In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:
- Cliff Asness – Never Has a Venial Sin Been Punished This Quickly and Violently!
- When Will We See The True Impact Of The Coronavirus On Markets
- Learning From The Future After Visiting Google
- Josh Wolfe Is On A Line Between Sci-Fi And Sci-Fact
- If The 30 Year Goes Negative, What Is Microsoft Worth?
- Michael Mauboussin – Managing The Man Overboard Moment
- The Market Exists To Humiliate Everyone
- “It Makes No Sense To Lend Money To The Government At 1.4% When It Is Government Policy To Have 2% Inflation.” Warren Buffett
- Advances In 3D Printing Could Remove The Need To Ship Items Around The World
References in this episode:
Market Timing: Sin a Little (AQR)
Never Has a Venial Sin Been Punished This Quickly and Violently! (AQR)
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Full Transcript
Tobias Carlisle:
One more time. This is bush league. I’m Tobias Carlisle. This is Value: After Hours. My cohost Jake Taylor and Bill Brewster here as always. Jake, what’s your topic this week?
Jake Taylor:
I feel obligated like we need to talk about Corona virus, since it’s such a big deal right now.
Tobias Carlisle:
And Bill, what are you talking about?
Bill Brewster:
Going to talk about thinking about the future a little bit more in my recent visit to the West coast and how it got my frame… my mind frame a little bit different.
Tobias Carlisle:
And I’ll be talking about the swift rebuke that the market gave to Cliff Asness’ article on sinning a little in value where it then sold off for the worst six weeks out of a really bad decade, which led him to write another note saying never has a venial sin been punished so swiftly. We’ll be talking about right after this.
Speaker 4:
Tobias Carlisle is the founder and principal of Acquirers Funds. For regulatory reasons he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds, or affiliates. For more information, visit acquirersfund.com.
Cliff Asness – Never Has a Venial Sin Been Punished This Quickly and Violently!
Tobias Carlisle:
we’re in the second day of a big sell off, just so everybody can contextualize where we are. I’ve been talking to a few friends of mine, Chris Cole who’s a value guy. He has all of these little… he monitors all of these different funny relationships between things, and one of the relationships that he monitors, which is something that I have believed for a long time, is that value… He monitors value relative to growth, value relative to the market. Because I have this theory that values sells off first. In a bull market, the tail and value just doesn’t get a bid. I think it’s because value guys tend to be a little bit more disciplined. That’s not the stuff that’s going up definition ally. That’s where everybody’s piling in. Value definitely starts pulling back first… saw that in 2007. Definitely saw that in 2000, although it was years early in 2000.
Tobias Carlisle:
And I think that we’ve been seeing it over the last five years where value sells off and then catches back up again and sells off. And I think that the most recent big sell off over the last eight weeks was interesting, and that it came on the heels of Cliff Asness that AQR had this article where he said, timing factors is really hard to do, but he advocates for… when they get to extremes, he advocates sinning a little, by which he means allocating a little bit more to whatever… whatever factor is the one that’s currently doing the worst at the time. He came out with this article saying, sin a little in value because it’s underperformed so well. Just as a precursor to those eight weeks where it’s had its worst six weeks in the last decade, it’s probably the worst eight weeks in the last decade. He had to come up with a second article where he said, never has a venial sin been punished so swiftly.
Tobias Carlisle:
I think it’s funny that value has been selling off pretty consistently for the last eight weeks, and now we have… everybody was wondering when the volatility from Corona virus was going to materialize in the markets. All of a sudden we’ve had these two violent days of selling. And I wonder whether it’s Corona virus, or whether it’s just the market’s been expensive. There’s a lot of weakness underneath. You look at Japan had that big negative 6.3% Q4 GDP, that’s pre Corona virus. Who knows what’s going to happen. Maybe it’s like a broken window fallacy that if you get it, you kill it off people. There’s enough of a response from all of the authorities that somehow that gives us GDP.
Tobias Carlisle:
I hate those theories. I think they’re wrong. But that’s… maybe that does show up in a quarter of… maybe it shows up in a quarter of people spending money on face masks or something like that. But honestly, I don’t think that’s going to happen. I think shutting down all the factories is really going to hurt, and the supply chain, and we’re going to see that in maybe not even in the next round of reporting. We’re going to see that in like that’s the Q1 reporting, which comes up mid Q2 reporting, which comes at mid Q3. I think this thing probably potentially rolls on all year long. I think I’ve just stepped on your topic Jake [crosstalk 00:04:45].
Jake Taylor:
I said we could just do a big blended show today if we want to. This can just be a [crosstalk 00:04:53] markets in turmoil, grab ass edition.
Bill Brewster:
It’s all right. I might have to go get a Corona.
Tobias Carlisle:
What do you guys think?
Jake Taylor:
Let’s go back to Cliff’s paper first. And first thing I would say is, boy, I miss Cliff on Twitter.
Tobias Carlisle:
I know it sucks.
Bill Brewster:
Why do you have to go away? Regulatory reasons. [crosstalk 00:05:20].
Jake Taylor:
He gets too angry and people not get it. He’s probably smart to do that. But to be honest, we’ll treat him well.
Tobias Carlisle:
He’s not the kind of guy, you don’t have to have a blue check to get response from Cliff. Any random dude who set up a Twitter account 15 minutes ago can come out [inaudible 00:05:38] Cliff. And he’ll take it earnestly. He’ll respond as if they’re not just trolling him.
Bill Brewster:
Maybe it’s a healthier way for Cliff to come back into the fold.
Tobias Carlisle:
As an egg.
Jake Taylor:
Yeah.
Bill Brewster:
He might be out there right now. We don’t know-
Tobias Carlisle:
Trolling.
Jake Taylor:
That’s right.
Tobias Carlisle:
He should stick a big shark fin in his bio… in his profile pic and just swim up and [inaudible 00:06:06] people, the way that everybody does to him.
Jake Taylor:
I’m going to check for random exciting AQR papers.
Tobias Carlisle:
He wouldn’t give it away.
Bill Brewster:
Anyway, what about the paper Jake?
Jake Taylor:
I just thought it was… I really appreciate the way that he approaches investing and has just has quant mentality, and he really is humble about it in a way that I find attractive. He doesn’t act like he’s got it all figured out, but he’s very… he sticks to his guns at the same time. I find that combination of humility but also discipline… I root for him to win, and obviously he’s won a lot already.
Tobias Carlisle:
His thought process is extent, it’s externalized. You can… he’s not saying, “I’m Cliff Asness with a PhD from birth, and $200 billion in a fund, and I’m a billionaire. That’s why you should believe what I’m saying.” What he’s saying is, “Here is the data and here is my interpretation of it. If that’s wrong, then show me where to approach.”
Jake Taylor:
He had a great line in there that I… let me see if I can find it. You guys talk while I’m looking.
When Will We See The True Impact Of The Coronavirus On Markets
Bill Brewster:
With respect to how long Corona virus goes on, I think you… I think it might be Q4 man. I think we might be into December still hearing about it.
Tobias Carlisle:
I’m sure.
Bill Brewster:
[crosstalk 00:07:30]. Dan McMurdy was pretty early on this. I don’t… like you, I don’t know how much is necessarily Corona virus related, but when you start working back through the supply chain with all the operating leverage that is in supply chains now and all the just-in-time inventory that everybody has worked so hard to get to, it could be a real deal.
Tobias Carlisle:
Yeah. It’s surprising that it hasn’t shown up yet. I guess the US just hasn’t panicked yet properly.
Jake Taylor:
Yeah. I don’t know… I think one thing that we all forget is that if we looked at a dollar weighted paying attention, there’s a lot of money out there that is not, they’re not living this stuff all the time. They’re living their lives, they’re doing other things, they’re going to their kid’s soccer game. They’re not hanging on every single report on that Bloomberg, or on Twitter, they’re just living life. And I think the under reaction sometimes surprises us because it’s like, “Dude, isn’t this seemed like a bigger deal. No one’s paying attention. Nothing matters anymore.” Right. But maybe it’s a little slower to diffuse out into the ecosystem than guys like us who are on the front lines think about.
Bill Brewster:
I didn’t think about it. I thought I was like, this is SARS 2.0, it’s bird flu. I’ve been through this before. It is bigger than that.
Tobias Carlisle:
Yeah. I always… I joke to my wife that the CDC has its annual advertising campaign and they come out with Zika virus. Be worried about that for this year’s SARS, this year MERS, this year… And then this year they were like, “Come on, we got to come up with something new, Corona virus.” But I don’t know anything about anything. I don’t know anything about anything, but it does seem to be worse than those other early advertising campaigns, I think. I think that this is a real blockbuster.
Bill Brewster:
Warren Buffett was saying it yesterday, right, where he was on CNBC and he was like, “I…” He was basically saying that he talks to Bill Gates, but he wouldn’t be like Bill Gates thinks is, but apparently Bill Gates thinks that it’s going to last through the heat, and we’ll see. But I think Buffett was hinting that he thought it might be a bigger deal than people let on. But I could be, I don’t know. I was tired when I watched that.
Jake Taylor:
What do you mean you don’t know anything? You’re… we’re all now virologists and supply chain managers.
Bill Brewster:
Haven’t you gotten your Twitter education on viruses?
Tobias Carlisle:
Yeah, it’s beyond me, honestly. I try to ignore anybody who expresses an opinion.
Bill Brewster:
I’ll tell you how it won’t get beyond you. You could have a concentrated position in airlines, and then it comes right to your front door.
Tobias Carlisle:
I got a little position, it’s hard to pick out the airline from the rest of the portfolio and there’s a lot already in there.
Bill Brewster:
I’ll tell you who I like. I like the guy I mentioned, and for anyone that thinks that I’ve fully abandoned value, this is a 10 basis point position, and it’s blank. And this guy is like, “I thought you were a value investor.”
Tobias Carlisle:
I saw that one.
Bill Brewster:
“Well, listen here dude, I still own the airlines and it hasn’t been fun. I’m so happy I have this label that you’ve put me in [inaudible 00:10:51], spirit off 10% Ryanair down 11. I don’t really care. But that was a painful thing to look at.”
Tobias Carlisle:
Is that impacting the domestic carriers because I’ve got a position in LUV. How’s that tracking?
Bill Brewster:
Yeah, I guess the argument is it’s going to reduce the amount of people coming into the US and that’s going to hit load factors. I don’t… I think that this is a good test, right? Everybody that is long the airline thesis has been saying like, “Well, they’re going to be able to pull in capacity. So let’s see.” It’s… we’ll find out if we’re right or not. But even if we get through this, people are going to be like, “Well, the Max was out of production, so we have to wait for a recession. I don’t care. Keep the cloud of doubt on, we’re just buying all the shares.”
Jake Taylor:
I know this man who runs a manufacturing company and he keeps six months of inventory on hand at all times, which every MBA from McKinsey would have screamed bloody murder about tying up that much working capital.
Jake Taylor:
However, on these type of situations when he’s the one who’s still delivering and no one else can, what do you think that does for his brand and for his company? And does it much more compensate the cost of carrying extra inventory? He said he does it for the same reason that we have two kidneys. You need to… you need a backup, right. Because shit can happen. And I think that’s really smart and I wonder if maybe where a lot of public companies especially aren’t doing enough of that kind of longterm thinking and trying to optimize for too short of a time horizon-
Tobias Carlisle:
Almost certainly. How could you justify that?
Bill Brewster:
Got to get your ROIC up.
Tobias Carlisle:
Yeah, that’s fine.
Jake Taylor:
So all the compounder boy can buy it.
Bill Brewster:
Yeah, that’s right. You got to sell all your assets, sale leaseback them, get your ROIC going, and get your stuff streamline. Especially with rates at like where they are, carrying some extra working capital is not… you just finance it.
Jake Taylor:
Yeah. What… one thing that’s scary to think about those if this type of thing creates a push away from specialization and a more towards localization of resources and economies. It makes… if you look at Tibet for instance, there are a relatively poor GDP per capita and it’s because they’re on an island, relatively speaking. They don’t… and they’re jacks of all trades, they know how to fix a diesel engine and do a million different things, but they’re not specialists at any one thing, which is what tends to create the most wealth when you have the facilitation of trade. If everyone goes back to being local experts more because of something like this, we could be materially poor potentially as a species.
Advances In 3D Printing Could Remove The Need To Ship Items Around The World
Tobias Carlisle:
Here’s another view though. Josh Wolfe says that advances in 3D printing are coming, and the impact of those advances in 3D printing is now you won’t be sending all of this stuff around the world on container ships. You need the raw materials and you’ll just make it close to where you are. Maybe there’ll be a fab in your little city or your town or something, or maybe you’ll have your own little 3D printer at home and that’ll get you most of the things you need.
Jake Taylor:
That would be awesome. I think that’s… it’s a pretty good reason to maybe question on an energy investment.
Tobias Carlisle:
Anytime you feel bad about the world, go on Washington interview with Josh Wolfe and all the great stuff that’s coming down the pike. I can’t wait. The thing where you get the… you don’t have to have a chip implanted in your brain. They’re going to stick something, a band around your wrist and it can interpret what you mean when you’re… You type something in air and it’ll appear on the screen, it’ll be nonsense and your frustration with what has appeared on the screen will teach this thing what you wanted to type, and it’ll eventually just figure it out. You will have different gestures to the person who’s beside you, but your band will know what you’re trying to indicate. You won’t have keyboards or any other interface other than this thing on your arm. That sounds great.
Bill Brewster:
That’s it.
Jake Taylor:
Do you like hiking?
Bill Brewster:
[crosstalk 00:15:19]. I need that.
Tobias Carlisle:
Do you want to do… Do you have any particular Corona virus inserts that… that’s your topic that I was stepping all over Jake.
Jake Taylor:
I shot my wad already, but I would say honestly, I don’t know enough to really say anything smart about it other than it could be a bigger deal, and I do agree with some of these ideas that it might take a whole year, or something to work through. Here’s an interesting idea though. What if because of this we shrunk the pile of goods and services in the world, and contrast that against 10 years of money printing. And this is what actually triggered inflation, a supply side shock.
Tobias Carlisle:
Right. We haven’t had one of those for a long time.
Jake Taylor:
Long time. Right? When’s the last one? [crosstalk 00:16:23]. Yeah, like oil embargo probably would be the last time we had something like that. But why wouldn’t stagflation be a potential outcome that I I don’t really hear anyone talking about much.
Bill Brewster:
You’re rooting for it so bad.
Jake Taylor:
No, I’m not. That’s awful, that’s terrible. That’s…
Bill Brewster:
It wouldn’t be permanent, right? You’re talking about [crosstalk 00:16:45] how long this stuff goes on.
Tobias Carlisle:
Could be years.
Bill Brewster:
Yeah.
Tobias Carlisle:
Why… I think that Corona virus is worse than everything else, but why is that? Why do you think that this is worse than SARS, MERS, Zika virus, whatever?
Jake Taylor:
I don’t know.
Bill Brewster:
For me, I’m [inaudible 00:17:06] too. So that’s here. But I think he had the best thread that I’ve seen on how it can ripple through the supply chain. And how much, when your cost structure is not linear, right? If you stop production or you’re under utilized, it’s not just so easy to absorb. And if that starts to result in layoffs and stuff like that, it can become a little bit of a reflexive downward spiral, I guess. I know… with respect to airlines, they get a fair amount of revenue from the cargo that they have under their planes when they’re flying. That’s gone down. I still see pretty full flights. I’ve been on two in the last two weeks and it hasn’t been a big deal, or four legs. But, that’s all domestic.
Tobias Carlisle:
You’re going to… you’re just doing your four week quarantine period [inaudible 00:18:07].
Bill Brewster:
Yeah, I was in California. They’re trying to keep me sequestered now.
Jake Taylor:
That’s what you should have told the Mrs. like, “I got to stay out in California. I’ve been quarantined.”
Bill Brewster:
I would wish. All if only it fall on me.
Learning From The Future After Visiting Google
Jake Taylor:
What’s your topic Bill?
Bill Brewster:
I had the ability to go out to Google, which was super cool to visit, and just being out in California. I find it interesting, the conversations that I had out there, not necessarily at Google, but just meeting with people. I think that there is an interesting arbitrage, for lack of a better term, between the West coast and the East coast. I sit in the middle in Chicago, the most exciting stuff that were around is how many dairy farms are popping up, but it is interesting how some of the people out there view it as an inevitability. That Tesla is going to own an electric car tomorrow. Right. And the… my mind as somebody that’s tied to value is to bet against change. To surround myself with people that are more focused on change and where the world is going, I found to be a hugely beneficial use of time, and I hope to do it much more often. I’d like to incorporate it into my life a lot more.
Jake Taylor:
What does that… how does that affect your investment outlook of the world? Or do you think… we’ve said before-
Tobias Carlisle:
It’s like you got to go buy some Tesla.
Bill Brewster:
No, I’m not.
Jake Taylor:
Very smartly have said before about the downside tail being respected by value investors and the upside tail being valued up, appropriately appreciated by growth investors. Does this change anything for you?
Bill Brewster:
Not really. I did take that massive position in Splunk, which may be the wrong one to take. It doesn’t even matter. It’s like I said, it’s 10 basis points. I know every dollar matters, but the function of that, it’s the only one that I have that’s like that. But I want to sign in, and if I check my portfolio, I want that as a reminder to think that way.
Bill Brewster:
If I lose 10 basis points, I don’t give a shit. It really doesn’t matter to me relative to the benefit that I think that that constant nudge is going to give me. I’m not going to litter my portfolio with that kind of thing. But I do, that’s probably the one tangible change-
Jake Taylor:
It’s a tuition investment.
Bill Brewster:
Yeah. I think it’s probably suboptimal, but whatever. And I think I need to spend more time studying some of the stuff that’s going on, specifically in the cloud, and how you… last week I was talking about data and how I think it’s akin to a hoarder’s house where people are like, “Oh look at all my stuff,” but you can’t find anything. There are companies that are helping people with that. I need to focus my time and attention on how people are solving that big need, and then be patient because I’m sure all that stuff is priced to perfection.
Jake Taylor:
How do you ascertain how knowable some of this stuff is? Because I know when… it’s, I find it to be, when they explain it to me, these very very smart people, I go, “Okay, now that makes sense to me.” And then it’s like the Chinese food effect with a Feynman where they said like they could have a conversation with them and it would all make sense. And then 20 minutes later it would be like, “I don’t… I can’t explain anything that he just told me.” Right.
Bill Brewster:
Yeah, I think that’s fair. I think that the best way that I am going to try to do it is to try to go out there more often, and to try to talk to people and figure out if I can figure it out. And if I can’t, then I can’t. But [crosstalk 00:22:11].
Tobias Carlisle:
… can beach in Los Angeles.
Bill Brewster:
Oh God, I love LA. I love Kelly’s so much. I don’t have to live there, I don’t have to deal with what you guys complain about occasionally, but I don’t know. I can’t wait to get out more often. And I guess it’s just surrounding yourself with people that are working in the companies, talking to customers and trying to piece together something. Right. And if it doesn’t work, then so what. But at least I’ll say, “Hey, I tried,” and have some interesting conversations.
Jake Taylor:
Toby, do you try to insulate yourself from those kinds of conversations? Giving your strategy? That’s more of, “I’m not going to make any predictions about the future. I’m just looking backwards and…”
Josh Wolfe Is On A Line Between Sci-Fi And Sci-Fact
Tobias Carlisle:
No, I like talking to people about… I like all that futurist stuff. I love science fiction, hard science fiction future. And I love the Josh Wolfe interviews for example. I love all of that. He’s like on some line between sci-fi and sci-fact, he says, he’s trying to see these things. I think all that stuff’s super cool. It’s super interesting, incredibly hard to invest in… the long term. I’ve looked at the longterm returns to angel, they’re not that good. Angels really hoard longterm returns to VC. Not that great. Unless you can get into those top quarter funds, and I think that the reason that they succeed so well is because it’s a signal for an entrepreneur and a startup to get an investment from Sequoia benchmark, whatever, and they do get the better cut of deals and they do a little bit better.
Tobias Carlisle:
I don’t think that they’ve got any better picking skills than anybody else. I think it’s incredibly tough. I think that what markets like this do is they make people forget that the objective when you’re investing is to find things that are mispriced. Whether you’re a value guy, whether you’re a momentum guy, whatever you’re doing, you’re finding things that are mispriced. What this market has done over the last five years is it’s rewarded that first order thinking where you say, “This is a really good business. I like Netflix, I like Amazon, I like Facebook,” and then you go and buy some, and that has done very well. Typically what gets rewarded is second order thinking. Where you say, “I like that thing.” What does Peter Lynch say? He says go and do a valuation. Oh, that’s really expensive, but no I like it. I’m going to watch it. I have pretty consistently over the last five years has been looking for mispriced things that hasn’t been rewarded, but it does work over the long run, that’s what I’m going to keep on doing. But I still love [inaudible 00:24:49].
Bill Brewster:
I guess that the one pushback that I’d give on that is some of these big tech companies have gotten I think a lot bigger than people thought that they could get, and a lot more profitable. I do think that there was an upward inflection. I agree with you on on many of the things that I look at that it’s just multiple expansion, but some of this has been like crazy growth that I don’t think [crosstalk 00:25:19].
Tobias Carlisle:
Microsoft, which has had… which has been doing very well and had lots of multiple expansion over the last period of time. You can go back the decade before and have a look at how it performed there. They’re doing pretty well through that period too. The revenue growth was roughly similar, but multiple compression did what happens normally to high growth companies that they see that high growth in the earnings, but they also see multiple compression because the market gets too far ahead. That is what has happened at almost every other juncture. It’s not happening at the moment. They’re getting multiple expansion. But I think that it’s almost a certainty that we’d go back into a market at some stage where high growth sees multiple compression, low growth sees multiple expansion. I don’t know when it’s going to happen, but I’m pretty confident that’s what happens.
Bill Brewster:
How do you think about some of the pushback that comes a value from the ROE perspective, or the low returns on invested capital? If you’re doing a value study, you’re rolling out of those every year, right? Is that accurate? I know that it’s… I’m trying to figure out [crosstalk 00:26:26]. When you read the studies, it’s not really like these businesses, if you hold them for five years, you outperform. It’s just in general the value factor if you keep rolling outperforms, is that accurate?
Tobias Carlisle:
The value factor is price to book. But let’s just say value generally, any low price to a fundamental, the back tests typically run rolling on an annual basis. I think the gold standard is lag that data’s six months, say you’re trading in June on the K data. Everything’s been disclosed to the market and then look at what the composition of the returns, and the composition of the returns over the next 12 months tends to be. The earnings fair value don’t do as well. They do seem to compress but less than the market anticipates. And so you get this multiple expansion. And that is typically how it has worked.
Tobias Carlisle:
When someone looks at my portfolio, they might say, “Well that portfolio is full of dog shit.” And I don’t disagree that those businesses are struggling. I think their balance sheets are very strong. They’re still generating free cashflow and they’re close to cyclical laws. What I’m trying to capture is an increasing return on equity, but from a compressed return on equity, increasing earnings, but from a trough, and an increasing multiple expansion.
Tobias Carlisle:
Last few years, for a variety of reasons, not all three of those have occurred at the same time, but I still think the businesses as a whole have [inaudible 00:28:00] you what the portfolio is like 11% free cash flow yield buying back about 6% of its stock growing at about 15% a year. That’s from my perspective. I like holding something that looks like that, I would buy a thing that looked like that.
Bill Brewster:
That’s a decent conglomerate.
Tobias Carlisle:
But it hasn’t been working. You can just see the… you can look at Hussmann has that chart that he publishes every now and again where he says, here are the 10 deciles and you can just look at how the 10 deciles have tracked over time. Last 18 months that value DSR has been falling in terms of its valuation. That most expensive DSR has been rising in terms of its valuation. That is what has driven over the last 18 months, two years value to underperform.
Tobias Carlisle:
Not saying that some of those very good companies don’t justify it. I said last week that I thought that it’s one of those unusual bubbles, or not bubble, sorry. One of those unusual booms where I do think that the ranking is roughly right. I do think that the better, more cash rich, fast growing high return and equity companies are the ones that are being rewarded. But I think that the train to make that investment, the point that you wanted to make that investment was roughly 2010 and you want it to get on that train. And that was when Jake had economic point of this out to me. Ford PE fair value in 2010 was more expensive than the Ford PE for the growth glamor DSR, for the expensive DSR.
Tobias Carlisle:
I’ve never seen that before. I didn’t notice it at the time, but I think that that explains a lot of the last decade of performance for that growth, glamor, expensive decile. And I think if that occurs again, then you want to be a growth guy at that time. But I think that if you look at the market now, and Cliff Asness has said this in his original Venial Sin paper, it’s like value was punished properly for eight years. Value’s been over punished for the last two years. And he says that now. That’s why it’s so stretched and now you want to be more of a deeper value guy. That’s my argument.
The Market Exists To Humiliate Everyone
Bill Brewster:
I like the framework of the market exists to humiliate everyone. It’s right that Cliff should write that paper and then get egg thrown on his face. That’s how the market should react. And now it’s time for everybody else to get egg on theirs.
Tobias Carlisle:
When do we-
Jake Taylor:
How many 2019 victory lap did you see? The market gods should, if they were just, would be very punishing.
Bill Brewster:
Yeah, that’s true. 2020 should be set up for some kicks in the pants.
Tobias Carlisle:
The the deep value DSR has had the last 17, 18, 19 have been among the worst in the last 20 years. It’s… [crosstalk 00:30:51]. I also think that, and this is something that I probably can’t mention his name, but this is something that I have heard from an investor who I have an enormous amount of respect for. Very, very wealthy. Very, very successful [crosstalk 00:31:08]. There’s a volatility… when there’s a regime change, there’s enormous volatility. And I think that we’ve seen and the way that that manifests is value… sell off becomes steeper and steeper, and the under-performance becomes greater and greater, and you get this enormous volatility. And I think that that indicates regime change. I thought that we saw it in August, September last year, but we have gone back into this sell off market. I think, maybe… I think it probably do need a real sell off for there to be a proper regime change.
Bill Brewster:
I tell you this Corona virus is… it has reinforced to me that balance sheets matter when they matter. It’s like one of those things that when everything’s going fine, you can push it a little, but when you need some anti-fragility.
Tobias Carlisle:
If anything, a really chunky balance sheet makes it hard to have that high return on invested capital, but have that high return on equity. If anything, it’s a drag through the good times. The only time that you want it is when the market gets the stuff and kicked out of it. Guys who’ve gone through big drawdowns a few times, one of the first… I’m pretty scared, but I first investing in the early… in 2000, and I’ve been through another one since then. I’m like risk first. I want to… what’s the balance sheet? Are these guys going to survive? If they get… if we really go into something nasty, does this company emerge at the other side? Worry about the return of your capital before you return about the worry about the return on your capital.
Bill Brewster:
I’m a living with that right now. My beloved AB InBev, I think they survive almost certainly, but when I entered that, I saw the leverage and I wasn’t as… I guess that in that story, in my mind, Latin America was a mess when I got involved. That’s where a lot of their profit comes from. You’ve got declining bud and bud light in the US so people don’t like that, but it’s somewhat offset by Stella and Michelob ultra taking some shares. Their dollar sales are relatively flat here, but it’s not ideal. But Asia was the growth engine, and now… and not yet. I hear you laughing. Not just that, they over-index. They’re sort of like this is an imperfect example, but they’re a little bit like Apple in that they sell fewer units, but capture a large majority of the profit over there. And the reason is they over-index in nightclubs. When no one’s going out right now. This is just going to be brutal.
Bill Brewster:
[crosstalk 00:34:04]. Yeah, it’s caused me to look in the mirror a little bit and be like, “Okay, are you going to be a business owner or a stock trader.” Because if I own a business and this is going on, I don’t sell the business ever in this scenario. I’m reminded of John Malone, two years ago, Charter was pretty low when he had his annual meeting and he was just like, “All right, fine. People don’t like my stock right now. They will later.” And it was a little comment that he said and it really clicked for me. It was very insightful. Like, “Fine, you don’t like my inventory, I don’t need to sell it to you.”
Bill Brewster:
And to me, if I owned AB InBev, there’s no way I would sell it right now. But the stock, it gets enticing to try to dance [crosstalk 00:34:49].
Tobias Carlisle:
… take advantage of the volatility.
Bill Brewster:
I don’t know that that’s the game I want to play. [crosstalk 00:34:56]. Yeah, I don’t know.
Tobias Carlisle:
Speaking [inaudible 00:35:03] even at good discoveries, try to [inaudible 00:35:05] up to $75 million. If you like that [crosstalk 00:35:09].
Bill Brewster:
That’s like no money. That’s nothing to him. That’s like you and me buying a Prius.
Tobias Carlisle:
It’s not nothing. He still run through his screens. Found out which one had the highest price to free cashflow and dropped what he had on it.
Bill Brewster:
Yeah, I’m just saying the 75 million. I discount-
Tobias Carlisle:
It’s not the scale of it. It’s the fact that he did it.
Bill Brewster:
That’s right. Yeah, that’s fine.
Tobias Carlisle:
He knows that business and he buys it at a price, and now you’ve got an opportunity to buy it at a lower price.
Bill Brewster:
CBS, Viacom, I just sold this trading below what CBS is trading, had tip to my man, Matt Ball. Wish I still had your service, but you discontinued it. Thanks for listening. One of the 10… [crosstalk 00:35:49]. The dude, we have so many. I think we have 12, 10 listeners and they’re fantastic people. No, but a lot of those media assets are getting crushed, which I get it. It’s hard to walk in front of the cord cutting train. But-
“It Makes No Sense To Lend Money To The Government At 1.4% When It Is Government Policy To Have 2% Inflation.” Warren Buffet.
Tobias Carlisle:
I’ve got a perfect quote for you from Jonathan Tepper. “It makes no sense to lend money to the government at 1.4% when it is government policy to have 2% inflation.” Warren Buffet.
Bill Brewster:
Yeah.
Jake Taylor:
Never heard of him.
Tobias Carlisle:
Good Lord.
Bill Brewster:
Who’s that guy.
Jake Taylor:
He’s been… he’s railed against longterm bonds, US, and I think otherwise, for a while now. He’s been a seller of those, but not a buyer, an issue or I should say.
Bill Brewster:
Short of being sued for breach of fiduciary duty, why would you recommend to anyone to buy bonds? [crosstalk 00:36:52].
Tobias Carlisle:
The theory is that if we go into a drawdown, then bonds should rally.
Bill Brewster:
Over the short term-
Jake Taylor:
From 1.3 down to what?
Tobias Carlisle:
But you… when they get to that close to that zero bound, they’re going to move a lot more. Every little… the change in the rate has more impact.
Bill Brewster:
That’s what I was talking to my buddy about Microsoft today and I told him, I was like, “Honestly, I could see it easily up 40, 50% from here.” And the reason is what you just said, when your cap rate is so minimal, small changes, it’s trading it… I don’t know, like at 3.3% free cashflow yield. Adobe’s a 2.5 ish, or whatever. That’s roughly 21% upside right now. I could see people saying Microsoft’s worth a lot more than Adobe. [crosstalk 00:37:51]. Yeah. The price can just go nuts. Right. And I would say, yeah, I get it. I wouldn’t bet on it, but I’d get it.
Tobias Carlisle:
The only thing is that Buffet did that in the 70s, right, when we had stagflation in the 70s. And the Yellow Rock did a lot better than Berkshire did through that period of time.
Bill Brewster:
The elusive Yellow Rock.
Tobias Carlisle:
I don’t know how elusive it’s. I hesitate to say it because this is basically a value and I don’t want to get hazed by all the people who hate on it, but I don’t own any at the moment either.
Bill Brewster:
I don’t mind it. [crosstalk 00:38:34] in the past. My grandma gave me some, and then I sold it in… I don’t know. It was like 1600 an ounce a couple of years ago. It was a good sale. [crosstalk 00:38:46]. Yeah, at the time I think I actually bought Caterpillar stock.
Tobias Carlisle:
I’ve got this… I’ve got a mailbag question. If you guys want to do that. This is… it’s a very, very long a mailbag question. But yeah [crosstalk 00:38:58]. I can’t read this whole thing out, but basically Yardi uses the fed model to provide a fair valuation of stocks relative to bonds. They use the 10 year treasury.
Bill Brewster:
However we disprove this model, or not?
Tobias Carlisle:
Yeah, we have. but this… [crosstalk 00:39:14]. It’s a specific question. They argue that based on the historical relationship of the two, the S&P 500 is actually in that region of 70% undervalued and fair value is in the region of 12,000, which is a 250% gain from here.
Bill Brewster:
Melt up.
Tobias Carlisle:
I think that the point of the question is from a purely objective point of view, 4% yield on equity with growth is more attractive than 1.6% no growth on the current 10 year. What do you guys think about that?
Bill Brewster:
Yes.
Jake Taylor:
Just because something is stupid and insane doesn’t mean something that’s a little less stupid and insane is a good idea.
Bill Brewster:
I don’t know, man. I don’t know that I agree with that. I really don’t. And this is why I… everything that I own is not sassy, other than my 10 basis points that disqualifies me from discussing value. But, I do think that there is room in a portfolio to hedge because there’s no guarantee that bonds don’t go negative. And it’s insane for me to say that, but if somebody said, “Look, I’m going to allocate 10% of my portfolio to a barbell strategy, and Adobe, and Microsoft, and all of them, are going to be that far out barbell, and they’re going to outgrow bonds. I don’t think that’s the craziest thing I’ve ever heard. I do think you’re taking some risks that I’m not comfortable taking, but I do get it. I don’t think it’s a rational behavior.
If The 30 Year Goes Negative, What Is Microsoft Worth?
Tobias Carlisle:
If the 30 year goes negative, what is Microsoft worth?
Bill Brewster:
So much.
Tobias Carlisle:
Infinity?
Bill Brewster:
Yeah, 4 trillion, 5 trillion. Why not? The numbers get crazy-
Tobias Carlisle:
Because it… there’s no price at which Microsoft gets a negative yield. Right? That’s a function of the underlying business. If you can yield 0.01% it’s still better than negative one?
Bill Brewster:
Yeah, and their services business is growing like a weed, and margins are inflecting, and you can really talk yourself into some crazy stuff.
Jake Taylor:
This time is totally different.
Bill Brewster:
The scary thing for me that I think about is, if this is really where we’re going to go, and by this I mean super compressed yields driving price, and I guess people would probably argue back to me that people have a floor under what their hurdle rate is. I don’t know that I actually believe that. I believe that theoretically there should be, but I don’t know that behaviorally there is. What do you do if you’re a young person? It’s hard… if you’re buying some of these companies at two X the value that they’re at today, I hope inflation never comes back because it seems like you’re going to end up… it just seems like ripe to just destroy people someday. And I don’t know when the day comes.
Jake Taylor:
I lived through this very similar thing when everyone I talked to in 2004 was telling in California to buy a house because otherwise you’ll never be able to afford one. And that was the argument was like, “You better get in now because you won’t be able to afford one if you don’t buy it now.” And that was what everyone said, and for two more years that was true and it got worse, but then reality reasserted itself and it turned out to be not true.
Tobias Carlisle:
Only briefly.
Jake Taylor:
For awhile. You had a few years there where it was you could buy a reasonably priced-
Tobias Carlisle:
It’s [inaudible 00:42:58] three standard deviations again, which is…
Jake Taylor:
It’s bad again.
Tobias Carlisle:
[crosstalk 00:43:02]. That’s Grantham’s definition of a bubble. It’s approaching his… And he had tracked it for a long time. He hasn’t for a while. All of the websites that he used to track it, don’t track it anymore, which I always find a little bit suspect.
Bill Brewster:
To be fair, you guys have unending demand and not enough supply and jobs. [crosstalk 00:43:23].
Jake Taylor:
Last year was the first year in a long time where there was-
Bill Brewster:
Net migration out.
Jake Taylor:
Yeah.
Bill Brewster:
My mom’s in Scottsdale. She says, a lot of people are going from California, but Oh God, I hope it implodes. Not for you guys, but for me. I thought I want to be out there so bad.
Jake Taylor:
Let me ask you this. As far as the argument of this melt up, and yields going even lower due to treasuries. Isn’t this by definition speculation?
Bill Brewster:
Yes. I think it’s hard to argue-
Jake Taylor:
You can’t really call it investment at this point, right? You’re speculating that someone’s going to pay you more because treasuries go lower.
Bill Brewster:
Yeah. I do think so. I guess it doesn’t feel like that to me yet. In the same Microsoft conversation I was saying… compare that to Delta, which is pretty front loaded with the cash flows. They guide the four billion in free cash flow. I said, I think in a down year, maybe you hit one billion, in a real down year. You’re probably going to be closer to four more often than one, but let’s call normalize like two and a half billion to three billion. Market cap is 33 ish. That’s like a pretty decent yield today. Microsoft is three and a half. To me Microsoft is a much higher quality business than Delta, but I don’t know that it warrants that spread.
Bill Brewster:
My buddy has been long it for a while, so I said I wouldn’t sell Microsoft right now, but I can’t get myself to buy it over that being the alternative. But you do have to get into some hair raising stuff to get any yield right now. I don’t know, it’s interesting. I’m not sure that I answered your question. I do agree with you that if you’re buying 3% expecting it to go to 2% on 50% appreciation, that to me is almost certainly, actually it’s probably more than 50% the way the math works. But yeah, that’s almost certainly…
Jake Taylor:
Speculation.
Bill Brewster:
Yes, that’s right.
Tobias Carlisle:
[crosstalk 00:45:48]. Microsoft’s a 3% free cashflow yield at the moment, and it’s off about 8% from where it was before. This kind of little Corona virus came through. I think it was 2.8% when we were discussing it last time.
Bill Brewster:
Was it?
Jake Taylor:
Oh, it’s on sale.
Bill Brewster:
I saw a lot of stuff. I’ll tell you what, like Pepsi and Coke. Ooh man, that’s rich. I know that they’re doing good things, but at least with Microsoft, do you have something growing like a weed and Pepsi and Coke? I don’t know. I wouldn’t lever up to buy them. I’ll tell you that.
Tobias Carlisle:
I’ve got lots of mailbag questions, but I’ve got them, they’re all spread all over everywhere. And honestly, I can’t track another one down. I’ve got… actually that’s not true. I’ve got… I feel like we’ve covered a few of these a few times, but here’s another one. Should we double down on our stocks after a thoughtful review is done? What’s your rationale for your decision? What are some other… what does some other investors suggest and what are you going to do in this review from Chris?
Michael Mauboussin – Managing The Man Overboard Moment
Jake Taylor:
I’ve heard Michael Mauboussin talk about this as the man overboard moment. You should be pre-planning on what you’re going to do when your stock drops 50% on you.
Tobias Carlisle:
I like that.
Jake Taylor:
And does that trigger… obviously it should probably trigger a reassessment, the market is telling you something, whether you agree with it or not is a different story. But I think you should be looking to see are the assumptions that I’m making this investment on predicated on still true. And if so, then this is an opportunity for you to potentially double down. If not, then maybe you hold or cut your losses, and learn something from it. But the time to be coming up with a strategy for the man overboard is while you’re calm, while you’re thinking rationally, while you’re… while the markets are calm also and not after the guy’s already fallen overboard and you’re like, “Oh God, now what do I do?”
Bill Brewster:
Could not agree more. Three examples that I have like AB InBev, I don’t know that I’m wrong yet so I’m not going to double down and I’m not going to sell. Wells, I think I might be wrong. I’m considering swapping out for Schwab, and Delta, I might buy more of, not financial advice.
Bill Brewster:
But those are three stocks that I still think I’m right on Delta. I think if you underwrote airlines and didn’t think you were going to have a drawdown, then you’re out of your mind. To experience it and live it, this is sort of, they have a strong balance sheet. If you believe in the thesis now is when you actually want to press your bet a little bit, I think. I think it’s very situational.
Jake Taylor:
Buffett’s got you shook on Wells, huh?
Bill Brewster:
Yeah, I don’t like it. I don’t like a lot of that. I don’t like a lot of the stuff in Wells. I think their board is really dysfunctional. And yes, I don’t think you fade Buffet and banks.
Jake Taylor:
Toby, from a quant standpoint, do you tend to more double down and even out positions rebalance?
Tobias Carlisle:
Yeah. The two best arguments I’ve seen John Hampton talking about is you’ve got John Hampton talking about Paul Tudor Jones on one hand, losers, average losers and Buffet on the other hand. And I think most value investors would say that they have made a lot of money from buying more of a position as it went down. What are the chances that you pick the bottom of the position that you’re trying to buy? [crosstalk 00:49:35].
Bill Brewster:
It almost never almost.
Tobias Carlisle:
Almost zero. You also have this problem where you’ve got some risk allocation. You want to be a 3% position, or a 5% position, or a 10% position, whatever you want. You put 10% of the portfolio at costs, it gets cut in half, rebuy up to 10%. Now you put 15% of your portfolio into this position. Goes down by half again. You can do that again. At some stage you’ve got this risk limit, but it’s being ignored by the fact that you stuffing so much of the portfolio into this thing that’s going down.
Tobias Carlisle:
And you could be wrong. There’s lots of stuff you don’t know. There are black swans out there. The way I deal with it is to punt a little bit because I just rebalance back to even. But then I’m also looking at back to equal weight, and also looking at, is the business deteriorating? Does that make it fall out of the place where I want to own it? And if that happens and that decision somewhat taken away from me.
Tobias Carlisle:
I also think that you have to give cup positions enough time to work out. What happens often is that a position is bought deteriorates over the first quarter or so, and then recovers. I think you need to give them at least a year to figure themselves out. That’s a really long, messy way of telling you what I do, which is just an equal weight and then keep on watching them in the screen. And I think that’s pretty effective. There are smarter ways of doing it. I’m not… there are lots of really, really smart, better ways of doing everything. I’m just always trying to find that the simple one that I can implement when I’m really, really under the gun and stress because that it’s coming again. There’s always one coming.
Jake Taylor:
What’s that gambling strategies like Martindale or he just doubled down every single time?
Tobias Carlisle:
I think that… Is that a reverse [inaudible 00:51:25]?
Jake Taylor:
Yeah, something like that.
Tobias Carlisle:
I always forget.
Bill Brewster:
Works until it doesn’t.
Tobias Carlisle:
Right.
Bill Brewster:
I think… I just think [inaudible 00:51:34] book has a lot of wisdom in it as far as putting up barriers around you, and I probably mentioned it before when we talked, but the idea that he won’t sell a position for two years, or… I don’t know if you want to do like a two and a half, 5%, 10% position going in or something like that, and if it’s 10, then you don’t double down if it’s two and a half, maybe you do, and whatever it is, I could not agree more with Jake that having a plan going in, and then monitoring whether or not you think you’re still right, which the best way to do that is to have a written plan going in, then I think these decisions get a little bit easier.
Tobias Carlisle:
It should also turn on the nature of the business that you’re looking at. Commodity, cyclical with a little bit of leverage that you get one bite at that.
Bill Brewster:
Yup.
Tobias Carlisle:
Compound… maybe you can double up a little bit on something like that. That’s probably something that you think is going to be materially bigger in three to five years time is a much different proposition to something like a cyclical, the cyclicals get really ugly at the bottom. There’s no floor on a cyclical.
Bill Brewster:
Yeah.
Jake Taylor:
And don’t assume that you’re going to have willpower at that moment because that’s how you end up losing money, or getting syphilis.
Bill Brewster:
He loved the syphilis [inaudible 00:53:01].
Jake Taylor:
I love the Munger joke. It’s so funny.
Tobias Carlisle:
I think that’s a good place to leave it because we’re out of time. Thanks folks. We’ll see you next week.
Jake Taylor:
Bye everybody.
Bill Brewster:
Have a good one.
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