VALUE: After Hours (S03 E25): Deep Survival And Hedging With Vol, VIX, Puts, $HYG And Cash

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In this episode of the VALUE: After Hours Podcast, Jake Taylor, Mike Mitchell, Bill Brewster, and Tobias Carlisle chat about:

  • Hussman’s Unhedged Strategy
  • Deep Survival – In Investing Choose Your Friends Wisely
  • How To Protect Yourself From A 50% Drawdown
  • Don’t Capitalize Your Gains In Your Head
  • Why You Should Hedge
  • Is There A Finger On The Scale?
  • What To Do After A Big Drawdown
  • Insuring Against Quotational Risk
  • Front Month Options
  • Individual Equity Options
  • The History Of 50% Drawdowns
  • Munger – How To Get Really Rich
  • Minimizing Tax Can Cost You Big Returns
  • Michael Burry – The Mother Of All Retail Bubbles
  • The Baupost Approach To Hedging

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:

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Full Transcript

Tobias: I hit the button. I hit the button, and I had an extra-large nitro coffee shot. So, I’m on firing about 12 cylinders more than I actually have at the moment.

Bill: Nice.

Tobias: I’m seeing the numbers behind the– I’ve entered the matrix.

Bill: Well, I like it.

Tobias: We’re probably live. What’s happening?

Michael: What’s up guys.

Jake: Dope.

Tobias: We’ve got much more symmetrical layout when there are four of us here.

Jake: That’s true.

Bill: This is true. Yes.

Michael: We have some pretty attractive people. I’m not going to say which one they are, but their name are not Bill Brewster and Mike Mitchell.

Tobias: I was glad to make the cut. [laughs]

Michael: [laughs]

Bill: Both true and hurtful, sir.

Michael: Oh, yeah. I do it to myself.

Tobias: Well, it’s been Value: After Hours, just in case everybody knows.

Jake: Oh, okay.

Tobias: We’ve got Bill Brewster, Jake Taylor, and the lumber baron himself, Mike Mitchell, for another week.

Michael: Let’s do it.

Tobias: I’ve no real idea what we’re going to talk about this week, though.

Michael: Can we talk about my hangover that I still have from last Thursday of hanging out with Bill Brewster in New York City?

Jake: That’s the jumping off point.

Bill: You can.

Michael: [laughs] I should say thank you to Shane Kleinstein for coming out. That was awesome, and thank you to everybody else who came up. That was a lot of fun. I really [crosstalk]

Bill: Yeah, real talk. We had Liberty IR in the building, and I flew to New York, and we had a FinTwit meetup, and it was super fun. It was a good time. Then, we did misbehave a little bit. But you know what?

Tobias: New York City.

Michael: [crosstalk]

Bill: I told Mike–

Tobias: You’ve got to do it.

Bill: I saw Mike for the first time in person. I told him that when I hugged him, it was as exciting as when I met my wife. Don’t tell my wife that.


Jake: Good thing is she doesn’t listen to the show.

Bill: We’re still working–

Michael: Hopefully, [crosstalk]

Bill: We’re still working on date three.

Michael: [laughs]

Bill: Because we had breakfast after.

Michael: All right. It was fun.

Bill: Anyway, I digress. I don’t know, man. I’ve been thinking two things. One, the role of hedging. I joke a lot about it being middle innings or whatever, and I know that a lot of froth has come out of the market. But one thing that Mike and I were talking about when we were sitting at breakfast is just the amount of people that are day trading stuff right now is overall a little concerning. I got my Uber on the way home, and the guy’s telling me about people that he’s driving around that are day trading crypto.

Michael: It’s not just day trading, it’s day trading successfully. Thinking like I don’t need to work. That’s really the stuff. The day trading thing is one thing, but the fact that everybody’s doing so well I think is [crosstalk] for me.

Bill: Yeah, that’s right. Overall, the level of risk taking is not low. Does it make sense to put on tactical hedges? And then, if so, how do you go about it? That’s one thing, and then the other thing that I’ve been working on a lot is Pershing Square Tontine Holdings. So, those are the only things that I can really talk about. Hang on one sec real quick.

Michael: Are you now– [crosstalk]

Jake: [unintelligible [00:03:04] at last.

Michael: [laughs] full splash in the middle of the day? Good for you, sir.

Bill: I’ll steady like the last time. [crosstalk] about a year.

Tobias: What do you on, JT, on the Bang energy?

Jake: Oh, no. Just a little Bubly. Cherry Bubly. The hard stuff.

Tobias: Where are you coming in from?

Jake: I’m in Reno, Nevada, for a weeklong baseball tournament for my son. So, I’m in foreign surroundings. I don’t have my books around me to keep me comfortable. Yeah, it’s a little hot here as well.

Tobias: I was going to say, how’s the weather?

Jake: It’s like being in a convection oven. It’s hot and windy.


Bill: You just put some olive oil on the ground and crack an egg to cook it?

Jake: Yeah, damn near. It’s pretty warm here, but that’s okay. We’re having a lot of fun. Turns out there are some very, very large 13-year-olds out there, and they all got together on travel teams and came here to spank us a lot.


Jake: We’ll see. We’re holding our own a little bit for being a little ragtag neighborhood team.

Bill: That’s dope. I hope he has a good time and remembers it for the rest of his life.

Jake: Me too, for the cost. I would really hope that.

Bill: Back in the day when I thought I was reasonably good at golf, I went out to Arizona to qualify for the National Junior Amateur, and at the time, my girlfriend was quite attractive, and I shot 75. I was pretty proud of my performance. I was like, “All right, I’ll wake up–” Because I was one under coming in, and I was like, “All right, I’ll tee off early, but if I go deep, I got a shot.” They were like, “Get here at 7 AM. The leader shot 62. You’re in 100th.” I was just like, “Fuck it. I’m out.”

Michael: [laughs] [crosstalk] hot girlfriend.

Jake: What did the hot girlfriend do have to do with that story or is it just that you peaked then?

Michael: That’s the important part of the story. Do not [crosstalk] part of the story.

Bill: No. It was the opportunity cost of continuing to try to get better. I was like, “I’m just going to give up golf for a bit.” Now, I can go out there, and slap it around, and I’ve learned a little something outside the golf course too. Not slapped it around that way, Toby. Come on now. I meant the golf course. Anyway, I don’t know what I do. I’m drinking.

Jake: [laughs]

Bill: What are we talking about?

Tobias: Who wants to take it away?

Michael: What? Bill’s idea, the hedging conversation, I think it’s very interesting.

Tobias: Let’s start then. Let’s do that.

Michael: It dovetails nicely with the Burry deleted tweet, and now, apparently deleted account from last week.

Tobias: Ah.

Jake: He’s off again? Oh, he’ll be back. Don’t worry.

Michael Burry – The Mother Of All Retail Bubbles

Michael: [crosstalk] I don’t even know. Yeah, he’ll be back. This is like the mother of all retail bubbles between crypto and GME, like meme stocks and crypto. And then, there was a response to that, that was saying, “Look, he could be right, it could be wrong, but does it make sense to have a parachute? If I’m going to be flying high, I might as well have a parachute on.” Now, there’s some logic to that. Then, Bill and I had this whole conversation of, well, if you were going to protect yourself and you’re going to buy an insurance contract, what contract would you buy? I’ve done a little bit of thinking about that. Bill’s telling me my thinking is probably incorrect, but it probably is. This is not a strong suit of mine. This is not what– [crosstalk]

Bill: I don’t know that I said your thinking was incorrect. I think if–

Michael: [crosstalk]

Bill: Yeah.

Tobias: What’s your thinking, just before hear the [crosstalk]

Jake: Or we tell you how dumb it is.

Tobias: Let’s see the thesis first.

Bill: I was going to set that up, Toby.

The Baupost Approach To Hedging

Michael: The thesis is buying the best and cheapest protection you can get. That’s a blanket statement. You throw that out, and then you say, “Okay, well, let’s go through and define each of the terms.” What are we protecting ourselves from? That’s the first thing you got to really define, because there’s a lot of ways to protect yourself. Last week, Jake talking about buying VIX calls. That’s one way to do it. It’s a volatility call. There’s buys, there’s [unintelligible [00:07:00], or you could go to specific factor happened to be long, lumber, which is long housing, so I could go in and do a specific factor and short that.

I think in the past when I’ve done it, I’ve taken the Baupost approach, which is you buy really, really cheap way out of the money insurance when it’s basically they’re giving it away, and the idea, as we talked about last week, it’s premium wasted. It’s my full crazy disability insurance. I’ve to convince myself that I pay that much money every month to have disability insurance, because if I do, there’s no scenario in which I’ll get disabled. The world will not let me get disabled, because I’ll make way too much money. So, it’s like Murphy’s law working in reverse.

Jake: [laughs]

Michael: So, I buy this crazy, cheap, disaster insurance, and if somehow it hits, March, April of 2020, it did hit, there’s a psychic income to it where you started like you’re getting a check, and so that you feel like you’re ahead of the game, so, you can play a little bit of offense, and then, of course, the check you can actually use to invest, which of course, we know now that that was exactly the right thing to do. That’s the way I’ve normally thought about it is buying like way, way, way out of the money like puts. I think the way Ackman did it was the better way to do it. I don’t have access to CDS, I think he bought CDS, my payout was like 26:1, and his was 200:1 or something like that.

Tobias: You could get a put on the HYG or something like that.

Michael: Right. Yeah.

Tobias: Probably, we get to the same–

Bill: On the what? Sorry, you broke up.

Tobias: HYG. Sorry, it’s the high yield ETF.

Bill: Okay, it’s the high yield. Yeah.

Jake: [unintelligible [00:08:44] bond ETF.

Tobias: Yeah. It trades in a pretty tight range. You don’t have to go very far out of it before you get to those five-cent options, which is what I have done it last.

Bill: Dude, you think the Feds [crosstalk]. You think the Feds going to let you get there.

Tobias: I have made money on them, but I’ve never cashed one, because they’ve always expired out of the money. But I have had them at the absolute nadir of the market. Remember, I think it was 2018 or 2000 something like that, there was a big crash, and the bottom was like Christmas Eve or Day.

Bill: December 2018. Yeah.

Michael: Yeah.

Tobias: Was it the one that was?

Michael: Yeah.

Bill: Yep.

Minimizing Tax Can Cost You Big Returns

Tobias: I had HYG puts going into that and struck $2 outside of– like $84, I’d struck $82 something like that. They paid off that all like a third of my book but they were expiring in January 22. So, I wanted to push it into the new tax year, plus, I wanted to keep the protection on, and they expired worthless.

Michael: Right.

Tobias: I’ve done that a few times [crosstalk] on everything.

Bill: Classic move.

Tobias: Yeah. I’ve ran crypto–

Bill: Yeah, I love it.

Jake: Thanks, Yellen.

Michael: Well, Toby, you can from this point forward just turn your microphone off. You’re done with this conversation. We’re going to–


Jake: Yes, sit this one out, champ.

Michael: [laughs]

Bill: That’s the old don’t make tax decisions when you should be making economic decisions.

Michael: I will tell you that is million percent right, though. Thank you for saying that. That is million percent [crosstalk]

Bill: That said, I don’t follow it.

Tobias: That’s a good point.

Bill: [laughs]

Tobias: Every single amateur in my life was telling me to close out that position, and I was just like, “No, no, no. This is just the beginning of the move. Wait until we’re down and up 30% from here in a month, think how much they’ll be worth then.”

Michael: My wife is telling me the opposite. I wanted to close out that put in April of 2020, and she was like, “Why?” We bought it for this exact purpose. She’s like, “This is what we bought it for. Now, you want to close it out?” I was like, “Well, there’s two outcomes. There’s the outcome number one, you figure it out, there’s a vaccine, we’re all fine, and in that case, you want to get long stocks. Outcome number two, we all turn into zombies, and I’m going to walk around saying, ‘Don’t eat me. I’ve got this put,’ like woo.” If the world blows up.

Jake: Yeah, Mike, is she taking outside capital?


Jake: Oh, she’s smarter than I am. She’s a better investor than me too. She’s a good partner.

Why You Should Hedge

Tobias: The part of the reason that you have a hedge on is so that you can– There’s two against. One is that it creates that third pocket of cash that you then get long in the market, which is why, I’ve always wonder if people who’ve got their money in hedge funds that are blow-up hedge funds, like, how do you get the redemption in order to get long at that time. That’s a challenge. The other thing, though, is that you’re using it like it’s a hedge. So, why would you take your hedge off, when you’re in the middle of a volatility and it’s acting cyclically to allow you to operate on the long side and do all the sensible stuff on the long side that you should be doing. I don’t have an answer to it. That’s just what I think about.

Michael: No, that’s exactly– The start of the conversation is, what are you protecting yourself against? If you don’t know that, you shouldn’t be protecting anything. You should just be going about your normal business. If this was I’m trying to protect against the end of the world, that’s one thing. You never sell it, because that one will only– end of the world will happen or it won’t happen. It’s binary. If you’re giving yourself some psychic income, you’re just like the world– Look, liquidity’s everywhere, we all feel it.

We’re all looking around going, “God, stuff’s expensive. We’ve all made too much money too fast, and it unnatural, and so man, if there’s a 30% drawdown from here, I’m going to be kicking myself, because I knew this was a good time. For whatever reason, I wasn’t–” If that’s your approach, then in my mind, when you have the 30% drawdown, even though it feels exactly wrong, you just unload it. You’re just like, “That’s what I was protecting myself again. I was not protecting myself against the end of the world.” By the way, you could do two. You can phase it. You could say, “Well, I want a 30% drawdown option, and I want an 80% drawdown option. In an end of the world type, Armageddon option, you could do both.”

Tobias: [crosstalk] expensive, though. Now, it’s getting expensive.

Michael: That’s the other side. Once you decide, “This is what I want to protect myself against,” that’s when you go into how much are you willing to spend? That’s where I was giving– I listed a couple options in my Slack channel today of, you could do it this way, you could do it that way. My bias was to– or at least the idea I had was the most expensive put you can buy today at the money is not the most expensive, but the most expensive one I was looking at was at the money. So, the S&P 500, 400 the SPY 400 are Jan 22.

The APR on that is 14% or something, and it only buys you 6 months’ protection. 7% is the cost. You can get your APR from 14% down to 7-ish, if you go out to Jan 2023. It’s twice as expensive, but you have 18 months essentially. So, your APR is quite a bit better. Is it guys just trying to make 10% a year, paying somebody else 7% for protection really creates a hell of a hurdle? My hurdle goes from 10% to 17% pretty quick?

I don’t know if that’s the right way to do it, but the idea I had was, well, what would it look if you sold the Jan 2022s at 400 and then bought the Jan 2023s at 400? You would cut the cost essentially in half of owning the Jan 2023s. But the risk we were thinking through is well, of course, the market craps out between now and Jan 2022, then you’re going to be long in the market, do you want to be long the market, even though, you could sell it for 12 months? I can sell 12 months from now at the exact same price I paid. So, I’m not taking price risk, but your opportunity cost could be gnarly, because if you really get those shots, the capital will be tied up in the S&P 500. Even at no risk, but you’ll still [crosstalk]

Tobias: You’ve got that big mark to market risk where that front month is going to be very volatile, and those back months won’t move as much, because there’ll be some expectation that we’ll get back to where we are. You have some weird shape to your holding. You’ll be down a lot on that front month, and you’ll be not up enough on that back month.

Michael: Are you suggesting there’s no free lunch? Because I’m told if I lend my crypto out, I can get 15% guarantees.

Tobias: [chuckles] Well, yeah, maybe that is– [crosstalk]

Bill: Can I make a quick comment on that real quick? When I was hearing that pitch, in my head, I was like, “This may imply some risk in the underlying,” and that thought turned out to be fairly smart. That said–

Michael: [crosstalk].

Bill: Sorry to all the bitcoin bulls when I blew it when I’ve interviewed Preston Pysh, I wasn’t trying to come at you, but I did call a top indirectly.

Michael: I think the top was Miami and cocaine. I think that was the top. I don’t think [crosstalk]

Bill: That could have been. That could have been.

Michael: I think that was the top.

Bill: It still could work. Look, those guys, they have their own thesis. Yeah, that’s what I was thinking, Toby, and that’s what I said to Mike, is I said like, the problem with the hedging strategy, I think is– that we’re batting around is, if the market does sell off in the event that you’re hedging for does materialize, your trade is a debit trade, because you’re buying– Your back, the longer dated futures contract cost you more money than you’re bringing in. But if the strikes are the same, when the market sells off, you basically give up your debit, and then, I think you forgo the opportunity to invest. So, I think it’s perfectly not hedged.

Front Month Options

Tobias: Well, are you hedging the front month and using the back month to fund it, or are you doing it the other way around? You hedging the back month and using the front month to fund it?

Bill: Yeah.

Michael: Buying longer duration by selling shorter duration.

Tobias: See, I think that a call repo might work better there. I think if you hedge the front month and then sell the back month, doesn’t that work a little bit better? Because that means you are financing it, but now the– [crosstalk]

Bill: Yeah, you are in the credit position out of the gate.

Tobias: The move is now in your favor. If you get a short-term move, then the front month is going to move more than the back month is going to move. If the market falls over, the front month is going to be the most sensitive, and the back month won’t move as much.

Michael: Right.

Tobias: So, you’ve better hedge in that instance. Then, if it doesn’t happen by the time, your front month expires, then you just do it again. You just sell two of those back months or reverse the trade in the back month and then do it again. I think that would work a little bit better, because I think you’re better hedged in that instance.

Michael: That makes a lot of sense. This is why I was saying last week– gosh, I thought I had it somewhere, but I don’t. I was saying this last week. When I go through this exercise of trading options, which I just don’t think makes sense, because I’m competing against guys like Ben who know this cold. This is his wheelhouse, and I just think when I get to this table– saying in Slack to Bill, and when I pull up to this poker table, I am the dumbest guy at the table. A 100%, I’m the guy, I walk in with a big target right here, and I’m so fat and juicy, and Ben is like, “I’m taking that guy’s money.” [crosstalk]

Individual Equity Options

Tobias: But as you point out there, you do have an advantage. The mathematical advantage is always Ben’s, and Chris’ and other guys like that. They’ve always got the mathematical advantage, and particularly, if you’re in VIX or something like that, they’ve got all of the advantages. You just about can’t win there. But in individual names, in equities, and the options on individual equities where you know that the distribution isn’t normal or isn’t the way that they’ve priced it, that’s where you have the advantage where the tail is fat to one side or the other, and you can harvest that asymmetry. That’s where you’re going to win.

Jake: Where the map doesn’t fit the terrain.

Tobias: There you go.

Michael: Right.

Tobias: Where the probability map doesn’t fit the actual terrain. Yeah. Which is like the Greenblatt strategy.

Insuring Against Quotational Risk

Jake: Pull it back a little bit in the less abstraction from the options. Assuming that you’re a business owner, which I think we all would like to think that we are of these companies, and assuming that you, theoretically, at least like the price that you own it at, what you’re really insuring against is kind of quotational risk of what you own.

Now, you can choose to do that or you can also self-insure that quotation risk through just your own mental fortitude of understanding what you own, and if Mr. Market shows up that day and has a crazy price, it doesn’t have to necessarily affect you. So, you’re insuring your psychology really and one way of doing that is self-insurance, and maybe if that requires you to hold more cash to pad your own mental ability to self-insure, like your own little umbrella policy, I don’t think that’s an unreasonable way to approach it either.

Michael: It’s probably the preferred way, frankly, because you cut out a lot of the complication, you cut out a lot of [crosstalk] reading.

Tobias: The cost.

Michael: Yeah, and cash. You guys remember the experts [crosstalk]. Okay.

Bill: Well, hang on. Real quick. Just taking a step back, and I know that people love when we get into personal finance, but part of the issue is-

Jake: [laughs]

Bill: -Mike’s got a big rights issue that he’s dealing with. He’s got potential capital call on his end. I have an issue where I’m funding a business project and I don’t know– My risk that I’m trying to guard against is having to sell at the bottom, and I don’t have an income coming in that’s consistent enough to be able to plan on it. That’s the context that we’re talking in, so sometimes having background on the incentives of the participants in the conversation helps frame why the conversation’s happening.

Michael: Right.

Tobias: Also, most people are just going to be earning an income on a month-to-month basis, and they’re just investing some small portion in this. Most people aren’t dealing with a fixed pool of capital that they have to [crosstalk]

Bill: Yeah, that’s why I think it’s important to contextualize. This is what why I’m having this conversation. I’m not trying to make some market call or whatever. It’s just that.

Munger – How To Get Really Rich

Tobias: What do you think about– if you’re– sorry, Mike. You should finish Munger thought [crosstalk]

Michael: No. Yeah, I just wanted to reiterate quickly just what Bill said, just to finish that thought on my end is, if you’re contributing your 401(k), never stop contributing to 401(k). Regardless of what you think about the market, just keep putting into your 401(k) and keep buying the S&P 500, whatever index you’ve decided to buy. It makes some sense. It’s a little bit different when you’re approaching it as, “This is where all of my family’s wealth is, and I’m actively managing it,” the question is, do you time it? Do you not time? It’s a big question.

If you want to try to time it, are you going to protect yourself? You’re going to go active and timing it? It’s a million questions that I’m not an expert at answering any of these questions, but I’d say the average person, like for my wife and her 403(b) at the hospital, we’re never going to stop contributing that. I didn’t stop contributing in March. We didn’t pull it. In my opinion, nobody else should either.

The point about Munger was a story he told. I think when he did that psychology speech and he was– I think that’s when he said it. A friend of his had the best advice for how to get really rich, and his answer was, “Always have $10 million in your pocket.”

Tobias: [laughs]

Michael: I think that was the answer, and if you think about it, it makes a lot of sense.

Tobias: That’s great. That’s great advice.

Michael: It was really good advice. Strong advice. The advice is always have– and the answer is, you always have a lot of cash when an opportunity comes, you’ll always be able to swing. You don’t have any cash, an opportunity comes… That was the Munger was talking about. [crosstalk] is talking about.

Tobias: I’ve seen some other approaches where, whether you get a fixed pool of capital and you’re always getting some income, there’s some dividend yield and some– the things are always getting– there’s some capital return, things are getting bought out, so you’re always getting capital recycled to, and the idea is that, if you get uncomfortable with the level of the market, you don’t reinvest. Which is I guess, a little bit like you’ve got an income coming in and you just not investing your income, you’re just letting the cash pile up. What do you think about something like that?

Bill: I would frame it slightly differently. I would say, if you don’t have any good ideas on your desk, I don’t know that I would make it a market level call.

Tobias: Yeah, fair enough.

Bill: Part of what’s going on is, some of the stuff I bought has ripped, and I’m not 100% comfortable with where it trades. That’s some of what’s going on.

Tobias: Would you punch out of it?

Bill: Well, that’s the thing. No. Me, 30 minutes ago says, “Don’t make economic decisions based on taxes.” Me, thinking about writing a tax bill is, “No, I’m not going to punch out.”

Tobias: Yeah. It makes perfect sense.

Bill: Yeah, thank you. I appreciate it.

Michael: Do as I say– [crosstalk]

Bill: It’s honest.

Michael: I think there’s something to Bill’s other point about personal finance is, when you marry that with what Toby was saying, when you have enough cash coming in from yield instruments, or preferred, or whatever it is, to pay all of your bills– God bless you. To pay all of your bills, you don’t have to worry about the price risk so much. At that point, you can survive it. Your family’s going to eat, you’re going to pay all your mortgage, everything’s going to get paid for. You don’t have to worry so much.

I think there’s something to that. If you’re over, so you’re earning more to your point about reinvestment and you plan on reinvesting, you can get tactical that way, but how much are we really talking about, like 2%? Okay, so I’m really going to– I always like– I kind of [unintelligible [00:23:58] on myself, and I need to call anybody out, but if somebody’s like, “Well, I lowered my exposure by 4%,” I’m like, “Okay, if-

Tobias: One dollar. [laughs]

Michael: -[crosstalk] goes down 50%, you save 200 basis points.” Cool. “Well, wait. You’re really put your balls out there, man.”

Tobias: Over five years, I think you get about a third of your capital back from– If you put together a portfolio and you hold it for five years, I think that roughly about a third comes back in terms of just some of the company– say an N30 portfolio. Some of the companies get bought out plus dividends, plus capital returns, you end up with about a third of your cash back. So, you’ve got to be reinvesting that kind of level every five years.

Bill: Oh, every five years?

What To Do After A Big Drawdown

Tobias: Yeah. Roughly on average. Funnily enough, if you go through a big drawdown, often just out the other side is where there’s a lot of M&A activity, because the stuff is cheap, but recovered so people are prepared to sell. Nobody wants to sell in March 2009 or March 2020, because they know that the prices are bad. People are only selling there, because they’re forced to sell. But a year beyond that, everybody’s up on their positions, now they’re looking to get out and crystallize what they’ve made. So, there tends to be a lot of– This is just my anecdotal observation of running lots of back tests, that there’s a lot of M&A activity about a year from the bottom.

Michael: I think that’s right for what it’s worth. At least I saw that at the board level, nobody will start the bottom. Honestly, for your fiduciary duty, you can’t, because you’re basically guaranteed to get sued. Once you see the rebound and stock prices start to come up, if you’re tired, you just throw up your hands, you’re right. It’s 12 months, 18 months, 24 months. I think– [crosstalk]

Jake: I wonder how much of that too is if it’s an anchoring bias thing where I got in at this price, I’m down 50%, I’m going to sell as soon as I get back to breakeven, and then I’ll feel better about this whole thing.

Michael: For most people, stocks don’t care, who owns them and what price they paid, but all of my stocks care deeply the price [crosstalk]

Tobias: That’s right. [laughs]

Michael: All my stocks sit around and think about the price I paid– [crosstalk]

Tobias: It’s the way. Isn’t it?

Bill: Qurate did, and that’s why they’re great.

Michael: [crosstalk]

Don’t Capitalize Your Gains In Your Head

Bill: One thing that I really admire about how Mike runs his stuff, and we’ve talked about this a fair amount, because I personally get more comfort from diversification, and I’m not trying to put words in your mouth, but Mike doesn’t capitalize his gains in his head. When he says like, “Oh, if all this lumber money just went away, my life was good before. My life will be good after,” it’s not bullshit. That’s such a strong advantage to not have that lifestyle creep, to capitalize, and not have to worry about, “Okay, well my fund got paid this year. Now, I got next year’s hurdle rate,” or whatever.

Michael: Yeah.

Bill: The way that he approaches his investing, I have learned a tremendous amount from– Now, if I can only structure my life like his.

Michael: Well, I appreciate that. Thank you very much. Well, you’ve got a home in Fort Collins, Colorado, if you ever need it.

Hussman’s Unhedged Strategy

Bill: Love you, man. The other thing is, it’s interesting is, I think we’d all agree Hussman is a really smart guy. This is his slide deck. His unhedged strategy, just equity and cash equivalents from inception that he shows would be worth 52 grand. His Strategic Growth Fund, which I believe is hedged is 10,948. It’s one of those things that, that is a huge difference, because that dude is mad talented at picking stocks. He would be– S&P is 31,000. He would return 51,000 on hedged. He’s at 11. Boy, that hedge better work at some point.

Michael: Too expensive.

Bill: Yeah, that’s life-changing money. That guy is smarter than me, and he’s objectively put himself behind the eight ball in that hedging game. If he can’t do it, can I? Probably not. I’m not trying to go at him. This is his slide.

Michael: No.

Tobias: I’m a big fan of Hussman. You’re going to say–

Bill: So am I.

Tobias: I love reading what he writes.

Michael: [crosstalk]

Bill: That’s what I’m saying. I’m bringing him up, because I have respect for how he does things. [crosstalk] I’m really not trying to go at him.

Tobias: He has kept his discipline over an incredibly long period of time, and they make small iterative changes to that process all the time, which he fully discloses. I don’t know, honestly, what the answer is there. It’s there, but for the grace of God, honestly, when I look at that, I try to figure out what the lesson is. I’d love someone to tell me what the lesson is. [chuckles]

Bill: Well, that’s what I’m trying to think through. This is his slide. It’s his presentation. I’m merely saying you can pull it up. If it’s cost him $40,000 since inception on that slide, how the hell am I going to do it better than that guy? That guy’s a PhD, and I really like how he writes. I really like how he lays out his thought process. Maybe I should just not worry about this stuff, is really the point that I’m making.

Tobias: The thing is, we’re probably looking at a trough to peak, and I think he would say, you’ve got to look at it peak to peak or trough to trough, and I don’t think we’ve– But then, I would say, we haven’t seen a full cycle and everybody said, well, it was March 2020, and I don’t really have a good answer to that either. I don’t think that was the full flush.

Bill: Yeah. Well, that’s what you have to say.

Tobias: Yeah.

Bill: That has to be your answer if that’s the position you put yourself in. I think for the average person, that’s probably a tough thing to come back from. He may be able to. I have no clue.

Tobias: I think you’ll come back. I think you’ll have a renaissance, and I think you’ll have a good decade coming, but that’s largely faith. [chuckles] I think that’s not just faith, I think objectively, if I set down look at the facts, that’s what I think. However, the market conclude– [crosstalk]

Jake: He’ll have ever earned it at that point, too.

Tobias: Say it again. Sorry.

Jake: He’ll have ever earned it at that point.

Tobias: Yeah. I think if the market comes back, which I don’t know, if the markets going to come back, I just have no idea, but I just think we’re an expensive territory at the moment. That’s really like all the other froth and all the other stuff going on, that’s just– It’s really neither here nor there for me at the moment.

I don’t really, that’s just a timing issue. I’ll look at the value of the market, and if you look at where it is trading on a CAPE or Shiller, any of those metrics, it’s expensive, and it’s historically expensive. Typically, what has followed from very high– When it’s really expensive like this, very reduced forward returns and lots of volatility in the interim. I still think that’s what we’re going to see. That’s my bias, just so everybody’s clear.

Bill: Well, we’ve been clear.

Tobias: I’ve just really [crosstalk] quick.

Jake: Totally wrong.



Bill: Oh.

Tobias: Now, you’re back. I just hard you then.

Bill: I was going to say, if you’re telling people to go back and look at what you’re looking at, the periods that you’re thinking of, how would you tell people to do their own work on this idea? Looking at the market, how do you think through when you’re looking back historically?

Tobias: Well, you can look at– You take Hussman’s method, Hussman has a method where he looks at Shiller and dividend yield, and he says that there’s a normalization over a decade, and then you can take any point estimate through that. You can look at what the market actually did do over the subsequent decade, and you can run that all the way back. I forget where the data goes back to. It could be 1850, it could be as far back as 1875 certainly, but you can run it in modern history too.

Then, you just look at the performance of the market relative to what this thing projects, and I’ve got this little chart that I run in real time pulling data from various just free sites, and it has been quite predictive. But there are certainly periods of time, and they’re all notorious bull peaks and notorious bear bottoms, where the expected return deviates quite materially from what actually transpires, and that’s because the bull peak, the expected return was below where the market actually ended up, and the reverse of that for a bear bottom. But on average, the relationship between the two is pretty tight.

Bill: Yeah.

Tobias: When I look at it now, we’re way above. The return is way above where you would have anticipated it would have been looking back a decade ago, and the forward returns are anemic. Like I say this every week that come on, it just doesn’t change that much from week to week.

Michael: [crosstalk] they are getting more anemic every week.

Tobias: Well, we’re at like 0.7% total return and that includes 1.4% of dividends. So, the index return is negative 0.7% looking at a decade, assuming that you get that mean reversion back to Shiller PE of 16, which might not be a reasonable assumption. But I want to make that clear that’s what we’re expecting.

Jake: You could say, and Buffett’s been saying this for a long time, is that if rates stay where they are or go lower, if margins stay where they are or-

Tobias: Will go higher.

Jake: – higher, then the market is probably reasonably priced. Hussman is basically taking that, and saying, “Well, I think that there’s reversion to the mean on these two ideas, and therefore, it’s pretty expensive.” I don’t think that they’re not saying– They’re saying the same thing, but just in slightly different ways.

Tobias: Yeah, maybe Buffett does– [crosstalk]

Bill: Yeah, I just want to make it clear. I’m not going at him. I’m using his slide because I respect how he does his work.

Tobias: He is transparent too. At least you know what he’s thinking.

Bill: Yeah, that what I’m saying. I’m not trying to be some guy coming at somebody else. It’s not the comment here. This is a 20-year period. This is not some short-term thing. When I’m thinking about hedging, and I see him– I know, you can say, “Well, this is a peak.” I get it, but if 20 years isn’t long-term, I don’t know what is.

Jake: Bit of a Groundhog Day of [laughs] 20 years, but yeah.

Bill: Okay, but the fact of the matter is that’s been 20 years. Whether or not it’s Groundhog Day, there’s a chance that the assumptions are wrong.

Jake: True.

Michael: Are we judging by the wrong at my time or–

Bill: We live in a world probability, right?

You Don’t Have To Do Something

Michael: It’s funny. I keep coming back to– I think Howard Marks, the best he said, “Being too early is indistinguishable from being wrong.” It’s like–

Tobias: You agree with that?

Michael: I do, personally. Timing is really important in this business if you’re going to play that game. If I’m going to play the hedge game, I’m going to play the market decline game, I’m going to play market valuation game, and I’m not saying that that’s a bad game to play. I think my perspective is I’ve been trained as a business analyst and as a more incrementally a people analyst. I haven’t been trained as a market analyst.

I haven’t been trained as an options analyst. When I get into the conversations, I look at– I always start with my portfolio. I always start with my management teams. I want to talk to all of them, I want to know what’s going on in their business. That is really interesting to me, and then, I look at the overall valuation if it was something that I like at this price, or do I not like it at this price. Every time I do that with my existing portfolio, which takes me about three minutes, because it’s one thing-

Tobias: [laughs]

Michael: -I like it. To Bill’s point, I’ve got a really unique set of circumstances that I’m trying to work out in my head. I’ve got to get the John Malone pickles, got to figure it out and get out of that jar, and we’ll figure it out. It’ll be fine but I feel good about it. But then, when I stepped back, and I do all my market thinking and I see things like Burry and this conversation about CAPE and PE, and I’m like, “My God, that’s true. Objectively true.” If you ask me, “Are interest rates going to stay here?” Again, my predictions have been terrible for 10 years, and I’ll keep making terrible predictions. I don’t really know, but it resonates with me that the setup is terrible. You’re like, “Can they go lower?” Yes, but not much. “Could they go higher?” 100%. I hate those setups. It seems like it’s asymmetrically skewed against me.

But the problem is, I’m just not good in that realm, and so I always come back and say, “Well, the number one thing we can do is we can underwrite the right security, and we can be confident in our business we can.” To Jake’s point, we know what we own. It’s our one business. We run it, and we do our best, and we just make sure that when the hurricane comes, because it will, that we’re not overlevered, that we haven’t extended ourselves, that we can survive the pain. But gosh, it’s so tempting to me, like that table I put out on Slack with options and strikes, I love activity. It’s probably one of my bigger downsides. I love being active, I love markets, I love trading. I love it, and I’m terrible at it, but I do love it. I just want it to be something, and it’s often exactly the wrong thing.

Tobias: One thing, Mike, I’d say is, you don’t take a lot of beta risk, because your theses are on different kind of– and I know you’re doing that purposefully. It’s not an accident the way you’re doing it. I appreciate that. The other thing is that you’ve got one position on, but that position does turn a little bit on macro pricing in housing and lumber, and so that’s where you’ve got to spend– It’s not like you’re not able to divorce yourself completely from macro. You’re more idiosyncratically to one commodity. I have a larger portfolio on where one of the commodities in my portfolio is interest rates. So, the price of money is going to impact the value of that.

Michael: It’s probably the biggest commodity you have right now actually, if I had to get one thing that’s going to move your portfolio, it’s probably interest rates.

Tobias: When you think about that, the best rule that I ever got out of commodity pricing is that the best guess for where a commodity is going to be in a year is where it is right now. Not because that predicts where it’s going to be, just because that minimizes your error.

Michael: It’s as good a guess as any. Everybody’s got a view on interest rates, everybody’s got a view on lumber, and none of us are right. Every time somebody comes out with a prediction, myself included, it’s like show me the person that got this right, who told you a year ago that this is exactly where we would be, and that’s the person I want to have the conversation with about where we’re going to be in a year. If you can’t find, just don’t exist.

If you want to give me this fact pattern or tell me, where wherever the 10 year be? After all this money and liquidity in the market and all this stuff, where were the 10 year be? That’d be like, 2 is the start. It could be four, and here we are at one-four. Then, the Fed comes out says, we’re going to raise it, it goes down, it’s like clearly this is– [crosstalk] too hard to predict.

Tobias: That’s the problem.

Bill: [crosstalk]

Jake: If you’re not confused, you don’t know what’s going on.

Tobias: That’s it.

Michael: Exactly.

Tobias: As Jake has pointed out a number of times, you look at the– I’ll give you the fact pattern in a year and you’ll just be 100% wrong, because that’s been true last rolling like decade, I guess.

Is There A Finger On The Scale?

Bill: Well, it’s all whole Lacey Hunt thing, I think, where all this debt is– I think the 10 year is telling you that it doesn’t buy growth. I think it’s telling you a little bit that it doesn’t buy inflation. We’re trading on the 10 year where we were in 2012, 2016, 2019?

Tobias: Is there finger on the scale?

Michael: No, that’s the question. Yeah.

Bill: Does it matter?

Michael: It is a conspiracy.

Jake: Yeah, it matters.

Michael: [crosstalk]

Bill: Why? Other than you want it not to matter, what do you do? You’re not the finger. You have no control over it. So, you’re living in that world.

Jake: It’s not that I don’t have control. I mean I don’t have control, but if you’re trying to use the natural order of things to then determine what might be coming next, if there’s something external to that that is not obviously baked into it, then some exogenous kind of deus ex machina type of thing putting their finger on the scale, then you shouldn’t be making those guesses at all.

Bill: Yeah, but let’s break down what you just said. If you’re trying to assess the natural order of things, but then you’re also attributing weight to the finger on the scale, what I would argue to you is the natural order of things doesn’t exist.

Tobias: Or it should– [crosstalk]

Bill: Your assumption of what it should be is flawed, because you live in the world that is, not what should be in a textbook.

Michael: Take that, Jake. [chuckles]

Jake: I know. Well, my counter is that, that assumes a level of omnipotence to some of our planning that I’m not sure is wholly warranted.

Bill: Oh, I strongly disagree with that. Strongly. What I would say to you is, it pushes risk elsewhere. It doesn’t assume omnipotence at all. I’m not saying that the people that have the finger know what’s going to happen. I do not disagree that it creates a risk. But I do disagree that you can invest under the assumption that it should not exist, or it doesn’t matter.

Jake: I’m not saying that you assume that it doesn’t exist. What I’m saying is that if you try to use logic of the price of money really which is what we’re trying to figure out, you can’t very easily do that without assuming that there’s not a finger on there. So, the price of it doesn’t really tell you the information that you would hope that a price that comes out of a natural process would tell you.

Bill: Right. But the price of it is determined by the supply and demand, and people can issue a ton of supplies. So, the price goes down, because the supply goes up. That’s the finger. And you can’t control the supply. This is why people like bitcoin, because it is really elegant and proven.

Michael: [crosstalk] says, is there something outside the financial system that solves this? Is there something out there that solves this?

Jake: It solves everything.

Michael: [crosstalk] heard of anything?

Bill: Well, I’m serious. That’s why they like it.

Jake: Yeah.

Bill: It’s a very elegant mathematical solution that removes the finger from the scale. But that’s not the world we’re living in. That’s the bitcoin world.

Tobias: Yet.

Bill: Yeah.

Tobias: Soon.

Jake: Yeah.

Michael: Did we solve it? Did that happen? I was listening, but I’m not [crosstalk] the answer in here somewhere.

Jake: I’m more confused than when we started.

Michael: Yeah. Same.

Bill: I’ve enjoyed the conversation though.

Michael: It’s an interesting topic. It really is. I think Toby’s framework is exactly right. We all feel it. I feel it every day when I wake up. I’m bullish, because I can’t figure out anything else to be. That’s really where we are. I just can’t figure out what’s the alternative to being bullish. [crosstalk]

Tobias: What about the Keynesian beauty contest where everybody’s bullish now? For all the reasons, none of us can think of a reason why the markets going to go down. Could that be the reason that the market goes down?

How To Protect Yourself From A 50% Drawdown

Michael: Hence the parachute. That is exactly why you just go to, well, what’s the parachute? This duration conversation, you can make it really simple and right now for 25 basis points, you can protect yourself against that 50% drop in the market for 25– [crosstalk]

Tobias: How are you doing it? I’m just going to write that down.

Michael: Just puts. Buy puts.

Tobias: How far are out of the [unintelligible [00:42:59] are you?

Michael: You can go– [crosstalk]

Jake: It’s for a week.


Michael: 50% for Jan 20– It’s Jan 2022s cost you 25 bips-

Tobias: Okay.

Michael: -for a 50% drawdown. Five zero percent drawdown.

Tobias: What’s the percent– your book is protected, or how much of your book is protected that level? 50% of your book?

Michael: I have no– I’ve zero. I bought zero, but let’s say you had a million of exposure and you wanted to protect yourself against–

Tobias: Say, five hundred thousand. You’re saying two and a half thousand protects it.

Michael: Yeah. That protection only kicks in down 50%. You can only go down 50%. Yeah, that’s what I’m saying. When you ask me about disaster insurance, that’s what I’m talking about. 30% drawdown, it’s not a disaster. A 70% or 80% drawdown would be a complete disaster. [crosstalk]

Jake: It’s a super cap policy, basically.

Tobias: Yeah.

Michael: Exactly. Yeah, it’s protecting yourself against getting cancer or something. That’s the stuff that you really– It’s going to be really expensive and totally terrible, but it’s better than the alternative.

Tobias: That’s the other approach to hedging that I really like that the only time that you hedge is when it’s a trade that is cheap, and it makes sense. You just don’t bother when it’s expensive. When you get to this point, we’re like, “Gee, the payoff here is wrong for the risk that this happened.” There’s a one in three risk that this happens, and the payoff is, it’s 10:1 or whatever it might be, 20:1.

Jake: The price implies odds that are way different than what you think they are.

Tobias: Yeah.

Michael: That kind of drawdown has happened three times in 90 years, so it’s not less than 1%. It’s definitionally 3.3%, is how often that has happened in– [crosstalk]

Jake: 1 in a 100-year storm. [chuckles]

Michael: Yeah.

Tobias: So, there’s been a 50% drawdown three times in 90 years?

Michael: Yeah, greater than 50%.

Tobias: How many 50% drawdowns have there been in the last 20 years? Two?

Michael: In 2008, we got over that, but for a very short period of time.

Tobias: Was 2000 not a 50% drawdown?

Michael: Mm.

Tobias: I guess it’s more than 20 years now.

Jake: It definitely was for NASDAQ. I’m not sure if S&P got down quite that far, but I think it was pretty close if it wasn’t.

Tobias: And what’s the other one, Mike? You’re going to go way back to 1929 or something?

Michael: You’re making me look for something I have it on my–

Tobias: Because I would have said there were a few pretty big drawdowns.

Jake: 1973, 1974, didn’t get down that far?

Deep Survival – In Investing Choose Your Friends Wisely

Tobias: Can we cram in some veggies before we make it out?

Tobias: Yeah, man. Let’s do it.

Michael: Okay.

Tobias: Let’s do it.

Jake: I’m going to try to tie it back in if I can. I’m reading this terrific book called Deep Survival. It’s about all these different, basically climbing accidents, airplane crashes, boat, shipwrecks, all these pretty harrowing stories of people out there taking these risks. The analogies for what we do are obvious and plentiful. I’m probably going to do multiple parts of this over the next few weeks, but the first one I’m doing is, in 2002, there’s these four guys that were climbing Mount Hood.

That particular climb is considered a beginner’s climb, which is actually one of the most dangerous things that anyone could ever say, is this is a beginners climb, because then, people don’t prepare, they take stupid risks. But what ends up happening is that as you’re working your way down, it’s like this big ice field, basically, that you can hike, but these guys are connected to each other with harnesses. What they do is the guy at the top is the anchor, and then the guy below him, he’s attached to him with a rope, and he’ll belay him, which means let rope out to let him down a certain amount. In this particular instance, you had a guy up at the top, who we’ll call A, a guy 35 feet down from him who was B. C was 70 feet below him, and then D was 105 feet. Basically, these guys are all stretched out on multiple ropes.

Well, what’s important is that the top guy can’t fall, because if the other guys fall, they can only fall so far before someone else arrest them. What ends up happening is that, of course, the top guy falls, and he ends up– then he’s traveling about 30 miles an hour by the time that the rope gets taught with the guy that’s was directly below him. It yanks him off of the of the– All these guys had been practicing their fall arresting, which is like you have this ice axe, and you basically jam it into the snow and then lay on it, and it’s like an anchor.

They all do it but because there’s so much stored energy when you’re up together like that, it actually goes back to this that segment we did on normal accidents, the nuclear meltdown, and all those things, you have a very complex system, high energy along with tight coupling, because they’re tied to each other. So, anyway, it cascades, and each guy pulls the next one off of the mountain, and now they’re all sliding and bouncing around, and the rope– a rope is an interesting thing from a physics standpoint, because it’s able to transmit force along it in lots of very interesting, weird ways. It’ll stretch, it’ll pull someone else in other direction.

These guys are just cruising down the mountain, they end up hitting two other guys that were below them, wrapping the rope up in them, and then that gets pulled down, and then, it hits four more guys, and then they all crash into the side of a wall, and then down into a crevasse and half of them end up dying, the other half are just shredded.

Well, what’s important, I think the analogy that we can make is that, that psychologically, mentally, spiritually even, you have to be very careful about who you’re tied to, and if they are going to fall off and potentially pull you down. You think about your friends that you talk about investing with, maybe where you work, if you’re in the investment industry, you’re effectively tied to those people psychologically because we’re a herd species. We’re very influenced by the people around us. You become the average of the five people you spend the most time with. When we’re climbing this mountain and if someone is to fall off in our group, and maybe pull another person down, and then they pull the next person down–

There’s a cliche in the climbing community that being tied in together is basically signing a suicide pact. We all are potentially signing suicide pacts of making suboptimal decisions if we get too influenced by the people that were around us. Sometimes, I think you almost have to be willing to cut your rope if everyone else is losing their minds around you, and maybe pulling you off of the mountain. The higher that we get in this mountain, which maybe correlates to some of the things we were talking about as far as how expensive things are, the setup, boy, maybe I need to be free climbing now, and not tied in with everyone else around me, because we have a ton of energy, we have a very complex system, we have a lot of interconnectedness, maybe that’s not the time to be tied in with everybody. Some interesting analogies in these life-or-death situations, and I’m going to come back in the next few weeks, I’ve got some more of them that might be kind of fun.

Tobias: Somebody wants to know, do you read these stories to your kids? They get to bed okay? [laughs]

Jake: I should, just to scare the shit out of them.

Michael: Like half of them died, it was a disaster, so just remember who you tie yourself to.

Tobias: Could not sleep.

Jake: Sit tight.

Michael: [crosstalk]

Bill: By the way, it was a super scary death, is they fell off a cliff and knew they were going to die. It was fantastic.

Tobias: All the way down. [laughs]

Bill: They couldn’t [crosstalk] halfway through.

Jake: Well, that’s that thing. It probably happened in less than five seconds, because when the first guy falls, and it’s like two seconds, he’s going 30 miles an hour already.

Michael: Right.

Jake: They’re just going down this thousand-foot face in five seconds, and then they’re all wadded up down at the bottom together.

Tobias: I like that analogy, but I think at that time you need to be careful in investing is as you’re ascending, because I think that as you get closer and closer to the peak, everybody starts cheering and having fun, and that’s the time when it’s most dangerous. Totally unrelated. I’m taking a fairly long Twitter break. I’m on Twitter every now and again, but I’m mostly off these days, because it’s all got a little bit loopy for me.

Jake: Twitter is totally tying yourself to a bunch of other people’s opinions letting that soak in. It’s by looser tie, probably than you talking with your friends or in a Slack channel like you guys have.

Tobias: If you want to look though, gets into your mind. Gets deep into your [crosstalk].

Jake: No doubt. I’m just kidding.

Bill: I’d like to say that. I’m very glad. I got on Twitter, and it got in my mind. It’s made me much smarter. I would have been a dumb ass without it. I’ve probably would have lost everything and– [crosstalk]

Tobias: You’ve got Qurate, who you follow? Who you pay attention to?

Michael: Ooh, Qurate.

Bill: [crosstalk] Oh, Qurate.

Michael: [crosstalk]

Tobias: Oh, there you go, fellas. [laughs]

Bill: If only Dave Venable could cook it up for me.

Michael: [crosstalk]

Jake: Full circle.

Michael: I like that story, Jake. That’s a good– In my mind, I’m thinking, it really matters, who you partner with. It really, really, really matters. Just it matters. It’s just keep coming down to–

Tobias: That’s a good point, but most of the time, they say the pilots, it’s like driving a bus 99% of the time, then 1% of the time, you need to find a pilot who knows what to do. Given that is the case is probably true. So, in investing, 99% of the time, it’s incredibly boring and there’s nothing much fun going on. Then, 1% of the time, it’s just brown undies time. You don’t really know what your partner’s going to be like through that time. So, how do you stress test them before the event?

Michael: It’s impossible. At least if somebody knows, I don’t know. The guy that I invest with, who does the private deals and I do the public deals, we do them all together, Bryant Kobe, he and I’ve been friends for a decade. I had no idea. We’ve invested together, but I had no idea what it would be like to invest with him our own capital and in times of stress, and he and I, from February really through the end of July, spoke every day, invested together, and did very, very well. For me, he’s my ride or die.

I know exactly what it’s going to be. If stuff hits the fan, and we’ve got a 40% drawdown, I know exactly what he’s going to say. I don’t know any other way to do it than to just do it. Maybe there is a way, but– By the way, I had some friends where it was the exact opposite of that in that exact scenario where I expected them to do something based on all the conversations and the thought process we’d had before, and they did the exact opposite of what I would have expected. It’s totally fine. It’s not positive or negative, it’s just– That’s good information to have.

Tobias: As we’ve pointed out, there are many theories that we all like to embrace, but when it comes to our own money, sometimes you just want to take the irrational approach, because the irrational approach makes more sense in your individual scenario.

Michael: It is amazing, fear of losing money, what that does to people. It’s really remarkable. Actually, when you have to see– I don’t know if you can predict it, but you know it when you see it. It affects people very differently. People get very, very weird. It’s what Bill was saying about capital, and that’s part of the reason why I think capitalizing your gains until you realize that it was a mistake, because when you get into that loss position, the fear just grips you, it turns you into a very different person. At least people that I’ve interacted with my investment career all become very different when they become afraid of losing money.

Jake: At the chemical level, it’s changing you.

Michael: There’s nothing they can do.

Tobias: Yeas. It’s physical. It’s physical.

Michael: There’s nothing they can do. It just takes over you. That’s why I say until you see it, you don’t really know what it’s going to look like.

Tobias: I think [crosstalk] little look like Keynes.

Jake: It’s literally your amygdala is driving the show then, because it’s a survival thing.

Michael: Right.

Jake: You don’t have time for executive processing in those– You don’t feel like you do in those situations. So, the amygdala takes over, and it has first lien on controls of this machine, because it got us to an evolutionary place, but it doesn’t fit our world now. [crosstalk] fear response.

Michael: No.

Tobias: I like Keynes take on it. When in 1929, he was running a few different accounts, King’s College and some insurance companies accounts, and one of the insurance companies made him liquidate all of his positions, but he said to the King’s College and to the other insurance company, if we liquidate now, then there’s no chance of recovery. If it keeps on getting worse from here, then it’s going to be Mad Max Thunderdome in the streets anyway. Really, the only path here is to stay invested and to ride this thing back up.

Jake: Pot committed.

Tobias: I think it’s true. Pot committed.

The History Of 50% Drawdowns

Michael: You guys ready for the periods where we had more than a 50% drawdown? I hit it in our direct message channel on Twitter, so you’ll have this, and I’ve texted to you, Bill, so you’ve got it too. October 2007, 56.8% of a 17-month duration drawdown, which is about the average, but a big drawdowns of more than 30% usually last 18 months.

Jake: I thought it was three weeks, and then it’s over and then you get– [crosstalk]

Michael: Yeah. Now, we’ve discovered a new financial system. Now, they only have to last a few weeks–

Tobias: Last crash.

Michael: Historically, they were 18 months.

Jake: [laughs]

Michael: September 2000, the drawdown was just under 50%.

Tobias: Ah.

Michael: 48.9% peak to trough. That was a 25 month by the way, that’s [crosstalk]

Tobias: That’s long.

Jake: That’ll grind you.

Michael: The worst was September 1929, obviously. That’s 86%, eight-Six. Can you Imagine that? 86% of your purchase powers gone. Oof, brutal. Then, in March 1937, that was a 13 month or so relatively short was 53.8%.

Tobias: 37, that’s an unusual day. Is that lead up to World War II? What’s the reason for that one?

Jake: Great Depression.

Michael: I just report the numbers. I don’t give the context.

Tobias: [laughs]

Jake: 1973, 1974. Where’d that go?

Michael: January 1973, that was down 48.2.

Jake: We’re in the neighborhood.

Michael: Yeah. It was a 21-month duration slowdown. I did this, because in 2018, when I was having a really, really tough year at work, I wanted to myself for my own psychology, but then also for my firm, I wanted to put it in context, are the drawdown that I was having, I wanted to put in the context of historical material drawdowns, that drawdown was two months old when I built this, and I was down 11%. It was the end of the fucking world.

Jake: [laughs]

Michael: I’m like, “Guys, this is nothing.” If you’re going to invest in public markets, you have two choices. It’s just like what Bill was saying. You have two choices. You can either say, “I’m cool with a 45% 18-month drawdown. I’m cool with it. I don’t love it, but I’ll get through it, and it’ll be fine. By the way, we’ll do we can, we’ll move pieces around, we’ll try to buy into it, we’ll lean into the pain.” As Steve Cohen would say, “Lets lean into the pain.” That’s the right answer. Or you can do, Sussman does.

Which is, “I’m always going to be protecting against that 45% drawdown and that’s going to cost me an awful lot of money in the good times.” I’m not saying one is right or wrong, they’re both strategies. You just have to kind of pick it. I’ve learned that I’m way better off just letting it– grip it and rip it, so to speak, and then just dealing with the fallout when it happens, and just saying like, “Look, we are going to get over it. It’s going to be fine.” Then, just that has worked for me historically. That’s why I’ve out the table together. [crosstalk]

Tobias: Value Stock Geek says, in 1937 they thought they were out of the 1929, 1932 recession and started raising rates and easing off the New Deal.

Bill: Value Stock Geek, that dude is crazy smart. Shoutout to you, Value Stock Geek.

Michael: Thank you, Value Stock Geek.

Tobias: One more from him too. We think of the Depression as one long slog but it was really two absolutely brutal recessions. Here we go. Same as 1973, 1974, those two.

Michael: Yeah.

Tobias: Back to back [crosstalk]

Bill: Talk to him in real life, too. Nice guy. Big shoutout to Value Stocky. Nice to see you here, man.

Jake: Didn’t we have a Federal Reserve back then, too? What happened?

Tobias: They didn’t have the modern technology.

Jake: Oh, now they got it all figured out. Okay, cool.

Tobias: Modern technology. Computers.

Michael: Two words.

Bill: Shit has changed.

Michael: Two words, block chain.

Jake: Block chain.

Tobias: That’s time, amigos. This was really fun. We’ll be back– [crosstalk]

Michael: Do I have one more, or was this my last one?

Tobias: You have one more. [laughs]

Michael: Sorry, guys. Sorry to everybody out there. You got me one more time.

Tobias: We’ll see everybody next week.

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