Jordan: Well hello again everyone. Welcome back to the Atlas Investor Podcast with Tiho Brkan. Thank you so much for joining us today for Episode 4. Tiho, my friend, how are you doing today?Tiho Brkan: I’m pretty good Jordan. A little bit tired from a lot of traveling through Europe, but also, enjoying myself. What about you?Jordan: Oh, I’m great. It’s morning here. I’m ready to rock-and-roll. I hope you are too. Tell me where you are today and what you will be covering.Tiho Brkan: Well, today I am in a beautiful city of Budapest. It’s actually called Buda and Pest on the famous Danube River, which runs through central Europe dividing the city. I’m in Hungary, so Budapest is the capital here. Hungary has almost 10 million people and it’s a very interesting place to discuss, including the
Tiho Brkan considers the following as important: Airbnb, Balkan, Bank of Japan, Bond Market Sentiment, Budapest, Business cycle, Business Expansion, Central Europe, Corporate tax, Croatia, currencies, Dividends, Drawdown, Eastern Europe, ECB, Euro, federal reserve, Flattening Yielding Curve, FOMC, fund managers, GDP, GDP per capita, hedge funds, Hungary, Individual Tax, Inflation Linked Bonds, Interest rates, Interest tax, Investment Cycle, late cycle, Long Duration Bonds, Podcast, Price per Square Foot, Price per Square Meter, Property Auction, Real Estate, Rental Yields, Residence Program, Residential Property, Sentiment, TIPS, Tourism, tourist arrivals, Treasuries, Treasury Bonds, US Dollar, Value-added tax, VAT, withholding tax, Yield Curve
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Jordan: Well hello again everyone. Welcome back to the Atlas Investor Podcast with Tiho Brkan. Thank you so much for joining us today for Episode 4. Tiho, my friend, how are you doing today?
Tiho Brkan: I’m pretty good Jordan. A little bit tired from a lot of traveling through Europe, but also, enjoying myself. What about you?
Jordan: Oh, I’m great. It’s morning here. I’m ready to rock-and-roll. I hope you are too. Tell me where you are today and what you will be covering.
Tiho Brkan: Well, today I am in a beautiful city of Budapest. It’s actually called Buda and Pest on the famous Danube River, which runs through central Europe dividing the city. I’m in Hungary, so Budapest is the capital here. Hungary has almost 10 million people and it’s a very interesting place to discuss, including the real estate, which people might be interested in. A beautiful country.
And on top of that, Jordan, we’ll be getting into the normal global macro talk, where we will be discussing US Government Bonds. I know, I know, very, very interesting topic, right?
Jordan: Yes, it’s… I don’t know if I’d say, ‘interesting topic’ because most people like to follow stocks. But as you know Tiho, bonds are very, very important because they influence all assets.
Tiho Brkan: Very, very true. I was being a little bit sarcastic there because people say, “Bonds are boring. Stocks are for the winners; they have the volatility, they have the returns”, but nonetheless, just as you said, government bonds are very, very important indicator to follow and a great asset class to invest in, depending on what kind of a cycle we’re in.
Jordan: Okay Tiho, so you’re in Budapest today. Let’s start by you giving us some general information about Hungary.
Tiho Brkan: Yeah, well, first of all, Budapest, what a lovely city. I’m pretty sure you’re familiar with thermo baths, Jordan. I’m sure you’re also familiar with Hungarian Goulash.
Jordan: Yes well I’m familiar with the Goulash because you informed me and educated me about that in the recent days leading up to this podcast.
Tiho Brkan: I’ve been eating Goulash here since the first day that I arrived so — I love it. I really love it, especially when the colder weather comes through. A little bit about Hungary: It’s a 125 billion dollar GDP economy and GDP per capita is quite similar to Croatia where I was last week. Almost 13,000 US dollars per person. A population of almost 10 million and predominantly unlike Croatia, Hungary is extremely flat, so great place for farming and agriculture… and has been historically. Here they use the Hungarian Forint — it’s very difficult for me to pronounce it properly, but I try the way that they pronounce it.
Hungary also has one of the cheapest stock markets in the world but unfortunately Jordan, there is no ETF. I’m pretty sure you remember our last few episodes where we were discussing US stock valuations relative to emerging markets and other foreign markets. Hungary would be a great place to invest and actually the stock market has been doing terrific over the last 12-24 months — but unfortunately, for the majority of us retail investors, it’s not that easy to invest. However, one of the things that I want to talk to you about Jordan is real estate.
Jordan: Yeah. Let’s get into that. What’s real estate price like in Budapest? I mean Budapest it seems like a beautiful city, it seems like there will be a lot of tourism there. There’s a lot of history and culture, as you noted. Is that having any impact on the real estate prices in Budapest or have recent economic struggles made the real estate more of a value there right now?
Tiho Brkan: Well, Budapest real estate has recovered quite well over the last 12-18 months. It’s jumped up by almost 20%. Having said that, it’s coming off a very low level and the prices per square meter in US dollars are about $2700 depending on which part of the city. In the central parts, even up to three, three and a half, $4000, which for my American listeners would be $250 per square foot. Budapest is part of the old Austro-Hungarian Empire with the two capitals that used to be Vienna and Budapest and also part of more dynamical cities within central Europe and these are in my opinion, Zagreb, Vienna, Budapest, Bratislava and the most beautiful of all Prague, which I’ll be at next week.
Real estate, in general, I’ve noticed is priced fairly good. Where I was several weeks ago — in Belgrade and Montenegro, basically Belgrade (Serbia) and Montenegro (Kotor Bay) and also in Zagreb in Croatia, as well as Dubrovnik — Budapest has prices that are at similar levels or even cheaper at times Jordan, so are quite interesting.
Jordan: Yeah, so it seems like there’s good value there given the history and culture so how could a real estate investor benefit from the opportunities that you see there?
Tiho Brkan: Well, one of the ways that I have benefited in being an investor in Budapest, is that I’ve made some connections with the local real estate agents — who are very familiar with auctions that take place every month or two because the local government is disposing of all socialist apartments. Basically, back in the day, during the years of communism and socialism, certain public workers were given apartments by the state and moving along many, many years, some of these apartments — which are totally not renovated and offer amazing value and amazing price per square meters — are sold in the center of the city through auctions for some of the more informed real estate agents and private investors. During these auctions, one can purchase apartment here for extremely low prices and then renovate it… and I think create amazing value. This is definitely one of the ways that investors can participate in the Hungarian real estate or Budapest real estate.
For investors that are thinking about that, I have to say the capital gain tax is very low at 9%. Corporate tax rate is very, very low once again, similar to Montenegro at 9%. Individual tax rates for salaries are also quite low, looking at the whole of the EU — at 15% — and withholding taxes on dividends and interest is 15% to a person or an individual, and 0% if you’re paying to another company. I think Jordan, one of the best tax option and tax rates in the whole of EU and as I should have mentioned already, Hungary is part of the Schengen area — so very interesting.
If an investor was to purchase something like that as I’ve just discussed through closed and informed auctions, one could either renovate the property and then lease it out to around 17 million tourists — which are visiting Hungary. Budapest is one of the 30 most visited places on planet earth, quite popular. Or one can just flip the property and not pay too much in taxes Jordan, so quite an interesting opportunity here.
Jordan: Yeah, I want to get to other business opportunities but if I can, I would like to just follow up about the auctions. Do you know when that process started and maybe how much longer is that going to last for? That’s an opportunity but is that something that could be over in a couple of years or … I’m just curious if you kind of had any details on that.
Tiho Brkan: Well, yes I can. If people who are listening to this podcast would have any more inquiries and questions, don’t hesitate to contact me at theatlasinvestor dot com and we can discuss this on a more private matter — because this is something that I do for myself and my clients only, Jordan.
Jordan: Okay. Fair enough. Let’s move to business opportunities and you mentioned obviously there’s a great opportunity in real estate. Do you see any other business opportunities there?
Tiho Brkan: Yes. Definitely. I mean the city is really coming of age after its socialistic downtime and the city is full of hipsters, it’s full of Café shops, shops are popping up with high-quality foods, amazing coffees that are brought from — and I’m quoting baristas here, from Kenya, Colombia, and Guatemala — so incredible culinary culture, as well as traditional side — so both old and new. A lot of digital nomads are living here, which are location independent workers, so you know the internet speeds are incredibly fast. The wages are much higher than other parts of Southern Europe, which we discussed — in particular for example Serbia, Macedonia, Montenegro — and the youth here is quite educated and quite tech savvy. But the opportunity that we talked about in episode one was Serbia and being able to hire great talent for cheap wages. That is not as attractive here.
Away from business opportunities, I would also like to discuss the Hungarian resident’s investor program, which was recently suspended, but it was a great program for high net worth individuals who are willing to invest 300,000 euros or more into Hungarian five year bonds and obtain a permanent residency for the purposes of taxes, which are incredibly low here. Unfortunately, that’s not in works anymore. The program is being suspended but that was a wonderful way to relocate to a lovely city and reduce the taxes too. That’s not a business opportunity but definitely an investor opportunity — but that’s kind of stopped. The program has ended, unfortunately.
Jordan: Yes, unfortunately. Tiho, you’ve covered a lot here on Budapest and Hungary. What’s your final verdict on the country?
Tiho Brkan: My final verdict on the country and city is that the goulash is bloody good. I have to say it’s wonderful, but other than that, I’m quite optimistic on Hungary. The stock market is priced so low. The real estate is priced pretty favorably too. The yields that can be obtained here depending on if you use let’s short-term listing with Airbnb and play the tourist side, is interesting. The tax side is also interesting and for those that might have ancestors coming from Hungary — just like Ireland — Hungary also offers citizenship by descent, even if your grand grandparents are from Hungary. Maybe something to look into for you Jordan, if maybe your grandparents came from Hungary, you might be able to apply for a citizenship here.
I’m bullish all around and definitely an investor already in Hungary.
Jordan: Thank you so much for that info Tiho. I don’t know if it applies to me but I’m sure it will apply to at least a few people in our audience. Okay, Tiho. Now we are going to discuss all things US government bonds. You are going to cover bond yields, bond prices, the yield curve and current inflation focus by the bond market. Tiho, as we start. Can you tell us, where are we in the general context of the US interest rate cycle?
Tiho Brkan: Well, over the last 30+ years since September 1981, bond yields in the United States and around the world, have been declining in a deflationary trend, or maybe dis-inflationary trend and kind of deflationary trend as of late. It’s hard to say whether or not this trend has ended, and we are coming to the end of the great bond bull market or the bottoming in yields, which has been falling. We’ve seen these episodes in history before, and for those that are watching our YouTube channel right now, they have a chart in front of them, which shows the great bottom in the yields Jordan, between 1938 and all the way to 1954. Back then the bond yields kind of dropped in a long base and a slow basing process, and finally we saw the great rise in inflation and interest rates rose all the way into September 1981, eventually getting above 15% on theTreasurysury 10 Year yield.
Jordan: What about the yields for government bonds across the rest of the world?
Tiho Brkan: Well, right now, the US is trading at around just above 2% as of this recording, so I think 2.2% or so and it’s interestingly enough, one of the higher developed market yields, apart from obviously high yielding commodity countries such as New Zealand and Australia… but really the yields that are attractive, are away from developed markets where we’ve had a lot of quantitive easing and artificial bond buying, which is suppressed yields. Yields that are in double digits, can be found on government bonds in Brazil, Russia and close enough to Turkey. I think as of this recording, Turkey is getting there, due to the current crisis. A geopolitical spat with the United States, which creates great buying opportunities actually.
Generally speaking, emerging market government bonds yield a lot higher and they also yield higher than inflation, so they have real yields that are positive. On the other hand, a lot of the developed markets, Eurozone, Japan, South Korea, United States, Canada, Australia and New Zealand, tend to most likely trade in a negative real territory and the nominal yields are quite small Jordan. Rarely can you see anything above 3%.
Jordan: Okay Tiho now, how have bond yields been affected by recent rate hikes from the federal reserve?
Tiho Brkan: Well, the last time we saw a rate hiking cycle by the Federal Reserve, was in 2006, so the recent cycle that started in December 2015 has been one of the slower ones, and it was almost eight years since we saw the last hike. Interestingly, the Fed started off with a single hike from 0.25% and up to half a percent and then they kind of slowed down. How the bond yields have been performing actually is that the two-year yield seems to be in a bull market — so basically the yield there is rising rather sharply. However, the five-year yield is not moving as much.
It hasn’t made any new highs as of late and even more so this is true for the 10-year yield and the 30-year yield. What this is doing Jordan, it’s slowly flattening the yield curve. Because the Fed is pushing short-term rates up, but the long-term rates are still looking at low inflation and the slow growth economy. I’m not very much excited about the economic growth of the world or the US in particular, remain below 3% in general. We’re kind of compressing towards a similar pattern that we saw in 2000 and also 2006.
Jordan: Right yeah. I wanted to ask you about the yield curve. Maybe you can speak a little bit of more on that in addition to the yield curve. How late in the business cycle do you think we are?
Tiho Brkan: Well, you know the yield curve is a great predictor of recessions. There is no perfect indicator but this one is pretty good. It doesn’t give too many false signals like some of the other ones — like the ISM for example or the unemployment numbers, or just the general GDP volatility. The yield curve has been flattening since 2010, but we did have a period where it flattened and then it once again widened (or steepened), but we once again continue to flatten since 2013 as the Fed continues — as I already mentioned previously — hiking rates in a slow and controlled fashion while the long bond remains in a steady sideways pattern. The yield curve spread right now between the twos and the tens as we say, is just below 1%, but it’s not inverted or going negative, which is usually a sign of a recession coming up.
This is very interesting Jordan, because I have to say this is one of the longest durations of expansion in a number of months that I can see going back to World War II — and even longer since the start of the United States republic, so back to 1700s. Usually, the business cycles used to last around 40 months during the 1700s and 1800s. Over the 1930s, we had a business cycle that lasted 80 months during the World War II period and then also in the 50s pushing to 100 months, towards the 60s. Swinging 60s, the great American boom and we also saw a great expansion that lasted 120 months to be exact during the tech boom of the 90s, and now we’re up to 100 months as of this month Jordan, so quite interesting.
The fact that we haven’t seen a recession yet in my opinion at least, is because the fed continues to be quite gradual. Interest rates on the short term are moving rather slowly and we still haven’t had an inverted yield curve, which usually tends to signal of tight credit conditions and that potentially is something could go wrong.
Jordan: Great, so obviously we’re late in the cycle but what you’re saying is the yield curve signaling that end of the cycle is not imminent. Now Tiho, let’s move along. Let’s look at the performance of different duration in government bonds, intermediate duration, relative to long duration, what returns have investors achieved recently and what can be expected as far as returns in the future?
Tiho Brkan: Sure. Well, one of the things we’ll cover, I’m pretty sure later in a podcast, is the way bonds peaked in July 2016. So returns haven’t been all that fabulous over the last year or two. Interest rates hit a very low level in July 2016 — due to flight to safety and flight to quality. Since then the intermediate bonds, which are around seven to eight years in duration, had a drawdown of around 8% — which depending on the volatility the people are used to in stocks may not sound a lot but historically, looking at bonds, rarely did they sell off that much under this duration and maturity.
On the other hand, the long duration, which is about 19 to 20 years — and the way that people at home can play these two is IEF ETF is the first one and TLT ETF is the next one, which is around 20 years, let’s say 19-20 years in duration. The sell-off was also quite big in TLT moving towards 17% from July 2016 down to December 2016. The recovery in the shorter duration, due to lower volatility and similar yield, is moving along much quicker until recently — we were pretty close to making new highs in short durations and intermediate duration. On the other hand, there is a long way to go, Jordan, for long bonds. Despite the fact that they’ve recovered very strongly since December 2016, there is still some ways to go and we are constantly getting small rallies followed by small selloffs — depending on how the Fed is looking at positioning future monetary policy decisions.
Jordan: Okay. Let’s talk about TIPs, which are also known as inflation-linked bonds. Why have they been underperforming equal duration nominal treasuries?
Tiho Brkan: Well, we’ve been in a dis-inflationary environment since December 1981, so as we continue to be in this environment TIPs — which usually benefit a lot more from higher CPI, as they protect investors from high inflation — have not been benefiting obviously because the CPI has been falling and kind of disappointing investors who are expecting inflation. Also, what I would like to discuss is the relative value of TIPs against nominal bonds of equal duration. When we compare TIPs to nominal Treasuries, we can see how the Asian financial crisis and the emerging markets crash of 1997 and ’98 affected inflation by subduing it and obviously creating underperformance of TIPs.
What central banks do is they react to this by loosening monetary policy. This tends to recover inflationary expectations for a while, until TIPs underperformed again during the Dot Com bubble burst of 2000-2003. Eventually, we had a strong commodity boom, which made TIPs outperform nominal Treasuries for a period between 2003 until 2007/8 — until Oil and other commodities like grains, like wheat, gold, and silver all ended up correcting. That was a Subprime crisis of 2007 and the Global Financial Crisis of 2008. This was probably one of the worst underperformance episodes for TIPs relative to nominal Treasuries, but it also created a wonderful buying opportunity for those who are contrarians among us.
The recovery was obviously carried out by the great General of “money printing” — Ben Bernanke, who started QE1 and eventually followed into QE3, QE4, QE infinity, as a lot of commentators in TV would say. From another side, he’s looked at as the hero, for saving the economy from a catastrophe. This helped TIPs perform nominals into 2013, but mainly the majority of the underperformance was at the beginning of the cycle. Once again, as we had a slow down in foreign markets — especially emerging markets and emerging economies, as well as the Chinese stock market crash of 2015 (including the commodity burst of 2015) — we saw TIPs once again underperform… especially as Crude Oil came down really really hard, Jordan.
As of late, we’ve had a TIPs trough in January 2016, central banks kind of pulled back from hiking rates very fast and the ECB & the Bank of Japan continued QE programs. This has been helping TIPs outperform. I’m sure you have a few question about of whether inflation will be coming back or not Jordan, so I’ll let you ask away.
Jordan: Yeah. Before I get into that Tiho, I know that … I just want to commend you because your calls on bonds have really been outstanding. Let’s go back to the peak July 2016, which was also the peak of gold. I know you correctly called that and listeners don’t need to take my word for it. Just go and look at MarketWatch because MarketWatch picked up your blog post and your call about that and even in last December, you called the trough and I remember I was talking to you on the phone briefly. I was at a restaurant, you’re also bullish on gold at the time and bonds and that like the July 2016 call, was right on the money. Tell us about these calls and how you did that.
Tiho Brkan: Sure. Well, thank you for bringing it up and it’s important to outperform markets. It’s important to have the ability to sometimes sidestep serious sell-off. I didn’t really know whether or not we were going to have a serious sell-off coming into July 2016, but I noticed that the so-called safe haven trade was basically gaping up, with every investor tripping over themselves trying to get in and buy TIPs and long duration Treasuries and short duration Treasuries, utility stocks and high dividend yielding stocks and real estate and gold and anything that was kind of perceived as safe. I decided here to totally go extreme underweight Treasuries and Gold to the maximum that I can for my clients and within several months, we noticed a mini-crash in Treasury bonds creating serious drawdowns historically, from five year all the way to 30 year duration.
I also noticed that a serious sell off in Gold went almost all the way back to the $1,100 level and back to the original December 2015 low, while the real estate continues to underperform ever since we made this call, Jordan. It became obvious that when everybody is on one side of the boat, maybe the smart thing to do is to just leave. Not necessarily short and go against them, but just leave the trade and raise some cash… and that’s what I actually did. But as the selling intensified, I noticed by December 2016 that investors were throwing out bonds and gold together with the baby and the bathwater. They were even throwing out the Hungarian goulash. They were throwing everything out, and at that point and time, I decided that it was time to step in — as I did many posts and tweets about bonds and why it was the time to buy them — as they were extremely oversold.
My clients luckily enough did that, following me into the purchase and we did very, very well for the first half of 2017 Jordan.
Jordan: Okay, so what that said Tiho, I know you’re usually a contrarian or an independent thinker. Tell us what the consensus expects right now, relative to what you expect going forward.
Tiho Brkan: Well, you know we’ve had an extreme period of bearish sentiment. As I already mentioned in December 2016 and even around March 2017, when bonds were really out of favor, this was really the period when I was buying bonds, as well as some other assets that are of similar nature, including TIPs. However, we’ve seen a decent recovery in bonds and I’m not saying necessarily that they don’t have to continue to recover, but I am not that much of a fan anymore because until recently, bonds have done really well. It wasn’t until the Federal Reserve started talking about unloading its balance sheet full of junk and Treasuries that they’ve been buying for the last several years, that the bond prices have started to back down again and yields started to rise.
It remains to be seen how the bond market will continue to play off from here, but the clear-cut opportunities that I saw in December in 2016 when I purchased bonds for my clients, does not exist here. For those that are interested in actually knowing how we’re positioned and what I’m doing in the bond market right now — relative to let’s say hedge fund managers and relative to other futures speculators — jump on the website and contact me and we can do an investment consultation. I’ll be happy to break down my positions in bonds and what I see happening in the future.
Jordan: Okay Tiho. With all that said, please give us a final verdict on bonds.
Tiho Brkan: Well, the final verdict on bonds is the great question of whether the great bond bull market and the fall in market yields has ended. The bull market, which started in September 1981, has last for 35 years or so. It will be an important period of, in my opinions, TIPs outperforming nominal Treasuries. Inflation making a bit of a return for a variety of reasons, but there are many great tests that remain for the bond market and whether the yields can rise that much. In particular, we are late in the investment cycle and as we approach the potential for the next recession, that recession could once again be the deflationary, due to such high amount of debt. We have stacked up a lot of debt globally, like a house of cards. In particular, with China and emerging markets and some other places in the world too.
The question is whether yields can rise as higher to trigger the end of the bond bull market and how the asset classes will perform considering that interest rates start to squeeze the global expansion and the global growth cycle.
Jordan: That concludes episode four of the Atlas Investor podcast. Tiho before we go, where will you be in episode 5 and what will you be covering?
Tiho Brkan: Well, I will be moving from Budapest through Bratislava and going to the old city of Prague, one of the most beautiful cities on the planet. The old Czechoslovakia, today is known as Czechia, Jordan. I’ll be talking to you about all things alternative. We will be talking about alternative asset classes and how investors can expose their portfolio there.
Jordan: Well, sounds good and I hope you’re able to take some goulash with you as you leave Hungary.
Tiho Brkan: I’ll try but I’ll tell you, they have very good sausages and beer up there, so maybe I’ll give goulash a break and I’ll be eating what they eat in the Czech Republic.
Thank you for listening to The Atlas Investor podcast. To be notified of future podcast episodes sign up for our free newsletter and join our Youtube channel. Tiho Brkan offers his clients a wide range of services. Including portfolio construction and wealth management. One on one consultations. Global real estate opportunities. International tax planning. Citizenship and residency planning. And one on one mentoring. For a free consultation, visit the Atlas Investor dot com and contact Tiho Brkan.