In this episode of The Acquirers Podcast, Tobias chats with Tim Travis, founder and deep value investor at T&T Capital Management. During the interview Tim provided some great insights into:
- Big Disconnect Between Value & Growth
- Biggest Positions In Your Best Ideas
- FANMAG Valuations
- Marrying Value With Options
- Choose Managements That Pick Up The Phone
- Imagine Bonds With Inflation
- Always Keep Cash
- Reflation Is The Smart Play
- Inflation Ultimately Drives The Fed
- The 10-Year Sweet Spot For Banks
- Finding Great Investments
- The Biggest Upside Comes From Equities
- Choose Managements That Pick Up The Phone
- Selling $CLF Put Options
- Misguided Fear Around Assured Guaranty ($AGO)
- AT&T’s ($T) WarnerMedia/Discovery Deal Is Transformational
- Alibaba ($BABA) – Offers Growth At A Reasonable Price
- Credit Suisse ($CS) – Great Wealth Management, Poor Risk Management
- Assured Guaranty ($AGO) – Strong Buyback Activity
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Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Tim Travis of T&T Capital Management. When I think about the things that are going on in this market, the things that stand out are value, financials, and options, and there’s no better person to speak about them. He’ll be coming up right after this.
Big Disconnect Between Value & Growth
Tobias: When I think about the signature of this market at the moment, I think it’s maybe a little value resurgence, seeing some life in the financials, and lots of option activity. When I think of those three things, the first person I think of is you. I’m just interested to get your take, what do you see going on in the market right now?
Tim: Well, thanks. To me, it’s peak euphoria. The biggest reminder to me or the biggest commonality is how it was in 2000, in the late 1990s. We were both pretty young back then, and probably weren’t quite as active in the markets. But back then, everyone thought they were market geniuses, and everyone seemed to be doing pretty well, and you’d only hear about the wins, and that’s how it seems to me.
People that showed no interest in the market just a year ago are now all on AMC train, or they’re very big in the crypto. I think that should be a warning that there’s immense amounts of euphoria and speculation going on. You just want to keep that in the back of your mind to make sure that you are making prudent financial and investment decisions. That’s where we are.
We’re really focusing on, okay, individual scenarios, individual securities, how can we structure our positions to best capitalize on that from a risk-adjusted return standpoint, and definitely, I think value still has a big disconnect between growth, but there’s some interesting growth names as well.
Marrying Value With Options
Tobias: Let’s talk a little bit about structuring, because you are kind of an options experts, and you’re a value guy. You’re one of the few guys who marries those two really nicely together. So, let’s just talk for folks who haven’t heard you before. Can you describe your strategy?
Tim: Sure. Definitely, we start first and foremost with identifying deeply undervalued securities, whether that’s equity, whether it’s fixed income. And then, what we do is we look, what’s the best way to play it? If we think this stock’s likely to double within the next two or three years, then certainly just owning the stock outright or theoretically buying call options would be the most sensible strategy. But perhaps, now, we’re a little concerned with the overall market, valuations are high, you’ve got the inflationary backdrop.
So, what we’ll also do is, we’ll look, okay, well, what’s the debt trading at? Most of that is yielding very paltry returns right now. Then, we might look okay, well, what about selling a put? Selling a put with the willingness to own the stock at a cheaper price and depending on the returns you can get on those puts, and how far away from the current market price, that might be a better risk-adjusted return. Particularly, because we’re not a hedge fund. We are a registered investment advisor. So, we’re investing for everyday people and making sure that we’re prudently doing it. So, that could be a good risk-adjusted return, especially in a market like this.
Tobias: Let’s just talk a little bit about the market. I see it as being very expensive too. When I saw this statistic yesterday that the spread between the high-yield junk bonds and investment grade was as tight as it has been since 2007. The first thing I thought was, well, I’m going to go and see if I can find some way to play that in the options on one of the junk bond ETFs or something like that. I was struck by how much vol there was in all of those positions. They are so expensive to get any of that hedging on that it has passed by, and that was one of the reasons I wanted to talk to you, because I thought if there’s anybody who can take advantage of some of that vol, it’ll be you. Are you seeing that in your individual positions?
Tim: Yeah, we’ve had a great start to the year. Value’s held up really well. We’re pretty big in financials. We were decently exposed to energy, which obviously both those hurt us last year. But it’s helped us really since early November. Right now, we’re looking at it and we see the market is being pretty inflated. I think there’s some major concerns coming up. What’s the inflation data going to look like? What’s that mean for interest rates?
And then also, you’ve got the hang hangover on spending. Right now, we’re going to have an amazing summer, hopefully, and you’re going to see travel numbers that are insane, and everything’s booked, and prices are sky high. But what does that look like when the stimulus tap is empty? So, I think that when you start looking towards the end of the year, and you go into next year’s earnings guidance, that could be a little a little iffy for some of these companies. We’re definitely pretty conservatively structured.
Selling $CLF Put Options
I’ll give you an example. One of our investments for the last few years has been Cleveland-Cliffs, iron ore miner, and they’ve got an amazing CEO. The guy is passionate. He’s a little controversial, because he’s very blunt, which is hard nowadays, of course. What they did was they bought AK Steel at pretty distressed levels, and then they bought the US operations of ArcelorMittal. They went totally vertically integrated. Goodness gracious, the timing could not have been better. They took on a lot of debt, but they did this.
They also built an HBI plant, which they financed themselves. They didn’t do any partners. Now, prices are sky high, astronomical. They’re projected to do– I believe it’s $5 billion of EBITDA this year. I think it might actually end up being higher than that. The stock’s got an enterprise value just over $17 billion. We’re not stupid. This is going to be close to peak margins this next year or two. They’re a huge supplier to the auto market, so steel for the auto industry. That’s gangbusters. The stock here, it trades at a low multiple. You could easily make the case to buy it. I could see it pulling up on your screens next year as the earnings come through.
But what we’re doing is worth selling puts. Just a month ago, for instance, with the stock trading at $19.50, we were able to sell $10 puts expiring in January of next year for about 71 cents, so 71 bucks per contract. You look at that, that’s just over half a year, you’re locking in 9% annualized returns, 10% annualized returns roughly, and you’re locking that in almost requiring a 50% drop in an already undervalued stock, and you compare that to junk bonds, 3.8%. Even the junkiest of junk is barely over that, the stuff that’s likely to default. For me, that’s an attractive risk -adjusted return. I’m happy to own the stock. I’ve owned it there. For us, I’ll take that any day of the week.
Tobias: Let’s just walk through how you come to those numbers. It’s a $10 strike on the puts and 71 cents, then you think about that as like $10 minus 71 cents, and $9.29.
Tobias: Then, you get to 71 cents on the $9.29. That’s how you get to almost a 9% yield on it.
Tim: Yeah, total return and then when you annualize that a little bit over half a year– this was about a month ago when this pricing existed. You annualize that, and you’re probably in double digits there. You really require a 50% drop in the stock just to get to breakeven. What I like about that company specifically is, I know, the CEO as far as I understand how he operates. He says he wants to be debt free, whether that happens or not, but they’re going to use this enormous windfall of EBITDA to dramatically reduce the debt. You’ve got these acquisitions, they’re going to have a phenomenal balance sheet, you’re going to see those credit ratings keep popping up, and so that’s going to de-risk the company a lot.
Then, if you get in at that lower price, well, that’s fine. That’s fine. We know it’s a cyclical industry. So, earnings are going to fluctuate, but they’re going to earn a ton of money this year. I think next year is probably going to be strong too. There’s still there’s a lot of demand, particularly, if we see some more infrastructure spending. For fairly conservative investors, like many of my clients are, that’s an attractive risk-adjusted return for me. I’d rather do that than buy bonds and take the interest rate risk, spread widening risk, and then ultimately, default risk on some of the more speculative stuff.
Reflation Is The Smart Play
Tobias: This sort of dovetails with a conversation on inflation. When you look at something like steel, which is a cyclical and doing very well, driven perhaps by some additional demand for cars, there seems to be something like that going on, you’ve got this potentially shorter-term bump perhaps from the stimulus and COVID. How do you see that playing out over a longer term? I guess I’m asking is it transitory, or is it here to stay?
Tim: You tell me.
Tim: I don’t know. I don’t know the answer to it. To me, I think it feels like real inflation. If you do study history, which I know you do, inflation was such a dominant aspect of society in the 70s. It really was. It was transformational. Those that were around for it have deeply ingrained memories of it. Getting mortgages at the 11%, 12% rate, which is just insane. Now, think of what that would do. You have these massively inflationary factors, the money printing. We’re going to Hawaii in September, and oh, my gosh, the rental car prices, it’s $200 a day for a crappy style car.
Of course, the hotels and the flights are now ramping up again. To me, it feels like it’s going to be real. But then, you do have some– I feel there is some deflationary aspects going on. You’re likely going to see a tax hike. I think that I’m just not super optimistic on the overall economy long term. You’re going to have a big hangover, like we mentioned with the stimulus where that’s going to wear off, and people that have dug into their savings are now maybe going to start using a little bit more leverage, they might get a little more tight fisted. I think that that’s the argument against it. But to me, I’d put the odds, I’m much more worried that inflation will appear. I think betting on the reflation play is smarter.
The reality is, we’ve been in a low interest rate environment, so things like the banks. Look, they’re going to be fine even if interest rates stay low. They’re not going to get a drastic rewriting higher in multiples, but they’re not going to get crushed either. Rates have been low for the last decade.
The 10-Year Sweet Spot For Banks
Tobias: There’s some suggestion that inflation is good for value. I don’t know how inflation impacts the banks. It probably tends to hurt them. But do you have any view on value and the banks?
Tim: Well, I think inflation in general– if it’s not like hyperinflation, or even a super severe, if you start seeing rates creep up, and you get to 3% or 4% on the 10 year, I think that’d be really a sweet spot for a lot of the banks and also the insurance companies. You’re going to get way more yield, you’re going to see returns on equity lift up pretty significantly, especially, because they’ve had to adopt their operating cost to this environment. So, there’d be some real operating leverage that they could pull from that. If it goes on a lot further, of course, it could be bad, but I think I’d rather have an inflationary environment for them. Of all the asset classes, I think energy and commodities probably do best. Financials are pretty, pretty strong in that area as well.
Misguided Fear Around Assured Guaranty ($AGO)
Tobias: You’ve been a long-term follower of Assured Guaranty, ticker AGO. Can you give us an update on what has happened there, and perhaps start with just an overview of the thesis in AGO?
Tim: Yeah, so what it is, they are a municipal bond insurance company. They’re really the only survivor from the previous bubble back in the financial crisis when almost all of them went bust. They’re the largest– There’s one other smaller competitor that’s gone on. They got through the financial crisis unscathed. They didn’t underwrite the CDO squared or any of that garbage, and then, they ended up getting reimbursed from a lot of the mortgage and structured finance losses that they did have, because of fraudulent rep and warranties from the bank. The banks had to pay them multibillion-dollar settlements. They’re strong underwriters, strong balance sheet, there’s still double A rated, and then they got hit.
As things are really starting to pick up, they got hit with Puerto Rico about five years ago. Really, the hysteria started about six years ago. That bankruptcy-like situation has been a nightmare. It’s taking absolutely forever. The oversight board that was appointed to it has been abysmal. They’ve spent over a billion dollars in legal and consulting costs. But we’re finally to the end line. By the way, between that, they got hit by two hurricanes, including Hurricane Maria, which set things back.
Then, you have COVID, which basically, they lost a year from. But anyways, to make a long story short, we’re at the end. They’ve come to agreements with all of their exposures where they’ve actually taken losses on. There’s about two or three credits where they haven’t taken any losses on, and those will just continue. But they’ve got resolutions. Now, they have to be approved in title 3 court still, but I honestly, don’t see a huge problem there. I’m very confident it’ll happen. They’re also getting a huge amount of stimulus money, Puerto Rico from the recent legislation that’s passed. The situation looks great, and on the last quarter, management flag that they’re fully reserved.
The bears like David Einhorn, they said that they’re going to have to add billions in reserves for Puerto Rico, and the math never added up. But it’s easy to install fear when you’re dealing with a bond guarantee company, because you almost always hear about the downside. You don’t really hear about the upside when almost all the credits are performing. That situation did not happen.
They’re fully reserved, and they’re likely overly capitalized now maybe up to about a billion dollars. This is a three and a half billion market cap company roughly, and so you could see a massive buyback. They’ve been buying back about $400 to $500 million in stock each year, and the stock’s been so perennially undervalued, that it’s enormous accretive. You’ve got this strong company, Puerto Rico, the biggest issue’s resolved. They’re going to buy back a ton of stock. It trades at $47, $48. It’s got a book value of $85. It’s got an adjusted book value that’ll cross $120 this year, and then you’ve got likely all this excess capital freed up, because Puerto Rico’s resolved.
Then, you look at municipalities, this is why this situation is so different. Last year, Toby, I was terrified of municipal finances, just because you don’t know the government’s going to come in like they did. You don’t know that they’re going to basically bail out all the municipalities like they did. You don’t know that revenues are going to hold up a lot better than what was anticipated, but look what happened? Revenues did hold up better than anticipated, and then you got the mother of all stimulus packages for these municipalities. Whether you agree on it or not, whatever, it happened. Now, even formerly troubled credits like Illinois are far less worrisome than they were before.
One more thing I’ll mention is, they’re below investment grade credits in their insured portfolio. Obviously, those are the ones you’re keep an eye out, they’re already the lowest in their history. At least that I’m aware of, at least 16 years, I’d say 16, 17 years of history. Now, over half of that is related to Puerto Rico, and that’s basically resolved, pending approval in title 3 court. You’re going to have that cut in half already from the lowest level ever, and what’s weird is the market just hasn’t really picked up on it yet. The stock’s moved for sure. It’s having a really nice year. But maybe they’re doubting it or maybe not many people are following the name. So, I think that one is one of the opportunities that has a chance to really run as we go on in this year and going into next year.
The Biggest Upside Comes From Equities
Tobias: When you look at something like AGO, how do you play? Is that an option– Do you sell options to get in, or is that just in the equity?
Tim: You have so much upside, it makes sense to own the equity. We’re dollar cost averaging into things, so I love staggering options, and maybe selling some shorter-term ones. If I already own the stock, maybe all right, if it trades down to $42 in the next 60 days, I’m happy to own some more stock there. You could always argue against her for that stuff, but I’m a big buyer. I’m sure you are too. I love dollar cost averaging.
I’m willing to buy the stocks that I own as they drop in price as long as nothing’s fundamentally changed on it. But mostly, you want to own equity. When we get the big upside in our portfolio, it’ll come from a stock like that, and then you have some of the ancillary names like the Cleveland-Cliffs position I told you about. That’s a fixed income surrogate. It’s going to behave differently. I’m not going to say it’s the same as a bond, but that’s how we look at it, like a surrogate, a refined strategy to generate income with a favorable risk-adjusted return.
AT&T’s ($T) WarnerMedia/Discovery Deal Is Transformational
Tobias: We’ve talked about iron and we’ve talked about a municipal reinsurer. Let’s take a complete left and do AT&T.
Tim: Sure. AT&T is a stock everyone loves to hate and I understand why. It’s just like GE in some ways, where they made ridiculous acquisitions and they paid way too much. The bidding war for Time Warner was sickening to watch.
These mistakes have been made. I understand why people are hesitant on the stock, but I looked at that Discovery deal as truly transformational. It also tells me that the CEO finally gets it. They’re getting a reasonable value for the Time Warner assets, and they’re combining with Discovery, which I think that they’re very complementary products.
To me, I would much rather have Time Warner plus Discovery, than then Netflix or Amazon Prime video. I think it’s extremely competitive. You have a different balance too between the dramas, the sitcoms, and then also the home improvement type stuff, or the reality TV that’s on Discovery. I think it’s a good mix.
Then, don’t forget. AT&T is going to own 71% of that. You’ve got John Malone linked to Discovery. My only critique on Discovery is the executive pay is out of control. But you have them, they know how to use free cash flow, they know how to use the capital structure. That’s going to be a leveraged bet, and I think they’re going to win. I think there’ll be a winner. Then, you’ve got the communications business which is fantastic. AT&T is going to be able to remove the debt problem.
They’ve already been doing a good job paying off debt, but now, they’re going to dramatically reduce debt. They’re going to be able to invest, just focus on having that be a lean operation, and then, you’ve got the stock. It’s trading at less than 10 times forward earnings. It’s got a 7.24% dividend roughly, and that’s going to get cut. You have a huge amount of sellers that are just, “Oh, they’re cutting the dividend, I’m out.” I understand that people that own it only for the dividend were total return investors. That dividend maybe drops to 4.5%, 5%, just depending on the share price. We’re still comfortable with that, that beats bonds, and then, I think you have a lot of upside. We’ll happily hold the Time Warner Discovery shares we get, and then we’ll happily hold the AT&T. That’s, I think, a good investment with not too much risk.
Tobias: When you’re looking at something like that, is that just a straight equity play or do you structure something like that too?
Tim: Well. that’s when it’s fun, honestly. We do it all. We own the stock, we’ll sell calls. There’s not a lot of value in calls. If you’re immensely bullish on AT&T, buying calls is free. It’s really, really cheap. I think Mike mentioned that on one of your podcasts not long ago. I think he looked at it and he’s right. But you could do some things with longer dated calls to generate premium, and then also sell puts behind it. You can use the whole assortment of strategies on that one.
Alibaba ($BABA) – Offers Growth At A Reasonable Price
Tobias: Another complete left turn, Alibaba.
Tim: Yeah, that’s kind of growth at a reasonable price. Obviously, the overhang is China, and trust me, I’m not a big fan of investing in Chinese stocks. I don’t like what’s going on there. I’m worried about the Taiwan situation. I don’t like what happened at that lab. So, I have a lot of concerns about that. But it’s an investment, and it does trade cheaply. It’s a high teens multiple on forward earnings. They’re growing robustly. They’ve got all the assets. They’ve got good competition with JD and with Tencent. But I think they’re poised to win, and I think they’ve resolved the worst part of the regulatory environment. It’s not something I’m going to bet huge in, but I think it’s a good play for growth at a reasonable price, like the FAANGs were last year. When they got a little bit cheap, there were good growth at a reasonable price. I think if you’re going to buy a Baidu or Ali Baba, now probably it is not a bad time to get in.
Tobias: Again, in something like that, equity or you try to structure something like that?
Tim: Equity and then selling puts. I like the upside. That’s one of those where if it hits. I’m willing to hold for a long time. Let it run, because it’s such a nice growth play. But yeah, there’s good premium in the equity. But you want to structure that from a position size standpoint with what you’re comfortable losing, because there is a lot of risk with the regulatory environment, and then also what happened.
China Mobile, when they got delisted, we owned some of that and we had to end up selling at a way discounted price than it should have been. That is a very valuable company, of course, and the valuation was fantastic. So, you never know about those type of things. But also, that stuff can happen in the US too. The recent Fannie Mae, Freddie Mac decision in the Supreme Court, to me, was an abomination. It’s not like you can’t get those types of issues that change the game for you here, either.
Credit Suisse ($CS) – Great Wealth Management, Poor Risk Management
Tobias: Probably right back in your wheelhouse with Credit Suisse.
Tim: Yeah, financials, we were not involved with Credit Suisse until they got involved with the Archegos blow-up, and then the Greensill. One, I believe, that’s how you pronounce it. The stock dropped materially. What I’ve liked about Credit Suisse for a while is their wealth management business. Recurring revenue, and that’s been their focus for quite some time, and they’re very good at it, just like UBS. You look at UBS, they trade at a very high multiple. UBS downsized their investment bank, where earnings are more volatile.
Credit Suisse was really doing the same thing, but obviously, they had poor risk management and some people were being way too aggressive, and management’s definitely to blame there as well. They got hit, they barely took a loss as far as the total company, because the other businesses were operating so well, and hitting on all cylinders. So, it’s not like really impaired their capital or anything.
As we emerge out of this, okay, sure, you’re going to have some employees leave, that are going to be bummed, because their bonuses are going to be down. But you’re still going to have that wealth management business. You’re still going to have a very competitive investment bank. Now, the difference is we’re getting it at 60% of tangible book value in a great investment banking environment, a great wealth management environment. I just don’t see us losing on a long-term basis on that. It’s not a structurally impaired company, like perhaps Deutsche Bank was.
Deutsche Bank, after the financial crisis where they actually did well, they came out of that structurally impaired, because they were just all in on fixed income trading, and that business didn’t return really until last year on all cylinders. Now, they’re doing a little bit better again. But this is like they’re in the right businesses, the right markets. They just had some one-off events that are really bad but I think that they’re correctable.
Finding Great Investments
Tobias: You run a very eclectic portfolio across lots of different industries and across different security types. How do you find these opportunities? What’s your search process?
Tim: Well, I think I’m different than most investment advisors in that I’m reading all day. I don’t golf. I don’t do any marketing. I’m not prospecting like that. The way that we get clients is by putting out research and putting out content. I think just like you, Toby, that’s one reason why I think we’ve hit it off a long time ago is that you and I are both like students in history, we read.
You develop that collection of businesses and industries that you understand, and you’re constantly growing that, and you have to know what your limits are, and what your strengths are, and work within those confines. So, it’s really just that. It’s just time. This will be our 10th year in operation at TNT Capital Management and almost 20 years in the industry for me, so it’s just time and focus really.
More Success With Managements That Pick Up The Phone
Tobias: Then, when you find these opportunities, what’s your validation process? How are you proving it up? Because I know you’ve spoken to AGO’s management, Don Federico.
Tobias: You know him pretty well. I’ve known him for a long time. Is that a usual step?
Tim: Yes, yes. I do get involved with management as far as– Just getting a feel for them. Sometimes, look, they’re not always going to talk to you depending on your size or whatever. It just depends on who they are. Honestly, I feel the companies that I’ve done better than the past, management has at least been willing to have a phone call, and just get to know each other, and just to get a feel for how they operate as managers.
Companies I’ve have had less success with are extremely resistant, and will only talk to the Black Rocks of the world. That’s part of it. I like to at least study their history, even if I can’t talk to them, really see what they did in the past, and how they acted. Capital allocation is a big deal. If I understand the capital allocation strategy, I feel good. Bad acquisitions are my pet peeve. It blows up so much shareholder value like we saw with AT&T, we saw with GE in the past, and so many other companies, and we’ll keep seeing that.
Assured Guaranty ($AGO) – Strong Buyback Activity
Tobias: Does anybody allocate capital better than AGO?
Tim: They’re pretty good at it. I like it. But truthfully, they don’t really have that many great opportunities, because the bond insurance business has slowed down since the financial crisis. It’s starting to pick back up, but that’s one that’s rate sensitive. If you get higher rates, you’re going to see geometric growth in underwriting premium, and then, it makes more sense to keep a little more capital. But because the portfolio’s been amortizing, they have excess capital, you have an undervalued price, and he’s smart enough to take advantage of it.
What I like about him is, if you remember last year, so many CEOs during the peak of the panic, they were like, “Okay, we’re going to stop buying back stock.” I get it. There’s some politics involved, but if you really believe your company is fully reserved, and in strong financial condition, and can weather the storm, and now your stock is trading 50% lower, buy back all you can. They did. The stock dropped a lot like almost all financials and it really got crushed, and they bought back hand over fist, and it created enormous shareholder value, and now, they’re in a great position.
Biggest Positions In Your Best Ideas
Tobias: We were speaking a little bit before about rebalancing, so you definitely buy as something’s going against you a little bit to take advantage of those lower prices. But when you think about constructing the portfolio, how do you think about sizing positions?
Tim: Yeah, we’re always going to allocate the most to our best ideas. There’s not a 5% rule where you’re going to have 20 positions at 5% or anything like that. We’ll definitely do the biggest positions on our best ideas. Then, we’ll build into other positions with options. It’s like, “Okay, well, if Cleveland-Cliffs goes lower, it might go from a 2% position to a 5% position with getting exercise on options, but that’s at our price.” So, it’s just basically a synthetic way of dollar cost averaging on the share. It’s structured like that.
Tobias: How do you think about sizing the options positions? You’re always thinking as the nominal position is capped at some 2% or 5% holding?
Tim: I’d say we’re fairly agnostic. I don’t really care for using options in the way that we use them. Keep in mind, we’re not buying options, not that there’s anything wrong with that, but I think that the odds are more in your favor with selling options. So, we’re pretty agnostic. We just want the best risk-adjusted return. But in this market environment, I’m not optimistic on the next three to five years on equities at all. I’m very bearish, I’d say.
ot John Hussman bearish, but I’m bearish. Normally, I’m very optimistic. What I want to do is, I want to take, okay, I’ve got a few bets, that I think the odds are stacked in my favor, where there’s a lot of upside. You could get a double on an AGO easily, or 50% in a year. That’s very possible from current levels. It would still be undervalued. But then, with the rest of the market–
Look, if you tell me, I could get 7% a year over the next three years, I would probably be comfortable with that. I’d be comfortable with where the valuations are. One thing I was thinking before, our call was, I was looking at 2000, because it’s a great analogy for the president. The 10-year Treasury was about 6.5%. Imagine that. You are a money manager too. Imagine 6.5% with no credit risk versus, where we’re at with multiples here. It’s an interesting conversation to have.
Tobias: That 6.5%, that’s a nice hedge too, because if you get some market volatility, it’s likely that there’s a flight to that. So, you get some rally in your holdings.
Tim: Exactly, exactly. It’s a huge hedge. Yeah, it’s stunning to think about that. That’s why this is the everything bubble, real estate, it is hard to find asset classes that aren’t in in a bubble right now.
Inflation Ultimately Drives The Fed
Tobias: Yeah, I watch the 10 year pretty closely, because I think it’s a reasonable proxy for not the performance of value, but as the 10 year seems to creep up, value seems to do a little bit better, and vice versa. If the 10 year fades, value seems to do a little bit worse. I’ve watched it over the last year, it got crushed March 2020 and then, at the start of this year, it started rallying and that seemed to coincide with value doing better, and then over the last couple of months, we’ve seen it soften up a fair bit.
Tobias: I have no idea what drives it, but it is one of the things that I’ve watched reasonably closely. I think that there’s some cap, though, there’s some point at which that the Federal Reserve can’t let it float up too much, because it then impacts the borrowing of the federal government. Do you have any view on that?
Tim: Yeah, I would definitely agree, but that’s why inflation is the most significant thing for sure. The Fed can keep buying bonds. I was thinking, okay. I don’t know if you saw it this morning, but Kyle Bass brought up China and the likely aggressiveness that they’re going to show for Taiwan over the next few years. That’s a huge situation. That’s a major risk that’s out there. Let’s say China stops buying US Treasuries for some reason. Maybe they can do that, maybe they can’t. It doesn’t matter.
But the Fed can keep printing money and buying Treasuries, of course. But what if you have inflation? If you have inflation that just keeps picking up and inflation expectations pickup, well, then, those longer dated bonds are going to start yielding a lot more. The market’s going to move those. So, it’s inflation that will ultimately drive the Fed long term. That’s why by far and away, that’s the most important thing to watch.
Just like you said, the 10-year Treasury has been driving value and growth. Imagine what a 4% 10-year Treasury was normal a decade ago? Anything close to that level now, what happens to the multiples of some of these glamour stocks?
How Will FANMAGs Respond To Increased Rates?
Tim: I read an article today. Someone was saying that 13 times sales is cheap.
Tim: Of course, I’m sure you remember the Sun Microsystems CEO letter, where he was talking about what expectations are implied with 10 times sales. Now, 13 times sales are cheap for a great company like PayPal.
Tobias: Yeah, I get called a boomer for pointing out that Sun Microsystems that quote where he said, it’s like at 10 times sales you get– that doesn’t account for any of the costs of running the business.
Tobias: It just seems crazy. But now 10 times sales, that’s reasonably cheap for growth stuff.
Tim: It really is. It’s night and day difference. These are great businesses. That’s one difference, and everyone will flag it. Amazon, honestly, I don’t look at– Amazon is okay, well, this is a massive bubble. I don’t look at Apple that way or most of them. Facebook was cheap. It getting a little more expensive lately. But I think some of those other ones, and you look at the tricks that they do with the accounting and the stock issuance, there’s a lot of signs of speculation. Obviously, you can see that in crypto and all that too.
Tobias: Yeah, I think funnily enough, those all the big tech like Facebook, Apple, Google have all been– They’re expensive, but they’ve reasonable for what they are. They’re really great businesses. There’s the other stuff, I think is the more egregious valuations where they’re all priced as if they are going to be an Amazon, and the math just doesn’t check out when you look at where they have to get to over the next 10 or 20 years to justify those valuations. It’s just they have to get too big. It’s not possible.
Tim: No, I’d agree. That’s why something as boring as an AT&T, you’re getting a really nice dividend. You’ve got upside. The shareholders own 71% of the combined Discovery-Time Warner’s, which is going to be a very formidable streamer. Something like that to someone like me is sensible.
I don’t want to get blown up by that chaos. Because think about it, all you had to do was buy Amazon, Apple, Facebook, and they all react quite a bit to the interest rates. If you start seeing selling pressure on those, whether it’s warranted or not warranted, you really could see a cascade. Of course, those other names will follow the more overvalued ones. I think that there’s risk there.
Always Keep Some Cash
Tobias: Given the backdrop of that overvaluation and there not being a lot of great opportunities in anything, it’s not a traditional hedge, but the 10 year or something like that, and I know that you don’t like buying options. Do you carry cash? What do you do in that sort of scenario?
Tim: I carry cash, and I also think about what I would do still. What do I do when the market crashes? I buy stock. When I’m selling a put at such a massive discount to the current price, you’re going to get jacked on volatility. That put that we sold for 71 cents a month ago or whatever, that could double in price. It could triple in price theoretically if the stock tanks with the overall market and you see volatility go up. But what matters to me is, look, the decision I made was, I’m willing to buy Cliffs at $10. That’s fine. I valued the company, I think they’d have a lot of upside from there, the balance sheet’s going to be good. That’s it. All I do is, you have to weather the volatility storm.
This is something where if you’re managing other people’s money, you have to educate your clients on this, because that is the hard part. You’re taking volatility hits. You’re not benefiting like you are buying options and doing that. But once you educate them and show, okay, look, once this option expires, volatility goes to zero, time goes to zero, the only thing that matters is where the stock price is at, and then, I definitely keep cash too. You don’t want to be 100% invested I think in this market. I think you’re going to have better buying opportunities.
Tobias: Do you find a lot of people who are coming to you right now with a pool of cash and saying, help me get invested? What do you do with someone like that?
Tim: Well, the options are a great way, and just focusing on valuations. There’s definitely names that we like, like an AGO. That’s a great way, because you’re not going 100% in at the market at these levels. We’ve got some people that did really well last year, and then, people that are coming to us now, they did really well with the ARK-type stuff, and then, they got burned pretty bad when that stuff started trailing in the first quarter. I think they see that, okay, well, growth has had a great run. Value’s still really undervalued. We’re just in the early innings of what could potentially be a big run. I think that there are some people that are realizing that, and I think that there could be a lot of momentum towards value if that 10 year continues to creep higher.
Tobias: Yeah, any view on what that’s going to do?
Tim: Yeah. I think it goes higher. I really do. I think barring– It’s always alarming, honestly, because you have all the fears about the variance and stuff like that, which definitely I don’t think that there’s reason to be very fearful of it. You don’t know what kind of the government’s going to do, but I do you think that you’re going to see inflation. People want to live, people want to travel, people are spending a lot of money on their houses, everything’s expensive. I don’t see these restaurants and things like that, they’re not going to be able to pull back prices. All these higher salaries that people are having to pay, people aren’t going to accept pay cuts at those companies. So, I think inflation will last would be my gut.
Imagine Bonds With Inflation
Tobias: I saw a tweet from Jim Chanos yesterday, where he pointed out that the yield on the high yield index is now below inflation, which is an extraordinary event to see in this market. I’m with you. I don’t how it stays where it is, but I’ve been shocked that it’s backed off from what is historically a very low level. I think it might have got to 1.7 or something like that, which if you run that chart back as far as you can, there’s nothing anywhere as low as that other than the last 12 months. So, I’ve been shocked that it’s run backwards, particularly, given what inflation is doing. But I guess that’s the question then is a transitory, is it here to stay, and I guess there’s this short-term view over the last few months that it’s transitory?
Tim: Yeah, the Fed’s doing a good sales job on it, at least. They’re still buying back so much. Imagine if they’re not buying back debt, what happens with that 10 year? It is, it’s a completely manipulated market. They’ve gotten away with it until inflation. Inflation will be the biggest determinant over the next 10 years on what’s successful from an investment perspective. Well, imagine bonds with inflation. There’s trillions of dollars allocated to bonds even at negative yields. So, it’s hard to imagine the carnage that would emerge from that. Think about it when we’re structuring our portfolios.
Tobias: Tim, it’s a fascinating discussion. We’re coming up on time. If folks want to get in contact with you, what’s the best way of doing that?
Tim: Sure. Just our website, ttvalueinvesting.com, and all our contact info is on there. We also have a blog that’s on there that they can follow as well. So, that’s usually the best way.[Twitter: @ttcapitalmgmt].
Tobias: I’ll link that up in the show notes. Tim Travis, thank you for your time.
Tim: Thanks, Toby. I Appreciate it, man.
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