Pain Ahead For Markets As Interest Rates To Rise "For Generations To Come" | Chris Whalen

The Charles Schwab

• Chris Whalen · Whalen Global Advisors LLCBearish

  Schwab will post ugly Q3 and Q4 numbers from unhedged bond-portfolio losses; a cost to shareholders.

  Whalen says rising yields push down the price of older, low-coupon, long-duration securities that banks hold. Schwab and several other banks have not restructured their books, so he expects ugly numbers in the third and fourth quarters. He says it is not fatal, but it takes earnings away from investors. He calls the losses from management failing to manage duration a cost of billions.

  “Bank America, Schwab is another one, there's several banks out there that have not restructured their book and they're going to be showing some pretty ugly numbers in the third quarter and the fourth quarter.”at 5:54

Bank of America

• Chris Whalen · Whalen Global Advisors LLCBearish

  Bank of America's failure to manage duration has cost shareholders billions in lost earnings.

  Whalen says Bank of America has not restructured its securities book. As the bond market backs up, its older low-coupon, high-duration holdings fall in price. He argues that management's failure to manage duration has cost Schwab and Bank of America shareholders billions, and that the peers that got duration right, such as Citi and JPMorgan, show the mistake was avoidable.

  “If you sat down and calculated how much the shareholders of Schwab and Bank of America have missed because management couldn't figure out duration, it's billions and billions of dollars.”at 6:24

American Express Company

• Chris Whalen · Whalen Global Advisors LLCBullish

  American Express is one of Whalen's favorites; it managed bond duration correctly through COVID.

  Whalen says the big banks, including American Express, one of his favorites, got the securities book right. They understood that the Fed's COVID-era policy was temporary and so avoided the duration trap that caught Schwab and Bank of America. This is the reason he holds American Express in high regard.

  “all the big guys, American Express, one of my favorites... they all got this right because they knew that what the Fed did during COVID was temporary.”at 6:37

Annaly Capital Management

• Chris Whalen · Whalen Global Advisors LLCBullish

  Annaly is a well-managed mortgage REIT he owns and likes for its flexible management.

  Whalen says he is a big owner of Annaly, the mortgage REIT, because he sees it as a well-managed firm. He is looking for companies with management that is flexible and able to react to things nobody expects, which he sees as the key requirement in the coming years of disruption. The case rests on management quality rather than on a specific mortgage or rate outlook.

  “I'm a big owner of Annaly for example, the mortgage REIT and I like them because they're a well managed firm.”at 41:13

Bitcoin

Across the shows: 2 speakers in other episodes, 1 bullish and 1 bearish calls, past 30 days

• Chris Whalen · Whalen Global Advisors LLCBearish

  Bitcoin is no safe haven: it tracks the dollar and US markets, so it is a speculative toy.

  Whalen argues Bitcoin's fate is tied to the dollar and that Wall Street has largely co-opted it. Because it follows US markets and the dollar, it has no protective value or safe-haven role until it correlates positively with gold. He says Bitcoin was meant as a replacement for the dollar and a means of exchange but became a toy and a speculative item. He also notes that Bitcoin's inflation-adjusted returns were concentrated in its first few years, so on a real basis it has not been a durable store of value. He concludes that gold has won this contest.

  “The fate of Bitcoin is tied to the dollar. Bitcoin has been largely co-opted by Wall Street. So until we see Bitcoin correlate positively with gold, it has no value as a protection or as a safe haven for investors.”at 58:14

Gold & precious metals

• Chris Whalen · Whalen Global Advisors LLC

  The world is returning to a pre-WWI system where gold is the chief reserve asset and fiat currencies compete.

  Whalen's long-term thesis on bonds and the dollar is a return to a pre-World War I world in which gold is the main reserve asset. Currencies will be fiat but will compete with one another, including the dollar. Countries cannot go back on the gold standard, but they will compete.

  “my whole thesis if you want to think about long term bond market and dollar is that we're going back to a world that's kind of pre World War I where gold is the chief reserve asset and everybody's going to have a fiat currency.”at 25:41

• Chris Whalen · Whalen Global Advisors LLC

  Gold is bullish: strong focus going forward as supply is short and central banks keep buying.

  Whalen has been adding to his gold and silver exposure during this year's weakness, which he calls a reaction to interest rates more than anything else. He still has a very strong focus on gold because there is not enough of it and global central banks keep buying it in volume. As evidence, he cites Russia delivering about 100 tons of gold to China over the past year to help pay for the war in Ukraine. He frames gold as a defensive strategy meant to protect capital first.

  “I have been adding to my exposure to gold and silver during the weakness this year because that's really a reaction to interest rates more than anything else. I still have a very strong focus on gold going forward because there's not enough of it and global central banks continue to buy it on volume.”at 40:25

• Chris Whalen · Whalen Global Advisors LLC

  Gold will become the chief reserve asset and a tier-one bank asset, restoring a gold-linked monetary system.

  Whalen argues gold will be the chief reserve asset because no single nation governs it, and many countries are comforted by that. He expects banks to hold gold as tier-one capital, and gold to become eligible collateral in swaps, so countries may use gold rather than Treasuries as collateral when paying for oil. He cites China's Shanghai Gold Exchange as a catalyst, since it created a payment route that avoids the dollar SWIFT system and lets trades settle in gold. He sees the reaction to US fiscal indiscipline and sanctions as a return to gold for reserves, with fiat currencies still in use but the question being how much gold each country holds. He adds that the gold price in each currency will act as a discipline on politicians, because a rising gold price in dollars mostly reflects a falling dollar.

  “I do think gold will be the chief reserve asset because it is not governed by any one nation... You're going to see gold as a tier one asset for banks. They're going to be able to hold it as capital.”at 48:57

Oil & fuels

• Chris Whalen · Whalen Global Advisors LLC

  Destroyed Gulf refining capacity means prices stay high and demand destruction follows.

  Whalen relays John Dysart's view that the world has too much oil but the wrong kind in the wrong place. Repairing refining capacity in Russia and the Persian Gulf, which is 30 to 35 percent of global capacity, will take time. He expects prices to stay high, leading to demand destruction from diesel and energy costs. He also says the West's lack of refineries will make the problem worse.

  “we can't fix the refining capacity. We have too much oil, but it's not the right kind of oil in the right place. We have to repair all of the refining capacity in Russia, the Persian Gulf that's been destroyed which is 30, 35% of total global capacity.”at 35:09

• Chris Whalen · Whalen Global Advisors LLC

  Energy is a no-brainer investment because the world needs energy and that will not change.

  Whalen has been increasing his portfolio's exposure to energy while decreasing exposure to cyclical and financial stocks. He says energy was unpopular under the Biden administration, when windmills and solar panels got attention, but the world ultimately needs energy to survive and that will not change. He frames energy as a stock group that will at least hold its own through the coming years of restructuring.

  “Energy, no brainer. Energy wasn't popular during the Biden administration... But ultimately the world needs energy to survive and that's not going to change.”at 43:10

• Chris Whalen · Whalen Global Advisors LLC

  Red Sea closure cutting oil shipments to Europe will create a terrible political problem this winter.

  Whalen cites the Saudis telling Europeans they cannot ship oil because the Houthis have closed the Red Sea to Saudi ships. He calls this a big problem and says it will put Europe into a terrible political problem this winter. The argument rests on the mechanism that Europe depends on shipped oil, and that the disruption to supply will hit it during the coming winter.

  “You see this in Europe too when the Saudis had to tell the Europeans, we can't ship oil to you because the Houthis have closed the Red Sea to our ships. That's a big problem. It's gonna put Europe into a terrible political problem this winter.”at 44:43

US consumer

• Chris Whalen · Whalen Global Advisors LLC

  Consumer lenders face rising credit costs, so Whalen is short several consumer lenders.

  Whalen says he exited Schwab with a gain and took short positions in a couple of consumer lenders. He thinks credit costs are rising because of the Iran war and higher energy and food prices. He describes the consumer as under stress, yet still spending.

  “I got out of Schwab a couple weeks ago with a very nice gain, I actually put down some short positions on a couple of consumer lenders because I think credit costs are going up because of the war in Iran”at 3:44

• Chris Whalen · Whalen Global Advisors LLC

  The K-shaped economy will turn into an L as consumer stress grows over time.

  Whalen says the K-shaped economy will turn into an L as credit costs rise. Consumers who cannot pay their bills are in trouble, and this is simple math. He sees the consumer weakening even as spending continues.

  “We talk about this K shaped economy. Well, that K is going to turn into an L over time.”at 30:07

US Treasuries & yields

• Chris Whalen · Whalen Global Advisors LLC

  Ten-year Treasury yield will keep rising, reaching roughly 5.5% to 5.75% within the next year.

  Whalen expects the ten-year yield to keep climbing. He says it could reach five and a half to five and three quarters in the next year. He calls the hope for a rally back to four a "head fake" that investors must manage, because the post-COVID low-rate regime is not returning.

  “So, my sense is ten year treasury keeps going up. I think it could be five and a half, five and three quarters in the next year”at 10:29

• Chris Whalen · Whalen Global Advisors LLC

  Current rates are as low as they will get for generations; the 5% era is not returning.

  Whalen says the post-2008 era of accommodation is over. Central banks held rates very low and bought large amounts of duration, and the Fed has since stopped buying mortgages. Fannie Mae and Freddie Mac also no longer hold big portfolios, so duration is returning to the market and rates should rise. He says Trump complains rates are too high, when they are as low as they will get for generations.

  “And he was complaining the rates were still too high when in point of fact they are as low as we're gonna see probably for generations to come.”at 15:27

US rates & the Fed

• Chris Whalen · Whalen Global Advisors LLC

  The Fed will eventually have to buy securities to support Treasury financing, which will be a turning point.

  Whalen argues that rates will drift higher because the Fed and the GSEs no longer absorb duration. The Fed can set the short end, but long-term yields are harder to control. He thinks that once the Treasury's borrowing strains the market, the Fed will end up buying securities to support the Treasury, and that will be when things get interesting.

  “I do think overall the Fed is going to end up having to buy securities to support the Treasury and that's when things get really interesting.”at 10:59

• Chris Whalen · Whalen Global Advisors LLC

  Warsh will be a hawkish Fed chair who lectures Congress on the deficit and avoids economic planning.

  Whalen describes Kevin Warsh as a conservative hawk who may lecture Congress about the deficit, which Powell would not do. He expects Warsh to be less interventionist and to function less as an economic planning agency. He thinks Warsh is constrained by the $40 trillion debt and will speak up more on deficits after the midterms.

  “[Kevin Warsh] is a great Fed chairman... he's the kind of Fed chairman who may actually go up to Capitol Hill and lecture members of Congress about the budget deficit”at 13:19

Banks

• Chris Whalen · Whalen Global Advisors LLC

  As rates normalize higher, banks and depositors will ultimately make money on the change.

  Whalen argues the system will tend toward higher interest rates as the Fed and the GSEs stop absorbing duration. In that environment, banks and depositors will make money. He notes that unrealized securities losses are a problem for some banks, so the benefit is about the longer-run repricing rather than a near-term gain.

  “So the tendency is for the system I think to rise in terms of interest rates. Banks will make money on this, depositors will make money on this”at 10:59

• Chris Whalen · Whalen Global Advisors LLC

  Bank and nonbank credit costs will rise sharply after seven quarters of decline.

  Whalen cites seven quarters of falling credit costs at banks and nonbanks. He argues that consumers who cannot feed families or who put groceries on credit cards they cannot repay within 30 days are in trouble. He says credit expenses will reverse and rise much higher, which he calls simple math given the war in Iran, energy prices and food prices.

  “This is why I believe credit expenses at banks and non banks are going to be going much higher. We've had seven quarters of falling credit costs. They're going to turn around and go the other way.”at 29:54

US deficit & government debt

• Chris Whalen · Whalen Global Advisors LLC

  Halving the deficit each year would slow Treasury issuance and push rates down.

  Whalen argues that investors wrongly think bondholders set yields. The biggest demand for Treasury collateral comes from trade and finance, so slowing debt issuance would lower rates. He says that if Congress shows discipline and halves the deficit every year, rates will fall every year.

  “if we do take those steps, if we do slow down the issuance of debt by the treasury, rates are gonna fall.”at 18:17

• Chris Whalen · Whalen Global Advisors LLC

  Ridiculous US deficits force the Fed to create more dollars, a mechanical erosion of dollar discipline.

  Whalen argues that the US is not going to become unattractive tomorrow. But if the country runs ridiculous fiscal deficits, the Fed has to create more dollars. When the Fed buys Treasury securities, deposits grow mechanically, and nothing can be done about it. He sees this as the discipline that will pressure the dollar and the monetary system, and he says Washington should issue less debt regardless of how debt is constructed.

  “It's not like The U.S. is going to become unattractive tomorrow, but if we're running ridiculous fiscal deficits, it implies that we're going to have more and more dollars because the Fed is going to have to create them.”at 53:50

US dollar

• Chris Whalen · Whalen Global Advisors LLC

  Forced Fed bond buying will trigger a stampede out of the dollar and Treasuries.

  Whalen says that once the Fed is forced to buy securities to finance the Treasury, the pain in the bond market will spread. He expects that to cause a stampede out of the dollar and out of Treasuries. He describes this as the catalyst that could push Congress to act.

  “They're gonna get painful and it's also gonna cause a bit of a stampede out of the dollar and out of treasuries in the bond market.”at 20:17

• Chris Whalen · Whalen Global Advisors LLC

  The dollar may get cheaper as US fiscal pressures build and global investors hold fewer dollars.

  Whalen expects a cheaper dollar as US fiscal pressures build. He argues global central banks and global investors may become less willing to hold dollars. He adds that the US economy will still be attractive, but that its currency could become cheaper in relative terms. This ties to his broader view that the dollar is losing purchasing power, as evidenced by everyday prices, and that dollar-denominated assets are suspect.

  “You may have a cheaper dollar as the fiscal pressures build in The United States. Global central banks, global investors may not be as willing to hold the dollar.”at 46:58

AI bubble & tech valuations

• Chris Whalen · Whalen Global Advisors LLC

  AI is a circular industry where firms lend to one another, which investors are now scrutinizing.

  Whalen says investors are starting to view AI critically. He says AI is a circular industry where companies lend money to one another. He cites a Bank for International Settlements paper calling this circular finance. He views this, along with other post-COVID arrangements, as unsustainable in a higher-rate world.

  “now that people are really starting to look at AI with a very critical view, it's a circular industry... They lend money to one another.”at 7:19

US inflation

• Chris Whalen · Whalen Global Advisors LLC

  Inflation will raise prices for everything within the next six to twelve months.

  Whalen argues that affordability is the dominant political issue and that inflation is hurting people. He expects prices to rise broadly in the next six to twelve months. He ties this to rising costs of energy, food, and credit.

  “Inflation is killing people. It's gonna raise prices for everything in the next six to twelve months.”at 27:54

US elections & politics

• Chris Whalen · Whalen Global Advisors LLC

  Progressive spending promises are unaffordable, so the progressive experiment will end in disappointment.

  Whalen says democratic socialist candidates are riding affordability concerns with promises of free stuff and cheaper housing. The US cannot afford these promises, so voters will be badly disappointed. He argues that the US is entering an age of constraint, and that whichever party wants credibility will need a fiscal agenda.

  “But we can't afford any of that. That's the punchline. The progressive experiment is over.”at 28:13

US housing

• Chris Whalen · Whalen Global Advisors LLC

  Home prices will rise in blue states and reset only modestly in red states by 2028.

  Whalen revises his earlier view of a 2028 housing reset. Blue states with little new construction will see prices rise because of inflation. Red states that overbuilt will see a reset, but a smaller one than expected. Overall costs will rise, which will strain the Treasury through interest expense and affect the stock market and dollar.

  “I think by '28, you may recall I had talked about a housing reset in '28, but now I think the blue states where you don't have a lot of new home construction, the prices are gonna go up because of inflation.”at 32:23

AI pricing & unit economics

• Chris Whalen · Whalen Global Advisors LLC

  AI will be a bust because cheaper models keep arriving, so monetizing it will be very hard.

  Whalen says AI will be a bust. He expects it to be a giveaway for consumers. Commercial users will pay for it, but new models are introduced every week and each one is cheaper. This pricing pressure makes monetizing AI very difficult.

  “AI I think is going to turn out to be a bust. It's going to be a giveaway for consumers... people are going to introduce new models every week that are cheaper. So monetizing this is going to be very difficult.”at 34:36

Agriculture & food commodities

• Chris Whalen · Whalen Global Advisors LLC

  Fertilizer use will fall by a third next year as farmers cannot afford it, cutting yields.

  Whalen says farmers cannot afford diesel for machinery or fertilizer because of high energy prices. Fertilizer producers are shutting down because farmers cannot pay. He forecasts a one-third drop in fertilizer use next year, which means lower crop yields globally.

  “We're going to see a one third decrease in the use of fertilizer next year. That means yields are going to fall. This is globally, by the way.”at 35:58

Middle East & Iran

• Chris Whalen · Whalen Global Advisors LLC

  Even with peace, rebuilding Gulf refineries, gas output and sulfur and helium supply takes years.

  Whalen argues that even if there were peace tomorrow and Iran allowed free passage through the Strait of Hormuz, rebuilding refineries, gas production, and output of inputs like sulfur and helium needed for an industrial society would take a couple of years. That is why ending the war is an imperative. He adds that the Iranians, like the Ukrainians, will endure pain and suffering much longer than people suspect, so the country should recognize the war was a bad idea and bring the conflict to an end.

  “Even if they had peace tomorrow, the Iranians allow free passage in the Strait Of Hormuz... That's still going to take a couple years to rebuild the refineries, the gas production, production of other things like sulfur, helium.”at 38:10

US stock market outlook

• Chris Whalen · Whalen Global Advisors LLC

  He is cutting exposure to cyclical and financial stocks as the next decade looks harder than the last.

  Whalen says he has been decreasing his portfolio's exposure to anything cyclical and anything financial. He reasons that the world will be very different over the next ten years than the past ten, so investors need to move away from the mindset of the last fifteen years. He suggests shifting toward stocks that will hold their own, with management that is flexible enough to react to unexpected events. The argument rests on the expected restructuring and realignment after the war.

  “What I've been doing just with my own portfolio is decreasing my exposure to anything cyclical and anything financial, and increasing my exposure to energy.”at 40:12

China's economy

• Chris Whalen · Whalen Global Advisors LLC

  China has been hurt by the war, and expects a difficult restructuring over the next few years.

  Whalen says China has been hurt by the war because many of its client states, which it trades with, have been badly damaged. He expects the world to face a couple of years of very difficult restructuring and realignment, with an interesting transition in China over the next few years. The argument is that China's trade partners' losses reduce its own economic position.

  “We're going to see a very interesting transition in China in the next few years. They have been hurt by this war too.”at 43:27

Manufacturing & industrial policy

• Chris Whalen · Whalen Global Advisors LLC

  Leaders will need national self-sufficiency in energy refining and industry; relying on just-in-time supply is irresponsible.

  Whalen expects a shift from price and just-in-time optimization toward greater diversity and national self-sufficiency in energy refining and industrial capacity. He points to the risk of California importing all its diesel and gasoline from Asia and to the US chemical and refining base as a strength even though it is not yet adequate. He argues that peaceful-world supply chains worked, but in the future it will be almost irresponsible for leaders not to take steps toward self-sufficiency.

  “But going forward, I don't think that's going to work as well. It will be almost irresponsible for leaders not to take steps to ensure some degree of self sufficiency.”at 46:15