VALUE: After Hours (S02 E11): Markets in Turmoil II, Fragility and Antifragility, High Yield Index

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In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:

  • Is Coronavirus The Crowbar On The Tracks Of Our Train Of Fragility
  • The Importance Of Focusing On Antifragile Businesses
  • What Is The High Yield Index Telling Us About What’s Coming
  • Don’t Shoot All Your Armor In The First Few Days When Buying Stocks In A Dip
  • Who Will Be The First ‘Bear Stearns’ Type Casualty?
  • What Was Occidental Petroleum Thinking When It Issued Preferred Shares To Buffett
  • Has The U.S Been Caught Flat-Footed From A Financial Standpoint
  • An ETF Is As Liquid As The Underlying Assets, Not The Liquidity Of The ETF
  • Forget The Share Price In Your Valuation Process

References in this episode:

ICE BofA US High Yield Index Option-Adjusted Spread (fred.stlouisfed.org)

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Full Transcript

Tobias Carlisle:
Welcome to Value After Hours, markets in turmoil Coronavirus edition mark two. I’m here with my cohost, Bill Brewster and Jake Taylor. Jake, what’s your topic this week?

Jake Taylor:
Well, I’m going to be discussing how this virus may be the crowbar on the tracks of our train of fragility.

Tobias Carlisle:
It’s scary and Bill, what are you talking about?

Bill Brewster:
I’m going to talk about how this all made me a little more introspective as an investor and my perceived benefits of holding more anti-fragile businesses.

Tobias Carlisle:
And I’ll be talking about what the high yield index can tell us about the stock market in decline coming up 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 acquirersfunds.com

Tobias Carlisle:
We’re recording March, 11 spy currently at 265. We’re down about 4.65% for the day. So, the market is truly trading like a penny stock. It’s up and down 5% every single day. I think that there’s some genuine damage occurring to the underlying fundamentals as well and we’re going to talk about that in a little bit, but let’s start with the topic that is front of mind and that’s coronavirus. Jake, that’s your topic.

Bill Brewster:
Wait real quick, a trigger warning to Google. Please don’t demonetize us. We are having legit discussion.

Tobias Carlisle:
No warheads.

Bill Brewster:
Oh, well we’ll have to have the conversation anyway. That’s why? Because we care about the people. We’re not in it for the money.

Tobias Carlisle:
That’s exactly right. The $6 is a full going though.

Bill Brewster:
I don’t want people to know how much we’re making on this, so we might have to rub this six bucks. We’re starting to really monetize those 10 listeners.

Jake Taylor:
Yeah, the ARPU is going through the roof.

Bill Brewster:
Strong, I’ve got to say, what do you guys think? You think we trade it 45 times sales.

Tobias Carlisle:
This is a podcast. Podcasts are very valuable right now.

Bill Brewster:
That’s right. High roic, quick growth. I don’t know, I think it’s worth at least $20,000. What do you guys think?

Jake Taylor:
Well now that we have your microphone actually plugged in, like the sky’s the limit.

Tobias Carlisle:
Right, there we go. Some of the parts.

Bill Brewster:
Now you hear my sweet, sweet voice.

Is Coronavirus The Crowbar On The Tracks Of Our Train Of Fragility

Jake Taylor:
So my segment is going to be how the Coronavirus might be the crowbar on the tracks that is derailing a lot of the fragility that we’ve built up in our system. So I’m going to do it in sections and maybe I’ll try to keep each section and then you guys riff on it.

Bill Brewster:
Sounds like a plan [inaudible 00:03:05].

Jake Taylor:
I didn’t say anything yet.

Bill Brewster:
I tried hold you back though, we won’t let it.

Jake Taylor:
All right, so first place to start is, let’s go with the supply chain. So just in time they like to talk about how it can increase the, or decrease your inventory expenses by up to 75%. And they highlight companies like Toyota, and Dell, and Harley, and how it’s such a good thing that we have this just in time. Well, that’s maybe turning out to be a fragile situation and a short win and a long loss, potentially. You look at the iPhone and it’s built in 10 different countries.

Jake Taylor:
Everything is shipping all over the world to get to us. 80% of our antibiotics are made in China. So we have all these different things that are very important to our day-to-day lives that are based on a just in time framework. So topic number one I guess is how fragile is our supply chain?

Tobias Carlisle:
Yeah, fragile, I’ve been saying this for a little while on different podcasts, but I think that some of that, China’s the just in time manufacturing hub for the entire world and you’ve got lots of things out there that even if they have just one component in them and they’re sitting waiting for that one component, the thing doesn’t get made. So I think that this problem is something that rolls on and on and on. I probably have to revisit just in time. I don’t know if that’s a sensible way of doing it, maybe you’ve got to stock par more parts.

Bill Brewster:
Yeah, I mean, I said it last week, I’ll say it again, Damick Mercury was like way ahead of the curve on this. I mean he highlighted this exact issue three weeks ago. My man Charlie Grant he just said on Twitter that he got some major Dow component company said like, there’s no way we’re going to vie back from this because the supply chain so messed up.

Tobias Carlisle:
Going to be back at all?

Bill Brewster:
No, so I think what his comment is if you are betting on a V-shaped recovery from this. It’s just structurally impossible for some of these companies to V back. I happened to be pretty bullish on service industry and travel related companies because you don’t need the supply chain to come back together. You just need people to be confident to travel again, and it’s also the sector that’s gotten the shit kicked out of it lately.

Bill Brewster:
So that’s where most of my focus is. But if you think … I mean whatever manufacturing company you to pick, it’s going to take a while to get all this stuff put back together again. I was talking to my neighbor is in private equity. He does a retail focused private equity. He has some company that distributes through either Walmart or Five Below or something like that. They’re planning on two months of no inventory. They’re just not going to have product for two months. That’s their base case. That’s crazy.

Jake Taylor:
Yeah, so speaking of travel, a few things for you that … I mean, we live in an interconnected world like never before and if you look at, Jeffrey West has this interesting book called Scale, which is all about networks and big cities tend to produce more of everything that is human.

Jake Taylor:
So including innovation, economics, but also disease, sickness, it spreads faster. And so the number of global arrivals, according to the world bank in 2009 was 900 million. So that’s how many people went to another country and touchdown down there. By 2018 it was 1.5 billion. So we have a disease or a virus like Corona virus has the potential of getting all over the world and really showing us that an interconnected world has its downsides as well.

Tobias Carlisle:
Here’s a question that I’ve been thinking about in relation to that. Why is it that some countries in the world are so far behind that the … Everybody knows that by now that it doubles every five to eight days.

Jake Taylor:
That’s what I’ve been reading so far in a couple of different places.

Tobias Carlisle:
And so you can look at what’s happened in these other countries and say that’s what the future looks like for the US but why is the US already so … What has happened to make the US, to make us so far behind that process? And it’s the UK, the US, Australia as well as sort of delayed. Whereas there are some countries like Italy, China naturally, Iran was caught really early. Why is that? Why is this such a lag between some countries and others?

Jake Taylor:
I don’t know, I think it’s we just haven’t gotten there yet. I think we’re just like on the same train, but a few cars.

Tobias Carlisle:
I’m just wondering why we’re that far back?

Bill Brewster:
Well, I mean, do we know that we’re actually that far back, right? I mean part of the issue is the amount of testing.

Tobias Carlisle:
That’s a good point.

Bill Brewster:
So, I mean, I was talking to my buddy’s girlfriend who is an ER nurse and she’s like losing sleep right now because she’s like, we are already at capacity and this flu season is already bad. And she managed through the swine flu. That was her first year nursing. They had to have pop-up hospitals. They had to build tents out back and she was like people aren’t really thinking like, God forbid you break your arm or you need an emergency service. How are the nurses?

Bill Brewster:
Your nurses might be sick, how are they going to be … I mean, there’s just a lot of issues right now that are coming in. I think maybe some are people are attributing flu symptoms to this. I don’t know. Google again, I’m sorry, I’m not trying to spread misinformation. I’m just having a discussion here.

Jake Taylor:
So, as of yesterday we were at 1000 confirmed cases in the US and, well, when you don’t test, you don’t have to worry about it.

Bill Brewster:
That was my high school theory.

Jake Taylor:
Doubling every five to eight days … Good point, I mean, there are anywhere from 50 to 65,000 ICU beds in the US and there are different numbers for some reason, I don’t know why, but we’re in 30 days from now doubling every five to eight days, we’re at 64,000 at that point, right? So within a month we’ll have all of the ICU beds full. If they aren’t, we’re already full with people with other things, right? So we’re medically, I think we’re very flatfooted for this, and not just medically, but actually from a health standpoint. One of the big predictors of morbidity for this is other cofactors like smoking and obesity. And that actually should be quite a bit of concern for us because we’re … In 2018, the CDC had us at 42% obesity rate in the US. We have a similar number who are deficient in vitamin D, which may be another thing that would help us fight off a virus like this.

Tobias Carlisle:
Just getting some help there.

Bill Brewster:
Yeah, are you telling me that I, this is my pitch to move out of Chicago? Vitamin D deficiency.

Tobias Carlisle:
Just go stare at the sun.

Jake Taylor:
I think this is the pitch for-

Bill Brewster:
I can’t dude. Have you seen Chicago weather in the winter? Actually this has been a nice winter.

Jake Taylor:
I think the pitch is honestly is for you. If you to manufacture that heart attack moment that makes you kind of get your shit together from a health standpoint. This is a great time to reevaluate your health protocols for your own health and if you ever needed a reason to want to take it up a notch and how you take care of yourself, this is a great reason to do it. 35% of us aren’t getting enough sleep. 9 million adults are diagnosed with chronic bronchitis.

Jake Taylor:
I mean, we are unhealthy already. I wouldn’t be shocked if we didn’t have even maybe somewhat higher mortality rates than what some people are predicting that one to two to 3%. If it gets into the population that is already at risk due to poor health previously, like, holy shit, I mean, this can be pretty bad.

Bill Brewster:
That’s sort of, I guess, in retrospect over the past three weeks how my thinking on this has really shifted is I didn’t understand how the wave worked. My mind wasn’t mathematically doubling every couple of days and I didn’t also understand sort of how constricted the system was in conjunction with the wave. So I think I thought this would be a lot shorter in duration than I do now, and what did you say? You said a couple of things that I triggered investment related thoughts.

Bill Brewster:
Oh, I was listening to a call that JP Morgan had and the guy said, part of the problem, right is … So I used to own ABM, Bev, I’m out. I’ve been out for a little bit and the reason is I was listening to this call and he just said, it’s about to get cold in the Southern hemisphere and they are fundamentally not prepared from a health standpoint. And if you are a company and your growth is dependent on emerging markets and God forbid you have leverage on top of that, I want nothing to do with it. I sold Philip Morris for the same reason.

Bill Brewster:
I thought that I had assumed a decline curve and this is totally illuminated a risk that I just don’t want to have to deal with because this thing is mowing down smokers. I don’t know, at the risk of sounding alarmist, I really hope it is sort of not what everybody’s worried about. I grew up in Florida, we always used to worry about hurricanes and they didn’t come and I was happy about that. But yeah, this thing could get bad.

Tobias Carlisle:
I think often the reason that things are better than people expect is that people do something about it as they see it coming, but the US has been quite fortunate in that we are the last train in the caboose and not at the front of the train. And so we have had more time but we have done nothing with it, so that makes me a little bit nervous

Bill Brewster:
Dude, it’s so frustrating and that’s what I … I mean I sent out a tweet today, we’ll see if Trump sees it. I’m sure I’m the only one he’s seeing, but that’s what I said. I was like, if you want the stock market to sort of-

Tobias Carlisle:
Get some confidence.

Bill Brewster:
Yeah, fucking come out and say the army is here to help and we are ready to set up temporary hospitals and we’ll get through this together and yeah, it might be bad. Floating a payroll tax cut, that is insane to me.

Jake Taylor:
Yeah, they cut rates. That’s the only thing-

Tobias Carlisle:
That’s the only thing that works.

Bill Brewster:
Okay, cool, we’re going to bail out the uneconomic industry in the US.

Tobias Carlisle:
What about bailing out the cruise companies? They’re owned by billionaires and they don’t listen. They’re not domiciled in the states for taxes. They’d go down if that happens.

Has The U.S Been Caught Flat-Footed From A Financial Standpoint

Jake Taylor:
So I think we’re also from a financial standpoint, flat-footed. We’ve come into this with rates that are already crazy low, trillion dollar deficits, tax structures already lowered from previous, all time debt levels out of control at different levels. I think there’s got to be a lot of questionable debt and then buy back management questions, like dude, what were you guys doing here, right? You are not preparing for a rainy day at all and then markets are crazy expensive. All of these things are from a financial standpoint, and then one other thing…

Tobias Carlisle:
[inaudible 00:15:07] markets are expensive because rates are low.

Bill Brewster:
Are they low or do they not exist?

Jake Taylor:
Yeah, right.

Bill Brewster:
So listeners, I’ve put my whole portfolio in 10 year treasuries. I’ve totally switched. I’ve determined that they’re going to 10 basis points

Tobias Carlisle:
We’ve got no idea [crosstalk 00:15:22] money, because we’re recording this 10 days before this comes out. Maybe we’ll try and release it a little bit earlier, but it seems like the moves are very violent in between podcasts.

Jake Taylor:
So let me ask you this, what jobs were added since 2009 for the most part?

Tobias Carlisle:
Instagram influencer.

Bill Brewster:
It’s been sweet podcaster.

Jake Taylor:
Yeah, how about more like service?

Bill Brewster:
I’m in service.

Jake Taylor:
Right? Like Bar attenders, baristas, if people stop going out for things for a significant period of time, all of those jobs that were supposedly added are I think the most at risk. [crosstalk 00:16:06] edge right?

Bill Brewster:
Yes, that’s why the payroll … Who does the payroll tax? I mean it helps a lot of us, but a lot of the people are white collar workers. They can work from home anyway. This is not going to do shit for the service industry. My buddy’s restaurant did 170 dinners two weeks ago. It did 70 last week. This is just the beginning.

Jake Taylor:
Operation leverage goes the other way too.

Bill Brewster:
Yeah, people don’t even know how Siri … I mean people are starting to understand how serious this is. But yeah, I mean that’s why I was saying two weeks ago before I sort of understood how the virus passed, I was like, we’re really going to shut down the economy. I mean, it’s not just the direct first order effects, it’s all the tangential industries. What does Vegas look like over the next 12 years or 12 months? It’s not going to be good.

Jake Taylor:
No. Okay, so one last thing, 60% of households with kids have two working parents. What do we do when they shut down the schools to keep from trying to infect everybody and all these kids are at home now with two parents who are supposed to be working? And you bring in the grandparents who are to watch them who are the most at risk? That’s a really nasty cocktail.

Bill Brewster:
Yeah, you just don’t work.

Jake Taylor:
You just don’t work, I guess.

Bill Brewster:
What do you do if you’re a healthcare provider and your kids are at home?

Jake Taylor:
I don’t know, but we need you on the front lines.

Bill Brewster:
Yeah, I mean, this is why the market’s off so hard. I think this is the exact-

Jake Taylor:
All the way back to 2019 levels.

Tobias Carlisle:
I hate to be a fear monger when the market’s off, but I kind of feel like the market is still expensive where it is, who knows what happens.

Bill Brewster:
Akron thinks so too. I mean, that was what he just wrote with the Pershing square letter. He said our hedges are working and I’m pretty sure he said, I don’t think this is a bottom.

Tobias Carlisle:
My shorts are certainly been working. I’m very happy with the shorts at the moment. The lungs have been letting the team down a little bit, value longs. If anybody’s been watching values again, the worst performing factor through the crisis. But we all hope that it comes back one day in the maybe the 2100’s or the 2200’s.

Jake Taylor:
But you have long duration.

Tobias Carlisle:
Yeah, not me personally, my descendants.

Bill Brewster:
I think a lot of value guys, I know certainly myself, I’m long financials. I’m not particularly worried. We’re going to be buying in shares here, so we’ll see in five years how it all looks.

Tobias Carlisle:
Yeah and in all seriousness, I kind of like the value portfolio here. I think the values are very, very cheap. I think I’ve been talking about this a little bit on Twitter, but I think sort of Berkshire’s getting to one of those generational half generational opportunities where it is right now. It’s as cheap now as it was in the 2009 low and the 2011 low. There are 68 days between now and the very peak in 2007 out of like 3000 something days where it’s been cheaper. So I think it’s stockingly good value here.

Bill Brewster:
It is. A lot of my portfolio and I have slept very well at night.

Tobias Carlisle:
If there’s two guys I trust to manage through it, it’s those two guys provided they avoid the flu and that is a genuine fortress balance sheet.

Bill Brewster:
I mean, I don’t want to lose those guys, but let’s say they don’t avoid the flu. I think they got a pretty good team behind them. Now, what happens in five years and do the managers continue to work? That’s sort of something you’ve got to watch. But I have gotten on buffet for the buybacks. I have gotten on them for accumulating all the cash. I have deferred to him because I thought he’s smart. Guess what? He is. Right now, it is super easy to sleep right now when you have Berkshire in your portfolio. Same with Charter. I hope this stock gets cut in half. They are going to eat so much of themselves because you’re going to pay your broadband bill, so let’s go.

Tobias Carlisle:
Might be the only thing I pay, the internet bill.

Bill Brewster:
That’s right. So let’s do it, chop it in half. I want to own more of that, I’m cool.

The Importance Of Focusing On Antifragile Businesses

Tobias Carlisle:
So maybe that’s a good point to segue to your topic Bill. You’ve given some thoughts to managing value through a crisis and we’ve sort of went down. I don’t know if we’re down 20% yet, but we’re down. We’re kissing it, we’re very close and the way that the market moves, it could go through it tomorrow. It could go through it before the end of the day.

Bill Brewster:
Yeah, I’ve been super public about thinking the airlines are different. That has been a situation where if in my underwriting you had said, okay, well what happens if you just chop revenue in half for a year or make it go to zero, park every single plane in the U S and what’s your business look like now? I would have dismissed that as like, what are you even talking about, right. And I guess what this has really forced me to think about is that’s actually a possibility and it’s certainly more probable than I thought it may be, and maybe we are looking at a black Swan, right?

Bill Brewster:
I mean maybe this is sort of the left tail manifesting itself. Maybe it’s just sort of natural order of things. But I think that really thinking about how resilient the businesses that I own are and do I want to really own them through the downside and not being as dismissive of what risk looks like.

Tobias Carlisle:
How are you assessing the resiliency?

Bill Brewster:
I think that with the airlines it’s sort of different. I mean, I’m concerned and remain concerned about liquidity and I have always been like, well, I’ll just buy the best of breed in balance sheet. But I mean it’s a lot of operating leverage in the short term and they burn a fair amount of cash. Now, they get some help on oil and you have your yields are like 65% I think I heard. But they’re losing all the business booking, and that’s a lot of the front end booking.

Bill Brewster:
There’s a lot of margin in that and I’m not sure the business … Like in the social media age, I don’t think you want to be the first business or a set of businesses that say go travel again. So I don’t know how long this can last. I think people are, or I know I certainly underestimated how long this could last because I thought it would be like a shock event and then you move on. I think they’re doing all the right things.

Bill Brewster:
I just don’t know how much is in their control. I think you find out after it. So to that extent that business fundamentally will always warrant a lower multiple than something like charter where you do have subscription broadband revenues that even if we all have to shelter in place, they’re getting paid.

Bill Brewster:
So that’s just sort of the stuff that I’ve been thinking about. And like I said, I sold ABM Bev. I was obviously wrong if I sold, I wish that there were alternative paths to the world that I didn’t have to play this hand, but this is the hand. So maybe in the future, I focus a little bit more on anti fragile businesses.

Jake Taylor:
Where’s the anti fragility come from for you? Is it just the balance sheet?

Bill Brewster:
Well, I just said it can’t be right? So it’s got to be some combination. It can’t be that alone, but it’s got to be some combination of the balance sheet and a cost structure that sort of allows you to flex up and down would be what I would say.

Jake Taylor:
How about management?

Bill Brewster:
Yeah, a ton and culture. I mean, I’m not at all worried about Markel and Sarov and Tom and Dan doing the right things right now. It doesn’t even cross my mind. If the stock got chopped in half, I’d be like, all right, cool, let’s go. These are my soldiers, I’m down to ride. Some of these other businesses though, I don’t feel that way about, and that’s why I sort of have avoided some of the less … I hate to pick on it, but like, EAF, now you get to see what credit risk on those contracts actually looks like. Is the steel industry ready to do this, if this is a prolonged problem? I don’t think so. That’s why I never really liked that idea.

Tobias Carlisle:
This is slightly tangential, but along the same line, energy a few days ago got absolutely taken to the woodshed. Oils are so much-

Bill Brewster:
I say 27 style, accidental of 53%.

What Was Occidental Petroleum Thinking When It Issued Preferred Shares To Buffett

Tobias Carlisle:
Oxy was where I was going. So Oxy, for folks who don’t know, so the way that they did the deal was they issued this $10 billion pref to Buffet that pays him $200 million a quarter. So they didn’t have to therefore go and get shareholder approval to get the deal through, and so now they’ve cut their dividend to the point where they’re paying. I think buffet gets half of the cash flows that get paid out in dividends and he’s got the 10 billion of proof.

Tobias Carlisle:
I said in Twitter yesterday, like congrats the Buffet. Nothing against him, he did a deal he can get, but that is sort of criminally dumb by the management of Oxy to have … You don’t go and get shareholder approval for something like that. That’s outrageous.

Jake Taylor:
It’s gross, corporate negligence.

Bill Brewster:
This is the energy fin twit is just shadow all over her for the entire time and guess what it happened. That said, I’m about to talk out of both sides of my mouth. Right now, something like Chevron is sort of intriguing to me because it’s very hard to argue to me that you can get a more bombed out story than oil right now.

Tobias Carlisle:
Energy and airlines, you’ve got to kind of have a little hedge built into it already. I kind of liked those traits. Get the fortress balance sheets, get the good businesses. That’s how this stuff works. You’ve got to get in there and buy that sort of stuff.

Bill Brewster:
Here’s the only pushback that I’ve given myself on airlines because since it’s been almost 100% of my time and Mindshare, is what’s this scenario? So you could wait to buy these things and you could see how they actually perform and what are you really going to give up on the upside versus what risk you’re taking by trying to be early on it. I think that there’s a legitimate argument to be made to me that the risk reward skew is potentially better waiting to the end of this and seeing like … I mean, right now people are game theory. What is the government bailout look like?

Bill Brewster:
I mean, that’s not super fun to invest into and I get that you’re getting a discount, but like Delta is still a $27 billion entity. It’s not like it’s … You’re not buying an option here. So I don’t know that the risk reward skew is quite what it should be and I don’t think they’re going to double overnight so you could watch it. That would be the only pushback I have.

Tobias Carlisle:
Yeah, that’s a fair point. So I have two thoughts there. One is you kind of got to strike while the iron is hot and when you get the opportunities you’ve got to buy them.

Bill Brewster:
That’s right.

Tobias Carlisle:
But you don’t necessarily have to fill up the entire position. You can buy some, see what happens and buy some more because you’re right, there is still a lot of risk in all of those positions. Oil, nobody really knows where that’s going. Airlines, nobody really knows where that’s going.

Bill Brewster:
And I do think there’s a lot of bets right now that are pretty correlated that if you look at a draw down perspective, like Formula One, booking.com, Live Nation, Vail Resorts. I mean those are some class A assets that I think have a lot of the same risk right now that you could probably hide in and make a very similar trade.

Tobias Carlisle:
The only safe place is Tesla.

Bill Brewster:
I know that’s sounding like a trader. Yea, and I’m not trying to sound like a trader, but I do think that that’s something people at least should think about. Something I’ve been thinking about.

Tobias Carlisle:
What are you doing Jake? You’re buying anything?

Bill Brewster:
Yeah, Telsa.

Tobias Carlisle:
Oh that’s for your investors to own, everybody else to find out.

Bill Brewster:
Are you selling puts on Tesla? Try to harvest that premium before you buy in cheap.

Jake Taylor:
No, it’s radioactive. It doesn’t matter.

Tobias Carlisle:
You can’t be long or short that thing, and I am sure that unfortunately in full disclosure.

Jake Taylor:
Too dangerous. Yeah, I mean I’ve been nibbling some of the things that I already owned that have gotten more attractive, but in general I’ve been kind of waiting and seeing like you said, I think it’s still pretty expensive relative to the bigger impacts that I think are possible. I think we’re still maybe discounting that this is just going to blow over and like V back and granted. We’ve had, what, 10 or 11 years now of every single little hiccup, whether it was a government shutdown or European crisis, Greeks. I mean everything has been a quick rebound and then onward we march upward.

Jake Taylor:
I’m not sure it’s going to be the same this time, I think … And granted probably would have thought some of these other things would have had bigger problems too, but we’ve just shrug them off. I don’t want to lose sight of being generally an optimist because I think that’s the right way to approach the world and investing. I think that you get paid to be an optimist generally. But in this case, I feel like we’re still sort of under appreciating … The price tells me that we’re under appreciating the risks still.

Bill Brewster:
I think that the real difference, like for me, the 2018 dip was pretty easy to buy. This one I have been much more cautious and I think the reason is, despite what you guys just told me that Minutian said is like this absolutely has an economic impact. And I think that anyone that doesn’t think that we’re … I mean, I don’t know what a … Gun lock’s 40%, must be at 80 now. I mean, the amount of economic activity that’s going to be pulled in for a while, I don’t think it’s that easy to just buy this step. And famous last words. I’m not going to cash or anything like that, but I don’t think this one is just some sell-off.

Don’t Shoot All Your Armor In The First Few Days When Buying Stocks In A Dip

Tobias Carlisle:
Yeah, I’m with you Jake that because I’ve been through two gigantic drawdowns, I sort of in every single one of them, I always thought, the rookie error is to shoot all of the armor in the first few days and weeks. And then basically what that’s meant is that in the last 11 years, every time it’s happened, I’ve kind of been just warming up and stretching and we’re already back to all-time highs.

Jake Taylor:
Yeah, same here.

Tobias Carlisle:
So, it’s a slightly different situation now, but I still have some cash. I still I’ve got a whole lot of cheap stuff and I like the way you frame it up all. It’s all got a lot more attractive since this whole thing started happening, which means it’s down a lot. The only kind of bright spot is that I feel like the portfolio has been doing much better than comparable value portfolios because I’ve got some shorts in there and I’ve tended to buy sectors that tend to be a little bit cheaper. So I think that they have been a little bit better protected. I don’t think you get to see the full strength of value until this thing really gets rolling. I really don’t think value is going to be punished all the way down. I think what happens is value-

Jake Taylor:
We’ve already gotten it.

Tobias Carlisle:
We sold off the two months before this started. So this is one of the funny things, okay? Corona virus is the trigger-

Bill Brewster:
Yeah, you did say that before.

Tobias Carlisle:
Corona virus is the trigger but I kind of feel like something was coming. I felt like something was coming a long time before that because we were already sewing off and you see it in value. When the value starts selling up. So value has already kind of … Values in its bare market now. Well and truly in its bare market, probably has been for four weeks down. Like look at a composite of value funds, Cory Huffstain has them on his side. I can pull it up and put it in the notes to this, but you’ll see that it’s 20% down. So definitionally my bare market, sorry.

Tobias Carlisle:
I think that it’s been coming, corona virus happens to be the trigger, but it just about could have been anything that gave people a little bit of fright. But I actually now do think that corona virus is going to be … You don’t see the reporting for Q2 when it really starts to bite until Q3, it’s something that is with us in reporting in earnings for a really long time, like at least probably till the end of the year.

Bill Brewster:
I’m pretty interested to see how true retail money starts to respond to the headlines. I mean, I’ve talked to some people that … Like my one buddy was just telling me how he thinks the market knows and I’m like, I don’t. I mean I buy that a lot and I can understand like, yeah, the market sees forward 18 months. The average person that I’ve talked to that’s outside of finance does not understand at all what the headlines are yet, and you start to see your … If I was a boomer, okay and I owned ETD, and I actually started to lose friends, and my ETF was down, and I had 2009 PTSD, I don’t know that I’d stick around. I think people are going to be put a pretty strong decision here and I’ll be interested to see sort of how that all goes because you could have some panic selling when the headlines get scary.

Tobias Carlisle:
I do think the market is often ahead of the headlines but I don’t know how that happens, but it’s just the market seems to bottom close to when the … I have no idea how it happens. It’s just one of those wisdom of crowds type ideas. It does seem to work, but I don’t know. So that’s why that makes it sound like I’m making a pretty strong argument for technical analysis, which I guess if I could read the charts, I would and I don’t think anybody can read the charts. I think it’s all obvious in hindsight and not prospectively.

Jake Taylor:
Yeah, I mean I think you have to be comfortable with the idea that you’re going to be early, but what’s a typical draw down has been 18 months on average? If you just had to throw a dart, something like that. All right, how far are we into this one? Like a month and a half or something. I don’t know, two years, it feels like it’s been two years. Or is it like five days?

Tobias Carlisle:
The crazy thing is that this has been so fast, so I know what that does. I don’t know what that means. I don’t know if that means recover faster too. I mean, I don’t think it’s a V bottom, but I don’t think it’s an 18 month one either because-

Jake Taylor:
I pick instead.

Tobias Carlisle:
Yeah, that’s probably a good analogy, but it’s funny. Maybe we are living in this accelerated age where when things sell off, they recover faster too, but I don’t think it’s like a V shaped bottom. I think it’s going to look more like 2000 or 2007, 2009.

Bill Brewster:
I don’t know. It’s going to be interesting, man. I a lot of these SaaS companies that rely on sales forces that get on airplanes to do deployments and stuff. You better take your growth assumptions and at least for a year and maybe it doesn’t matter, but we’ll see. I don’t know, people are going to be … You’re going to find out how much conviction there is in some of these names. I’m hoping not much.

Jake Taylor:
Conviction in your Vanguard ETF, I mean, does anybody really have conviction in that or is it more just like?

Bill Brewster:
Yeah, well that’s panic selling, right?

Tobias Carlisle:
A lot of that is investment that just comes out of paychecks that people never consider it all, like they have no emotion about it whatsoever. It just gets funneled into too many of those ETF’s. So that beard is still going to be there.

Bill Brewster:
When things are going up.

Tobias Carlisle:
Well, that’s true. Do you change? It’s going into your retirement account.

Jake Taylor:
I remember the people that I worked with in 2009 and it was like, now let’s go into cash now. Let’s go into another money market account, not the … Market just keeps going down, why would I put it in that?

Tobias Carlisle:
Couldn’t hide in money market accounts either.

Jake Taylor:
I know that’s true.

Bill Brewster:
You’ve got no trading fees now. I don’t know, I just think it’s interesting.

Tobias Carlisle:
Well, you can’t try it on Robin Hood.

Bill Brewster:
Yeah, that’s true.

Tobias Carlisle:
No fees, but no trading either.

Who Will Be The First ‘Bear Stearns’ Type Casualty?

Jake Taylor:
Who do you think … Where’s the first like Bear Stearns hedge fund that blows up?

Tobias Carlisle:
I can’t believe we haven’t seen it yet.

Jake Taylor:
I know, something has to have blown up by now, right? Where’s the high profile explosion of something?

Tobias Carlisle:
I’m astonished we haven’t seen it.

Bill Brewster:
It’s not Ackman. He hedged. He crushed it on that hedge. I just think that there are times that I have held cash and I’ve done it in order to be sort of like anti fragile and on the way up it hurts. It really sucks to underperform and it feels so good to watch something like this and be like, you know what? This is why I planned, and I just think that that’s why people need to think about the bad times when it’s good times. And then in the bad times, there’s some names here that probably you’re going to be a lot higher in 18 months, 24 months. So, it’s a matter of being able to live through a little bit of a draw down.

Tobias Carlisle:
Three to five years.

Bill Brewster:
Yeah, we’ll see.

Jake Taylor:
I’m going to paraphrase Bill. Here’s what Bill is saying, suck it all, you grasshoppers.

Bill Brewster:
No, that’s not what I’m saying. I have gotten blown up in some names. I fucking bought Schwab. Schwab has been just decimated. I’m not sitting here like a Twitter flex saying I’m up 70%. That’s bullshit. It’s been painful, but I am happy with the top of my portfolio and I’m not selling any of it.

Tobias Carlisle:
All right, let’s do my topic.

Jake Taylor:
Yes, please.

What Is The High Yield Index Telling Us About What’s Coming

Tobias Carlisle:
So Dan Rasmussen had a nice tweet where he said, if you watch the high yield spreads, they are often early too big draw downs and then you can take away some guidelines for when the market recovers and so on. So if you watch them, so the high yield spread, you can actually dig this data series up for yourself. It’s available free online. You get it from the Louie fed, St. Louis. How do you say that?

Jake Taylor:
St. Louis.

Bill Brewster:
I think it’s St. Louis. I mean, at least in America.

Tobias Carlisle:
Yeah, that’s my accent. Sorry St. Louis, I’ll get that right next time. I will put this in the show notes as well, so you can look it up yourself, ICEB of A, Bank of America US, high yield index option adjusted spread. So the numbers in … The data series goes back to 1996 and you can see very clearly it blows through. So the numbers to watch is sort of somewhere between six and 8%. When it comes to-

Jake Taylor:
How could you explain what it is? It’s high yield debt minus…

Tobias Carlisle:
Yes, sorry, it’s so it’s the high yielding debt minus the tenure and it just looks at that. So this is the junk spread. This is what leverage borrows typically have to pay. So when these rates blow out, this is often when you see it’s not just equity correction, it’s there’s some underlying problem as well. I think that’s what it sort of demonstrates because they start demanding high yields to underwrite a lot of this stuff. So we saw-

Bill Brewster:
And then just real quick, the OAS is option adjusted spread. So when I was in CFA level two preparation, I could tell you what that means but I’ll tell you now is Google it. It’s the proper one to look at.

Tobias Carlisle:
I did say option adjusted spread, didn’t I?

Bill Brewster:
Yeah, I’m just saying because we had asked what it was. So I was just saying it’s option.

Jake Taylor:
He had to just drop that CFA.

Tobias Carlisle:
What level CFA did they teach you there?

Bill Brewster:
I think it’s two. I think two is the one that you got.

Tobias Carlisle:
There we go.

Jake Taylor:
I’m lashing out because I’m afraid of coronavirus. I’m sorry Bill.

Bill Brewster:
Okay, put your mask on.

Tobias Carlisle:
The only point that I would make about this chart is that it blew up in 1998, blew up in 2007, it blew up in 2011, it blew up in 2016. 2011, 2016 were pretty mild. It only just got to eight in 2011. It didn’t quite get to eight in 2016, but it went through like six pretty in both instances. The 2001 and the 2007 one were very substantial. You can look at it on the chart, you’ll see how kind of how picky it got.

Tobias Carlisle:
So it doesn’t necessarily have to get to that kind of level, but we have gone through six. We went through 6.8 yesterday. We’ve come back a little bit today to 6.38. It’s updated every single day, and it’s very, very steep at the moment. So I don’t know whether that means it’s going to come back down very steeply with we’re at the beginning of something that’s a very violent move, but it’s worth just watching that because it sort of gives you an idea.

Tobias Carlisle:
And when it starts recovering, I think that that’s a pretty good indication that a lot of the underlying credit pain is leaking away. And I would say that’d be close to the bottom for the stock market. It moves all over the place, but it’s just worth watching because it tells you something more than you’re not trying to just pick a bottom in the equity market. You’re looking at the fundamentals of the market too.

Bill Brewster:
And probably come back in when we bail out Shale. I mean how much of that index is Shale? I bet it’s a ton.

Tobias Carlisle:
I have no idea.

Bill Brewster:
I bet it’s a ton.

Tobias Carlisle:
But there’s a lot of energy in there, I’m sure.

Bill Brewster:
Fuck yeah, there is. I mean it’s going to be … The idea that we might bail that out is really funny to me. I mean it’s very infuriating, but it’s also very funny.

Tobias Carlisle:
One of the bio that’s going to Shale and to carnival cruises.

Bill Brewster:
These are the questions that I have as well, sir. They should be going to the service sector.

Tobias Carlisle:
I think either of those things can kind of either we can lose them and we’ll be fine. Sorry to all the shale and carnival cruise goes out there and also the carnival cruise lines are all domiciled offshore and not paying tax in the state. So that kind of excludes your run.

Bill Brewster:
Yeah, the waiters should be cut direct checks. I know it’s hard to do it, but if you want to help people, help the people that are hurt, not over levered billionaire oil people that are hiding in an LLC and levering up like crazy. Get out of here, you can take your loss. I’d be more in favor of removing their limited liability company protections and clawing back their actual personal wealth that I would bailing them out.

Tobias Carlisle:
Well, that should go first before you get the bail out.

Bill Brewster:
Yeah, get out of here with this, but I guess it gets systemic if you have too many debt defaults.

Tobias Carlisle:
But isn’t that what bankruptcy does? It just wipes out the equity, wipes up the next layer until it get to the folks who were lending securely and then they take control of the assets and hand it onto the next entrepreneur who’s got some plan for them. I think that’s a pretty good way of doing it, isn’t it? That’s the fairest way of doing it.

Bill Brewster:
I think you just described capitalism, but unfortunately we sell puts under everything now, so that doesn’t exist.

Tobias Carlisle:
That’s crazy.

Bill Brewster:
It’s insane, terrible policy.

Jake Taylor:
Well, I mean it’s not surprising though. I mean, we have a track record of that now, right? The quickness that they already were talking about it though is what surprises me. Like shit hasn’t even gotten real yet, and they’re already talking about bailing people out. What? I mean I get it. Maybe I don’t get it actually from a long run perspective, but all right, GM, AIG, maybe the banks. Some of these things maybe in 2008 were actually systemic risks-

Tobias Carlisle:
Just to wipe out the equity.

Jake Taylor:
Well, they kind of did with AIG, but to already be talking about that is just to me like you were just telling them like you know what, just keep doing all the dumb things you were doing because we got your back.

Bill Brewster:
I have a soft spot in my heart for airlines, obviously. I would say that that’s actually an industry that I would be okay bailing out given that if we’re saying like-

Tobias Carlisle:
But what level is the pilot coming at? This is my question. Do you buy that the equity holders or do you buy that the airline and wipe out the equity holders? And I say this as an equity holder.

Jake Taylor:
I know, that’s the thing that’s tough about it and I guess … I mean I’ve had this conversation with myself. So I’ve thought like on one hand you have got to at least let the equity holders keep some of it, otherwise you may not get the financing in the future, right? [crosstalk 00:46:01].

Tobias Carlisle:
There’ll be people there. That’s what happens. That’s business.

Jake Taylor:
It’s called progress. You know what I just realized is that we’re all Sears.

Bill Brewster:
What?

Jake Taylor:
I realized that we’re all Sears, we’re all heading towards Sears.

Bill Brewster:
I don’t know, I’m pretty optimistic. I think this is going to be a painful period, but I think we’re all going to get through it just fine.

Jake Taylor:
No, I agree, that’s how I feel about all the serious real estate. It’s just who’s going to be the owner of it may dramatically change?

Bill Brewster:
Well, and that’s the thing about the cruise. Why do you need to bail those guys out? Don’t they have debt holders there? Let those guys fight it out, figure out where the fulcrum asset or whatever is. Just be done with it. So we’re going to write them a check? That doesn’t make sense.

Tobias Carlisle:
All right, a question-

Bill Brewster:
I got a mailbag too.

Tobias Carlisle:
You got a mailbag? Good, you go with your mailbag question.

Bill Brewster:
No, you go ahead because I’ve got to find it.

Tobias Carlisle:
This is from Kevin Marks. This is a tough one, so enjoy this one. Buying a bond is secure, because one can always hold it to maturity. If we’re talking about government back instruments, you can see how that’s a hedge, that’s insurance. So we’re talking about owning TLT or something like this. If you buy a bond ETF, they’re not market driven. Can they not drop like other equities responding to liquidity issues?

Jake Taylor:
Bill I’ll let you handle this easy one. I don’t claim to understand all of the dynamics of some of how these funds work. I’ve heard people talk about how a mismatch in liquidity of the underlying compared to the derivative of it, which is the TLT for in this instance that that could cause serious problems. I don’t quite understand why. I guess you probably just … The price can just move more than you’re willing to imagine when you thought you were buying something very secure. I don’t know what else you guys have to add to that.

An ETF Is As Liquid As The Underlying Assets, Not The Liquidity Of The ETF

Tobias Carlisle:
You’re always as liquid. An ETF is as liquid as the underlying assets, not the liquidity of the ETF, so you can’t buy something that’s … You can’t have an underlying asset that’s very illiquid and put a liquid ETF on it and expect for the liquidity in the ETF to persist through the most illiquid times in the underlying asset. I think that TLT though … I mean, I said TLT, I introduced TLT. That’s not actually in a question, but I sort of assumed that that’s what the question was driving at. I think government-

Bill Brewster:
High yield isn’t as liquid as the ETF is, right? I mean, ETF and high yield, you could have some underlying issues.

Tobias Carlisle:
They can be trading in the ETF. You don’t have to. That doesn’t necessarily make any impact at all on the underlying instrument because people can just buy and sell, but there are times when the liquidity dries up. Like when markets crash, that’s when the liquidity goes away and the underlying asset liquidity becomes the question. I still think government backed securities, government back bonds still going to be very, very liquid.

Tobias Carlisle:
I wouldn’t be too concerned about those ETS. But it is always, that’s a good question to ask though. You should look at what you’re buying. Are you buying an exchange traded note? Are you buying an exchange traded fund? Where is your counterparty risk? What happens if … What is the fund made up of? Is the fund made up of holdings in the underlying asset or is it some sort of a swap written with a bank where you’ve got to watch that now, you’ve got to watch their credit readiness?

Jake Taylor:
Counter party risk.

Tobias Carlisle:
Yeah, you do have to think about those things. Look at who your counterparties are, make sure you understand the structure, make sure you understand the underlying liquidity in the assets because that’s the time when you go to lean on these things is probably when all the liquidity dries up. So great question, thanks Kevin.

Bill Brewster:
Well, and the biggest problem with a lot of these bond constructions, is they are market cap weighted to the debt outstanding. So if you’re holding a bond ETF, you are actually holding more of the issuers that need to issue more paper, which means fundamentally your credit quality is not as good as you may think it is. I personally have never understood bond ETF’s and I think-

Tobias Carlisle:
What about TLT?

Bill Brewster:
Yeah, I think that’s probably fine. I mean, I don’t-

Tobias Carlisle:
You mean like the corporate, the high yield stuff.

Bill Brewster:
Yeah, that’s right.

Jake Taylor:
What percentage of people who own a bond index fund have even a 10th of the knowledge or understanding of how it operates that to actually be an owner of it?

Tobias Carlisle:
Not one, but then I really-

Bill Brewster:
The 1%.

Tobias Carlisle:
There’s also an argument that that’s kind of why you invest in a fund rather than going and doing it yourself. You trust the manager to execute the strategy that they have kind of written down. But that’s why you should read … You should at least have a look at the documentation on it. I know it sounds terrible.

Bill Brewster:
No one does that.

Jake Taylor:
No one does it.

Tobias Carlisle:
So hard to.

Bill Brewster:
You know what’s going to happen is it’s all going to blow up and then people are going to be like, oh, the system screwed me. You screwed yourself. You played yourself fool. You bought stuff you didn’t know, you played yourself. Get out of here with that nonsense.

Tobias Carlisle:
Hope this doesn’t come back to haunt us, this conversation.

Forget The Share Price In Your Valuation Process

Bill Brewster:
It may. All right, next one from my man Brock Briggs, listener 10, he murdered listener nine to get to right in the 10 slot, which is aggressive, but I appreciate the commitment. Anyway after my bad jokes, for all of us that manage our own personal money, especially small amounts, how can price play a role in stock selection? I don’t want to dictate what I buy based on price, but if a guy only has a few hundred bucks a month to invest, buying one share of Apple may not be as effective as maybe buying five to 10 of a stock that’s cheaper. I wouldn’t think that way personally.

Bill Brewster:
I think you value the business and then you buy the fractional interest in the business that you can afford to buy, and that’s how I would think about it. I wouldn’t think about share price and actually aren’t there studies that show that higher share prices actually lead to out performance? It’s clearly not causal-

Bill Brewster:
I think it has something to do with management teams that are not very concerned with doing stuff like having-

Tobias Carlisle:
That would make sense.

Bill Brewster:
It’s obviously not the cause, but I think it’s a correlation.

Jake Taylor:
Isn’t it just the fact that they went up to a high share price kind of make them by definition? Like your sampling error seems like it would be high there.

Tobias Carlisle:
That’s a good point.

Bill Brewster:
You could have a one for 10 split, right? Or would it be the other way? You know what I’m saying?

Jake Taylor:
Yeah, get it up there.

Bill Brewster:
What they were doing…

Jake Taylor:
That’s share Viagra.

Bill Brewster:
Never doing that.

Tobias Carlisle:
I never ever look at the share price. I almost couldn’t tell you what the share price is of half a thing. It’s just not at all relevant to me that the number that you’re buying it at … How many pieces of … When you cut your pie up or your pizza or your cake, if you’re feeling hungry, do you cut it into eight pieces? Or do you cut it into four pieces? It’s totally irrelevant to the valuation.

Jake Taylor:
I use this actually as a, maybe I shouldn’t even say this publicly, but I use this as a towel when I’m talking to someone to see kind of what kind of investor they are. If they talk in share prices, that’s completely different to me if they talk in market caps.

Tobias Carlisle:
Or even enterprise value.

Jake Taylor:
Now that’s the Winnie the Pooh in the tuxedo.

Bill Brewster:
I tell you the one thing that I do like the restoration hardware research project that I did, I will look at potential dilution. That I think is really important because if you just look at market cap and you don’t know what kind of dilution might be on the com, you might quote a market cap and be completely wrong on what the actual true market cap that you could be buying is versus what you-

Tobias Carlisle:
Fully diluted.

Bill Brewster:
Yeah, that’s right.

Jake Taylor:
Yeah, that’s a good nuance there.

Bill Brewster:
Yeah, that’s the only nuance. That’s it, there are no others.

Tobias Carlisle:
I couldn’t agree more.

Bill Brewster:
Well, this has been fun. I’m in quite a mood. I’m amped up today. I got my bike working.

Jake Taylor:
Did you get your Peloton delivered yet?

Bill Brewster:
Yeah, man, I did. I told you I’ve been boozed free for what? What are we on? Like day 12. I’ve been Pelotoning, shit is looking up for Bruce Day.

Jake Taylor:
You’re ready for Corona, I love it.

Bill Brewster:
I’m trying. I’m not trying to get taken out by this thing.

Jake Taylor:
Or even more than that, I don’t want to be a vector for other people who are at more risk.

Bill Brewster:
I canceled my flight to see my grandma. I just told her, I said … I mean, she means too much to me. She’s 91. I’m not taking that risk. So we’ll see.

Tobias Carlisle:
You could be carrying it to her.

Bill Brewster:
Yeah, my mom too. I was like, just be careful. So to anyone out there, be safe. Stay safe out there.

Tobias Carlisle:
Thanks folks. We’ll see you next week.

Bill Brewster:
Monetize us Google.

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