In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:
- Ghost Town Economics
- The Problem With $UAL Securing A New $5 Billion Loan Using Its Frequent Flyer Program
- Do Fundamentals Matter?
- Is Value Dead Because Of Winner-Take-All Industries
- The Facebook Boycott And Virtue Signalling
- Physical Gold Or Gold Related Companies
- Cash Is Trash
- Could BRK Be A Risky Investment
- Do Companies With Huge Pensions Benefit If The Dollar Is Debased
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
Tobias: And we’re live. It’s 1:30PM Eastern, 12:30 Central, 10:30AM Pacific, 5:30 UTC. Hello to wherever you are. We’ve got zero eyeballs.
Bill: That’s a shame. No one likes us.
Tobias: Am I connected?
Bill: It’s fine.
Jake: This was bound to happen eventually.
Bill: And we’ve peaked!
Tobias: There you go. [crosstalk] We got one, first.
Bill: We peaked at 10. We’ve got till 11 for one episode and now we’ve gone to zero. We are the shale producer without any cash flow.
Tobias: Here we go. We got some fellow, we got some numbers now. Okay.
Bill: All right, boys.
Tobias: Who wants to do the intro?
Jake: I’ll do the intro this week. Yeah. All right. Welcome to Value After Hours this week. I’m one of your hosts, Jake Taylor. We’ve got Toby Carlisle. What are you going to be talking about, Toby?
Tobias: Just a little humblebrag, had a chat to Cliff Asness last week, going to be coming up on the podcast. One of the really interesting things from the last paper that Cliff and his colleagues wrote, the Death of Systematic Value was this analysis of how important fundamentals are. It’s not necessarily a question about value. It’s just a question about the relationship between fundamentals to prices, how predictive it is. I think it’s a really fascinating little part of that paper. And so, I’m going to talk about that in depth.
Jake: And my esteemed cohost, Bill Brewster, what do you got for us, Bill?
Bill: Far from esteemed, but I think I’m going to talk about United Airlines because I know everybody wants to hear about United [unintelligible [00:01:48] package. Big package in the United.
Tobias: What are you doing, JT?
Jake: All right. My veggie segment is going to be economic lessons from a ghost town.
Tobias: In California, or just generally? A mining town?
Jake: Yes. You’re getting warmer.
Bill: You want to get it? Let’s get into it.
Jake: After this.
Tobias: Right, after this. Terrible, how we do it [unintelligible [00:02:19] great song.
Bill: How’d you turn our intro music into clown car song?
Tobias: [laughs] Appropriate.
Bill: Probably appropriate, yeah. [laughs]
Tobias: You want to do it, JT? I’m kind of intrigued. I like those little mining ghost towns in California. Which one are you talking about specifically?
Ghost Town Economics
Jake: This one is a little town called Bodie, California, B-O-D-I-E. A couple summers ago, I took the family on a little RV trip and we stopped by there. The place is pretty crazy because if you know the eastern side of the Sierras, it’s down this Highway 395. The place is about as close as you can get to Mars in the United States, I think. You’re up on this plateau and so it’s windy as shit. It’s 100-mile an hour wind sometimes there. It’s tied with some other place in Alaska for– it averages 300 days a year where it’s below freezing overnight. That’s because you’re at 8000-feet elevation. So, it’s pretty—[crosstalk]
Tobias: Why is it abandoned? [chuckles]
Jake: Yeah, right.
Bill: Can’t figure out why this went wrong.
Jake: Yeah, exactly. It was found in 1876 and it peaked in 1879. You had a three-year boom here basically. And what’s nice about this is that– why it’s good for economics lessons, is that it’s a very self-contained little universe to study and it also has this rapid boom and bust that happened. And then, the gold that was the reason why people came there will help inform some of the things that we’re going to learn. A couple quick stats on it. It peaked with 7000 people, had like 2000 buildings, and there were 65 saloons on a one-mile stretch in the main area. If you thought you had a drinking problem– [crosstalk]
Tobias: That’s my kind of town. [laughs]
Bill: A bunch of dudes just hammering rock and getting hammered.
Jake: Pretty much, yeah. Now, let’s transport ourselves to that time period. 1879, we’re walking down the street, looking around. How does it get decided what we want to consume now versus what we consume later? There’s no central planner that’s telling you that you need to go have a drink now or do you go build something?
Tobias: Sixty-five saloons, I guess, is a bit of a hint.
Jake: Yeah, that’s true.
Bill: I mean, dude, your life probably sucks. I’d just get drunk all day, and then I’d go hammer some rock and try to get some gold out of the ground. And then I’d hope to God, I could stop that process, it would be bad. And probably most people would be dying super young.
Jake: Yeah, you probably have a shorter time preference than what we might have today. You’d be more in favor of consuming now. Let’s assume that the more that you save for later– basically the more supply of capital that’s available for later, which then lowers the price of capital for later. What do you call these coordinating prices between today and tomorrow? We have a name for them.
Bill: You talking about interest rates?
Jake: That’s correct, Bill.
Bill: Thank you.
Jake: I’m going to send you a prize. Interest rates are the prices that coordinate time preferences between us. What we want to do with our capital now, our consumption now versus later. Let’s assume that there’s more investment today versus consumption. You could actually think about wood as a pretty good little proxy for this world because being that it drops below 30 degrees 300 days a year, you need wood to keep warm overnight most likely, or you can use it to go say, build a saloon or whatever. We have a very real consume now versus build for later dynamic that’s happening with pieces of wood.
Let’s say that there’s a gold rush what’s happens. And now, gold actually flows into the banks that are inside of this little town, and by the way, there was a Wells Fargo there at that point.
Bill: Shoutout when the brand was strong.
Tobias: They had 14,000 accounts.
Bill: Taking advantage of customers for hundreds of years, folks.
Jake: Yeah, it’s a good one. Well, I am going to make this a little more realistic because just like today, as more deposits come in, they counterfeit that money to create more. This is just how fractional reserve banking works. And it’s no different than it was back then. You deposit a piece of gold, they may loan out more pieces of paper against that gold. As long as no one comes back all at the same time to get claimed their gold back, it works out fine. With a gold rush like that, what’s actually doing is it’s lowering the interest rates there because it’s an increase of the supply of money, so to speak.
Well, let’s pretend that an enterprising young businessman goes to the bank and he decides, “I want to build the biggest hotel in all of Bodie, California.” And he borrows the money from Wells Fargo. He builds this big hotel. So did nine other people. They build these giant hotels. They see this boom, they think they’re getting out in front of it. Well, what happens, when it’s 1880, a year later, and they have these hotels, and there are no customers to come stay in the hotels because the boom is over.
Bill: Wells Fargo has more branches.[laughter]
Bill: That one’s loan loss reserves are going up.
Tobias: They’ve opened another 7000 accounts too.
Bill: Yeah, you’re hoping that that one’s in one LLC, or C-Corp and you can fold it.
Jake: That’s right. So, there’s no way to service that debt. The debt now basically has to be destroyed. That capital is disappeared. We need new ownership most likely of these hotels. That malinvestment took place. This is very analogous to what we see today with the Fed, basically creating a gold rush in a way. They lower the rate of interest for everyone. And by the way, that hotel, that enterprising entrepreneur, if he saw that the interest rate was 10% to borrow the money, it’s most likely that he would say, “Oh, my project doesn’t really pencil out at a 10% rate.” But when it’s 1%, all of a sudden, my project makes sense. The nine other guys looked at that same math and did the math and came up with it was going to work or not based on that low rate versus a high rate.
Well, we get to the future period. And it turns out that that low rate was a bit of a mirage, and that people didn’t actually want that much hotel space. So, we end up with what economists would call a confluence of entrepreneurial errors. Why does everyone make a mistake all at the same time? It’s because the low rates told them– it gave them the green light that this was a good project. That people wanted to consume things more later than they do now, which is what a low interest rate is telling him. But if it’s a head fake of a low-interest rate, now we get everyone building things that we don’t actually end up wanting.
One of the things that’s amusing to me is that, if Greenpeace knew what was really going on in the world, they’d be protesting the Fed. There’d be people out there in front of the Fed protesting at all times. Because the Fed has really is pulling so much from the future, they’re greatly increasing the chances that we use people, energy, capital, material, and tax the environment in a way that ends up being not building the things that we all wanted. We send all these green lights to everybody and they build things that turns out that we didn’t actually want.
It’s so amazing to me to think that you could take all the consumer tastes– all of our things change all the time, what we want to buy, take all the time preferences of do you want to save a little bit more money now versus later. The labor force, the skills as they change as people move. You don’t go tell the Fed, “Hey, I’m planning on moving to Colorado next week, does that work out with your model okay?” And we take all this stuff including resources that we discover or deplete, and we have all of these things happening. And the idea then that we try to enforce stability on this kind of a system that is changing so much, is to me is so asinine. It gets to what Hayek called, The Fatal Conceit, to think that you could understand and try to keep stability when there’s all these factors changing is just the height of being conceited.
That leaves us with where we are today, which is we are doing everything in our power, basically to stop the liquidation of that bad debt that can’t be repaid because we had all this boom time and probably a lot of malinvestment. How much retail space do we have in the United States that we probably don’t need at the moment? I think it’s quite a bit. All of these things have been built that are probably ahead of where any of us ever needed them or wanted them or the world changed. How much office space do we have now that we may not need as much because working from home is all of a sudden, much more palatable? The long story of this– Well, go ahead, you had a–
Tobias: I’ve just got a few questions, but I want to wait until you finished. I’ve just got a few devil’s advocate positions but I’ll wait until you’re done.
Jake: Probably can’t answer them but go ahead.
Tobias: Well, the first one was, in this town, I don’t know if this is the analogy part, this is the case. When you’ve got your gold and you’ve deposited your gold, you weren’t storing your gold in a lockbox. They were giving you some sort of right on your gold. You were depositing it as money?
Jake: You would deposit the gold and they’d give you a piece of paper that said, “We own this piece of gold for you. Now, you can go out in the world and trade it with other people for a drink at the saloon.”
Tobias: You can show that to other people. Right.
Jake: And then anytime, you could go take that down to the bank and say, “I would like my gold back, please.”
Tobias: And then the way that they’re creating money is they’re lending against the gold that’s in there as well. So, you deposit the gold, they give you cash for it, and then they also lend against your gold that’s deposited there?
Jake: Why not be able to just give two pieces of paper for every one piece of gold?
Tobias: So that’s what they’re doing?
Jake: As long as no one comes back. As long as two pieces of paper don’t come back at the same time, we can figure this out.
Tobias: As long as there’s no run, right. And so your gold is fungible in this instance. You put it in, you’re just like “I’m going to get some gold back, not the gold that I’ve put in my lockbox.”
Bill: It’s just fractional reserve banking.
Tobias: Yeah, I just wanted to make sure that that was the– just understanding the analogy properly.
Bill: And then you dial up how many pieces of paper you can give. Right now, we’re not allowing banks to give as much pieces of paper as we used to. The banking system is less levered than it used to be. But I digress.
Tobias: The next question I have, so they built 10 hotels at once. We’ve got two– or we’ve got multiple electric car companies at the moment. Are we building multiple electric car companies because it doesn’t cost that much to build an electric car company. Let’s say, it costs a billion dollars to build an electric car company, but in the market maybe it costs even less than that. You’ve just got to tell people that you’re going to do it, and you get a gigantic valuation. That’s the market telling people that they want more of these things, which is what inspires the overbuilding. Is that more important than interest rates or how do they fit together?
Jake: Well, I think a couple things to think about there. I’d like to go back to our little town or ghost town. If you think about the lowered rates, which ends up happening, all that money now is out there and it’s bidding up the price of labor, supply. All the factors of production now are more expensive. And so, it looks temporarily things are more profitable than they are. You end up with an over-profitability estimation at that point. The other thing to take away from this is that the closer that you are to the consumer with your product or service, the less variability there is in these booms and busts that can occur. And the farther away you are, the longer your timeline from when production actually gets to the consumer, the more variants there is in how big the boom and bust can get. So that’s why commodities tend to have much bigger boom and bust cycles than say like retail, historically.
Bill: Is that true? I mean isn’t part of the commodity thing is just so easy to recreate? And retail is historically a distribution advantage, and you’ve got to set up suppliers and whatnot? I guess the thing that I keep thinking about is, in this analogy, that what you have to allow eventually is for the lenders to go broke because the lenders are the one that are increasing aggregate credit. If this guy’s hotel goes down the dumps, he still transferred money to employees and stuff to buy it or to build it. There was still money that went to the people that supplied the commodities, there was logistics. The only people– it seems to me to be a wealth transfer. Obviously, once you add on like all the fractional reserve banking stuff, then you get a problem, if it’s systemic, but–
Tobias: Wouldn’t you be better off building something that’s going to be useful in the future then?
Bill: Yeah, but I just don’t know that you can say– I agree that there is overbuild. I don’t think overcapacity is a new story. I just don’t know that I necessarily agree that there’s all this waste going on. I don’t disagree that there’s some malinvestment, and I think people are way pushed out on the risk spectrum, because to your point, Toby, you’ve got people that are looking for some return and some of the people that are looking for return or pension funds and they’re underfunded, and they have obligations that they have to go to, so maybe they don’t have the choice to not lend. There are motivating reasons that are causing behavior. But it seems to me if you let the lenders get wiped out in this scenario, a lot of this stuff fixes itself.
Tobias: Well, I’ve got the solution. What that town needs is a central bank and what they do is they go and buy up all of the debt. But because they can’t buy the debt directly, they need some sort of ETF to stand in between. That ETF buys up all the debt, then they buy units in that ETF. Problem solved.
Bill: Yeah, well, look, man, this is part of why I railed against corporate debt. And then, if we rewind to March, I thought corporate debt might actually own everything. I don’t know what I know. But this is why I haven’t liked corporate debt because I think it’s hard to argue that the spreads aren’t artificially compressed.
Tobias: You don’t like the fact that the Fed is buying Berkshire Hathaway debt and Apple debt?
Bill: I doubt they’re buying that. I think there’s enough–
Bill: [crosstalk] –to that. I think they’re probably buying United more than Berkshire.
Jake: [laughs] Yeah, it’s not about return of the money.
Bill: I don’t know that Fed [crosstalk] people are okay holding that. I think they need to step into the places that no one wants.
Tobias: All right, JT.
Jake: But isn’t that signal that it needs to be liquidated and that we need to clean it out so we can start from a fresh base as opposed to–
Bill: This is the same conversation we had three months ago. Look, if they sustainably support zombie companies ad infinitum, I agree with you. Right now, we’re in the middle of a pandemic and cases are spiking again. I don’t think this is the time, dude, to say, all of our policies that have led up to this, now we’re going to get religion and start a deflationary bust in the middle of a pandemic. No, I think that’s a horribly flawed policy. Might be nice in a textbook, it would be terrible for society. You’d have people running out of their house. You’d have people totally freak the fuck out in the middle of a pandemic. “That’s what you actually think we should do? That’s insane.”
Tobias: But it’s fine backwards.
Bill: But I [crosstalk] with the textbook.
Jake: That’s fair. I think the problem was the 10 years before that.
Bill: Yeah, I don’t disagree. That’s like I was saying yesterday about this– Don’t extend the unemployment benefits. The idea that is being floated today, like no, we shouldn’t have had trillion-dollar deficits for the last three years. You’re going to throw people out on the street now? That’s inhumane. The problem is all the shit that we did that led up to this. Sorry, I ranted.
Jake: That’s a good rant.
Tobias: No dispute from me. Did I cut you off, JT? Do you have concluding thoughts?
Jake: Well, just one other thing that, you think about all those hotels that were built in our little ghost town that now sits there as a state park monument– and those counted as GDP by the way and were cheered, but that’s why GDP is such a stupid measurement.
Tobias: Well, I can keep the GDP up. What we do is we go and chop those– we hire guys to chop those hotels down, burn them for firewood. Rebuild them.
Jake: Build them again.
Bill: That’s right. With government stimi.
Tobias: And I get my first vote for federal reserve board governor, fed chairman.
Jake: You’re a shoo-in.
Tobias: Yeah. I know how this stuff works. This is easy. Get GDP right up, I can really get GDP red hot.
The Problem With $UAL Securing A New $5 Billion Loan Using Its Frequent Flyer Program
Bill: I’m going to steal the next segment because I actually think this is an interesting– I think I can segue pretty decently. The United bond offer or the debt offering, I think it’s bonds but whatever. The debt offering, look it up, I tweeted about it last night, it is insanely interesting. What we’re talking about people getting pushed out on the risk spectrum and everything that Grant has been writing about for the past three years, about how there’s no covenants in bonds and the asset transfers and stuff have been that your ability to transfer assets out of the entity, on the equity side has exploded as people have continued to chase yield. People last year were buying United bonds yielding 4% to 5%. I don’t know that there were no restrictions on asset transfers, but it’s hard for me to think that there were a ton and this also occurred.
Goldman, shoutout to you guys, because you did a solid job structuring this deal. They basically transfer the intellectual property from the MileagePlus accounts into a bankruptcy-remote entity. Okay, so the lenders of this new debt issuance– I think it was like 6.3 billion is what it was upsized to, and I think the interest rate’s roughly 3%. They have a direct claim on that entity which is the MileagePlus account. The way the MileagePlus account works is, MileagePlus pays United one cent for every dollar it acquires. United gives MileagePlus two cents. So, it’s basically like a 50% gross profit entity. It’s got some SG&A on it, but it’s probably 40% free cash flow margins, and it’s got a flow component to it. So, if you can actually buy the argument that it’s a separate business, which I’m not fully there on, I view them as pretty tied, but in a lot of places, they are separate businesses. That’s a pretty good entity. And that was just transferred outside of United’s asset base and fully leaned up.
And the bondholders that used to get bonds that yielded like 4% to 5% just got totally screwed out of one of the best assets that United has. I mean, United has $20 billion of liquidity or something like that, and I bought the same bonds that those people bought, but mine are yielding 10% yield to maturity, and I view it almost like equity. It’s just shocking to me that there were no restrictions on one of the greatest assets that this company had, and here they need the money. I don’t see how you don’t feel screwed if you own those bonds through all this. But you did it to yourself, read the fucking documents. That’s rule one. It’s not like it was hidden. But it’s just crazy that has happened. And I think it’s such a good illustration of, like Jim Grant has been writing and writing and writing for two years about how these companies can transfer assets out of the company, and the bondholders can get screwed. And this is the best example that I’ve seen.
Regardless of whether or not you like airlines, it’s a really, really fascinating structure that they put together. I thought it was a very solid job by some investment bankers and some really good attorneys. Goldman, I’ve said negative things about you. I take some of them back.
Tobias: Let me just see if I understand. The original bondholders, they’ve bought some bull markets special, covenant-light deal that had no restrictions on the underlying assets that presumably had some security against being transferred out. Somebody has figured that out at Goldman probably, and they’ve said what you should do is– the most stable part of your business or the most attractive part of this business at the moment is not flying the planes, it’s the mileage program that you have. We can take that “business,” we can take that business out, put that into a separate entity, we’re going to make that bankruptcy remote. Then we can part–
Bill: There’s 100% only on subsidiary area, right? It was structured as a separate business unit anyway.
Tobias: It was.
Bill: And yes, then they put it into bankruptcy-remote entity.
Tobias: How do you do that?
Bill: They just transfer the intellectual property assets. I’m not 100% sure.
Jake: And it’s gone.
Bill: I haven’t done a super deep dive on the thing. I was flipping through it last night. And as I was reading, I was like, “This is incredible. Whoever structured this did a really good job for their client.” And a really bad job for existing bondholders.
Tobias: If you were the bag holder in the original bonds, would you want to litigate that transaction? Assuming that it goes– they’ve probably got some period of time, they’ve got a hold on for bankruptcy over a period of time, otherwise you can look back to a transaction like that?
Bill: I don’t think so, man. I don’t think it’s a fraudulent conveyance claim. Now, we’re talking about stuff that I barely remember from law school. But the reason that they’re doing–
Tobias: Because they’re saying bankruptcy is not here. It’s bankruptcy remote. We’re not thinking about bankruptcy at this point.
Bill: Yeah. And honestly, man, they’re not. Scott Kirby from the jump has been the most nervous out of the Big Four CEOs. And he cut the deepest and he’s got the most liquidity. So, this guy is going super serious about saving the equity of the company. I think they should issue shares here. I don’t know why they aren’t. Especially since I think the equity’s got a pretty nice bid.
Tobias: Have they spoken to Robinhood?
Bill: And to be fair, I should be fair to him. He has issued equity once and then I think they’re registered to issue it again. It’s not as if he’s just levering it up.
Jake: This is like the capitalism. In order to save the equity, we have to destroy it.
Bill: They need a lot of liquidity. Liquidity matters more than anything for them right now. And they’ve got, I think they’ve got roughly– [crosstalk]
Jake: Eventually, you put enough people in line in front of you, there’s not much leftover for you.
Bill: I know, there’s a reason that I’ve told everyone that’s buying the equity, “I think you guys are making a mistake.” And if United now has done this to their balance sheet, I would be shocked if American is not having the same conversation. And now you have a system that had four healthy participants, and now you have two of the biggest ones are limping at a minimum. [crosstalk]
Tobias: Same old airline story.
Bill: Yeah. This is why Buffett sold. He’s seen this movie. Now, it might work. You might have enough consolidation to come out of this. That’s very possible but I think the odds are– [crosstalk]
Tobias: Are people flying again? What sort of capacity, do you have to have any idea?
Bill: I think the last time I looked– I do like a five-day average and I think it was down like 78%. United ticket [crosstalk] Yeah, dude, I think that– I don’t mean to laugh at them. I feel bad and I really do like Scott Kirby. But, dude, what a shitty year to take over. I think I saw that they said their ticketed passengers are down 90% in May. Running a hub– you need all that throughput through a hub–
Tobias: Good place to base the options and the restricted stock units, get them priced in here, get a big slug. Just see if you can fly it through. Get it out the other side. Make some real money.
Bill: Look, I’m sure they’ll do some of that. I don’t know that Scott Kirby– he doesn’t strike me as that kind of guy. He’s like—I don’t know. I like him.
Tobias: What do you mean he doesn’t strike? They’re all that kind of guy.
Bill: I know. I get it. I get what you’re saying. I fully expect American to do that. I hate those guys probably for no reason, but I don’t understand running a levered buyback strategy on an airline. It just doesn’t make sense to me.
Tobias: I think I can’t try that in the 80s. I think it’s been tried quite a few times. I don’t think anybody’s succeeded in it. Maybe this time.
Bill: Maybe. Fundamentals don’t matter. Why don’t we talk about your section now? See that at 1:00– [crosstalk]
Jake: When do we stop touching the hot stove of cove light? This happens every single cycle. This is supposed to be smart money buying this stuff.
Tobias: Memories are too short.
Jake: What is that?
Bill: Then in March, here I thought everything was going to get recapped and the bondholders are going to own everything. I don’t know. But this is the problem with cove light. I mean, when I was reading this transaction, I was like, “Oh, Jim Grant would have a wet dream over this after how much he’s written about it.”
Jake: This basically is just unsecured credit card debt for the– There’s nothing backing these bonds now. Some airplanes that no one wants to fly?
Bill: Well, it’s not even the airplanes because all those are– Yeah, well and they’re all mortgaged through asset-backed facilities. Basically, you have the holdco of the airline is– or maybe the opco, I’m not sure exactly what I’m trying to say. But, yes, you have the fundamental operating businesses cash generation now, which is not the most fun thing in the world to own.
Tobias: You forget the Davey Day Traders out there, long jets. That’s going to keep on working for a long time.
Bill: Now to be fair, the structure of the deal, they got a free cash flow sweep, it’s going to pay down. I don’t think United is going to disband. It certainly increases the probability. It’s not good for the current bondholders. Jaketrix
Tobias: Is he stuck? [chuckles]
Bill: I think so. Yeah.
Tobias: All right. Well, I’ll move on to my–
Bill: [crosstalk] then when he comes back.
Tobias: We’ll catch him up.
Bill: We’ll move him back in.
Do Fundamentals Matter?
Tobias: Yeah, he’s heard it. I’ve told him this one before. Is systematic value dead? Cliff Asness from AQR has a post on it. The post accompanies the paper. There’s lots of good stuff in the paper. Basically, the idea is that they’re trying to go through and identify each narrative about why value is not working and then to kill that narrative. And this is one of the last things buried at the end of the paper. I just found it interesting because it’s just funny. This is not necessarily about value investing. This is a fundamental investing question, wherever you find yourself on the spectrum. I know that growth and value are tied at the hip, but you could be more growthy than value. Is that right, Bill? Are growth and value tied at the hip?
Bill: I think they’re tied at the hip. I need to go back to the tape for that one. But, yeah, I think so.
Tobias: It looks like they’re tied at the hip.
Bill: Something about the hip.
Tobias: So, the question is how important of fundamentals to stock price performance? It’s interesting. The way they set it up, they have to create a test where it’s not a test of value skill or value. So what they do is that they say– and this is an example, this is not the way they do it, because they run it backwards, but they say, “Let’s get the 2022 forecast from 2021.” The forecasts that will be made in 2021 for 2022, and make it appear as if they’re available now. They’re explicitly cheating to do this. And if you had this data available to you, you’re looking into the future. It’s explicitly look-ahead bias. And, of course–
Jake: Well, are they forecasting the earnings?
Tobias: Earnings, yeah, in the future. So, you don’t get the actual earnings number, you get the projection, but it’s available a year in advance. That’s not real world. They make it very clear that it’s an explicit sheet. And of course, that strategy generates incredibly high Sharpe ratios, if you get an idea what’s going to happen in the future. But the problem is that it varies from year to year. You don’t get very high Sharpe ratios every single year. And so, the two years that it didn’t work, in the 1990s, in 1998 and 1999, it was negatively correlated. It was a low Sharpe ratio, but it was a negative Sharpe ratio. What that means is that the better the fundamentals or the closer you get to picking the fundamentals, the worse you did in that year, in 1988, and 1999.
It’s true also for 2019 and 2020. It’s unusual, it doesn’t usually happen. I find it hilarious that there are these 20 years apart. To your point before that, how people’s memories so short. I guess there are not many people around who were around even 20 years ago now. But it’s amazing to me that fundamentals basically provide a negative– the more you concentrate on fundamentals, the worse you’ve done over the last two years, and the last time that happened was ’98, ’99.
Jake: So, buy? [laughs]
Bill: I’m pretty sure that’s what I’d take.
Jake: That’s what I heard.
Tobias: Don’t concentrate on fundamentals. You’ve got to use something else.
Tobias: [chuckles] Scrabble. Davey Day Trader’s channel. That’s how you do it.
Bill: The only thing that I don’t know about this is how much of the finding is because people are basically just requiring less return because that matters a lot in the math. If people have just thrown in the towel and said, “You know what? If I can get 4% to 5% out of equities, if bonds give me one or half or I’m worried about it going negative,” you can talk yourself into paying pretty rich prices even if the fundamentals don’t look very good in the front years.
Tobias: Yeah, I don’t know that.
Bill: I just don’t know if that’s part of what’s driving the behavior.
Tobias: Yeah, I don’t know what’s driving it, but do you think that it’s because people’s preferences for forward returns are lower? Do you think that that’s the thought process?
Bill: No, I think what’s going on right now is, if you are running outside capital, it is really, really hard to look at your clients and say, “I’m going to bail on tech and everything that you can sleep well at night and go long financials or something that you have pretty substantial business risk right now in the middle of a business risk.” Like Blackstone Schwarzman, I was watching him today, and he was like, “We’re not going into challenge business models because of valuation. We’re just completely avoiding it and that’s our strategy right now.” And I think that’s a lot of people’s strategy, because I don’t think that most people are worried about valuations rerating down in the next 18 to 24 months, and I think that they’re terrified that a second outbreak could actually destroy the businesses that they’re investing in.
Jake: An airline?
Bill: Yeah, that’s right. Banks or retail or anything that has a lot of–
Bill: Yeah, that’s right. I think that’s what’s going on.
Cash Is Trash
Tobias: We’ve had this resurgence in the number of cases and the hospitalizations seem to be up in other parts of the country, not the hotspots previously. That’s not really reflected in the market at the moment, is it?
Bill: It doesn’t appear to be. I don’t know how much we’ve sold off and how much the cyclicals have sold off, I really don’t know. Now, I guess the one pushback that I would have to why the market should sell off is, I thought that one of the biggest risks to the next round of fiscal stimulus was Republicans saying no. Now, you’re seeing a lot of the Republican states are having flare-ups. So, the idea that they’re not going to try to help their own people now, I think that’s been reduced. So, you might actually see a lot more fiscal stimulus. I continue to think cash is a really, really risky thing to hold here. I just think they’re going to do everything that they can incinerate the value of it.
Tobias: Well, in that case, buy gold. Gold’s bounced today. Buy Bitcoin.
Bill: Yeah. I guess. LVMH something, something that’s got pricing power, I can understand that. But you’ve got to pay a shit ton to buy it. You got valuation risk in there if rates ever go up a lot. You’re going to get hammered, but I don’t know that that’s what the risk that I would worry about the most right now. That said, it’s a perpetual asset. So, you’ve got to think about it.
Jake: I saw something interesting in Grant’s that was from yesterday we’re talking about. There’s $4 trillion expected to need in bond issues, like we’re basically deficits of 4 trillion this year.
Tobias: Is that a lot? I don’t even know anymore.[laughter]
Jake: Well, I think it’s a lot. Yeah, I don’t know. Those numbers don’t even mean anything anymore. But like the Fed right now is on pace to buy like a quarter of that, something like that. So, the question then is like who’s going to buy the other $3 trillion worth and at what price? That’s the other thing. Eventually– [crosstalk]
Tobias: Do you have the answer? Because I’d really like to know. [chuckles] If Fed’s going to eat it all, surely.
Jake: Okay. So, what does that mean for us, then? They’re basically going to double their balance sheet again from a year ago?
Jake: I don’t know. These numbers are obscene.
Bill: The answer is maybe. I don’t know. How long can you do it? How long can the system withstand it? Should we run America like an LBO? I think those are all valid questions.
Tobias: We’re already doing that.
Bill: I know. That’s why I said, my beef was with the last three years and even if you want to go back further than that. The problem with Keynesianism is no one actually wants to tighten the belt when times are good. They just want to keep spending.
Tobias: That’s one problem with Keynesianism.
Bill: Yeah, that’s true.
Jake: I think that that’s a fair– I think that Keynes would probably agree with you that people have bastardized his name in that way. They don’t save for the rainy days ever. It’s just more and more and more.
Tobias: Just to go back to something you said before, so cash is trash now. You want to pin that to the top of the feed?
Bill: No, I don’t think cash has done particularly well over the last 10 years. My cash balance is half of what I ran coming into this year. Berkshire is less of my portfolio, but has been making up a lot more lately. That’s what I’ve been buying mostly. I bought some more Schwab recently. I have more corporate debt than I have, but I view it closer to equity, like those United bonds are basically an equity position. I own some TransDigm bonds.
Tobias: Why do you they’re in equity position? Because you think that potentially the equity actually gets wiped out and they become equity? Or they going to behave like equity?
Bill: You’re so deeply subordinated structurally that I don’t think that you can look at it like you’ve got a second way out. I think you’re either getting paid back with your cash flow or a refi. And unless you’ve got two ways out, I don’t really think about it like debt, I think it’s closer to equity risk. But if equity gets wiped out, or they issue more equity, I’m ahead of them on that. I sort of think it may be closer to preferred stock.
Tobias: What about like the long bond or something like that instead of cash? Because that tends to rally in a crash.
Bill: I just rather own gold if I had to choose. I couldn’t get super long interest rates here. I don’t know. That would be hard for me.
Tobias: There’s an interesting study that looked at– the one that Dan Rasmussen and Verdad brought out on Monday. It said that, in the late 1990s, Japan had a similar cut– or not similar, but Japan had a bubble in everything. Things that had suffered in the run-up were small value, as you can imagine, and real estate and then naturally they outperformed afterwards. But one of the interesting things that I saw was that the thing– one of the things that’s done quite well through that period is the JGBs.
Jake: Yeah, I think what he said was it didn’t do well, but it still served as a diversifier. So, a 60-40 portfolio still worked. It took some of the volatility out without too much change in return. So, it helped the Sharpe ratio basically.
Bill: My gut is like this is almost how I view SaaS. If I were going to get a really long duration bond, I’d rather just buy something like Tyler. Their free cash flow yield out of the gate is virtually nil. But at least it’s growing and you’re selling to governments and you could probably take them to the cleaners on price. I could see it being a growthy bond. I can see losing a lot. That’s why, I don’t know, I’m just not comfortable taking a whole bunch of interest rate risk.
Could BRK Be A Risky Investment?
Tobias: Let’s start taking some questions. I’ve got a few good ones in here. Could BRK be a risky investment?
Tobias: Care to expand?
Jake: Could be a lot of BRKs come in for–
Bill: It’s your very long financials. If you have a huge default cycle and the US doesn’t bounce back, and for some reason, there’s another– the insurance market should get hard. Berkshire Hathaway Energy is a hell of an asset. The railroad’s a hell of an asset. I don’t think you’re going to have some permanent loss if you have the ability to [unintelligible [00:43:55] but could it be a disappointing investment over the long term? Yeah, it could underperform for sure. Plus, a lot of the value’s in Apple which I have a hard time getting there on the valuation for Apple right now.
Tobias: I wouldn’t want to buy Apple now, but would you sell it now?
Bill: If I was Buffett or like me?
Tobias: Well, if you held it, would you sell it?
Bill: Yeah, I probably would.
Tobias: You think it’s that expensive?
Bill: I sold it lower than here, so yeah. I don’t think–
Tobias: I know Buffett’s a hold forever guy. I can understand why. Even on a valuation basis, I think that buying is one thing. Selling it here, I’m not sure. I know that I’m a deep value guy and this is not what I do. I’m talking outside what I do, but I can see that you would potentially just hold and not worry about it here.
Bill: I thought that, my man, Jerry Cap had the best articulation of the never sell philosophy that I’ve heard thus far and he was like, never selling is not about a single trial. It’s about a philosophy that adds to– a portfolio of those adds to superior outcomes. And I was like, “Alright, I sort of buy that.” You’re removing one behavioral aspect from the equation– [crosstalk]
Jake: It’s a lifestyle.
Bill: Yeah. Well, dude, it’s worked out well for Buffett and Munger.
Tobias: Helps to have Buffet putting them in the front end though.
Bill: No doubt.
Do Companies With Huge Pensions Benefit If The Dollar Is Debased?
Tobias: So, I’ve got an interesting one here. Don’t companies with huge pensions really benefit if the dollar is debased?
Jake: Well, I think it depends on the structure of what they’re promising.
Tobias: It does a little bit. But it’s an interesting question. Somebody’s getting hosed there. Either the company gets hosed or the people who are the beneficiaries or the pensions get hosed. That’s ugly.
Bill: If we’re talking about debasement, I assume that, we’re thinking– [crosstalk]
Tobias: It’s just lots of printing, like if you print a lot.
Bill: Yeah, so that would be inflationary generally. Would you associate those two things?
Tobias: It has to be, yeah.
Bill: Okay. So, yeah, I think debt holders and pension holders, anyone with that is counting on a fixed amount to come back to them, yes, they are the losers.
Tobias: Are there many defined pension benefit guarantees around anymore? There aren’t really. They got rid of them a while ago. Legacy.
Bill: Yeah, I don’t think there’s– Maybe in the financial industry, there were a couple in the early 2000s, but I don’t think you have many left.
Jake: Well, a lot of the companies have been trying to buy out the employees from them. I’ve seen that quite a bit.
Bill: Does Boeing have one? Do you guys know? That would be one that might still have one.
Jake: I don’t know.
Bill: Their union contracts are fucked up. It’s technical.
Tobias: That’s a technical bankruptcy you [unintelligible [00:46:41].
Jake: Technical for one sided.
Bill: Yeah. I was talking to my buddy, I was like, “Oh my goodness. How do you manage through that?” He said, one guy does the rivets, he’s the only guy that can do the rivets. And he’ll go get drunk for three days not show up. Well, you’ve got to change your manufacturing around that guy’s drinking schedule because it’s so hard, you can’t just fire him for cause. He said the contracts are insane.
Jake: That’s lean manufacturing there.
Bill: Not exactly.
Is It Better To Own Physical Gold Or Gold Related Companies
Tobias: So, I got another good question here. Is it better to own gold companies instead of gold itself, like Newcrest Mining?
Jake: I don’t know. I’m sympathetic to that idea. It does seem like there’s more gearing there to the price of gold. However, it seems a lot of times the costs of the company go up just as much as the price of gold does, and you end up treading water. And there’s a lot of question marks about the capital allocation decisions of gold mining managements. So, I don’t know, that’s a tough one.
Tobias: I’ve spent a little bit of time thinking about this and testing it. There’s a few things that I would say. One is that the gold miners tend to be more sensitive to the movements in gold than gold itself. It’s a levered bit on gold. So, if you have a view, you might be able to express it through like a gold mining ETF more than the underlying gold itself.
The other thing is the guy who introduced me to value investing, who’s an econometrics professor at the university that I went to, he said exactly what you just said. When you look at the margins for gold mining companies and other kind of miners stay pretty steady, because in the boom times, and this is something we were talking about earlier, the cost of the inputs gets so much more expensive that they never really have that really good blockbuster. They do have better years because they mined more, but it’s still much more expensive for them. So, the margins aren’t ever as good as you think they’re going to be.
Jake: They do have the energy helping you now. Like your cost of input for energy is lower than it’s probably been in the last five years. So, that’s a bonus.
Tobias: The other thing I was gonna say is I went to a Value Investing Congress like a long time, 2010, maybe even earlier than that, and the first person I talked to, they’re like, “Oh, my big idea is I’m going to buy long-dated puts on the junior gold explorers with the highest cost base.” Because when gold goes up, they’re the ones that show the most profit, because they flick into profitability and then they move a lot and so you buy OTM options and there’s just a massive levered bit on big move up in gold. So, if you believe on it– this is not financial advice, you’re going to lose all your money if you do it, but they move a lot if it happens.
Jake: Yeah, there is something kind of interesting about the idea of taking, call it worthless pieces of paper, and then trading them for the productive capacity to get this sift through all this earth to pull out these little pieces that are hard to come by. And then as inflation comes, you give back the pieces of paper because the gold is getting so much more. You’d think that that might work really well somehow in sort of outside the matrix idea.
Tobias: The way to make a lot of money is when your commodity is absolutely trashed, coal or whatever. You go and buy, you get– There’s an Australian guy who did this. He was an electrician in the coal mining industry, and gold got completely bombed out. And he put down a million dollars on a $30 million deposit and– a million-dollar option on a $30 million deposit. And so, he just borrowed against his business. And then, when coal came back, I think someone paid him– I forget the exact number, but it was like 100 million or 300 million for that, which he took in stock. And then that company got a bid and he rolled that into another thing and he ended up– for a million-dollar loan, rolling on a coal deposit turned it into about 500 million, and then he dusted the lot because he couldn’t stop. He rode it all the way back to zero.
Jake: I’m hot.
Tobias: He spent about 100 million dollars in racehorses. My boss commented that he just decided that 400 million posts was enough for one man to live on. I’m sure there’s some Aussies who know who that is?
Bill: I’m just looking at like the GDX which is the gold miners versus GLD. They don’t seem particularly correlated to me. With the miners, you’re introducing a lot of risk that is not pure gold risk. But people that know what they’re doing, like Sprott and Grant, and those guys know gold a whole lot better than I do and they’re always pitching gold miners, but I don’t know how much of that is because their business depends on pitching that shit versus like whether or not they believe in it.
Jake: Hard to tell.
Is Value Dead Because Of Winner-Take-All Industries
Tobias: This is a good question. Is value dead because of winner-take-all industries? Seems like mean reversion of junkier competitors is dead like retail, legacy tech. Value and mean reversion are tied at the hip.
Jake: What’s legacy tech? Is that airplanes and radio?
Tobias: Steel. Steel’s tech, was once.
Jake: Was tech, very tech.
Tobias: I think that’s a really good question. But the thing is we’ve always had technological evolution. As we were just pointing out, we’ve had it forever. We’ve had railways with tech. Survived that, the space race and all the stuff that came out of that was tech. Electrification, that’s tech. Rolling out electricity everywhere, that’s at least as important as rolling out the internet everywhere. And value’s always come back. I just think you get big booms and when the big booms happen, stuff just gets untethered from the fundamentals. And this one’s persisted for much longer than probably anybody thought was possible. But then, we’ve had a central bank that’s been much more activist than we’ve ever seen in the past. Maybe that helps inspire the animal spirits a little bit.
Jake: Except for maybe the 1920s.
Tobias: That’s fair.
Jake: If you like analogies and history rhyming.
Bill: I’m just thinking about what would be value right now? It would probably be full of industrial and financial-type companies, if you were to look. I don’t know, is that true? What’s in there, Toby? You know better than I do.
Tobias: There’s some financials, there’s some energy, but I’ve got a portfolio of stuff that’s not. I think it’s just cheap. It’s cheap on a ratio basis. It’s cheap on a DCF. Anything that’s cheap on a ratio basis, you DCF, and it’s going to wind up being cheap, because your growth assumptions are so modest. That’s the point of doing the expectations analysis. If your yield is so fat, you can put in really, really modest assumptions for growth and you’ve still got an NPV that’s much than where it’s trading right now.
Bill: Here’s a good example, Wells, my boy, the Science of Hitting Investing. He tweeted this out the other day, I think they’ve quadrupled book value since 2004 or something like that. That’s not a horrible outcome. The problem is the price to book contracted from 3 to 0.8. So, that’s one of those– I don’t know. Is Wells not a compounder? Is it a crappy business? No, it was a bad stock, you paid too much.
Tobias: Now imagine that same thing happened to all of the expensive stocks. And all of the cheap stocks seeing a little bit of it going the other way. And that’s exactly how value and growth work together.
Bill: Right. So, is Wells dead? I would say probably not. If multiple doesn’t go up and they’re going to eventually unless they are dead, be able to return some capital to shareholders. And I think that’s a common denominator of what you see Buffett look for is usually some capital return plus a reasonable entry multiple. And eventually that [crosstalk] should work.
Tobias: What a strategy.
Bill: Yeah, exactly. Right. It’s thought out by some people.
Tobias: That makes sense.
Bill: Yeah. If only one of us ran that strategy. Oh, wait! One of us does.
Tobias: [laughs] It doesn’t work. I can tell you it doesn’t work. It doesn’t work in 14 months or something.
Bill: We’ll see.
Tobias: Well, it works really well.
Bill: But I think that makes sense. So, I don’t see that strategy long term– I don’t see how that could die. That seems to be a rational strategy to deploy.
Tobias: In the short term, the market does what the market is going to do. We all know that. Graham said it a million times. Buffett said it a million times. It’s just the case that if you rely on a little bit of irrationality or subnormal rationality for your purchase decisions, you can’t get too upset when it doesn’t immediately manifest. The market doesn’t get immediately rational after you buy something. And you’re always looking at things that– There’s got to be a little question, otherwise it doesn’t get cheap. You’ve got to resolve that question one way or the other. Going to make mistakes when you do that. But the idea is that you get paid when you ride asymmetrically. That’s the entire strategy, but it doesn’t work in the short term [crosstalk] every time.
Bill: Well, a lot of businesses got impaired over this time. If you’re going to own an asset for a perpetual duration, which is basically what equity is, you’re going to have some shitty years. In a marriage, you’re not going to like who you’re married to every single day. You just hope that you get through it together. Or at least, that’s clearly how my wife feels. I feel differently. I love her all the time.
Bill: But I digress. It just seems to me that there are some situations that people are saying, “Oh, this is dead.” And I think it’s the way, the path, this just how the cards came out. It’s not like it was predestined to happen. So, I suspect that in the future, it may look better. And usually, it looks better when everybody says it’s dead. But there’s no guarantee, it might be dead. Who knows? I don’t know what the heck’s going on. You know tomorrow as well as I do.
Jake: Is there anything about the internet in particular though that this winner-take-all will mean that the– the profit pool of the entire world, all the world’s businesses tend to accumulate more there on the internet than it is like, say, in the world of atoms?
Bill: Yeah, I think that the internet tends to have winner-take-all effects within internet businesses, but I don’t know that that means that all the business– I don’t see how that’s going to affect the aggregate earnings of utilities, for instance. But, yeah, I think Twitter is never going to be Facebook. Unless people leave Facebook.
Tobias: Isn’t that true of most industries though? Don’t most industries wind up with a handful of dominant players?
Bill: Yeah, relative scale advantages,
Tobias: They either consolidate or they just grow there by themselves and then, their competition for the most part becomes, to use Munger’s words, much more gentlemanly by the time they get there. And they all do pretty well.
Bill: And I think the problem too with the internet is the scale combined with fixed costs. You can get some real barriers to entry going once you’re at scale.
Jake: Isn’t that the same argument everyone made about Exxon when it was the most expensive company in the 2000s– [crosstalk]
Tobias: Narrative follows price.
Jake: –scale. No one can keep up.
Bill: Yeah, I think it’s harder to enter the internet industry than it is the oil industry.
Tobias: Come on.
Jake: No way.
Tobias: Run that again.
Bill: Yes, fuck yes. You guys think it’s– [crosstalk]
Jake: Try that again.
Bill: You think it’s easier to compete with Facebook than to get some dummy to give you money to drill a hole in the ground to sell oil? That’s like super easy to do.
Tobias: Are we talking about competing with a junior oil explorer? I can do that. Are we talking about competing with Exxon? That’s a different question.
Bill: That’s fair. But I think that you have more chance– you can exist in the oil market. The collective you can enter, which is basically what we saw with the shale industry.
Jake: If it’s easier, then why aren’t every VC company funding shale-drillers and not SAS?
Bill: Because there’s no money in it. The profit pool of oil is–
Tobias: Of energy. It’s pretty crushed. Yeah.
Jake: But I thought that was winner-take-all for the tech.
Bill: I never said that about oil. I said that about tech and there’s a ton of money going into tech right now. I think it’s harder to compete. So, why aren’t people funding competitive products? Because it’s really hard to compete.
Tobias: I think they do. I think that Instagram would have eaten Facebook’s lunch but Facebook bought Instagram. I think TikTok is now eating Instagram’s lunch. I think that– and I always say this, but it’s just the youngsters don’t want to be on the same platform as the oldies. That’s all it is. TikTok will have its day in the sun, and then the next thing will come along.
Jake: Is TikTok a Chinese spy app by the way? I’ve read somewhere.
Tobias: Well, it’s been banned in India now.
Bill: It’s why I don’t have it on my phone, that no one wants to see me TikTok.
Tobias: I don’t have TikTok either.
Bill: I think you’ve got a long way to go. I was intrigued by the Twitter thesis and like, can they close the gap? And the more I learned about it, the less I think they can.
Jake: Do we have time for one more?
Bill: Do it.
Tobias: Well, it’s 11:30. So, I’ll have to save it for next week.
Bill: Ugh. We all want it.
Jake: Give the people what they want, Toby. Come on.
Is The Facebook Boycott Really About Virtue Signalling
Tobias: [chuckles] All right. Here we go. I’ve got one more. Yeah, here we go. Do you think the advertisers leaving Facebook has more to do with economics than virtue signaling? That’s a good question.
Bill: It’s a good question. [crosstalk]
Tobias: I’ve got some data to answer that question. A little bit of data. So, I think it’s Procter & Gamble. I think their annual advertising budget is something like $12 billion. You’ve got to move your head. Did you move your head, so people can see? Jake’s background is 100% Facebook free? I think this is roughly but P&G, I think, they spend like a billion dollars– these numbers are probably wrong, but this is roughly right. I think they spent a billion dollars a year on advertising. They’ve yanked their advertising, I think, only for Facebook, only in the States, and only to the tune of like $12 million, something like that.
Bill: [laughs] Quite a statement they’re making.
Bill: Boy, it’s almost as if we’re approaching a recession, they need an excuse to cut their ad budget and Facebook happens to be the scapegoat. That’s almost like [crosstalk] on here.
Tobias: That’s perfect. Make it look like it’s–
Bill: 100% what’s happening. You get the virtue signal, send some smoke out there, cut what you were going to cut anyway, and you’re done. Good job seeing through the matrix [crosstalk].
Tobias: Maybe you get a little bit of free marketing out it. Maybe CNN picks it up, “Oh look, they cancelled that.” That’s worth a lot more than 12 million bucks, that on CNN run that for a day or so.
Bill: It’s a slam dunk decision.
Tobias: All right, amigos.
Jake: Does it actually show up though in Facebook’s Q2 numbers?
Tobias: I doubt it.
Bill: Man, their top hundred advertisers or something are like 25% of revenues. This thing is a beast.
Tobias: Although Zuck did seem to blink a little bit, didn’t he? He’s come out and said, “We hear you. We’re doing something different.”
Jake: What does that even mean?
Bill: Yeah, what would he say? We don’t care? Of course, he’s going to say that. It’s like throwing human tranquilizer darts at the hulk. It’s not going to do anything.
Tobias: I think that’s all we have time for.
Jake: All right, [crosstalk] guys.
Tobias: Thanks, folks. It was really fun.
Bill: [crosstalk] position.
Tobias: See you next week.
Jake: See you.
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