On this week’s episode, I’m joined by Chris Zhang, Partner and Chief Investment Officer at Interplay, on the current state of the world markets and the shift in interest rates signaled by the Federal Reserve. This is Chris’ first time back on the pod since June, so we have a lot to dive into.

We discuss the mixed reactions in the market, with some seeing opportunities amidst the changes, especially in commercial real estate, while others are concerned about the potential long-term effects. Chris explains the implications of this shift on various financial assets and the mixed reactions in the market. We dive into political tensions and emphasize the importance of monitoring the 10-year Treasury yield as an indicator of economic health. 

Chris also shares some hopeful news, highlighting that consumer spending and the job market remain strong, which provides a sense of optimism and supports the idea of a "soft landing."

As usual, big thanks to Chris for taking the time to share his insights! 


Transcript (this is an automated transcript):

MPD:  Welcome everybody. I'm Mark Peter Davis, Managing Partner of Interplay. I'm on a mission to help entrepreneurs advance society. And this podcast is definitively part of that effort. , today we're back at it with Chris Zhang. he's the partner and CIO overseeing our family office side of the house. Chris usually covers market stuff.

He does the same thing again today. Brings us a lot of context about what's going on in the world. He hasn't been on the podcast since our summer break. So a little bit to catch up on and without further ado, hope you enjoy my friend, good to see you, Chris 

Chris Zhang: Good to see you, MPD. How are you? 

MPD: Doing well. You're probably tired. You've got a young child at home. Yeah. So today's 

Chris Zhang: The hundred days celebration. It's been a journey. What is she doing to celebrate? Mooncakes because it's also a mid autumn day and second, second biggest holiday in Chinese culture.

And one of those, you have to get together with the family and eat mooncakes.

I don't know the best way to describe it except that it's a cake reserved for mid autumn day with a, usually a egg yolk inside symbolizing wholesomeness and, and family values, but it's delicious, tons of calories, definitely not healthy, but you eat it once a year. 

MPD:   They gotta fatten you up for the winter.

Makes sense. That's right. That's right. Post beach bod, pre cold layering. Got it. This is our first chat post summer break. Probably a lot's happened. You wanna ramp us up on the world markets? 

Chris Zhang: Sure. The last time we chatted was, we're, the whole world, and especially the U. S. economy is in a different regime.

I feel like we just... Take a step back this time and just recap where we are and where we're headed on a more macro level and without looking into all these sort of details and numbers. But long story short, honestly we're currently in an environment that we talked about six months ago, we thought might happen and it just happened, which is higher interest rate for longer last week.

The fed came out with their revised dot plot, which is basically the feds officials own guidance on where they think interest will be going the next 2 to 3 years. And to save everyone's time, the headline is previously the whole market, including the Fed thought that right now we're, in the past two years, we're just trying to conquer inflation.

And eventually interest rate will be normalized quote unquote, and that normalized means we're going back to maybe two to 3%, which implies that this year going into next year, and by the end of next year, especially we should, we're supposed to see, let's say, three to four cuts from what's effectively a 20 year peak in interest rate.

That's no longer the case. Now the revised plot shows that going into the end of next year, we're going to be at most 2 cuts. Which is 50 basis point from where we are which means it's still 5 percent and then it's still very much elevated in interest rate. This has a tremendous amount of implications across all financial assets, as you can imagine, from a discount rate perspective and equity market to cost of capital, cost of borrowing and interest in real estate market or any market that's heavily dependent on leverage.

And that doesn't really historically run a large cushion when it comes to, when it comes to profit margins, this has, this is basically just turn all these businesses upside down which is, really definitely at the bare minimum headwinds in, in financial markets and equity markets.

This has also implications in currency, right? So beginning of the year, we talked about how, since we're on a cutting cycle and the rest of the world is on a still on a hiking cycle, the dollar is supposed to decline, which it has, it basically reversed the entire gain experience during COVID as right at one, when we last talked about this in middle of summer, but because of this whole reversal from the fed.

We're now seeing momentum in, in dollar strength again which makes total sense now has implications that has its own sort of secondary derivative implications in commodity market, which is still denominated in dollar in, in oil, right in gold and in, in international trade. So this is big news.

I think everyone needs to take a second to mentally adjust to this new reality that we're in. But this, 

MPD: Look, the interest rates are still up. There's still a lagging adjustments in the market to these, this new paradigm. I'll tell you, my experience is for sure less sophisticated than the way you're looking at it is I'm like, I'm on all these investment groups of all sorts and all different groups of populations of very sophisticated people.

Anxiety is no longer high. That is a noticeable thing. People have acclimated to this new state. They don't seem to be super nervous about it, and people seem to be talking very opportunistically. In fact, I'm not hearing a lot of people talking about, protecting their wealth. I'm not hearing people talk about complaining about how bad the markets are.

They're talking about... What are the opportunities that are going to be coming up? And it's a very optimistic mindset of opportunism. The one that everyone seems to keep bringing up is there's an expectation with a lot of people, that commercial real estate is going to fully unwind in 24. A lot of people are saying there's gonna be a bloodbath or keeping their cash ready.

The irony though, is I've heard that from so many people and I think that means that the opportunity won't be as good because a lot of people will pounce on fire sales and drive the price up. So it's unclear to me, I'm not getting the sense of where we were a year ago, where there's unknowns, there's anxiety, it's changed, everyone's stressed.

It feels like everyone's cool. Things are a little slower. They're picking their spots a little bit more carefully, which is probably all signal that this famed soft landing. It's happening. Is that's my human read of it. Is that what you're seeing reflected in the data? 

Chris Zhang: Yeah. So it's more nuanced here.

We need to, which we need to talk, check, chat about. So this is, by the way, I'm not saying this is the end of the world's doomsday scenario. It's not that right. Like it's simply, it's just an interest rate regime change. What the implication of this is regime change is that there's going to be dislocations in the market and dislocations all over the market.

In fact, they're winners, they're losers. And if you're an investor this is actually quite an amazing environment once, potentially once in a decade type of environment to actually deploy capital to take advantage of those dislocations that we just talked about. So it's, I would say it's definitely a mixed day for, depending on which position you're coming from, if you're a regional bank.

And you've got a ton of commercial real estate on your balance sheet, and you're seeing the fall rates picking up, and you're seeing interest going up, you're seeing the entire capital stack going upside down unfortunately, it's not going to be a good day for you. It's not going to be a good year for you potentially not a good decade for you going forward.

So it really depends on where you are at in terms of your positioning. Second thing I want to say, which is super important, and to your point, the reason why people are not really panicking people in general, is that consumer spending and jobs market are still incredibly strong. It's like these two markets, like it never blipped, it never even blinked during the past couple of years of high inflation.

We're still at historically low unemployment rate. And historically low jobless claim rate and consumer spending is still incredibly strong. We're seeing retail spending across all segments, not really a slowdown in anything. There's been some volatility in that dataset, but nothing that would indicate a reverse, a reversal in trend.

And more importantly, maybe on the flip side of that is. Because people are not getting much, much higher wages people are spending like crazy. So you're seeing a bit more take up in, in sort of consumer debt, which ultimately asked the burden of the economy. But regardless, the day to day average, the day to day sort of behavior you're seeing is that people are spending money.

People are not looking back. Saving is not almost a thing still and jobs is strong. So that adds to the rosiness and it's so called the soft landing prediction that the market is still seeing. Does 

that make sense? 

MPD: Yeah, it does. Does it mean though, there's two ways to interpret that.

Does it mean that, hey, we're just delaying the pain? People are still spending, but eventually they're going to get to the bottom of the loan barrel they're going to max out all their credit cards, et cetera, and pain, like a bigger cataclysm is coming, or is it a transitionary period where we've adjusted from hyper growth to this new reality and it's going to be a little bit smoother?


Chris Zhang: always two possibility here. So this spending behavior versus the the wage growth and the slowdown in. In Denmark and broader economy this, these 2 cannot coexist forever. At some point, you're going to see either a slowdown in spending or increase in saving, or there's got to be some sort of shift in the overall economy for us to see next stage of growth.

Maybe it could be fueled by a, I could be fueled by all these advancement in technology and all of a sudden we're experiencing 1. 5 X and productivity across the board. Which could salvage all of us in a situation of that burden and all these things so it's really depends if we don't have a tectonic shift in productivity in the medium term i think the more likely scenario is that people will have to eventually adjust their behavior and slow down in their spending and do more saving which then trickles down to.

Perhaps reduce top line for, businesses across the board. And, but as, as long as businesses are staying efficient with their cost structure, you will still see earnings, right? So it's not companies will go get bankrupt. It's just that the growth itself will slow that, which is healthy in all countries and business society go through cycles.

And that's just part of the game. I don't see us all of a sudden hitting this sort of emergency stop and so called hard landing. And all of a sudden we go back to 1930s and 30 percent of the country. Don't have a job. It's hard to see that scenario just given everything that's happening. So hence the soft lending, which is more likely just it just saying that's part of the business cycle that we're going into a trough, but eventually we'll come back up again.

But even 

MPD: if, yeah, I think one thing that's striking in all this is even if things are still going to contract a little bit. Even if we're still in that trajectory, it's when it's not a surprise, everyone can hedge and adjust and cut costs. And if they're overexposed to, commercial real estate, they can buy insurance on that or sell things at a discount.

And there's moves to do to balance out the sudden shock factor that I think happens that is more disruptive to business, right? The people who are overexposed to dangerous assets right now know that. They know that. And if they're not doing anything, then I don't know, maybe they deserve to go out of business, but I'm sure most of them are doing things to hedge it, sell it, whatever they need to do.

So if it's not overnight shock therapy, you can spread some of the pain by liquidating, hedging, et cetera, early. And I think that's what it feels like. That's what's happening. The people are preparing the writings on the wall. It's pretty clear. Yeah. And people are making moves. Yeah, 

 Chris Zhang: there are always ways to kick the can down the road.

And that's 1 of the most cynical way of doing this is, if you're if you own commercial real estate and chances are it's collateralized and it rolls up to a bank portfolio. So you default on it. The bank, the banks take ownership. And the banks don't know how to manage it. So they will go to the Fed, for help.

So these banks are mostly too big to fail and you will see a rescue package, which is obviously funded by taxpayers. And it's more printing them a dollar in the system that that, that make all that possible. So it's just kick the can down the road, Ray Dalio type of scenario.

And eventually though, right? That increases the debt burden of the economy of us as an economic entity, which weakens the dollar. It's, that's the sort of the cycle you don't want to see happening but could be inevitable. The point is that's not, none of that is going to happen over a short term or medium term, even that will transpire.

The end result of all of that will transpire in the next decade or two, maybe three. Yeah, I, that's the cynical way of looking at this and regardless what, which way you're looking at, I think we're going to be fine in the short term. 

MPD: How does this fast forward a year and look back over your shoulder to now?

What are we getting? What are the things that we might be getting away wrong? Are you factoring in political paradigm enough in this thinking? There's a lot of change coming on that front. Some forward thinking folks about evolution as a side are actually. Expecting that regardless of the outcome in 24, there's going to be some form of violence.

So There's just there's black swan stuff on the horizon Which by definition we're not going to guess because that's what a black swan is. You can't guess it 

Chris Zhang: Yeah, you're definitely seeing increased tension here I mean as we speak or we're at the foot of yet another potential government shutdown Obviously the last one was really a technical one as caused by the debt ceiling.

This one is a political one The Congress simply can't come together and agree to effectively pay these bills and this is inherently a political move and which is evidence for increased political conflict within the country and that just adds fuel to the fire for next year's election.

To me this is the part that unfortunately is we as America is really playing with fire here. Focus so much resource and attention on domestic internal fights and these fights are ideological fights and a lot of levels. So it's difficult to resolve overnight.

And meanwhile, the rest of the world's moving along, and there's all these happening on a global stage, international financial geopolitics. That I feel like we as a country are not paying as much attention to as we should. So this is not trending in the right direction. I think it is very much in line with what again, going back to Ray Dalio's prediction on sort of internal struggles, where we're headed as investors we need to look at all these things and evaluate opportunities within these macro contexts.

One gauge I've always recommend everybody to always pay attention to is the 10 year treasury point. Okay. Thank you. I believe it was Bill Ackman from a few months ago it's really tweeting about how, he's going to short the market in 10 year betting on yield going higher for all these different reasons.

And I was very much in agreement with this analysis. And if you look at the 10 year treasury. We, since I believe July or April this year, it was when we at the low in recent low, which is around 3. 3%. And we're half a year later where we stand the treasury is sure enough, 10 year treasury sold off by over 120 basis point.

That's by whatever metric you're looking at, it's a three to standard deviation move within the year. Very unhealthy for an economy that's so dependent on debt. Just think about all the mortgage rates that are going to go through the roof on the back of this. So this is always a point where I look at, this is the point in the economy that if I have to pick one data point that I look at to gauge.

Risk sentiment and gauge the health of the economy and where we're headed. It's this 10 year treasury point. So I encourage everybody just to pay attention when and if it goes above 5%. I think it will. It's headed that way. It will trickle down to everyday life and it will trickle down to spending behavior and saving rates and overall likelihood of a hard landing.

So let's just. I'll pay attention to that. Very cool. 

MPD: Good to catch up, my man. Thank you for coming back and doing this. And we'll talk to you again soon. And a quick reminder to everybody, Chris is an SEC registered RAA. Nothing he said should be misconstrued as investment advice.

Thanks for listening, everybody. We'll catch you next week.


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