Are We At The Bottom Of The Market? | Meet Kevin

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Let's get started with Mr. O'Leary. Are we at the bottom of the market?

No, not yet, but we're getting close. You know, we were fribulating right now trying to figure out what the earnings next year are going to look like, and so every time you have a rally like this, you've had extended rally multiple days now to the upside. It's because the belief in the market is that the FED is finally going to slow after this next 75 basis points and kind of wait and see what happens. We got a little signal from that up in the Canadian market where they decided not to increase the sort of broadcast amount; they went 50 basis points instead of 75, showing an idea of a, you know, a moderation if you want to call it that.

Now, normally we do not take signals from other countries, but Canada being the giant trading partner it is just north of the border, it's the first time in decades I've ever seen anybody wake up and look at what the Bank of Canada was doing, and that's what happened this week. It actually forwarded this theory, this philosophy that maybe the FED is going to pause.

Now, do you think this is potentially a blink of the FED in the face of, or if the FED here did pause, would they be blinking in the face of inflation? Giving up, essentially saying, "Look, we've been saying two percent for years that we're trying to get back to two percent now, but we're not going to make it there quickly. Let's just give it time and not be so aggressive because we realize we're just going to push the economy into a depression if we do push for two percent."

You have to remember the most hated man on Earth is always the chair of the FED, regardless of who they are, man or woman. Everybody hates the FED. Everybody second guesses the FED. Everybody says they're doing the wrong thing all of the time. You can't make anybody happy when you're the Fed chair, and that's exactly what's happening here. He's trying to, in this case, in Powell's case, engineer a soft landing, which is near impossible. No one's ever seen that happen.

However, data coming out this morning proves that we are not yet in a recession. Everybody kind of knows that just by the feeling of the consumer being so strong. And so, for the first time in a long time, people are thinking, "Wow, maybe he can pull this off." And we would know sometime in Q2 next year that he could actually bring in a soft landing, slow down inflation after all. All he needs and the FED, in aggregate, needs, the board itself needs, is some indication that the rate of increase of inflation is slowing. That's the key right now, and so we don't have that quite yet.

There's a narrative in the market I want people to understand. This and how CPI data is gathered, so much 40 percent of CPI data is housing. Shelter and shelter is a very slow index, and so it takes up to 18 months to actually have an effect on it. But people in different markets are starting to see rent rates slow or flatten or housing prices flatten. So really what we're probably doing in the CPI number right now is over-reporting inflation, and that narrative has been coming in with Professor Siegel, who's been talking about this ad nauseam for the last six weeks. But, you know, he has a point. You can't deny the fact that 40 percent of CPI is shelter, and maybe we're over-calculating it.

Now, people do this all the time, and I'm guilty of it right now trying to say, "Well, here's why we shouldn't believe this number." It's just more Fed beating and more Fed hating and more, you know, telling the FED what to do. The truth is they don't give a damn—they don't listen. They have their own mandate; they're going to do what they're going to do. And I say that'll be 75 basis points coming to a theater near you in the next few days.

Got it. So do you think they're looking at these leading indicators that we've hit peak rental inflation and that that component is going to start reducing that sort of core inflation that so far has been broadening and increasing?

I mean, we still haven't seen transitory. We were hoping it'd be transitory before the war, then we were hoping it would be transitory by Q3 of this year. Now it's like, "Okay, maybe it'll be transitory sometime next year." Well, I've come to the conclusion because I have my own index to look at, which is my 50-plus private companies, that 50 of this inflation is actually because of supply chains that still haven't been fixed—de-globalization.

I'll give you just a case study—I’ve used it so many times. Let's say I'm making gym equipment in Fargo, North Dakota, where I am, and prior to the pandemic, we used to buy all of our metal, our barbells, our screws, some of the infrastructure for the benches from Asia, from China, from Vietnam, from other countries where it was 30 percent cheaper. We can't get those supplies anymore, partly because the ship that has it on it is stuck at La Port. Yes, it's still a problem. La Port has not been fixed yet. And so we are forced to go buy that steel made here domestically.

Now, whether that's a good thing or a bad thing we can debate that to the cows come home. However, it's 33 percent more expensive. So, we take those barbells and those benches, mark them up 33 percent, sell them into an ever-increasing demand market. Our sales have not slowed, but it's 30 percent more expensive. That, my friends, is inflation, and it's not going to change until I can buy those barbells again in Asia at 30 percent less, which is no time soon.

So, the fact is that inflation is self-inflicted by the fact that we are starting to slow down in cooperation with global suppliers. We're fighting with the Chinese; we're cutting off their chips— they're reciprocating. All of that stuff is occurring, and on top of that, people are concerned about domestic supplies of things like semis and oil and gas because it's the only thing you can count on. You don't want to be begging, hat in hand, with foreign dictators like Venezuela or going to see the Saudis and asking them to increase production when they're just not listening.

And so, at the end of the day, we have this transition occurring, and that's part of the inflation number. The economy itself though, proven again by numbers today, is doing very, very well. That's because, again, I'm speculating 6.7 trillion dollars which of cash was printed in the last 30 months still sitting in the checking accounts of the consumer, and he and she are spending it.

Yeah, absolutely. Yeah, the fact that the personal savings rate is still positive is remarkable, but you're right—it's being supported on travel spending, it's being supported just on general spending across the board. Now, you bring up this narrative of the deglobalization that's happened because of supply chain issues. A lot of folks have come to this argument that we should just stay deglobalized and never essentially re-globalize.

Do you think that's impossible in a capitalistic world—to just have localized supply chains and just continue to be cut off? I mean, we've been fighting with China for decades. Do you think we'll end up re-globalizing?

I don't think it's possible to de-globalize, and I'll tell you why. There are certain product categories once they become commodities or better manufactured in low-cost countries. You know, the idea that you shouldn't manufacture socks in Vietnam because of some protectionism or the fact that you'd rather pay five times more for socks—that makes no sense whatsoever. Yet if you're building a new chip that actually can fuel AI, artificial intelligence, yeah, I can see—I'd rather do that domestically and keep that away from our economic competitors like China, who don't want to play in a level playing field unless they're willing to cooperate, and that's the leverage we have over them.

So, you know, different product categories. And I would argue energy—we should remain self-sufficient. That was a mistake the administration made, you know, prior to the election. The country was completely independent in terms of energy production, oil and gas, and obviously high plans for shutdown policy change. And I think that this current administration realized as they went too fast, too soon, and now we have to pedal back.

And I'm not trying to play politics, but it'll be reflected in the midterms in just a couple of weeks. And I think what we'll have after that would be very welcome by investors: it would be total gridlock in Washington. That is a wonderful thing—the pause that refreshes, no more bills, no more spending. Let's take a break for a while and then do jump ball in the election, you know, 24 months later. I think that's a really good outcome.

Why many people like me are optimistic.

That's interesting.

Yeah, of course you're referring to the shutting down of the Keystone Pipeline by the Biden Administration on day one of him taking office. And what I think is fascinating is this idea that grid—you just said it—gridlock is wonderful. So this is really because when nothing gets done, markets can just take into account the earnings that we're expecting and not have to worry about intervention.

And that brings up, though, this idea of the Inflation Reduction Act, which according to Wharton doesn't actually reduce inflation, but it has some benefits for the EV sector. What's your take on the Inflation Reduction Act? Would you be increasing your allocation to some of these energy plays that could potentially stand to benefit from that?

I think that act is very inflationary. I think the idea of forgiving student debt is very inflationary and incredibly unfair to generations who were burdened with that debt or in fact couldn't even go to college because they couldn't take on that debt. I have never seen an act more un-American than forgiving student debt. I hope that gets stuck in litigation and gets reversed. It's outrageous what's going on there, and that's extremely inflationary.

And that has nothing to do with politics; that's just bad policy. You know, doing nothing is always an option that never happens in government until there's total gridlock, which we're going to get assuming the house flips. Nobody knows what the Senate is going to do yet. It's jump ball, but bottom line is gridlock is a great thing. It's a good thing politicians can't get any bills done and nothing happens, which is a great option. A great option because it's a form of certainty in the market. And we've had so much printing and money, so many bills, so much bad policy regardless of what side of the aisle you're on.

And I just detailed my own personal opinion about student debt, which I think is just the more I think about it, the more my blood boils—it's just so unfair. But at the end of the day, all that stuff gets shut down, and that is what I'm looking forward to. And I'm very encouraged by it.

Now, some people might respond to you just on that note and say, "Hey, well, isn't it unfair what outrageous tuitions are being charged for college, and then folks might not be able to get a job that actually pays them enough to pay off their student debt?" What would you say to somebody who says that?

It's a fair comment—let's work on that problem, but let's not forgive one cohort's debt when generations passed never got that opportunity. This idea of free money for just the select is absolutely un-American. That is not what built this democracy; it's just outrageous. And the idea that you just pick one cohort—they're the special ones that don't have to pay for their debt.

I agree with you; education costs are too high. Let's work on that problem. Let's figure out a new way to approach that. Let's use technology to maybe make it a more level playing field, but not giving one cohort—just one, the special ones—they get their debt forgiven. Outrageous.

Well, hey, if you wanted another stimulus check, you could always move to California, where Governor Gavin Newsom is now providing inflation relief checks. What's your take on Governor Gavin Newsom providing these to people earning up to five hundred thousand dollars a year?

Well, you know, there are some ideas that are bad ideas, and there's some ideas that are stupid ideas. Very rarely can you combine both, but that's what you've got here—a really bad and stupid idea. Because you're just fueling inflation. Now, the great news about what's going on between state to state is we're finally getting competition. Idiot management—states are losing taxpayers, losing capital from companies, and lots of movement out of them. California, New York, New Jersey, Massachusetts—people are leaving there, and companies are leaving there and moving to places like Colorado, North Dakota, Florida, Montana.

I am doing my fair part of that too. I'm moving companies out of California. That place is great to visit but not fit for business. I would never invest a dime there. Same with New York—I moved a big project out of New York to Norway, a data center there because New York policy is unstable. And I spent a fair amount of my time on the hill showing these examples to lawmakers on both sides of the aisle. I'm just one investor, but we make aggregate decisions—millions of them—buy the day, and those places are uncompetitive.

Elizabeth Warren's Massachusetts is not a place for business, and that's why they keep trying to overtax and overtax their past 50 percent. California past 50 percent—New York City's past 50 percent. No problem—people are fungible; they move—they're not stupid. Why would you go sit in a cubicle in a New York high-rise when you can be in great weather in Miami and save a ton of money on taxes? Exactly what everybody's doing.

Well, on that note, I'm curious on your thoughts on scaling single-family real estate investment. That's something that I've launched a startup on. We've raised over 25 million dollars; it's House Hack is the name of it. We're looking to buy single-family homes and potentially multi-family and then rent them out with a combination of short and long-term rentals, so we have a nice mix of cash flow in various different markets—South Florida, Texas, and maybe even, I know you might not like it—but even some California to diversify the portfolio. What's your take? Would you follow the jobs? Would you follow where the new offices are being built, like in Miami, in Brickell?

You've got, not that people like them on social media, but Citadel investing over a billion dollars in Miami. You know, I've been quite an investor in the Miami market now for six years in terms of my allocation of real estate investments. I would say one thing about real estate that's unique is a sector. Now, normally portfolio theory would say this: no more than 20 percent in any one sector, no more than 5 percent in any one position. That has been a standard in the indexing market for sovereign wealth and pension plans for a hundred years, and I abide by those rules in most of the mandates that I'm involved in managing, with the exception of real estate.

In our operating company, our holdings in real estate now are 39 percent, which is significantly—it's a heavy overweighting—and the majority of that is in Florida, where we have, are very positive and constructive about the demographics that are occurring there.

Now, I've heard all the arguments about Miami sinking underwater, and I get all that—we've been talking about that for a hundred years, and there is always that risk in any coastal investment. But when you look at the demographics and demand for properties and office property in South Beach or Miami proper or Brickell or even Palm Beach or West Palm Beach and other areas where I am an investor, we see this continuing on an ongoing basis.

And I have to thank the politicians in New York and Massachusetts and California for this wonderful investment opportunity because this is why prices there have not corrected and why they continue to be very buoyant and demand remains strong. The harder you make it to start a business in New York, the better it is for me in Miami, and so that's the bottom line.

And I talk to Mayor Suarez every day and all the other politicians there; they are very open to business. They understand the advantage they have. They're running around the world with their arms open, and on top of all that, we've got the crypto community, which some people think is going to be the 12th sector of the economy in a decade, and I agree with that theory centered. One of the global centers now is Miami, so I spend about five, six months a year there just dealing in that sector.

So you're—you have roughly twice your typical sector allocation now allocated to real estate. You said 39. Obviously, mortgage rates have increased from two and a half percent in December to now on average over seven percent, which is remarkable and potentially indicates that buyer purchasing power should go down by about 45 percent. Not necessarily to say that real estate prices would fall by that, but it does look like there is an inflection point. Housing prices have started to fall since about March to May. What's your take on how deep this correction can go?

You've got, you know, some folks screaming we've got a 50 percent coming, and then the counterargument is this is no 2008—lending standards are too strong. Maybe we're in for an average 15 percent correction. Where do you stand?

We haven't seen a 15 percent correction in any markets yet. There's fundamental demand, obviously, and the consumer remains buoyant. But you're right; we could have that. Traditionally, the real estate cycle used to be seven years. That has gone— we haven't had a significant correction, I don't care what market in North America you look at, for 25 years, and that's because of change of demographic and demand for housing, both rental and assumed ownership.

But, you know, you got to look at it this way: real estate cycles are really interest rate sensitive, as you've detailed. But these mortgage rates right now are still traditionally very low. If you go over a 40, 50-year period—I’ve been an investor in real estate when interest rates are 15—one five. I've been an investor when mortgage rates are under four. And so at the end of the day, fundamental shelter and housing and office space and demand— industrial demand for real estate remains a constant in any economy at different levels of trajectory.

But as an asset class, it has proven to be buoyant for hundreds of years. You know the old adage: they stopped making it a long time ago, particularly that applies to beachfront properties and vacation properties. And look what's happening in Montana; look what's happened in North Dakota; look what's happened to farmland. These are all investments that I look at every day.

You know, each of them have their own merits or risks; there's no question about it. But at the end of the day, it's a fundamental building block in anybody's portfolio, and the only decision you have to make when you're young is how much debt do I want to take on, and that's governed by the percentage of that mortgage.

And so you're right: if mortgage rates go past seven percent—and I think the terminal rate on the FED will be under five—so you could see some high-risk mortgages at seven. That's still traditionally not a very high mortgage rate. Now, some would argue that, look, last time we had 15 percent mortgage rates, the median home price was maybe 80 to 120,000. Now we're sitting at 400,000—around four times that.

Do you think that we could be more sensitive because of these higher prices? And then also sort of a part two to that: You mentioned we haven't seen a significant correction in 25 years. What about '08?

That's true, but it was a very, very short period—18 months. And so when you think about an asset class like real estate, it is a very slow turn asset class. The entry and exit fees are very high. You don't flip it; you don't trade it—you really have to think about what the cap rate is reflecting.

But I would agree with your statement in '08 that with the financial crisis, cap rates went up, and so it's the inverse. So if you buy a building at four and a half percent cap rate—which was AAA office towers in Boston—you know, hey, yeah, they spiked up a bit for that 18 months, but there were very few trades in that market.

So, you know, these assets—people think very long term on. Now I would agree there's a new reason to consider cap rates going up in industrial and commercial real estate. That's because of a new trend in work environments, which are not so focused on office anymore for most companies. Now they have flexibility, and up to a third or half of their employees never come back to the office, and that's probably permanent, particularly in sectors like technology.

So, that may put some pressure on cap rates for commercial, which means their values go down if cap rates are up. The building's worth less. However, in the case of residential, the inverse is true because all of a sudden you've got rural communities like Champaign-Urbana and places where people want to live, raise their kids, go to good schools, get more house for the dollar.

Those cap rates are—the cost of those houses have gone up, and the cap rates have gone down because all of a sudden you don't have to live in Chicago; you can live in Champaign-Urbana, and the lifestyle there on Greencroft Avenue, right on the golf course where I used to live a long time ago—that's a beautiful place to raise a family, and you can still participate in the Chicago community.

Wow, wow, that's a very good point.

So, some real demographic changes there. So, what advice would you have for scaling sort of a single-family portfolio? Would you be following the jobs? Would you avoid any particular—would you avoid short-term rentals? What’s your take on that?

No, I do a blend. I like your idea of a blended portfolio. I like a real diversification of duration when you do rental deals. You want diversification just in case rents go up, then you have the ability to reset them at a higher rate if they're shorter-term. But that's all part of the portfolio analysis I do.

However, I prefer putting in my investments into business-friendly states where you've got the constant amount of entrepreneurs starting businesses, which will bring you more and more customers. I mean, customer acquisition is what you care about in a real estate portfolio. So I prefer places like Florida, like Texas, like Montana, like North Dakota—any state that is pro-business that is not raising its taxes past 50 percent because that is just the breaking point.

Remember, when you pay 52 percent tax, that's the money you can't pay for your rent because you're giving it to a poorly managed government who goes and wastes it for you—that's what's happening in Massachusetts, that's what's happening in New York.

There's a reason these places are uncompetitive. Look at San Francisco—walk around downtown; that is a war zone. Los Angeles—a war zone. It's a complete collapse in society because what they've done is they've broken management. They have no way of managing those anymore. They've squandered their resources; they've squandered their money. California is a disaster—great place to visit, wonderful to take that drive down the highway, but I wouldn't touch it as an investment. And at night, my goodness, I wouldn't wear any of my watches out—that place is—I wouldn't even walk in San Francisco at night. It is literally a war zone.

You wouldn't recognize it anymore. I got so lucky. You know, I bought—I almost bought in February of 2020. I almost bought one of those painted ladies that you saw in the intro of Full House—those row houses— a complete fixer-upper. And I would have been locked down forever and not been able to do anything on that project because COVID hit right after.

It turns out that seller who beat me by five thousand dollars, like three and a half mil, tried reselling it—permits approved—two years and five hundred thousand dollars later just for paperwork—tried selling it for what she paid for it after having spent five hundred thousand dollars and had to delist it after six months because nobody would buy it.

No, I agree. I mean, this—you think about that. That market has suffered because of policy, bad decisions by government, bad overall policy. And then, of course, the collapse of society. Nobody wants to invest in a war zone.

And I would argue Los Angeles and San Francisco, they are modern-day war zones.