In this episode of The Acquirer’s Podcast Tobias chats with Nicholas Pardini, Managing Partner at Davos Investment Group. During the interview Nicholas provided some great insights into:

• How Investors Can Capitalize On Future Macro Trends
• The Era Of Hard Choices
• Micro Risk Parity
• We May Be Headed Into A Period Of 70’s Stagflation On A Lighter Scale
• Global Macro Trends Will Include Onshoring And Tightening Of Supply Chains
• Here’s Why The Majority Of Tech Companies Are Clearly Overvalued
• Are A Lot Of Our Existing Jobs Simply Unnecessary?
• An Alternative Method Of Calculating CPI
• Is It Possible For Society And The Economy To Survive On Universal Basic Income?
• The Chapwood Index

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

 Apple Podcasts

 Breaker

 PodBean

 Overcast

 Youtube

 Pocket Casts

 RadioPublic

 Anchor

 Spotify

 Stitcher

 Google Podcasts

Full Transcript

Tobias Carlisle:
Okay. When you’re ready, sir, let’s get going.

Nicholas Pardini:
I am ready.

Tobias Carlisle:
Hi. I’m Tobias Carlisle. This is the Acquirers Podcast. My special guest today is Nicholas Pardini of Davos Investment Group. He’s the managing partner. There are two parts to his business, a macro fund and some institutional research. We’ll talk to Nick right after this.

Speaker 3:
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 the comments 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:
Hi, Nick. How are you?

Nicholas Pardini:
I’m doing well.

Tobias Carlisle:
Tell me a little bit about Davos.

The Era Of Hard Choices

Nicholas Pardini:
Okay. There are two main parts to what we do at Davos. The first is the platinum research business, which is an institutional research platform where I help a lot of larger funds figure out the inconsistencies between what certain asset prices are mispriced, versus the fundamental macro narratives and/or volatilities implied. I’m very good at finding the unquantifiable risks in the marketplace that are mispriced by conventional Black-Scholes models, or by just the standard narratives. My background prior to this is, I’ve worked as the head analyst at a large options hedge fund, and people are good at, just on a hard quant basis, figuring out what the fair relative volatility of something is. But if the risk cannot be easily quantified, for example, if there’s something that would cause a jobs report to be more than one standard deviation away plus or minus, bull markets don’t capture that very well.

Nicholas Pardini:
I think, in a lot of the probabilities of things that are not easily quantifiable, and coronavirus is actually a perfect example of this, get mispriced, and that’s where the opportunity is. I mean, the reason I started my firm when I did at end of 2017, is because I think we’re entering from a macro perspective, what I call the era of hard choices, where basically the combination of extended levels of debt and income’s no longer rising or actually falling, the level to service it, and the inability to lower interest rates to cover those costs, is causing, not just businesses, but individuals and governments to finally make the hard choices that you could have easily papered over through refinancing. And that’s why you’re going to see more binary outcomes and higher realized volatility, whether the VIX confirms it or not.

***

Tobias Carlisle:
What’s your background and what influences do you have in the fund?

Nicholas Pardini:
Okay. There’s three main investing styles that I’ve learned over my career. I first got into trading when I was younger, in my early teens when my grandparents would give me shares of stock instead of cash for my birthdays. I remember the first stock I ever owned was Canadian Railway International, CNI Ticker Symbol. It’s still around. And, I, well, learned from a value perspective, they got it started … This was in their early 2000s, and that worked quite well when I was doing my early investing in my high school and early college years. And then 2008 happened, and I ended up working under a family office in Santa Barbara, where I went to university, to learn about everything I do now outside of value, which is macro trading, how FX works, emerging markets, short selling, growth investing.

Nicholas Pardini:
And I shifted more from a pure value to a growth at a reasonable price, plus a macro narrative catalyst. And then I worked at a few various firm in some proprietary trading roles until I ended up at working at larger hedge fund in San Francisco that specialized in options and relative volatility. But I never traded an option prior to working there, and once I got involved with being on a options desk, I learned the importance of volatility, not really in the sense just appear like relative, like something is cheap on an option basis, because the vega is low or the seller, because the vega is high on a pure basis, but more about how to manage position size based off volatility, and what the changes in vol are telling me about the future changes in price direction, and what risks are being priced in, and what risks are not being priced in.

Nicholas Pardini:
And then I started to see really just some certain turning points is going on the world such as Brexit, such as the 2016 presidential election, and a lot of countries hitting that 100% debt to GDP wall, and I was like, “They assume …” The other thing that got me into this ironically, was the fact that you saw so much net outflows of capital from hedge funds, and such a violent flows towards passive. Apparently I was two years early on that, but I thought, “This is …” With a lot of just money that’s not really paying attention to what’s going on, or not discriminating based on price, and you have all these just big time generational shift type catalysts out there. This is the time to capitalize on a new vol regime and a new opportunity of just a binary decisions.

Nicholas Pardini:
A good example of this is something that I’m looking at right now, is the cost benefit analysis of living in major cities after this COVID crisis. I mean, you start to see net migration of millennials from cities to suburbs before this happened, and from higher cost of living cities to lower cost living cities.

Tobias Carlisle:
Like Austin or Nashville?

Nicholas Pardini:
Yes, or even just my example, I moved from San Francisco to Orange County, which still not a cheap place, but relatively it is.

Tobias Carlisle:
Cheaper.

Nicholas Pardini:
It’s cheaper. So, you starting to see that already, but now with rural promote becoming more socially acceptable, and online education becoming more viable, you don’t have to live super close to these urban centers, and you don’t need to commute to the office every day. And there’s a lot of ripple effects that people are going to choose to live a more comfortable lifestyle, and be able to afford to have a family and live out in the, not the suburbs, but the rural areas of the exurbs, where they’re going to choose their access to restaurants and entertainment venues, and being where the “action” is. That was the harder choice, now it’s becoming a more easy choice. And then you’re seeing the disruption, the relative performance of different types of REIT’s, is where you’re starting to see. And I think you’ll see that in other industries eventually in the marketplace.

Tobias Carlisle:
So, what big changes are you seeing? There’s the remote work, is one, government debt levels relative to GDP. Let’s talk about that one first. What does that imply for the future?

Nicholas Pardini:
Well, it implies that there’s debts are going to have to be either paid back through default or inflation. Historically, governments who have their own currency do not default. I mean, a lot of the criticism of people who have this type of argument that I’m presenting is, “How come you haven’t seen higher CPI prints already,” or, “How come the dollar is still strong?” Well, I just think FX volatility should be ignored, because there won’t be any FX volatility. If every country is doing the same thing, or mostly on the same direction, then the relative value of currency should be constant. And this is really why I have not been active in the FX markets as I used to be, because there’s very few currencies that have some sort of catalyst that will differentiate their trajectory.

***

We May Be Headed Into A Period Of 70’s Stagflation On A Lighter Scale

Tobias Carlisle:
Is that new though? That hardcore money printing has been going on for more than 10 years now. You know that famous interactive brokers ad where they have all of the investment banks shooting out piles of money, that’s got to be 10 years old, that ad.

Nicholas Pardini:
Yes, the difference between now and, say, 10 years ago, is that, where the money is being sent to. I think one of the big potential macro catalysts is whether Western societies adopt a universal basic income scheme or not. I think that might be the defining issue of the 2020 and 2024 elections coming up, because if you have all this inflation in terms of increase of money supply, and it actually gets into the hands of people who are most propensity to just spend it, then you’ll actually start seeing an increase in velocity of money and price level. The QE inflation from, say, 2009 to very recently, it increased real estate prices and asset prices, because it just was in the form of lending, and the only people who had access to credit were those who already had money to spend on risk assets.

Nicholas Pardini:
And also, you had massive deflation, or just no price appreciation in general things that people spend money on outside of housing, such as food, such as transportation. If you look at, example, airlines, prior to this event, airlines relative to average wages has been all time lows. That’s why we’ve had such a big boom in tourism. And consumer goods, and everything except, really, for housing, health care and education, food prices, energy, all fell drastically the last 10 years relative to incomes. And because of that, people were able to spend a larger percentage of their disposable income on rent and mortgages. If you start to see the prices of other stuff increase, especially given how low of a base we have now on a lot of commodities, the remaining amount of money to be spent on rent and mortgages as a percent of income is just, isn’t available anymore.

Nicholas Pardini:
So I think you’ll have the reverse type of inflation where housing inflation will be flat or lower than general CPI, and other goods will be much higher.

Tobias Carlisle:
So what’s a good analog for that? Is it 70s with stagflation?

Nicholas Pardini:
I think it was 70s on the lighter scale, I would say. It would take a lot … I mean, if you look at just the debt to GDP levels of the US, if we were trying to get debt GDP back down to pre ’08 levels, which would be 60% of GDP and maintain the 2019 deficit, which was 4.6% of GDP. Then you would need to have inflation average 9.2% to get those real debt levels down. I don’t really think anybody has the goal of getting debt to GDP down to 60%, but I think you could see a consistent four to 6% inflation rate. The tricky part is that, will you see in the CPI? Because all the political incentives in terms of COLA adjustments and tax brackets, and a variety of other fiscal issues, have incentives to keep that down.

Nicholas Pardini:
I mean, that’s how China has incentives to keep its GDP up to keep all their regional governors paid. You have a similar incentive problem. I mean, America has a better quality of data and more freedom than they do in China, so it’s harder to pull that thing off, but the incentives are there to do it, which makes this a little bit trickier of a trade.

***

An Alternative Method Of Calculating CPI

Tobias Carlisle:
What do you think about the current method of calculating CPI? Is that a little bogus?

Nicholas Pardini:
Yes. I mean, I run an alternative measure of CPI for my clients, where I use the same weights as the BLS, but I use private sector data to get all the components where there is private sector data available. Right now, it’s trading a little bit lower than inflation. My model is showing actually moderate deflation right now, mainly due to oil collapsing 60% year over year, but excluding energy, it’s usually about two to 3% higher than standard CPI. It’s not enough that it’s like, oh, it’s shadow stats in the end of the world, but you’re starting to see … There is a gap, and the particular reason there’s a gap, and then this is why Europe has also an artificially low inflation rate too, because they don’t even keep track of this number at all, is that underestimates housing prices and health care to a certain degree. And those are the main two drivers of inflation.

Nicholas Pardini:
In Europe, I don’t even think they have CPI model. They even have as housing price inflation, and the owners equivalent rent in the US is where you have most of the fudging, if there is any. Because, I don’t think it’s intentional, but when you call somebody and ask, “How much would you rent your apartment for?” If you’ve been living in your house for 30 years, and you’re just paying your mortgage, you probably just assume whatever your mortgage payment is, and don’t even think about what the open market is. And so, there’s a lot of room for error there.

The Chapwood Index

Tobias Carlisle:
What about something like the Chapwood index? Have you heard of that?

Nicholas Pardini:
No, I’ve not.

Tobias Carlisle:
So they track the 500 items that most families spend the most money on for each city in the States, and the data are available for free on the website. If you run it back 10 years, the numbers are … Sorry, run it back five years, the numbers look like they’re running between 10 and 12% annually for those items that folks spend the most money on. So, I think that squares more closely with shadow stats than it does with other CPI measures. You think that’s too high?

Nicholas Pardini:
Yes, but probably is too high, because if it was that bad, you would see a lot more … Or higher poverty rates. I mean, you are seeing … The other thing, as I mentioned this on my Real Vision interview a few months ago, is that there is an age gap in inflation. If you’re in your 60s, you have deflation right now, because your house is paid off, you’re on Medicare, and you don’t have to pay for your own college or your children’s college anymore. If you’re a younger person, say 30s, you have probably double whatever the inflation rate is, and probably closer to the Chapwood number than even my estimates, because your primary spending is on housing, health care and education, which are all going up much higher than CPI. So, I would say the delta between the inflation for older people and inflation of younger people is three to three and a half percent.

Nicholas Pardini:
And that is why you see this gap, because the economists out there are mostly older people who don’t have inflation, because the stuff that’s inflating, they’ve already paid off or don’t need to spend money on, and the stuff they do spend on, like plane trips to visit their kids, or going out to eat, or buying a new car, that stuff is down in real terms. And that’s where you see the socio political disconnect, and I think a lot of the political issues, this is another big theme of mine, are not the 1% versus everybody else that is popularly narrated, but it’s young versus old. And you just can’t … It’s just politically unacceptable to say, “I hate old people. I hated my parents.” And so that’s why they have to brand it that way.

Tobias Carlisle:
There’s a pretty popular boomer meme that does the rounds.

Nicholas Pardini:
Yes, OK Boomer.

Tobias Carlisle:
And the one of the boomer Steve who’s … “I worked a part time job and paid off my college kids these days.” [crosstalk 00:15:58] concept.

Nicholas Pardini:
Oh, the economy Steve, I remember that.

***

Tobias Carlisle:
Oh, the economy Steve. So, what are the big changes are you seeing? What happens over the next 10 years to generation?

Nicholas Pardini:
I think there’s going to be an inevitable wealth redistribution down the age curve. I’m not sure how that’s going to go about. I’ve my personal political beliefs on this, but I try to keep them out of my analysis here. In normal times, with terms of generational transitions, you had older generations willingly step down or mandated by law to step down from professions, or be out of politics, or sell their assets at a certain age. The retirement age of 65 was a standard part of society, but as of increased health standards, and a lot of baby boomers want to live above their means for a longer periods of time, or just maintain higher means if they’re living within their means, or they actually like their jobs, because jobs are a lot more intellectually rewarding right now than in the past. The people are not stepping down.

Nicholas Pardini:
And you see the average age of a CEO from 2004 to 2019 increased from 45 to 59. It’s almost year for year.

Tobias Carlisle:
Just to stay at the same role.

Boomers Have An Iron Grip On Controlling Society

Nicholas Pardini:
Yes. This is similar for politicians and members of Congress, senators. Half of our senators are over 65 in the United States. Look at the presidential election, the last two presidential elections; every major candidate in the general was 69 or older. Hillary Clinton was the spring chicken at 69, which shows you how iron grip of the control of the boomers of society still is outside information technology. And then, on top of that, you’ve had years of regulations being passed to prevent new entrants into businesses outside of technology. So anything a boomer understands, they pass rules to lock people out, whether it’s increased licensing requirements, or NIMBY anti-construction rules on the real estate side, or just piles of regulatory barriers of entry all across the economy. And, you have on top of that, a pay as you go style retirement system, and their generation did not have as many kids as previous ones, so there’s less people to pay for it.

Nicholas Pardini:
And so, you’ve seen this massive wealth transfer up the age curve, basically since the ’80s, and that’s why you see the average millennial, or a person in their 30s is poor than their parents, by a considerable mile, in terms of income and net worth, and-

Tobias Carlisle:
At the same stage of their career.

Nicholas Pardini:
Yes. And then you’ve seen other statistics showing that … I mean, I saw a Nexus survey that show that 60% of boomers don’t plan on giving any money and inheritance to their kids. And the problem is 70% of millennials expect one. And that’s been a thing. A lot of the hope is that, “Oh, maybe I’ll just get an inheritance when my parents die, and that will help finance my house or my wedding, or having my own kids.” And, it’s the combination of longer life expectancy and less willingness to pass money down, that’s not going to happen, and that’s going to cause socio political resentment.

Tobias Carlisle:
So how does that get resolved?

Nicholas Pardini:
It gets resolved through either one of three things, that historically, what we saw the last generational wealth transfer was the ’70s, which, that was done through inflation. Inflation eroded the real value of the assets of the older generations, and the younger generations’ incomes kept up with inflation, so they didn’t really get hurt. So, inflation was how we solve this. I mean, I don’t think that was the reason for it, but it coincidentally resolved this issue in the 1970s. So, I think that’s probably going to be part of it, and I think might drive that is more MMT style policies, whether it’s a universal basic income, or unlimited health care for younger people, or an infrastructure projects, or depending on what side of the aisle, you have some sort of stimulus projects that disproportionately help working age individuals over retirees, where, they may not get a nominal cut in their social security, but they’ll get a real cut, or you eventually just, if that doesn’t happen, the society eventually runs out of money, and you just have structural defaults in the pension system and in the entitlements in actual hard cuts.

Nicholas Pardini:
I think it’s the least likely outcome, just because it’s politically not so friendly to do that, but we saw examples of that in history with great empires have fallen. I mean, the USSR breaking down is the most recent example of a whole old institutions collapsing and people’s just getting their pensions completely wiped out. I just think the problem is that all those is timing. I could have told you the pension system in Illinois is insolvent five years ago, and it was, but somehow, the state is still not filed chapter nine yet. So, that’s the tricky thing with these generational type cycles.

Global Macro Trends Will Include Onshoring And Tightening Of Supply Chains

Tobias Carlisle:
What other big themes do you see coming?

Nicholas Pardini:
Well, I think on geopolitical realignment, I think the whole idea of traditional free trade has been … What we think of is not really that historically viable. You’ve only had one era in history where you’ve had open free trade with even countries that aren’t allies with each other across the world, and it’s fairly safe to exchange goods, and that was basically 1989 and 2015. And, the old school way in history is that you’ve had mercantilist blocks or spheres of influence where countries, allies, or dependencies would just trade within their own networks, and have their economies relatively isolated from rivals networks. We had this with the iron curtain at the end of the 20th century. We had it with all the colonial empires in Europe before that, and you’re probably going to have a US sphere and a China sphere.

Nicholas Pardini:
These tensions were already there, but what’s going on with the Coronavirus and the need for blame is going to accelerate that. And it’s also emphasized the fact that we had lacked critical medical equipment then needed, the geopolitical danger of relying on a country you don’t 100% trust to manufacturer critical strategic resources. So, I think on-shoring to a certain degree, plus just tightening the supply chains. And so, the whole idea of developed and emerging markets is also shifting because of this. It’s not going to matter, GDP per capita is not going to be the main driver of investment in a country more like it was the last 20 years. It’s going to be who we geopolitically aligned with, and where do you fit within the supply chain? And that will determine returns relative across countries in terms of equity and currencies in the future.

***

How Investors Can Capitalize Of Future Macro Trends

Tobias Carlisle:
With themes like that, how do they manifest in your trading strategies in the fund and in your research? How do you recommend that folks place trades to realize those big themes?

Nicholas Pardini:
It’s a multi step process. First, I try and figure out where the ball is rolling in the world, and then I keep a list of, within every sector … I’ll start with equities, then we’ll branch out from there, of every sector of the best quality company in that sector, and the worst quality companies in that sector from more traditional fundamental metrics that I use. And if I’m bearish on trend, I try to find the worst of those companies and short it, and if I am positive on that trend, I try to find the best of those companies and go on. [inaudible 00:24:27] just an example would be, say if I had a view on the auto industry, and I thought that cars are going to have a Renaissance, then I would want to go long, say, BMW or Daimler, because they’re the best of breed in terms of car companies. I mean, I haven’t done that much research in the auto sector, so I don’t really know how their numbers are right now, but that goes in my bet that I think people are going to be driving more, or if I was the opposite, I would try to find a fundamentally unsound company that I think would crash if people stopped using cars.

Nicholas Pardini:
I mean, that might be a consequence of the UBI economy. If you don’t have to go to work anymore, why … Two of my biggest short traders, I’m not going to mention, are involving less use of cars, and especially among the people who are the more marginal levels of employment. If they’re getting guaranteed pay not to work, they have no reason to borrow excess amounts of money, or maintain having a car. And there’s a few trades I have … I don’t talk about specific portfolio trades publicly, but there’s a few companies on the short side that would fit that category. So that’s how I look at it. And then, with other things such as currencies, and bonds, which … I don’t really trade bonds anymore, because I think they’re the fixed income market, as a high probability of just being politically manipulated in the form of yield curve control. So their relative value there is going to be limited, and especially if you’re a longer term investor, your best case scenario is you have deflation and so, with deflation, you’re probably almost better off just keeping that in cash.

Micro Risk Parity

Nicholas Pardini:
I mean, you can make money speculating on bonds going up or down the short term, if they go, say, negative, but I just think in terms of, from the perspective of an investor, it’s not a good place to be right now. But in terms of commodities and FX, I try to look if there’s any catalysts that will change the existing narrative or trend that’s coming, and once I see it, I’ll put on a position when my risk models permit and let it ride. In terms of how I manage risk, I use volatility to manage risk. I size positions depending on volatility. So, if it’s something that doesn’t move very much, say, like, I don’t know, FX pair, a much bigger percentage of my book, say, 20% of my book in an FX pair, even though it’s only worth maybe 25 basis points at risk, because the difference between my entry point and my stop is 25 basis points. But since currencies don’t move very much, you can have a much bigger position. Then, on the other side, something like, say, Tesla stock, which moves $20 a day often, you have to have a much smaller position adjusted for volatility.

Nicholas Pardini:
And I call it, in a way, micro risk parity, in the sense that, every one of my positions is worth the same amount in terms of risk. And I do that to prevent blowing up. I think the biggest risk that a lot funds make the mistake of is, apart from shorting gammas, mis-sizing positions without factoring in volatility. They’re just on pure blind conviction. I mean, I may feel like I have more conviction in something more than another in terms of the theme, or even a specific company, but historically, those intuitions don’t line up with the results. You have to look at it while … I mean, like in sports betting, where you just have even sized bets on every portfolio, because every game, because you don’t know which one is going to be the one that’s going to win. At least, I mean, I haven’t gotten to that point in my career where I can say, “This is by far my highest conviction trade, and the results reflect that.” I don’t know if you’ve had experience for your experience like that, in terms of sizing positions, but that’s how I do it.

Tobias Carlisle:
I find it difficult to size positions properly, so I tend to equal weight, but I’m in a equity world, long short equity world, so the volatility isn’t that different from position to position, although there’s a lot of difference between Berkshire Hathaway and, to your point, Tesla, speaking of which, do you have a view one way or the other?

Nicholas Pardini:
Yes. I mean, I have a bearish view on Tesla, and I have a short position in Tesla. I mean, I was kind of ignoring it until recently, but it’s already back within 20% of its all time high, even though I think you’re going to see a major demand crunch for cars in the future.

Tobias Carlisle:
With this quarter.

Nicholas Pardini:
Yes. I mean, they’re the company that changes brands on just pure momentum. But that’s the thing with the market right now, generally, which is making it a little bit challenging, with everybody writing off 2020 as just, this is just going to be a bad year because of COVID, and two months being shut down, maybe more. Fortunately for you up in LA. And therefore, we just are not going to have any guidance, we’re just going to write it off, we’ll forget about it, and let’s just hope 2021 is back to normal. But we have no idea if it’s actually getting back to normal, because nobody knows what’s just a temporary change, or if it’s a structural change. And so, the market with a lack of fundamental anchors, and with the possibility nobody knows who’s going to get bailed out by the Fed or companies who are going to give more favorable financing because they’re hoping that the Fed will help them if they get in trouble, that it’s basically, it’s pure emotion. Every stock is Bitcoin now, to a certain degree.

Tobias Carlisle:
Not the stocks I own. They seem to be pricing in a lot of COVID based disaster.

Nicholas Pardini:
Well, I mean that in the sense that, it’s moving the same way as Bitcoin. What I mean that more in the sense is that, there’s little to anchor it to. I’m not a big fan of crypto currencies just from a conceptual basis, but the, really, role of them is that it’s the most pure beta out there. You have no earnings, reports are nothing to be accountable on that. There’s no cash flow or interest rate expectations, so you can’t peek at zero rates, because you’re not expecting a cash flow anyway. And unlike other commodities, there is no storage cost, so you don’t have to worry about what happened with oil a month ago. So, if you want just a pure animal spirit beta, risk on, risk off, Bitcoin is the trade, because the only thing driving it is sentiment and emotion.

Nicholas Pardini:
I mean, actually, I used to be a really hardcore gold bug, and I still like gold from a structural point of view, just given its historical role of money, but how I started to see crypto, the arguments in favor of cryptocurrency merge with the arguments for gold, has made me more skeptical on precious metals, to a certain degree.

Tobias Carlisle:
So you don’t think gold will serve that same money function, or risk off function that it has in the past, and maybe that goes to crypto?

Nicholas Pardini:
I think they’re both trading similar in that way. I think crypto is more aggressive version of gold. Crypto is like … A lot of people argue that it’s digital gold. I think it’s more just pure beta. Gold is a mix of … It seems like the narrative of gold is continually changing. When I first was trading, gold was known as the inflation hedge, as a way to protect … But then you don’t see inflation, and gold goes up, and when you have inflation, gold goes down, but I think, really, gold is the proxy for real interest rates. The more negative real interest rates go down, gold should go up. It’s the inverse of real rates. And that’s, in essence, I think, real rates are structurally going to remain lower. I’m still positive view on precious metals.

Tobias Carlisle:
Let’s talk a little bit about Coronavirus and the market. You seem to be saying that the market is untethered from what is actually happening underneath, or people are just assuming you can write off the front month of the DCF, and then you look further out and your terminal value’s not changed. So, it makes sense we’re back to where we were before the shutdown. How do you see it playing out? What do you think about the way the market is now?

Nicholas Pardini:
Well, I think the market is pricing in a few possibilities here. If the base case that they give you, just as if this is a normal market economy, and the recovery is like a typical recovery from a contraction of half of the magnitude of this one, then the asset prices need to go down across the board, especially in some of the more overvalued, speculative names with a lot of leverage. People think tech all is clean balance sheet. There’s plenty of tech companies that have debt to equity ratios well over one, and that’s probably if you want to go short where your opportunities are with little to no profit and high levels of debt. So, you’ve got …

Nicholas Pardini:
That’s probably the basics that the market will catch back down to the economy. And, you could see a little bit of recovery in the short term, because going from zero to reopening, and a lot of people have to [inaudible 00:34:17] as there’s some pent up demand. I bet a lot of people in California really need to get a haircut now.

Tobias Carlisle:
Yes, I’m one of them.

Nicholas Pardini:
I’m one of them too. And that will probably make things look good, and in the shorter term, I think that’s starting to get priced in, but unless if this Coronavirus was just a complete hyperbole overblown, which there is a possibility that everybody was just wrong, and this lockdown is unnecessary. And this is no … I mean, this is just like a more potent version of a flu, then things could catch on a little faster than expected. I think that’s not the most likely scenario, but I think that’s a possibility. The other arguments to the bull case are, that this is the beginning of the major inflationary crack up from an Austrian perspective. And, really, the argument for that is, look at what gold and crypto are leading the way higher, and how you’re seeing things that actually require structural demand not recover as fast.

Tobias Carlisle:
What things require structural demand?

Nicholas Pardini:
Travel, transportation, industrials, and also you’ve seen REIT’s, like office buildings, not [inaudible 00:35:41], those are facing the work remote, but even residential REIT’s too. The basic things involved in the production of goods and services are lagging, whereas the stuff that’s leading the way is a lot of inflation hedges, along with health care, precious metals, and also the lagging of non US equity markets too, are the other thing on that side. The third argument is that the market is starting to price in basic income, and these … I’m just going to start these are the bull arguments. And I think, though, you see what’s going on, is that a lot of this stuff that’s leading the way higher is stuff that people will buy on an income that’s enough to keep them alive, but not enough to really live a life of luxury, or have a family or anything like that. So things like video games.

Nicholas Pardini:
Video game stocks are one of my favorites on the long side, because there’s a few reasons for that. One, going long, video games just short the earnings prospect of American and Western men generally. If you have a down economy, then video games are the one of few affordable forms of entertainment. I mean, as a younger guy, I know from my experience, the poorer I’ve been, the more I play video games. I don’t know if that’s the same with other people you know, but that’s-

Tobias Carlisle:
It’s certainly been a feature of this shutdown that there’s been an explosion in video games being played, so that …

Nicholas Pardini:
I mean, Animal Crossing sales … Nintendo stock has shown you what’s going on with that, but video games are big. They’re the new staple, I think. A lot of the old staples such as cigarette companies, and alcohol companies, and junk food, due to health choices were fading out, but maybe in a basic income, they have a chance of coming back. But fast food has been another leader on the way higher. Chipotle is back at all time highs. McDonald’s is close. You’ve also seen health care be a leader of that, because that’s a basic service that would be provided by government. And, you’ve seen a lot of internet entertainment, stuff like Google for YouTube, Netflix for streaming, et cetera, and you got eCommerce. So, those are telling me that the market is pricing us, and gold rallying too, is that, it’s going to be, central bank finance basic income is, I think, the most bullish scenario for markets, even if it has societal implications that aren’t so great.

Is It Possible For Society And The Economy To Survive On Universal Basic Income?

Tobias Carlisle:
Is it possible for the society and the economy to survive on universal basic income, and men of employment age playing computer games, rather than being productive? How does that play out?

Nicholas Pardini:
That is the question of our generation. That is the one to decide our politics, that’s going to decide how our society is structured. That really is kind of … I don’t really know the answer. I mean, I have a few questions for you, if you want to make this more of a conversation.

***

Here’s Why The Majority Of Tech Companies Are Clearly Overvalued

Tobias Carlisle:
Let’s do it.

Nicholas Pardini:
First, on the terminal value side, especially with tech companies whose technology become obsolete really fast, or just the level of disruption, how can you have a terminal growth rate higher than zero? I mean, when you do that, it gives you overly conservative DCFs possibly, or maybe just the market is that overvalued, but at the same time, it’s difficult to see anything that has a lot of staying power, that the terminal value should be sufficiently higher than that.

Nicholas Pardini:
And then, on the basic income side, how much people do you really think we need to be working especially if a lot of the more service in-person type businesses such as travel, and tourism, and restaurants become just structurally less in demand, and that those employed a disproportionate amount of people in the last cycle, that you need to run the pre-Corona level of the economy plus two or 3% GDP? If that number’s under 80%, or even under 85% of the working age population, we’ve got a real problem.

Tobias Carlisle:
There’s two questions there. So, the DCF one, the struggle for the last decade has been, to the extent that, if you’re a fundamental investor, if you’re a value investor, and you’re looking at the inputs to a terminal value, you’ve got two; you’ve got the discount rate, and you’ve got the terminal growth rate. The discount rate has been, if you’re conservative, you’re assuming that the discount rate is too low, and you assume some sort of mean reversion. It shouldn’t be zero, it shouldn’t be very, very low, it’s typically run around 6%. If you use that as your input, your terminal value is just too low, and you really haven’t been able to find much to buy. But here we-

Nicholas Pardini:
We’re talking about the R minus G part, not the R being zero, but the G part that you subtract off the continuing values.

Tobias Carlisle:
Well, there has been growth, but now you’ve got to factor in a lower G. So that makes it extremely difficult to value a lot of these companies. And, in addition to that you have, if this dotcom … Not dotcom, sorry, but if the software as a service style businesses are as easy to create, and are able to supplant each other pretty easily, then maybe they’re more akin to they know … Where previously, if you built a business, it was like sinking an oil well that would run for 30 years. Now it’s shale, where you punch a hole and there’s a gusher at the start, and then there’s really not much terminal value because it’s supplanted by new technology. So, we’re recording this over Skype. You can use Zoom, you can use WebEx, you can use Teams, you can use Slack, there are any number of these services.

Tobias Carlisle:
And you look at Zoom, it’s got a $48 billion market capitalization, and we use it for free. Skype’s free. I find it difficult to see how some of these businesses are ultimately going to monetize and create a moat, maybe get some sort of network, but even then, anything that’s had a network in this world has been replaceable. So, I think, Google’s probably hard to replace, YouTube’s got probably a stranglehold, Gmail, Google search, or the Google ecosystem’s hard to replace, the Microsoft ecosystem is hard to replace or compete with. Netflix, I find … I just don’t see why … When you look at YouTube, and there’s Joe Rogan putting up a three hour episode, three times a week for virtually no cost to him, but he gets paid by YouTube after the fact, after they aired and to show those commercials, I don’t see why that is any less … If that’s going to capture less attention than Netflix, which has to go out and create that content first, then show it to you.

Tobias Carlisle:
It’s going to be easy to put shows up. It’s the best time in the world, probably, to be a studio. It’s the worst time in the world to be a distributor, because you can put up any kind of … So, I find tech is almost uninvestable, but if you look at the trajectory of the prices, there aren’t very many people who feel that way. They’ve been running pretty well. Valuation is extremely difficult with interest rates at zero and growth trending towards zero. It’s virtually impossible, I think, for some of this stuff. How does that strike you?

Nicholas Pardini:
Yes. I mean, I have a similar sentiment. I think some of the tech companies have some structural advantages, but I just think you have to have a higher required rate of return given the shorter length of the company, and a lower G. That’s been the problem. I basically have, say, a required rate of return on my DCF model, seven to 10%, depending on the company, and have a G at zero to two, and if you run anything with that kind of … It’s going to show that the prices are worth half of what they are now. And that’s with something that has a sustainable cash flow. There are some exceptions to that. I think Google’s going to be fine, and a lot of … But there’s a lot of tech companies, I think, especially the ones that are constantly losing money is base this on the bet that basically users are worth more than dollars.

Nicholas Pardini:
I mean, this sounds like ’99 but there is a way that you can monetize this data and attention, it’s just that it’s just hasn’t been … Only one’s really successfully been able to do that on a large scale is Facebook so far.

Tobias Carlisle:
And Google.

Nicholas Pardini:
Yes, Google.

Tobias Carlisle:
Google has some paid services, but it’s mostly advertising supported.

Nicholas Pardini:
But those two dominate all the entire advertising market. And that’s the other problem, if a FAANG company decides to enter your business, they could put you out of business overnight. You see all these tech companies, you’ll see a headline says, “Google decides to do whatever you’re doing. The stock’s down 20% in the pre-market.” That makes it difficult to invest in a lot of tech companies as well.

***

Are A Lot Of Our Existing Jobs Simply Unnecessary?

Tobias Carlisle:
On the number of workers front, I don’t know the answer to this either, but it’s something that I have thought about a lot. Since the Industrial Revolution, we’ve had this movement towards increasing productivity, increasing output per person. Anytime you have a machine that can do the work of many people, the spinning jenny could do, could create a lot more cloth than we could at any other point in the past. And since then, we’ve grown a technology capital at an exponential rate. And still, we’ve been close to full employment as recently as six months ago, three months ago. So, I think that every time we find a more efficient way of doing the jobs that are easier to do, there’s just a natural reordering of society where people move to a more … They just move up the chain of stuff that they do into jobs that are probably a little bit more rewarding.

Tobias Carlisle:
I’m sure it’s not fun making cloth, I’m sure that it’s better to have the machine do it, and then you find some more creative, intellectually stimulating part of that process. So, I don’t necessarily have the same concern. I think that, for the most part, humans are pretty resourceful, and adaptable and you adjust. You see some opportunity, you find some way to use these new tools to do something new. I mean, who would have thought that you could play computer games and stick a video of yourself up on YouTube, and make millions of dollars a year doing that? I don’t know that that’s necessarily productive for society. But it’s, it’s certainly you can make a living doing that. I don’t know if that’s necessarily productive for society, but you can make a living doing that. So, there’s just types of work that we can’t imagine at the moment that will appear out of that. And I’ve just base it on the fact that that’s what we’ve done for 200 years.

Nicholas Pardini:
Yes. I mean, I understand that argument. That has worked, but at the same time, you haven’t had a political will to basically give people the ability to opt out of the system and there’s no consequence.

Tobias Carlisle:
That’s new.

Nicholas Pardini:
That’s one thing. So, there isn’t that urge to have to find a role for yourself if you know you’re going to get taken care of. Second thing to mention is the accelerating pace of technology, and the higher cognitive requirements for newer jobs. And some people, due to age or just the lack of ability to catch up, are not going to be able to retrain fast enough within their lifetimes, or have the desire to do so, and that could be another real risk to this as well.

Tobias Carlisle:
Well, that’s a good point. Two of those things, and you’re right. Although there are other countries in the Western world that have some form of … Not necessarily universal basic income, but some sort of dole or welfare. The UK has it, Australia and New Zealand have it. And so there are people who are able to not work, or just for whatever reason they can’t work, who are supported through that, whether that’s good or bad for society, sort of a value judgment beyond what we’re talking about here, but there is a model for it in other countries. The really new thing is now that we’re at that vertical part of the technology adoption curve, where through your life … Even 10 years ago, they said through your lifetime, you’ll have three different jobs. Now they say that just the rate of change itself becomes so fast that it becomes impossible for a human to adapt to it. I don’t know what necessarily happens then. That’s brand new territory.

Nicholas Pardini:
That’s the fundamental risk, I think, a lot of this. And then, the other question is, are people more valuable as consumers and producers? Because I think the final problem of the last decade, which has really yet to be resolved is that, in most major metropolitan areas in the United States, and I see this is the same in other developed countries, and possibly China too, the average living cost to live independently by yourself is higher than the median wage after tax. And that is why you’re seeing such a slow level of growth, because disposable income is not there without debt. And so, if that’s the case, and you have … I think that’s also, I think, the key to this Corona recovery, is, will housing prices fall and the healthcare prices stay relatively in check, so that that disposable income does come back on the same level of wages? If it doesn’t, then I think the malaise will last a lot longer, and it may lead to more social tension.

Tobias Carlisle:
I think, even ignoring Coronavirus, a lot of these problems were there. I don’t know whether Coronavirus accelerates it or whether that changes the course of it, I don’t know how that plays out, but I think that we’d have had this consistently aging population. You can drive around anywhere and see the number of aged care homes, but I think that’s been coming my entire life that there are going to be these requirement for aged care homes, for example. But I think what happens beyond that, the aged care homes, people don’t go into aged care homes forever. They’d leave those aged care homes, and all of a sudden you’ve got this infrastructure built out for part of the population that’s just not going to need it, because there’s just not going to be as many people underneath. But that’s a destruction of capital.

Nicholas Pardini:
That could be converted into apartments, or into others, or retail or something else. I’m not as worried about that. The other factor on the job side is how many jobs in the last cycle that were created were jobs that are fundamentally not needed? Even though I fundamentally disagree with this person about dimensions, economic philosophy, is this Marxist professor named David Graeber, wrote a book called BS Jobs. And it’s based on a paper he wrote for Strike Magazine in 2013, and I read it, and it’s basis is this idea that shows that the jobs that have the least amount of impact on individuals daily life are the ones that tend to pay the most, and a lot of jobs only exists really to lock in a certain class structure, in a way, and to be …

Nicholas Pardini:
For example, if we had a lot less litigious society, how many compliance professionals would we need to work do? How many jobs in a lot of these tech firms that are such as they … A lot of roles that are not in the primarily, either in selling the product or producing the product, there’s a lot of fluff everywhere, whether … And I’m not going to go into specific roles, because I don’t want to attack everybody’s profession on this show, but there’s a lot of stuff that if we really just, or really decided just to maximize output wouldn’t be needed. They’re there for social reasons, or to provide a certain class role for people, so that they are satisfied with their lives. I had to post something on Twitter yesterday, a reply to [inaudible 00:52:33]. I forgot, that DC who’s been protesting the bailouts. I can’t pronounce his name, but basically I wrote … It’s the most engagement I ever got on social media, basically saying that, for those who are unwilling to be entrepreneurs, the only real value of a degree and how prestigious your school is, is where you deserve by society, if you fit into the social class hierarchy.

Nicholas Pardini:
I think a lot of jobs out there, their whole job is to create something to give somebody what we consider a lower middle class income, or an upper middle class income, or a rich person’s income, even if they don’t really create that much actual value. And, if those jobs do not come back, or get phased out, just because of need of cost cutting through all the corporate leverage out there, then you might have a real employment problem. I mean, that’s the thing. And how many of our … And this is, again, this is more of a question than … Because I don’t have the answer to this. How many jobs in the economy are there just to serve a social need, rather than an economic one?

Tobias Carlisle:
Do companies hire on that basis, though? I think that companies hire because they feel that there’s a need. I think that you might be able to make that observation at a macro level across all of them, but at a micro level, it doesn’t feel right. Though I’m always struck by, anytime a tech company lays off 3000 people, I just think, how is there that much fat to cut in a business like that, that you can just … Uber lays out 3000 people. My co-host on my value after hour show, Jake Taylor, says that, you look at something like Google. Google is basically … Basically, the machine runs itself. It’s basically autonomous, and it’s controlled by three people. It’s controlled by Sergey Brin, Larry Page, and Eric Schmidt, who have the only voting shares and everybody else’s trading shares that have some sort of economic claim, but no vote on what Google does. So basically, there’s three guys who control what Google does, and they can hire or fire vast swathes of people almost without impacting the business.

Nicholas Pardini:
Well, yes, example would be things like quality insurance, compliance or HR, there’s probably some role for those, but do you need a 100 person HR team versus a five person HR team?

Tobias Carlisle:
Middle management.

Nicholas Pardini:
Middle management generally. I think middle management, it might just be … I mean, again, this is just more of bringing up a question on it. Middle manager could possibly just be a job designed just to give probably a middle class income. That’s why you seen also last surveys on Gallup, particularly and Pew Research show that 80% of Americans hate or actively disengage with their jobs, because we have a system that rewards the most prestigious jobs, and the ones that pay the most often, again, are the most disconnected from society and people don’t enjoy doing. I mean, I didn’t pick going to finance because of money. I actually like what I do. I probably would have gone into tech or oil if I was trying just to cash out, but there’s a lot of people who are just trying to cash out, and a lot of those people are unfulfilled as a result. But the thing is … This is the question, is how many of our jobs in society are needed? I don’t know the answer to that. [crosstalk 00:56:01]-

Tobias Carlisle:
Well, we’re going to find out.

Nicholas Pardini:
We’re going to find out. And I think that’s the cost for this recovery too, is we have, based on these claims numbers now, if we want to play our rate in the 20% plus range, again, how many are … I think we’re going to need to come back. I mean, I think we’ll have at least half of them be back by the end of the year. But even if we had half those jobs back, that’s still the peak of unemployment in the 2008 recession.

Tobias Carlisle:
Yes, it’s a scary thought. Nicholas, we’re coming up on time. Absolutely. fascinating discussion. If folks want to follow along with what you’re doing or get in touch, how do they go about doing that?

Nicholas Pardini:
You could go to my website, davosig.com. You can follow me at @Nicholas_Pardini on Twitter. You can email me at Nick@davosig.com. And those are probably the best ways to get in touch with me.

Tobias Carlisle:
Oh, that’s great. I’ll make sure to link to all of those in the show notes on Nicholas Pardini, Davos Investment Group. Thank you very much.

For all the latest news and podcasts, join our free newsletter here.

FREE Stock Screener

Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple: