going to help keep a bid. And the other thing, your point about multifamily is a good one, because as much as prices of homes have gone up and there’s still a pretty strong bid, prices of rents are starting out pace that so you’re that sort of arbitrage between buying and renting. Well, if you’re an investor in multifamily or you’re buying places that you’re going to rent, you’re right, that rent is outpacing your costs. So there’s more profit in that trade as well. So a lot of conflicting things. But you’re absolutely right on that property front. 

Buck: You talk a little bit about, of course, in the US, we’re kind of looking at what’s going on here, and we don’t have a good sense of what’s going on in the rest of the world. How is the current crisis, whether it’s inflation, the war affecting some of our major partners, or nemesis in the world, like, say, China? 

David: I was just speaking with someone else about inflation, and we were talking about what it means for the dollar. And the thing about inflation, when you’re talking about different countries and different currencies. What you care about is the relative level of inflation. Right. So because inflation is pretty consistently high around the world. Right. Because again, most of the world responded to the pandemic the same way most of the world uses the same toolkit in terms of fiscal and monetary policy. So inflation is rising steadily around the world. So I don’t think that’s going to cause a huge change in currency rates or balance of payments because everybody is experiencing the same inflation. But there is this dynamic that’s going on now more so I think related to what’s going on with Russia and the Ukraine in terms of the dollar’s role as the reserve currency of the world, which it still is by far. Right. If you look at international trade, 60% of international trade is done in dollars, 20% is done in Euro. And I think the Chinese currency is less than 5%. Which, you know, they’re underweighted in terms of their currency in international trade relative to the size of their economy. So I don’t think we’re going to see much change on that front, because what gives the dollar value isn’t really anything that we do. It’s the underlying strength of our economy. And it’s also the perception that people put into it. They want dollars. Even our worst enemies out there, geopolitically still want dollars because it’s such a stable currency. Russia right now the sanctions were imposing or because Russia needs dollars because their currency is depreciating. And the only way they can maintain what they’re doing is to have a stable currency. So I don’t really see a seismic shift. I mean, China will try to tweak the rest of the world. They’ve been trying for 15 years to get people to move away from the dollar as the reserve currency. But there really isn’t a viable option just yet. And I’m sure we’ll talk about that when we go onto crypto in a little bit. 

Buck: But, yeah, it’s interesting to me about the whole Chinese thing, too, is that in my estimation, their primary goal has really been to be seen as the world’s economic leader and take over that role of the US and this whole conflict. And I think their lack of joining the rest of the world and condemnation has really hurt that it’s sort of an aside. But I’m curious if you have any thoughts on that. 

David: Yeah, I tend to focus on these issues from the economic perspective, less so from the geopolitical

Buck: But don’t they kind of affect each other, though? I mean, if you’re going to be a geopolitical leader, you’re going to have to have that perspective. 

David: They do. But what I would push back is the following. So what we’ve done, for instance, with Russia, where we’ve cut off our importing of Russian oil, which was marginal anyway. Right. It was only about 3% we haven’t done. Now if we really wanted to cripple Russia’s economy, we could completely deny them access to the dollar market for any oil. So even the nations that continue buying oil from them, we can essentially freeze their dollars and not let them have access to it yet. We’re still willing to do that, right? Right. So ultimately, now, again, there are very good reasons, one of which is Russia could actually interpret it as an act of war and might escalate things. The point is, everybody always winds up being somewhat pragmatic in what they’re doing. And I think obviously it’s an awful humanitarian tragedy, but hopefully it resolves itself sooner rather than later. But I think ten years from now, it’ll be in the rear of your mirror, and everybody will just be focusing on the economic issues of the day which take precedence. 

Buck: So one of the things that leads us to is I’m a Russian citizen, and I have an idea that this is about to happen. Personally, I’m thinking about moving a lot of my rubles into Bitcoin, if possible. Did that happen? 

David: I don’t think so. Just because of the price action that we saw last week, plus the fact that rush, pretty quickly, I think, to cut off. Now, they have a very sophisticated tech community out there, so I’m sure a lot of their citizens have found ways around that. But here’s the thing. The people who hold most of the assets in Russia, the oligarchs, weren’t holding their assets in Russia to begin with. Right. They’re all offshore in dollars and euros. That’s why those guys have those 500 million dollar yachts and the $20 million apartments in New York and London. So I think the bulk of Russian wealth was already held outside the country. Your point is correct. I mean, when the ruble took a bath in the last few weeks, that certainly is going to hurt the average Russian citizen. But again, only to the extent that they had to buy imported goods, which they probably weren’t that many anyway. I think, unfortunately, the average Russian citizen had a pretty poor standard of living before Russia invaded Ukraine, and they still have a pretty poor standard of living. So I’m not sure it’s had a huge impact. You know, obviously, Visa and Mastercard shutting down are going to affect some of the middle class in Russia, but I don’t think they do such a good job of controlling the narrative that I’m not sure it’s going to have much of an effect on certainly getting them to be a regime change or anything like that. 

Buck: One of the arguments that I think cryptocurrency, particularly Bitcoin proponents, have had for years now, which I don’t know that I believe in Bitcoin. I own it, but I don’t necessarily see it right now as an asset that is somehow protected against other markets. To me, it’s not right now. It basically rises and falls based on what the other markets are doing. What is your take on that? 

David: Yeah. So I think in the last six months. What we’ve seen is that Bitcoin has basically become pretty correlated with the Nasdaq. Right. So it’s sort of a higher risk. It’s not a blue chip stock, but it’s sort of a higher risk asset, and it moves pretty much in tandem with that slightly bigger moves up and down, but it’s pretty correlated to what Nasdaq did. So I think the way the trading community views Bitcoin is that it is just in that category of what we would call risk assets, higher leverage, normal stock trades. And I agree with you. Could Bitcoin ultimately become sort of a version of digital gold? Possibly, but it’s not there yet. Right. I think what’s intriguing about Bitcoin is that what we’ve seen from central banks in not just the last two years with the pandemic, but the last 30 years of financial crises is that every major currency around the world, ultimately there’s some central bank that can use that currency to manage their domestic economies and they have some control over it. So with Bitcoin, and again, I wouldn’t say all cryptos because there are dozens, if not hundreds of cryptos. Right. So the first shake out is going to be which is the crypto that becomes what we think of as crypto going forward. Right now, it’s probably Bitcoin as much as anything else. And then does there be enough global demand for people to rely on that, not just in the sophisticated investor community, but what I’m thinking more of is people in underdeveloped economies who literally suffer as their currencies fluctuate on an everyday basis. I think those are the people that potentially could have a lot of value because they won’t see that standard living fluctuation that happens with weak currencies. But a lot of time between now and then. 

Buck: Right. I mean, it’s hyperinflation in Zimbabwe versus Bitcoin volatility. Take the Bitcoin volatility. 

David: Exactly right. El Salvador. So the fact that countries like El Salvador are making that move, again, it’s highly symbolic, but if the technology is stable enough in the rest of the world, I mean, that those people in those poor countries actually have cell phones and actually can access their digital wallets or maybe even local crypto platforms, then maybe there’s a chance. But again, we’re talking years away from something like that, even becoming a seed of an idea. 

Buck: My view on cryptocurrency has largely been this idea that for the most part there’s Bitcoin and then there’s everything else. Bitcoin for the most part has been accepted to some extent by traditional money Mark money Wall Street as some type of digital gold, and it’s here to stay. Everything else is essentially, in my view, kind of a software company. It’s like some sort of a software startup or tech, but obviously it’s decentralized, so it’s different out of that. First of all, I’m curious, your thoughts on that. Second of all, what cryptocurrencies do you think are out there that are doing something that might make it more dominant in the future. So it’s interesting. 

David: So my background is in financial markets. Right. So I approach this purely from the sort of trading and investing perspective. And the part of crypto that scares the heck out of me is the technology side. Right. So I sort of understand how blockchain works, but I’m not a blockchain expert. Right. So my understanding of Bitcoin is that the algorithm is such that there’s a diminishing amount of Bitcoin. It basically becomes a finite asset. The way crypto vaults work, they’re essentially unhackable. And again, my belief in that just comes from the fact that I know that there are hundreds of billions of dollars of Bitcoin that’s lost and locked up. So if someone had a way of hacking into it, there’s a huge financial incentive to do it. The rest of these currencies, I don’t know enough about them to really opine on them. Right. And then ultimately remember, whether we’re talking about Bitcoin gold, US dollars or euros, it really has nothing to do with the underlying technology or who is writing the pieces of paper. It has to do with people’s belief in it. We don’t know how that’s going to play out. I mean, right now it seems to be Bitcoin and maybe to a lesser extent Ethereum. And I can’t believe this is true, but I’ve heard of these sort of scandals where someone literally just creates a cryptocurrency, goes out and sells it, and there’s not even any scarcity associated with it, which we look, we saw that with meme stocks a few years ago. There’s sort of the power of markets, which obviously is huge and is big. And then there’s also some underlying sense of reality, and I’m not sure where we’re at yet on cryptos. So it’s going to be a learning process.

Buck: Although I do see, at least in your bio, it mentions that you have some opinions on Dogecoin, of all things. Is that accurate?

David: Is the perfect example, though, right? Elon Musk says something is that end of the spectrum. I don’t even know if Dogecoin has the same type of algorithm that Bitcoin does. Does it actually have that selfending algorithm where there’s some scarcity associated with it? Is it as technologically secure as Bitcoin seems to be? This is where we need some computer scientists to help us. Because my biggest fear is you wake up one day and somebody has figured out a way to crack the Bitcoin algorithm. Right. And then all of a sudden it’s a printing press. Now, again, that fear is no different than the fear that we wake up one morning and we go onto our banking account apps and there’s all zeros there. Right. Because theoretically that could happen as well. So there’s just a lot of technological uncertainty because the technology is constantly evolving and we don’t know what’s next. So in my role as a Bitcoin expert, and I say that with parentheses around it. I’m often asked to give investment advice, and my advice typically is don’t invest more in Bitcoin than you’re willing to lose tomorrow. Right. Because that’s okay. As part of any investing strategy, having some high risk assets is okay. Right. But you have to have the right percentage of them. And obviously, that depends on your stage in life and all that kind of stuff. 

Buck: What is your take on, not necessarily investment advice per se, but my listeners are investors. And so when you look at what’s going on with the Fed, when you look at the war, the volatility, what is a good way to frame this for an investor looking at allocating money for their own net worth? 

David: Sure. So let’s go back to where we were, let’s say, two years ago. Right. The pandemic hits, the stock market gets annihilated. And then, like I said, roughly three or four weeks after that, I think we sort of knew that things weren’t going to be that worst case scenario that the market was pricing in. Right. So at a time like that, you can sit there and look and say, okay, what is the symmetry of risk? Well, I think the symmetry of risk back then was that the market was more likely to go up than it was to go down. Right. And then obviously, since then, the value of the market has doubled roughly. And then once we got to that point, the economy was firing pretty well. We’ve got stimulus, fiscal stimulus. We’ve got easy monetary policy. About a year ago, we probably were in a 50-50. Right. It could go up. It could go down. And then as we sort of got towards the end of last year, my opinion, even before the Russian stuff started, was the asymmetry probably was a little more likely to go down than up again, nothing. Because more than we go in cycles. Right. So we had this huge amount of demand. Right. Supply couldn’t even keep up with the amount of demand that we had. So the fact that inflation finally reared its head wasn’t a shock. We know how central banks deal with inflation. They Jack up interest rates. And that generally is going to lead to a little bit of a down cycle. So I’d say if I was waiting for the chance of it going up versus going down here, I’d say 60-40, it goes down 65-35. And again, I think what investors need to do is and I’ve been guilty of this my whole career. You can’t just pick the top and the bottom. Right. You have to sort of think on balance. So that means shift your equity percentages a little lower even now. Right. I mean, if you think about how much we’re up in the last five years, anyone who’s been in the market for the last five years is sitting on some pretty good gains. So scaling back your percentage of equities is probably not a bad thing if we do get higher interest rates, four, five, six, 7%, that means in the next twelve to 18 months you’re going to have a chance to move some of your assets into fixed income at decent returns. Part of the problem is when rates are low, we all chase returns by increasing our risk. Right now those rates are probably poised to go up. We can take a little risk off the table and then hopefully lock in some higher rates via less risky assets as interest rates go up. But just constantly be thinking about the balance of what’s more likely to happen and obviously where you are in your life cycle. Anyone who’s had money in the market for the last few years has done pretty well. And even though it’s down a bit from the highs, it’s still a decent time to pare back a little bit. 

Buck: David Sacco, everyone. David, thank you so much for your time and your perspective in these uncertain times. 

David: Thank you for having me, Buck. It was a pleasure. 

Buck: We’ll be right back.