Steve Johnson: What the market is missing about the AI boom

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1:04Everything you're about to hear is for education and entertainment purposes only. Whilst we are licensed we're not aware of your personal financial circumstances. Any advice is general advice. Equity mates operates under Australian Financial Services License 540-697. Every single bubble has a true and strong narrative behind it and the stronger the narrative the bigger the bubble. Look, it's the theme driving life too. I think over the next 10 years, I mean people that are at the call face here are talking about it destroying humanity. I know. I know. A not insignificant probability. If that breaks, that is the huge problem for Australian public. Welcome to another episode of Equity mates. The show where we explore what's possible in the world of investing. If you've just joined us for the very first time, a massive welcome to our community. My name is Bryce. And I'm Ren and today we're talking to one of the most candid fund managers out there. He recently wrote a letter to his investors telling them to expect under performance. Gotta respect that. Gotta respect that. We love transparency in the industry.

2:08We are welcoming to the studio Steve Johnson. He's the founder and CIO of Forage at Funds Management. He has an Australian fund and a global fund. We start the conversation with his letter, as you said. And we should be clear. He didn't just say expect under performance forever. He was talking about it in the context of the AI trade. Yes. He said as long as the AI trade continues, his fund will underperform. So we start with where he thinks the trade is out and how he's counter-positioning his fund against it. But then we go beyond AI. Yes, we talk what's going on in the world of small caps here in Australia, where he's finding opportunity beyond the AI trade. He brings a couple of stocks to the table as well that we go deep on. And then we get his thoughts on Australian property because back in 2017 he said he would always be a renter and that stocks will be property. No, I guess. Yes. Love that. Well, without any further ado, let's get to our conversation with Steve Johnson. Well, Steve, welcome to Equity Mainz.

3:09Thanks. Good to be here. The recent CIO letter you wrote, as long as it being the AI trade goes on, you should expect both funds to continue their underperformance. Now, this is an unusually candid take from a fund manager. What was the response from investors? I think amongst our client base, it's a welcome message to them. Most of our clients are using index funds or have the core of their portfolio in those big large blue chip companies. And they are getting exposure to everything that's working in that space through that. And our job is to give them something different. And I think if anything, it's also just, I'd say over the past decade, we've not been as counter-sickly cool as I would have liked. And part of that is making too much money in the good times. I think to actually protect yourself in the down time, you need to be willing to lose out on some of those opportunities. And we're trying to do a much better job of that in our portfolios. And I think that's what our clients want. And it's the message that they want to hear. So it was interesting.

4:10I saw that question on the list that you put forward. I haven't actually had one client query about that as a concept. I think it's actually what they expect from us. That's our investment strategy. And it's the product that they've invested in. And they want to see more of that, not less. Well, we want to hold on the AI trade. And we promise we're not going to just talk about AI for 35 minutes. But it is front of mind for everyone at the moment, the theme driving markets. We're coming up to almost four years since ChatGPT was first launched. What's your take on the AI trade today? Look, it's the theme driving life, too, isn't it? I think over the next 10 years, I mean, people that are at the call face here are talking about it destroying humanity. I know. I'm not in significant probability of it destroying humanity. So if that's going to happen, I want to be alive for it. And it's going to be an interesting decade ahead as all of that unfolds. And I am a big user of the product. I think this is a genuinely transformational technology. I don't know that it's that much more transformational than electricity or than sewage works back in the early days.

5:12Like there's been a lot of things that have changed our life as we know it dramatically. Combustion engine being another one. Maybe this one is faster. And that's been a trend with technology is that these things get quicker and quicker in terms of the impact that they have. But it is a genuinely transformational technology. We're using it in our business more and more. We're on a race really to try and keep up with what everyone else is doing to start with. But it is doing a lot of things that we used to do ourselves better than we used to do them. So I think the technology is amazing. And it's only going to get better. Every model that comes out is better than the one before it. Are you sending you notice where we often run out of tokens or usage capacity at forager within the first few hours of the day? We started to ration the use. What are you using it on? Research mostly. This is and building models. And I think part of that message that I was writing about in the letter is I think this is a really, really useful technology for certain types of activities. It can do a very wide range of activities.

6:14But I don't think it's the right tool for a lot of those other activities. And we actually had a consultant come into our business and we're just talking about little things like the unit price every day. How do we calculate that? And this consultant said to us, look, anything that's actually determinative and you need an exact correct answer every time, you're actually better off building a piece of technology that can do that calculation from start finish in order get you the right answer. Perfect. AI can do that. It's really slow. It's really inefficient. It needs to go and work out how to do that every time. And it actually just costs a lot of money. The technology is expensive. And now that you're paying for tokens and we're still really not paying the economic cost of it, that cost goes, okay, this is going to take over 10 minutes. It's going to cost me a certain amount of money. I could actually build a piece of tech here that can do that correct all the time. So I think that's a really important thing to recognize about it. It's a probabilistic, I think at the moment, mostly a content type tool. So you want to code, right? There's a bucket load of content out there that it can go and look out and say, well,

7:15I've seen someone else has done this. I'm going to take it and I'm going to show you how to do that over here. If it is, I want to know what's happened with the CEO of this company yesterday or, you know, in our world, small cap companies where there's not a lot of information about them, it's probably wrong 30 or 40% of the time to the point where it's become almost useless for me to do research with that as a tool because it doesn't have enough information to work with. So I think we're going through this phase of, wow, it's amazing. It can do all of these things. The next step is, well, what is it economical for it to do relative to, I can get this done by someone in India. I can do it myself or I can build something else to do it. I think as we go through that process and as all of this capex that is being spent needs to earn a return and we start paying the economic cost of it, there's actually going to be a lot of activities where it can do it. It doesn't mean it should. Yeah, yeah, yeah. So I guess you're using it a lot. You're seeing the transformational benefits on one hand and yet from an investing point of view, you're steering clear of it as a theme.

8:17How do you reconcile those two views? I think if it is truly world changing, surely there's some winners that you want to ride. And look, we've made some money. I wouldn't say it was necessarily, this is the AI trade and we're going to make some money out of it, but we own some stocks that did very well over the past sort of 18 months. One, US, HVAC installation company, they are doing a lot of data set of work. I think the US, that share price has gone up four or fivefold and as that started on fold, we recognize that was a tailwind for that business and we held that for a long period of time. I would just say now the prices for almost anything that's associated with the space have become so disconnected from what I think those businesses are going to earn in profits that we just don't want to own them. And I would say every single bubble has a true and strong narrative behind it and the stronger the narrative, the bigger the bubble. You need the story. Jeremy Grant, I'm certain some really good stuff about this recently. You need a story and you need a story that the average person on the street can understand

9:21because you need to be able to, you know, you're using this product. Look at how amazing it is. That's how you sell all the, why don't you go and invest in this business on the back of that and you know, what's happened I think is you are just seeing prices for some of this stuff that is absolutely crazy. And I think back to what we were talking about before, the economic model is not clear here that this is as good a business as online advertising was, right? I think those tech founders didn't necessarily sit down. I think this is going to be a great business, but they ended up with the greatest business models that we've ever seen, right? They were CapEx, like the profit grew like crazy and you didn't have to keep reinvesting your profits. And now this is one thing that we know for sure. It is a very, very capital intensive business. Are the returns going to be great on that capital? We don't know the answer to that yet. It can be like electricity, right? Electricity is an amazing technology that is not a great business because the returns are pretty low on the amount of capital that you have to put in. So there's a lot of questions there about business models and I think at the moment most people are just, if it's got AI in the name, they're buying it and one thing you can

10:26rest assured from in the broker world is that they will sell you things that will sell. And you see your IPOs and you're going to see all of this stuff coming to mind. Yeah, yeah, yeah. There's so much money to be made by selling this stuff to investors and where there's money to be made, it's going to happen. People speaking of IPOs, do you have a view on firmness? Look, I've been flicking through that. We've got sent some of the slide decks and the materials. I mean, this is for me, this is the epitome of bubble-like behaviour. It is at the moment, nothing. That is what you are buying is a promise. And I would say the baseline probability here for CapEx overruns and lake delivery and the return to not being what they've put in those slide decks is very, very high. And you're probably going to see that pretty quickly as my guess that in 12 months time it's this thing is going to cost us twice what we thought it was going to cost and it's going to take longer and we've been delayed because of regulatory, whatever. There's actually just not much to it when you look at what that business is here and now

11:29is a very small company not going very much. And they've got this huge pipeline that's going to again require an enormous amount of CapEx to build out. It is the epitome, I think, of something that can only sell with this narrative behind it. There's no way in the world you would get away with listing that stock on the stock market without the narrative that we have behind AI at the moment. Yeah. Final question on AI. How do you think it ends? What are the red flags or data points that you're looking out for? Well, I think this return on CapEx is really, really important. I think we're spending all of the money and all of those people that are providing the money want returns and especially I think with the leverage that's involved in a lot of this. So, within a couple of years we're going to start seeing whether the returns stack up in terms of profitability on this. I think that's number one from a fundamentals perspective. I'd say this interest rate environment is a problem for the CapEx that needs to be put

12:31in here. There's a bit of chicken and egg there. I think a lot of the capital that's going into the AI trade is sucking out of other places and therefore the returns on bombs and everything else are going up. But also I think if you start providing debt to these things with the interest rate before margin is sixes and sevens instead of threes and fours where it was a while ago it's just more expensive. And then look, I think bubbles just end in and of themselves to a certain extent. It gets tired. It's sucking in an enormous amount of capital. And then at some point in time people want to take some of that capital out and where does the next dollar come from. Often, I mean this is, it's not going down but what are we maybe four or five months with sort of bouncing along here and a few little downturns and it's actually been better certainly in our portfolio. We've done really well over the past three months relative because there's other things that have started doing well particularly on the software, on the anti AI side of the industry which we might talk a little bit about later.

13:32I think there's some really attractive opportunities there. Some of that stuff actually worked quite well over the past three months. So if anything, I think the strains of the amount of capital that it needs are already showing. I don't have any insight into whether this is 12 months, 24 months or five years but I think people are going to be disappointed over a five year period about what sort of returns they own. One other thing that we saw in your letter that we thought was interesting was it was an admirably candid letter. I think your investors would appreciate it. You spoke about some of the mistakes and you said you acknowledge it was a tough year for the funds as we've spoken about but you said part of that was self-inflicted. One mistake costs significantly more than the largest winners in both funds. You didn't say what the mistake was so we thought we had to ask what was the mistake? It was in the, we were talking about both of them in the fund specific parts of that one. Okay, that is behind the CIO letter.

14:32Just as a bit of backdrop, the trust and the transparency that we have with our clients is our number one asset. It's actually all we've got that is different from what other people have. You can have the same philosophy as another fund manager. You can have the same intelligence that we have executing on that is really, really hard if you don't have a client base that sticks with you through the inevitable difficult times. We have that because we tell them the truth. We lose clients as well. They go, you're stupid. You're made that mistake. The people that want that transparency and like that transparency are incredibly loyal on the other side of that. When we have these difficult periods, we don't have outflows and then we don't have the deal with selling stocks at the worst possible time. It's not just, we're nice guys, we're honest and transparent. It's a really fundamental part of our business and our relationship with our client base. Look, we had a difficult year last year. I'd put it in the normal difficult year for us. I say to everyone, you can expect a tough year. You can expect a really good year and you can expect probably three in between in every

15:34five. For us, down 10 is in the relatively good bad year if that makes any sense. We've had a year where we were down more than that, down 30% coming out of that COVID. We had the other side of that. The difference between down 30 and down 10 in terms of... Stress level. No, just in terms of long term returns. You go down 30, you've got to be back up 45 or 50% just to get to square. Down 10 is much easier to recover from and I think for us being defensive and making sure that the drawdowns are limited is a really important contributor to long term returns. Look, the two stock specific EML in Aussie Fund, which has been an absolute disaster over a fairly long period of time. Actually, we invested in this as a turnaround that was well underway a couple of years ago. It would have been through its first round of troubles. The share price actually recovered quite a bit after we first invested in it and then

16:37it's been at all time lows again now as the troubles have come back and the turnaround has really struggled. Then in our international fund, FICE, which is actually... It was meant to be a big, fairly stable part of our portfolio. It's also in the payment space and that's probably a bit of a theme. Globally, payments has been a very, very difficult sector. It's been more competitive than we had anticipated when we invested in these companies. I would say mistakes are part and parcel of our investing style, so I don't beat myself up about mistakes. I think in both of those cases, you can question the portfolio waiting side of it and it's something we work really hard on, his legs. Let's try and minimise the damage that the mistakes cause here. How do you do that? Start with smaller, sensible weightings and you're really trying to avoid the doubling down on the things that are not going well. We make a lot of money out of market pessimism. Part of our strategy is we buy things when everyone's being super pessimistic about it.

17:37I think you need to be really, really careful about those situations where it's actually going worse than you first thought. It's easy, okay, it's down 20, it's a bit worse than I thought. It's still an attractive opportunity. It's down another 20, it's still a bit worse than I thought. The clock just ticks a little bit at a time before you know what it's midnight and it made all these little adjustments around the way. I think when you lay out your thesis and if you start getting evidence that you're wrong, I think moving on from those things and starting with the Clean Shader paper is really, really important. I think in both of those situations, we broke some of those rules and we've generally done a really good job of it over the past couple of years in terms of buying more as the share price fell and then we did sort of restate a thesis and say, okay, we've got a new thesis here and it's going to be great again. More often than not in my life, I've had some successes out of that as well but more often than not, it's been a mistake. Well, you mentioned Steve that you're seeing some pretty good opportunities outside of the AI trade. Where are you seeing values today?

18:39Yeah, I think software is a really interesting one and it's not without its risks. I mean, every single model that comes out in the AI space is better than the one before it and I've noticed this new meta agent running around. Yeah, it can do everything in your life and you start thinking, well, I've got all these software things, the dual of this stuff for me, is it going to start doing that? I think there are risks to the space but I think the pessimism that came in was way, way overdone and I think there's some, we're looking for some characteristics in those software businesses around firstly the cost of the software, the lower the better. I use zero as an example in my own business. I think we pay them $150 a month, probably tells you something I don't even know what it is. It's about $150 a month, I think. So $1500 a year, the amount that you are saving me by coming to me and saying I've got an alternative for you is very, very small in the context of the cost base of our business. So it's going to take a lot for me to switch and it's probably the most important piece

19:41of software in my business that does payroll, does all the tax stuff, it does all these things that we don't have a business if we don't do that properly. I don't, we have seen in that accounting software space how sticky it is through multiple transitions, the whole industry moved to the cloud and people are still sitting there, my mum is still sitting there on my OBE on a computer like putting discs in or something. It's such a sticky software that that's the characteristic that we're looking for there, low cost sticky. And then I think there's some great opportunities out there in that space, particularly here in Australia, in the US it's already recovered quite a lot over the past three months, there's a lot of stuff just bouncing along the bottom here in Australia that I think's pretty interesting. Zero is a funny one, Bryson, I've debated it a lot this year. Did rebound? I don't know in the stock to be clear. Okay, yeah, we don't know, I can't make the valuation stack up still. Yeah, fair. It did rebound, it got into the 80s again and it was like, okay, Sas-Pocka-Lypses over it's coming back. Yeah, that's just absolutely bottom-stripped out again.

20:45And that's been pretty common because Catapult, I was going to touch on it later, it's one of our biggest holdings in our fund and it's been a very similar trajectory, it sort of halved. It went up way too much, we sold it really, share that we've owned, we've invested back into that business recently. It had the same sort of trajectory, you know, it bounced from three bucks back to three 80 or something and now you're back in the loose frees again. Yeah, yeah. I think there's some other, maybe it's a different topic we're going off. No, no, no, no, no, no, I think this small capital Z space, there's some other structural things going on that, so you've got the Sas-Pocka-Lyps narrative. Yeah. I think in the US that has unwound quite a bit, we own Wix in our US fund, it got down to $42 at straight at 80 at the moment. One good result, but also just the pressures come off. The US moves first in everything we do, where we've had a thematic investment like this, like we think the sector is just being unfairly punished. In our international fund, you can go to

21:47the US first and then you can go back to the UK and go to Asia and you can buy the same thing. Yeah, it's like a daughter. A month later, exactly. And they move first in the US, so that's just a function of it, but I also think we've got some structural things going on here in Australia, in terms of super funds taking money out of small caps. There's a lot of nervousness amongst investors out there, and I don't want to be exposed to Australian shares because I'm worried about the economy and I'm worried about interest rates and I'm worried about all this stuff. Yeah, okay. Are you're hearing that from your client base? Yep. And tax changes as well. People are going to want to be in something that's mostly capital gains here. And where the turnovers typically hire, and the way these changes have come in, you can't, you don't get the inflation indexation on the stuff you lose money on, right? And in small cap world, you've got more, we lost it here and we made a lot of it. Yeah, yeah, yeah. So I think there's lots of reasons why there's, you need to be doing something really good in small cap land at the moment to be attracting people's attention. So we had that rally and then it's all fallen back in. Yeah, yeah, yeah. We're going to need some good results,

22:48I think, for people to get excited about things again. It's interesting. I swear at the start of this year, like almost every year, this is the year of small caps. Yeah, and I think that's wishful thinking to be honest with you from fund managers that like that where your livelihood depends on it. Yeah, yeah. I think from our investing strategy, like this whole we're going to buy this thing and the market's going to rewrite it. It's just not going to happen over a sustained period of time. I think you need to be buying businesses that can either migrate into index level. Yeah. Yeah. We've owned Cousquel done really well out of that over the past years. It went up 10 on Friday afternoon as the index clothes happened, right? Yeah. It was literally a broker's where they need there's 10 million shares that need to be bought for index funds on Friday afternoon and in the match, there's this huge transaction that takes place. So I own a business that can grow to the point where passive is going to play a role because that trend is just not changing. Be your own businesses that someone else is going to buy. So we've had probably three or four takeover options. Yeah. Yeah. Concluded. But over the past four months. But I think just sitting

23:51there in your liquid small cap land and thinking this thing's going to get re-rated is it's just wishful thinking the money is not going to come back in. That creates huge opportunities, right? That the valuations are low. I think the opportunity for us to add value to people's portfolios is very high. But you do just need to recognize that this is the world we're in and it's not going to change. Yeah. Yeah. Yeah. On small caps, when we speak to small cap managers, one thing they all were the same to talk about is just the increase in volatility and like the divergence of outcomes. Like obviously it's been pronounced this year with materials and resources doing incredibly well and some other sector is not doing well. But just tell us like give us a sense of what's going on below the surface and how you're managing it. Well, I don't even know that that's, it's maybe relatively worse in small caps, but I would say the volatility in large cap land. That is fair. I saw a chart the other day. It was number of ASX 50 stocks that moved more than 10 percent on the olds day and if you go back to pre 2020, it was zero pretty much all the time and now you're

24:52getting 20, 30 percent of stocks that are moving in that sort of magnitude. So there's a lot of algorithmic money in the market now. It's probably more prevalent at the larger than it is at the smaller end, but it is very much programmed for beaten miss and the magnitude is almost irrelevant. If this result is worse, the algorithm has been taught that that is bad and share prices go down and therefore because it's so much algorithm money in there, share prices are just going down 20 percent on the basis that you miss what the market expected of you. Now, you think that would be a pretty simple thing for management to self correct, right? Like, do not go into results with market expectations higher than where your results are. Under promise over deliver. Yeah, even get a head of it, right? Get the downgrade out there earlier or something so that it's not doing that. I think that is one factor in terms of the volatility is just that increase in programmatic money. And then I also think that again, there's just less liquidity makes the moves more significant.

25:56I was talking earlier about, okay, if we change our mind, we're getting evidence that our thesis is not quite right. We want to exit a stock. There's just not that much liquidity in the market for us to exit it. So the results come out. It's not what we wanted. Let's be really disciplined here and cut our investment. The cost of doing that is higher than it used to be because the liquidity is just not there. So I think there's also just that even the fundamentals base people, the cost of transacting in your portfolio is just high. Yeah. Yeah. So you mentioned earlier, we're going to talk about catapult. We asked you to bring a stock that we could dive deep into. I'm assuming that's the one you want to talk about. I thought I'd touch on it. It's about to being our biggest waiting. We've talked about it a lot. I know. I think you've had them on the show. We've spoken to, I don't think we've actually had catapult. We've spoken a lot about catapult. We've interviewed them on another show that we did. Yeah. Yeah. Yeah. Yeah. Yeah. I think I own it. So it's one of our biggest holdings. And we can keep this bit pretty short. I've got a more interesting stock to talk about.

26:59Okay. I think it's more reflective of the market environment that we're in. Let's put, let's tick catapult off quickly. Let's get your thoughts on that. It's come back to, so to paint the story here, this IPO in 2016. It was a darling stock. They did a couple of data acquisitions, bad strategy, burnt cash for a long time. Everyone got sick of it. The share price was down to 70. New management team came in and laid out a pretty clear plan for this thing has been growing all through that period. 20% per annum. We can keep growing it at 20, but we can be more disciplined around how we spend the cash. And what you're going to see here is 50% of that revenue drop through in terms of incremental learning. So every bit of revenue we add, you're going to see that translate to earnings. And we've had, must be four coming up to four years now of that new management team delivering on what they said that we're going to do. And you can see it. Here's the revenue. Here's the additional cash flow. Yeah. And it's now gone through that cash flow neutral point. And they should keep doing that to the point where we're generating really nice cash returns on today's

28:01market cap. It ran all the way up to seven bucks. It's come back to close to three more recently. And my view is it's trading, I think, about four times revenue at this price. It is very soon going to be at margins that would justify four times revenue for a mature business. And yet this business is still, I think the growth prospects here are just longer than most people are anticipating. This is one of our, how do we identify opportunities? Most analyst models out there go, okay, it grows at 20 and then it's 18 and then at 16 and then we just blend everything down. That's what you do. Yeah. Just things get old. I think with this business, the number of sporting teams that are using the product is just going to keep growing for a very long time. And then once it does become mature, I think the pricing potential is very much untapped in this business. And they're not trying to touch pricing yet, which I think is the right strategy. But at some point in time, you go, you're Chelsea Football Club and you're paying us 50 grand a year.

29:04It's always been my thing. I just can't comprehend how you are with the richest sporting clubs in the world and you're charging them. It feels like almost free. They pay their play. Chelsea, as an example, pay their players more than that each week. We're on expert interview with a guy said, if this product can keep one of my star players on the field for one game, it's paid for itself, football club. I don't think it's a bad strategy. There are still, I think we're still in the land grab phase here. Get yourself as intertwined and integrated into these businesses as you possibly can. Get all of their data on your system. They've been with you for 10 years. They have all their historical games. Then pull the pricing lever. Have they spoken about pricing? I think they've spoken about not yet. It's basically it, but I think everyone understands that there is more pricing here at some point in time. The only question is, are there because there's private equity back to competitors. They're not the only ones in that space. If they tried to over time double their prices, would someone come in and undercut them? I don't

30:09know how to answer that. My understanding is there's a bit of the main competitors owned by private equity. They have put their price up. It causes angst with your client base. I think even when it comes to pricing time, you put it up at four or five a year and you just keep doing that over a long time. You just want to give people a reason to try something else. You've got them integrated and just keep going. They are even at this pricing. They should be a nicely profitable, they talk about rule of 40 and software, but that's where they're headed to pretty soon here. We're going to have a lot of money to reinvest in products as it is. Then you can pull the pricing lever down the track. That's the biggest investment in our Australian fund. It's the stock that I sleep best at night over. I said, do the guys at work now? Let's go through the whole portfolio and say, what are we nervous about the next result that comes out? What are you sitting there saying? I wish this result would come out tomorrow because I want the market to see what this business is. It's in that category that it didn't report through reporting season. I think it's one of the

31:12reasons that didn't participate in some of the recovery because it's a September year end. It's a business that I look forward to reporting because I think it's an opportunity for them to just keep showing what they have been doing over the past few years. I wanted to talk about a company called Motorcycle Holdings though because I think the other big opportunity that is pretty broad out there is this small industrial space in Australia. Everyone's gone, consumers suffering, interest rates, house prices. Don't want to own anything in the consumer space. I think there's some really interesting opportunities in there of businesses that are profitable, growing, paying your dividends where you don't need to rely on the rate rate. Modos has been listed for ages, MTOs, the ticker. It's a small couple of hundred million dollar market cap company. They are 20% of motorbike retailing in Australia. They're sort of APE gives in cars, market share is what they have in motorbikes. The difference is there is no one else you go down to I think 2% market share. It's a bunch of mum and dads underneath them.

32:15Despite that, they're not making any money retailing motorbikes. It's a very difficult business and they're in the midst of a turnaround and that part of the business. They have the exclusive distribution rights for a Chinese brand called CFMOTO and CFMOTO is doing in motorbikes what BIDs done in cars but they have it to themselves. They're not electric. It's a good quality Chinese product selling for a massive discount. And in the farm for wheelers market, the government brought in some safety legislation about you need to have these raw bar things when you have for wheelers to protect you when they roll over and Honda that had that market themselves said, Australia is a tiny market, not worth it. We're not going to do anything and this Chinese brand said, well we'll build a motorbike Australian market and it started there. They're now doing road bikes. They're not reported in the official statistics but that business is growing really really quickly and it's become 80% of motorcycle holding as profitability is that import distribution business and it's a much more

33:19stable reliable business than retailing motorbikes because you don't have the same fixed cost base that you have in retailing motorbikes. So the guy who owned that business is now major shareholder in the business and in the management team and the attractive piece here is I think this keeps growing quite nicely over the coming years. It trades six and a half times earnings. You're getting half of those earnings as a dividend. So it's a seven fully franked dividend yield plus they keep half the earnings and use that to grow the business. So it's just an example I think of yes, the Australian economy's got some headwinds coming but people are just so pessimistic about it there's some good opportunities I think to own businesses that are going to grow through that difficult environment. The first I heard about motorcycle holdings was about halfway through last year this was the stock that Hamish Douglas first came back and bought it. Does he still is he still a major shareholder? I would imagine he is but I haven't actually looked at that so I think you're checking. I don't know. Yeah, yeah, yeah, he popped up and it was like in the air firing stuff

34:23it's like he's bought 10% I think he helped get someone on the board or something like he was getting involved and it's like easy back but then I don't think we've heard anything from him since. And look to be clear, I don't want everyone to run out and buy this stock. It's a pretty small waiting for us. It's a small market cap. It's a fairly liquid stock and it's in motorbike retailing right. It's a difficult low margin, low margin business but I think it's just an example there's quite a few of them out there and I think people are a bit well maybe running a global fund. I think relatively people are too pessimistic about Australia. Yeah, I'm going to sell all my Australians stocks and I'm going to buy a global fund. I'm like well have you looked at the US government deficit? You worried about government spending here in Australia. The US is running a six and a half percent deficit. Yes, yeah. And it's intractable. There is no, if you go health care defense it's 90% of what they're spending. I've got to save the money. Payment on interest which they have to pay. So if there's a reckoning here around government prolificacy, it's going to

35:25hit the US and the UK and France way before it hits us. That might be a good thing for us because we wake up to ourselves before we get to the point but we are 40% government debt to GDP. They're 120. Yeah, exactly. Yeah, yeah. We're running I think it's a two percent deficit. They're running six. So and our savings rate is actually quite high here. I was really surprised when I went and looked at this because I've been worrying about this myself. House prices are going down. What's they going to do to consumer spending? Well, we haven't actually been borrowing more against the value of our houses over the past three years. It was a trend for 10 years leading up to 2020 but the amount of debt relative to incomes in Australia has gone down over the past three years. The savings rates at 8%. That's historically high levels. I actually I actually think if we get some sensible government response here, that's a big big if I know. A big if I know but I think the country is better place to handle this than a lot of other places. So I'm not super optimistic about it. I

36:25just think people are being too pessimistic and also optimistic about what's going on in other parts of the world because they have bigger problems than we have. Yeah, yeah, yeah. It's a funny dynamic. It's one of those things where it's like when sentiment turns, it's like really hard. It's a hard thing to change I guess. It's like what's the catalyst for people to re-rate Australia as a country? Yeah, and I think to your point earlier, there's so much momentum and algorithmic money in the market that once the momentum starts, it doesn't stop for a long time. So trying to pick the bottom of that I think is very, very difficult. But I just think if you're thinking how do I allocate my portfolio over a 10 to 20 year period, I still think if you're an Australian based investor, you're going to need Australian dollars. It should be an important part of your asset allocation. I say to a lot of people try and get that piece right, I want X, I don't know what the number is. Let's say it's 40 to 50% of my money is Aussie, is equities and half of that is Aussie. You can play

37:29with the ranges but some people just make these drastic decisions of I'm going to all cash. You've got to get the timing on that right, then you've got to get the timing right about when you put it back in and equities have done 8% per annum here over 120 years and I think they'll do something similar over the next 30 or 40 years. It's a question where you get a lot, particularly in like the because the ASX200 is underperformed like the Misski or World or the S&P 500 people are like, well should I just get rid of Australia from my core index holdings? But my response is always zoom out and Australia is a star. Australia has had decades where it's been the best market in the world and over the long term. It's been one of the best performing markets. Don't throw it out just because of short term. It comes in a pretty tax-efficient way because some of that return is in the form of fully-franced dividends and some of the comparisons don't do an accumulation index equivalent. We have a very high yielding market because of the way the tax system works here. So in the US they don't pay dividends. They do buybacks. So all of your return comes in the

38:31form of capital gains and if you don't wrap that into your index comparison to get a really different number as well. And I actually think people should be thinking instead of those markets have done really well, this is not I think you should have allocation to them. But I also think you should be sitting there going, well I've actually got a lot of exposure here to the AI trade, to what are historically expensive large cap US stocks and maybe the fact that there has done so well for the past 10 or 15 years is a reason for me to be thinking, well maybe Australia with its resources and mining companies can play a role here. If that stuff keeps doing 12, 13% per annum great fine and your Aussie only does eight, I think eight is the number that you should be happy with and it's got an important role to play and you put foliar. And I think about that in terms of our role in people's portfolio as well. Obviously we need to deliver higher returns. That's our job. But I think delivering them at a time when that other stuff is not working as well is a really important part of what we're offering people. Yeah.

39:36Car crashes injure over a million of us every year because we're human. For over a decade, we must have been building a driver that's safer. Statistically 10 times safer in the cities we serve. Not because humans aren't enough. But because they're everything. Based on over a 94% reduction in serious injury or worse crash rates learn more at Waymo.com. At Peloton sometimes thinking big means thinking small. Introducing the new Peloton tread flex. Our first foldable and movable tread that's just about three feet stowed so you can roll it away with an ultra quiet and comfortable belt that quisper's while you run. Made to fit however you move and fit to move wherever you like. Let yourself run. Explore Peloton tread flex at one peloton.com. We're Steve. We wanted to close with a few questions on property. In 2017 you wrote that you planned

40:46to retire a renter and made the case that stocks can beat property which we love. So firstly, are you still renting? Secondly, can you unpack the case for us? I'm not renting unfortunately. I'm not changing it in ten years. It was actually my first mortgage that I ever had in my life was 2.05% fixed for four years. There was that point in covert where you could actually admittedly for a limited period of time but you could buy something for significantly less than you were renting for and smash the mortgage off as much as you can. So we bought a house. It was a terrible financial decision. I've got to tell you. You just keep cutting checks. People don't understand just the ongoing maintenance costs of a house. If you don't do that, the value of it is going down. It has a reinforced view that stocks make property from a financial point of view.

41:46It has kept property going for a really long period of time as being the capital gain component of it. If you look at the actual return, it's maybe 2% net or something that you get if you buy a house and you rent it out or people do need to think about that from a buy versus rent if you're considering owning. That is the opportunity cost of you having a mortgage is the rent that you would otherwise pay that too as not stacked up for probably 15 or 20 years. It's been going down because prices have been going up so much. I think that's a dangerous algorithm because if the capital gain stops working then you're left owning an asset that's a very, very low yield asset. But I'm not anti it. I think the big positive is force saving for a lot of people right. Take out a mortgage, pay off the mortgage over your life and you end up owning a house. For a lot of people, that's a better financial outcome than they're going to end up with you going by shares and all of a sudden you want to go on a holiday to get your mates and you can cash the shares into my, I think there's a discipline

42:49required to play the I'm just going to build an equity portfolio over a property portfolio that most people frankly just don't have. That's why we advocate for a 30-year mortgage product. For a portfolio of shares. I think as long as people have got an out on that, it's really difficult to do. Or super right, I think getting the super when you can't get it out is not a bad idea either. It's just too illiquid. It's too intangible. Intangible is the word. I think people just, that's another thing I struggle with is like get your super right. It's one of the most important financial decisions you make in your 20. Just feel low to start with. Get the feel low low. And most people don't even look at it. I don't know where it is. I've got five different super cases. Sort that out. You can do it in an hour. Sit down an hour on a weekend and say, I want to fix this stuff up and you can do it. Sort those things out. So there's lots of other. So I'm not, I think for a lot of people buying a house is a long-term financial decision that

43:49it's not the most optimal return, but it works out fine because they retire owning a roof over the head. Now we're not going to ask you where you think the future direction of house prices is going to go. But you did write another article. I think it was around that same time. I think this was in 2018. So you're obviously housing was on your mind at this time. Where you spoke about a factor that probably is not thought about enough when it comes to the property price debate. We talk about supply and we talk about investor demand. But really your view is that credit availability was a big driver and a big driver of the house price boom was the structural decline in interest rates. Can you unpack that and I guess on the flip side if we're in a high inflation, higher for longer rates environment does the counter apply as well? Well, I think you'd have to sit here now and say I was wrong. Okay. Because we went from 2020-10. So that first mortgage I took out was 2.05. I think we're paying 5.8 something or 5.9 on

44:51the current mortgage and it did not smash property prices the way I thought it would. If you run through the mass of that and say what can someone on a 200 grand salary buy, their purchasing power has been curtailed dramatically. How did it all hold up? Well, the bank of mum and dad seems to have stepped in a very, very significant way. And it showed to me that the psychology around just owning your house in Australia is a very, very strong contributor to that as well because the banks have actually lent less money as a portion of purchase prices. But somehow people have topped up the difference with equity contributions that have started to fly through now. I feel like it is, I don't know whether it's the credit side flowing through or the psychology piece. If that breaks, that is the huge problem for Australian property because if you start just thinking about it financially, you go 2% yield and I can get 5 in the bank, why would I do that? From just a straight cash returns perspective,

45:52the whole reason that you buy it here is because you think it's going to keep appreciating capital wise. That's the whole reason you go on borrow from mum and dad to do that. So that breaking, if it actually breaks, I think at the moment it's still this is a dip and everyone who's got a vested interest is out there saying it's all going to go back to growing nicely over time and this is your opportunity. If it stretches out and if it actually breaks people's psychology and they start saying, well this is not something that's going to appreciate, then for me it makes the downside more significant in terms of where people start. Where does the investor start stepping in here and pricing this stuff is a pretty interesting conversation. And then you say, well how do we build houses, if all these builders are going broke with house prices where they are, how do we build houses 20% down in terms of price? That has been an interesting mechanism as well that you can't make much money it seems doing property development even with prices where they are. And we did a renovation on this house that we bought. I don't know that you can replace most of the housing stock for

46:55for the cost of what it cost you to buy. It was just basically expensive to do the renovation that we did. There was some number that came out that was like 40% of the cost of a new build is taxes. Is that right? Yeah, yeah, yeah. And I guess land is the piece that's the bit that can move in that as well. Yeah, we just got a quote for a Renault for just a couple of rooms and I was just like, how the hell are people renovating for houses? It's just wild. Put that to bed. And whatever they're telling you, it's going to cost double so. Yeah, yeah. That's right, that's not right. Yeah, that's it. Yeah, yeah, yeah. Well, the takeaway there is that stocks are accessible and a great wealth building vehicle for the long term. I guess, Steve, to leave everyone listening today, if you have a piece of advice for people who are on the wealth building journey, maybe a bit worried about Australia and thinking about what they're going to do with their next dollar. Do you have anything you want to leave us with today? No, I would say have a written down investment strategy,

47:58a really simple portfolio allocation plan and stick to it. That is my number one piece of advice. You can play around at the edges with the give yourself some ranges. If you're feeling nervous, go to the bottom end of your ranges, but don't be scaremungered out of the benefits from long-term investing. Have a long-term strategy and stick to it. The best clients that I have that have made the most money, they don't even know how much they've got with us. They organize calls and I ring them up. Oh, wow, it's a million bucks is it? Because they are literally put it in the bottom drawer and forget about it and they do better than I've got very very smart clients that are trying to get the timing piece of this right all the time and my experience has been the stick at it's do better. Love it. Great place to end Steve. Thank you so much for appreciate your time. Thanks for a few minutes. Thanks, Steve. This podcast is intended for education and entertainment purposes only. Any advice is general advice and has not taken into account your personal financial circumstances. Before acting on

49:01general advice, you should consider if it is relevant to your needs. If unsure, speak to a financial professional. The host of this podcast and their guests may have positions in the companies mentioned. Equity makes media is part of the beta shares group but maintains editorial independence. We operate under Australian financial services license 540-697. At Peloton, sometimes thinking big means thinking small. Introducing the new Peloton tread flex. Our first foldable and movable tread that's just about three feet stowed so you can roll it away with an ultra quiet and comfortable belt that whispers while you run. Made to fit however you move and fit to move wherever you like. Let yourself run Peloton. Explore Peloton tread flex at 1peloton.com. Car crashes injure over a million of us every year because we're human.

50:09For over a decade, we must have been building a driver that's safer. Statistically, 10 times safer in the cities we serve. Not because humans aren't enough. But because they're everything. Based on over a 94% reduction in serious injury or worse crash rates, learn more at Waymo.com.