VALUE: After Hours (S03 E38): Drawdowns, How Does Quality Work? And Love And Meditation

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

  • Adopting Kaufman’s Win-Win Approach To Investing
  • How Does Quality Work?
  • Dealing With Drawdowns
  • Was Covid Our Cambrian Explosion?
  • Fewer Big Winners In Future
  • Strong Inverse Link Between Stock Returns & Hospital Admissions
  • Prem Watsa’s 10 Year Record
  • You Can’t Forecast Anything Five Years From Now
  • Separate Yourself From Your Returns
  • Energy Prices Spike
  • You Can’t Buy OTC Stocks
  • Helping Others When The Next Crash Happens
  • Proliferation Of Internet Entrepreneurs
  • Omnichannel Retail
  • Quality Is More Predictive In The Future
  • $CROX Up 100%+ YTD
  • $CRI Trading Flat YTD
  • Quality Is Not The Same As Growth
  • Chase Risk Or Put It In The Too Hard Basket

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: We’re doing it. Hi, gents. It’s time, 10:30 AM on the West Coast, 1:30 PM on the East Coast, 3:30 AM Australian Eastern Standard Time. No doubt, everybody’s up. What’s happening, fellas? Everybody’s in Cali today.

Jake: Yeah. Westside.

Bill: I’ve got audio issues over here.

Jake: [laughs]

Bill: So, I’ll be playing with my mute a lot.

Tobias: Play with the button. This is Value: After Hours. I’m joined as always by Bill Brewster and Jake Taylor. I’m talking about the Verdad’s quality paper which came out on Monday, which is excellent. What are you talking about, JT?

Jake: I’ve got a little segment that’s going to be kind of a PSA in some ways, that’s really about leadership, and actually, what I expect from our fans. So, it might be a little sanctimonious. We’ll see. [laughs]

Tobias: What about you, Bill?

Bill: I have a number of things. I have a correction to make on something that I said. I have some thoughts about Jake’s comments last week, and then I was going to talk a little bit about my drawdown, which is always fun. Maybe I can start with the correction and frame a little bit of something.

We were talking about Ray Dalio and he said that Evergrande was contained, and I made an offhanded joke about like, “Yeah, they’re selling China,” or whatever. One of our listeners happens to work at Bridgewater. Sometimes, I forget that some of you are very intelligent and, for some reason, listened to me, I can’t fucking figure that out, but I appreciate it. He said, “That’s not what’s going on, and if you’d like to get on the phone, I’m happy to.”

A, apologize for making a joke and saying somebody’s name. I should joke about collective people or by category, and not an individual. So, I apologize to him for that they may have been doing anything nefarious. I was not thinking, I assure you, I have no information into what they are doing. I think generally as you’re listening to this program, you should understand that it’s basically three guys talking as if we were at a bar, and sometimes, I say things at a bar that are not necessarily well thought out, and that’s going to happen here too occasionally. So, I apologize, and to the extent that it went at anybody’s reputation, I am making a formal retraction.

Tobias: Everything on this program is for comedic effect.

Jake: Yeah.

Bill: Yeah, that’s how I tend to think about it too.

Tobias: Satire.

Bill: Yeah, I think that’s right and hopefully, get some education too. But it is for comedic effect. Two, thinking about Jake’s stuff last week, I sat down and I really thought about it hard, and I don’t think it’s possible to argue that–

Jake: What did I say, first of all? I don’t even remember.

Tobias: [laughs]

Bill: Oh, everybody should know. They should all know.

Jake: [laughs]

Bill: They should have memorized it.

Jake: No, I don’t remember it.

Bill: You should think on your own, and then talk to other people, and then update your expectation or your own projections. I came off a little bit dismissive when I listened to that back. That’s not how I meant it. I meant it that I’m too stupid to figure stuff out on my own. So, I tend to talk to people in order to work through things to come up with my initial conclusion. But I do agree that it’s very important to understand people’s incentives while doing that. So, those are sort of my two follow up items.

Jake: It’s good. Get those checked out.

Bill: Okay, good. Now, should I just go into what it’s like to get my ass kicked or should we do something else?

Jake: Let’s make some new errors, okay? [laughs]

Bill: Okay, cool.

Tobias: This is next week’s retraction coming up.


Bill: I don’t think that this is going to be a retraction.

Tobias: [unintelligible 00:04:24] doing the house [crosstalk]

Adopting Kaufman’s Win-Win Approach To Investing

Bill: It’s interesting that people talk about the dangers of talking publicly about a specific name. I think that one of the dangers of sort of being out there and being public for me last year, was I’ve always visualized reacting rationally in a crash, and I think I did a pretty good job of that last year. Then, I went through the stuff with Robinhood. Then, I made some moves in the back part of the year that worked out very well. I think that I started to almost believe my own shit a little bit and I think I did get lax with some of the things that I should be demanding out of investments and some things that I owned.

I posted on Twitter, I can cite my returns, I don’t want to run money, I don’t run money, I’m never going to run money. So, whatever. I said I was down 16% on the quarter. Now, what I didn’t say is things are still going fine. But that kind of a correction has made me have to really think about, one, do I want to run this kind of a strategy for my family? It may honestly be more volatility than I think my wife and I really want to incur at this time. Two, what do I need to demand out of the investments that I have currently in my book and will be there in the future? Then, three, looking through the reasons of why the events unfolded as they did. Some of it, I had a huge position in a stock that was just too stretched, and I knew that, and it came in. Some of it, you hear me bitch about Qurate all the time. I just don’t fundamentally really understand that why that’s selling off like it is. Some of it was bad execution on management teams. Some of it was bad execution on me.

So, I think taking that inventory, and then reflecting on, “Okay, where did I fuck up? How can I avoid messing up in the future? Do I really need to change what I’m doing or my strategy?”, is how I’ve internalized it. I know that a lot of people seem to be avoiding carnage. I think it’s probably closer to they’re just not being totally honest about the carnage because there is a lot out there of stocks that are down a big, big amount. Whether or not the index is, that’s a different issue, but there’s a lot of pain out there.

I think that’s how you deal with it, that’s how I’m responding to it. I’m going to try to adopt a little more Peter Kaufman win-win-win in me. If you want the bottom set for all Altice, you’re welcome for last week. That’s probably about the best contrary indicator you’re going to get, me getting on the podcast and bitching about it. But I think that something that I’m going to focus more on and be more demanding about is probably businesses that are operating in the win-win-win mindset. I think it probably got a little bit loose on that, and I think I had some trades that worked out well, and I think it got me a little bit too lax. So, in all my visualization, I always visualized how I would do in a downside. I never actually thought about how I would respond to being successful and I think that without thinking through that, I mismanaged some success. But don’t cry for me, Argentina, things are just fine over here.

Tobias: There’s a little bit of a drawdown going around. It’s contagious. There’s nothing you can do to avoid that one, unfortunately.

Bill: Yeah, well, I do think like, people said or at least one fan said, I’d like to hear you talk about it. Look, I think that there are some names that I’m not the smartest person. Like Google, I just don’t have this unique view. Some of it is just holding something that I’ve won big on and I’ve learned a little bit from Chuck Akre, and that when you’re winning and the business is performing, you probably don’t want to let something like that go. Maybe that’s famous last words.

There are other things that I really think are really cheap here. So, I’m either going to get my ass kicked or I’m about to do okay and we’ll all sort of find out together. The one thing I don’t want to lose to any more is quasi-shitty execution. Companies with bad culture and stuff like that, I don’t really want to lose to that anymore. I’m tired of that shit.

Tobias: Why do you worry? That’s a good comment here. Short-term prices are a poor measure of investment performance. Why are you worried about a month or so of– or whatever it is, six months of like share price performance? The reason we’re doing this stuff is because we think that this share prices are irrational and they’re not a great indicator of underlying fundamental business performance in many cases.

Chase Risk Or Put It In The Too Hard Basket

Bill: I’m more worried about the behavior that I exhibited that was maybe a little more risk seeking than I think was prudent at times. I don’t really care about my mark. I also do think that it’s important to at least acknowledge that the market is telling you something. I’m not going to adjust what I’m doing. I’m not selling Qurate because it’s down, for instance. I do wonder what the market is trying to signal, and I think that’s prudent. I’ve been reading a lot of Mauboussin.

Tobias: Debt ceiling nonsense. Debt ceiling is going to be resolved. It always is resolved. But maybe you’ve got to think about it a little bit. People have got to hedge it out. Maybe that’s what creates the selloff. We were off a lot yesterday and we’re up a lot today. You can’t really deduce anything from either, can you?

Bill: No, but I’m getting eerily close to the index on a five-year basis, and I think over five years, that matters. So, I don’t know. I think it’s always good to reflect on who you are, the behavior that you’re exhibiting, and whether or not the market is– I don’t think the market would be causing me to act in a certain way, but there’s an argument to be made that I’ve maybe chased some ideas that were overly risk seeking. I probably should have put those in the too hard pile, and that’s on me. That’s not about a mark. So, improve and keep going.

Jake: Yeah, I agree. Toby, do you want to do–

Tobias: Yeah.

Jake: I think because it kind of fits on a little bit of what Bill’s talking about as far as quality versus value, and holding periods, and–

How Does Quality Work?

Tobias: Verdad, this was written by Greg Obenshain. I’ve heard Dan Rasmussen on the podcast. The article was how does quality work? I thought it was a fun article because their definition of quality, they’re using a variety of factors but they’re using the Novy-Marx gross profits on total assets as their main one. Then their value metric is gross profits on enterprise value. So, it’s like a book value version– or sorry, like a PE version of value. So, they’re comparing the two.

What they have found is that value slightly outperformed quality over the full dataset that they have. The margins, not much. The most interesting thing I thought was that there seem to be– if you take the long-short version, so the market neutral version, and you take quintile, the most expensive quintile minus the cheapest quintile, or you take the best quality minus the worst quality, quality minus junk, which is the way that AQR characterized it in their paper which came out in 2013 I think something like that, basically, you find that it has this interesting performance where when value does really badly quality seems to do quite well, and then when value does quite well, quality seems to not do as well.

So, they’ve got the chart in it, I think that is the most interesting one. It is just the long-short comparing. It’s only a couple of decades, it’s 1996 to 2021. Not really sure what quality looks like outside of that. I know that it has outperformed, but I just don’t know if it has exhibited this particular behavior where there have been two kind of big selloffs for value over that period of time, 1996 to date. Late 1990s, of course, and then more recently. They’ve characterized the most recent one as finishing in 2020, 2018 to 2020. So, I was very relieved to learn that so far. [chuckles]

Jake: [laughs]

Tobias: They’re bolder than I am, but I’ll take it out of mind. Confirmation bias is how I keep going. Quality stole that from about 2013 to 2020, and this is something that I’ve observed a few times. I’ve been running my own little tests on this stuff, that really quality was very, very flat. Then around 2018, quality just took off, and I don’t really know why.

Then, that’s exactly the same period that value really started selling off. It may be that the just that definition of quality, the gross profits on total assets, has captured that particular technology industry sector, or that part of the market that took off, and so it’s a complete fluke, but I don’t think so. I think that this is a version of the paper that James Montier wrote that came out a long time ago when he was examining the little book that beats the market strategy. He said in that, that there were these times where value basically works outperforms over the long run, but you have these painful periods like the late 1990s where potentially you get fired as a value manager, because he just can’t keep up.

So, I just think it’s a very interesting paper. But the most interesting or another interesting part was the drivers of returns to quality in value. Quality, the drivers of returns seem to be asset growth, which is probably what you’d expect. That’s why you’re buying a quality company because it’s able to generate reasonably good asset growth, and then the drivers of value returns are rerating, so multiple expansion.

Jake: Really, reversion.

Quality Is More Predictive In The Future

Tobias: Yeah. The other thing that you can learn from that is that quality tends to be a little bit more predictive of quality in the future. So, if something is high quality now, it tends to be quality next year and the year following. I think they can predict that to about three years. Whereas value, you’re relying on value, not being value in the future. You want value to mean revert. You want that gap to close and so that quality tends to be a little more durable. So, when I think about that strategy, how you combine those two, I immediately think that’s what Buffett’s doing. He’s trying to hold quality businesses, but he’s trying to buy them when they become value. I think that the other papers that I’ve seen on quality, the returns to quality do seem to be dictated a little bit by the multiples that you pay. So, long multiples for good quality tend to deliver pretty good returns, and high multiples for good quality tend to be flattish. So, that might have been what happened in 2013, 2017. What do you guys think?

Bill: Over what timeframe do you say that the multiple matters? Obviously, it always matters, but I’m just trying to– when you say that returns are flattish, I’m just trying to figure out what you’re saying exactly.

Tobias: Well, this particular one is 2013 to 2018. There were just a few a long short quality, so quality minus junk, you didn’t make any money for five years there. This is just my recollection of the QMJ paper by AQR, which I haven’t read in a little while, but I should go and revisit but they had this, what drives the returns to quality? This is assuming that you’ve already created a quality portfolio that follows the rules, and they have other measures in there like gross margins and return on equity in addition to gross profits and total assets. They said in that paper that if you pay too much for it, you get bad returns. Quality doesn’t really have a fall over, but it just seems to deliver flat returns for an extended period of time. Whereas you’d expect value to be driven by the value multiple that you’re paying. But quality is also driven by what you pay, which is why I think it’s a pretty good approach to what Buffett is doing.

Jake: Yeah, I think that the concept of persistence there, and then, how you should formulate your strategy is pretty important. If quality is a more persistent strategy, like quality begets quality, at least over some time period, I don’t think that that is true. Capitalism is broken if it doesn’t eventually mean revert. That would imply then that longer holding periods, less turnover, more letting quality run probably and beat quality. And then, obviously value, if it’s about mean reversion of the multiple then you want that to happen relatively quickly for you to have a better IRR, and you want to turn over the portfolio to the cheapest things that you can find again, when what was cheap became not so cheap.

Tobias: Yeah. Someone left a comment here that a lot of value investors anecdotally switch to “quality” so they will underperform so much. I think that that’s fair, because it’s still fundamental analysis and it’s still very, very close. It’s what you’re paying for what you’re buying. So, if your universe gets increasingly constrained to high return on invested capital, which is what’s been working–

Quality Is Not The Same As Growth

Jake: Gun to your head, Toby, do you think that the price of quality has gotten to the point where you might expect less optimistic returns from here of the quality factor?

Tobias: Quality is not growth. Quality is not necessarily buying something on the basis of the rate at which the revenues and so on and everything is growing. Quality is still some sort of internal look at what kind of revenues the business can generate, and how stable those revenues are, and what proportion of them translate into cash. So, I don’t know necessarily that quality has caught that– It’s not growth, but having said that, it’s clearly the fact that it’s had a pretty good run indicates that it’s more expensive now than it was in 2018. So, yeah, without having looked at it off the top of my head, I’d guess that it’s a lot more expensive than it was and probably value is unusually cheap right now to probably there’s more return to value than there is to quality over the next said five years.

Bill: This is such a cop out answer, but it’s what I actually think. A lot of it’s about time horizon, and then whether or not you’re right. It’s obviously a lot harder to be right for an extended period of time. But I think that– I don’t know, I’ve been reading a lot of older Mauboussin– I’m sorry, Mike. I know, you’re a big fan, and I always mess up your name and it stinks. It’s got to be so hurtful to you. [crosstalk]

Tobias: Mauboussin.

Bill: Yeah, anyway.

Jake: [laughs]

You Can’t Forecast Anything Five Years From Now

Bill: But his paper on competitive advantage period is something that the Randolph Duke on the Twitter machine sent me and that was excellent. I just got Expectations Investing, I’ve been reading Think Twice. I’m really deep in it. It’s just got me re-appreciating that we’re all playing a game that the cash flows are greater than five years out. So, if you’re going to hold quality, I think you’ve got to think really long-term and the business should probably be in an industry that’s probably growing. It’s got to have the moat for lack of a better term or whatever. I don’t know. I think those are like overly found. I’m not sure how many moats actually exist–

Jake: Or ever.

Bill: But I don’t know. I don’t know where I’m going with this. I do know that I find there to be a somewhat of a disconnect in at least how I have processed multiple reratings in long-term thinking. But I think in order to be correct that a multiple is low that you have to be able to think long term. I just think this game is really hard. That’s what I think.

Jake: I’m kind of reminded to of probably the preeminent researcher on forecasting, Phil Tetlock, saying that, anyone who gives you an estimate that’s further than five years out is really doing you a favor, because you can basically safely ignore anything that they’re saying. That’s how hard it is to forecast anything five years from now. [laughs]

Tobias: It certainly stands up in the data. I think value gives you excess returns after the five years, but the very vast bulk of them are in the first few years, one, two, three.

Jake: That’d be nice. [laughs] Is that is still a thing we can do?

Tobias: [laughs] I don’t know. I hope so.

Jake: Yeah. [laughs]

Fewer Big Winners In Future

Tobias: The competitive landscape has always been tough. I don’t think it’s a new thing that there’s increased competition or anything like that. Maybe it feels that way. Maybe it always feels that way. Because every good idea is pretty rapidly adopted to the extent that it can be. So, right there is your excess return, your super economic profit getting eaten away. I don’t know whether the result is that we’re going to have a fewer bigger winners, which is certainly what seems to happened or whether we just get shorter periods of dominance and everybody adopts that thing. I honestly don’t know which way it goes. But it does look like fewer bigger winners at the moment.

Bill: Well, just from a business standpoint, I think that many industries have gotten to this stage where there are legitimate– Costco is really, really hard to outcompete. There’s real scale benefits that they have at this point. That’s really, really hard to displace and I think that there’s a number of industries where we’ve had consolidation to the point of– It may take a lot longer to compete away or you may need a real government intervention but I don’t think that’s going to happen. So, I don’t know. That’s the only reason that I think that maybe this time is different and maybe it’s not. But I would be open to accepting that there’s some probability that capitalism is somewhat broken. I would not dismiss that possibility.

Was Covid Our Cambrian Explosion?

Tobias: The problem that we have at the moment is that all of the COVID restrictions make it much, much more difficult for little companies than it does for big companies, because big companies can– I’m not sure whether it’s Costco. I forget exactly who it is, but there’s a container shipping blockage all over the world there. You can’t get container ships, you can’t get pallets. Everything’s backed up at the LA port. You can see it out in the water here. So, some of these bigger retailers have been able to buy a ship, load the ship up, and they’re using a dedicated ship now to do their own shipping. A little company’s not going to be able to do that. They’re subject to and now because it’s so hard to get a container. Container is super expensive. You got to prepay your shipping. We need to get back to normalcy for competition to really start kicking in. At the moment, this is massively beneficial for big companies and tough for small companies.

Jake: In the Cambrian explosion, one theory of why it happened and– what that is, I don’t know, roughly 500 million years ago, we saw a sudden wide diversification of species. That’s what we’re talking about here is that like, there’s a few dominant large species and not enough broad niches being filled by a lot of different species. We’ve talked about this on the show with adaptive radiation. But one of the theories is that ecologically, there was all of a sudden, a lot of oxygen available right before the Cambrian explosion and the idea there is that then animals that– oxygen is hugely important for the Krebs cycle and creation of energy within an animal, and the vitality of the animal is dictated by the amount of oxygen in the atmosphere. It feels like maybe COVID has sucked the oxygen out of the economic ecology in a lot of ways and then therefore, there’s maybe less vitality for smaller competitors against bigger competitors.

Proliferation Of Internet Entrepreneurs

Tobias: But then, the flip side, the fact that people were forced– there are many fewer people work from home, it turns out, than you might think. It does seem to me that there are a proliferation of little businesses, all of them are built on the bigger platforms like Instagram, or Facebook, or Twitter, or whatever where that’s basically their single channel for sales. But it doesn’t take much now to set up a company selling board shorts and plaster them all over Instagram and some money, make reasonable money doing that.

Jake: Yeah, maybe but– [crosstalk]

Bill: It looks like a job, though.

Tobias: It is a job. Yeah.

Jake: And also, you can’t own that.

Bill: That’s not like a [crosstalk]

Jake: You can’t own that. You don’t own that as an investor.

Tobias: You’ve got the brand. You’ve got something in it. You are right. It’s a single-person venture. But most of them are going to fail and most of them, they’re not going to outlive the people who run them. But some of them are going to establish a brand and extend beyond those channels. But then, I don’t think that they’re really competing with anything. I don’t think the board shorts– [crosstalk]

Bill: Well, the weird thing is we’re part of it right now. We’re donating time to YouTube that they’re not paying for and demonetizing us-

Jake: [laughs]

Bill: -God forbid, we say the word of the biggest pandemic going on in a year and a half [crosstalk]

Tobias: Pandemic might be enough.

Jake: Yeah. We’re done.

Bill: [crosstalk] COVID. COVID, COVID. Anyway, sorry guys. No, we don’t make any money. But it’s interesting, my buddy and I were talking last night about how many– you need to verify your phone number for a lot of these tech platforms or PayPal wants you to have a bank account, eBay wants you have a bank account. How much of that is just outsourcing all of your– making sure basically your know your customer stuff. I feel there’s these businesses that are just extracting value from people and then the answer’s like, “Oh, well, you can have a board short company.” It’s like, “Yeah,” but that kind of sucks relative to the person that is the aggregator of all the attention and whatnot.

Jake: Was one of those down yesterday?

Bill: There will be successes, but turning everybody into an entrepreneur is a cutthroat outcome. You’re going to have some really good outcomes from it. This is how capitalism works. It’s just interesting how there’s a lot of aggregation of economic profit in the middle.

Tobias: So, what you saying is [crosstalk] centralizing technology that will allow us to get around all of those platform-type things. It’s like a pretty good argument for blockchain, bitcoin, Ethereum.

Jake: DeFi.

Tobias: DeFi, yeah. I think that’s a good idea.

Jake: Bill, you’re our resident bitcoin expert.

Bill: I’m not a bitcoin expert. I’m just crypto curious–

Tobias: [laughs]

Bill: Preston Pysh sent me some money the other day on a Strike wallet, and I thought that was pretty cool. I will admit that.

Jake: Was that measured in something or is it measured in dollars?

Bill: I received dollars. According to him and somebody else, a couple of fans of the show sent me some. I’m always open for your tips. Lord knows Google doesn’t pay and neither does Toby.

Jake: [laughs]

Bill: But [laughs] hang on.

Jake: Both assholes.

Bill: I think maybe that came out incorrectly. But anyway, long story short, if you want to send me money, you can. It seems as though it’s always converted to US dollars.

Jake: Interesting.

Tobias: I pay in exposure. JT–

Jake: Can we–

Tobias: Let’s do yours.

Jake: Okay. I’m not going to call this veggies even because it’s more of a bit of a PSA, but I thought it was important. I had a couple things that connected that inspired me to want to talk about this. In past shows, we’ve talked about this Buddhist concept of mudita, which was vicarious joy. Basically, genuinely celebrating the success of others and how it’s the opposite of schadenfreude. In this industry especially, you see the worst of humanity, I think, when it comes to schadenfreude except maybe Instagram. Over the weekend, I watched the movie, Boiler Room. I don’t know if you guys have seen that one.

Tobias: Classic.

Jake: It’s a Wall Street classic. It’s 20 years old now, turns out. So, Giovanni Ribisi, he’s the main guy in it, and he’s on the phone with this guy who’s like a purchasing manager, middle manager, and he’s got a family, they’re living in apartment, it’s too small for them. Ribisi talks him into putting $50,000 which was his down payment on a house into this just total vaporware, bullshit, penny stock pump-and-dump thing. Of course, all the money disappears, and this guy’s housing– the down payment is going to pull on his house is gone now. His wife leaves, takes the kids and you see this guy just sitting there with his head in his hands, broken from this scam.

Strong Inverse Link Between Stock Returns & Hospital Admissions

Jake: I recently saw some research on– There were two researchers, Engelberg and Parsons, who published a paper in 2016 in the Journal of Finance. What they looked at was from 1983 to 2011, they looked at individual patient records in California hospitals, and they found a strong link between daily stock returns and hospital admissions, especially around psychological phenomenon conditions like anxiety, panic disorders, major depression.

When the market goes down, people end up in the hospital often from the trauma of it, and Wisniewski and Lambe in 2020 in the Journal of Financial Research found robust and significant relationship between stock market returns and suicide rates. In the bankers’ panic of 1907, the bankers and brokers at the time had 2x the suicide rate of the general population.

Of course, they’re these this folklore of 1929, brokers jumping out of windows and things like that. But I’m joking now when I say this, but now, I finally understand that magazine cover that has Powell with the Superman shirt, when he’s ripping his suit off and it says Superman under there. He’s saving all these people.

Helping Others When The Next Crash Happens

Jake: Anyway, it’s easy to forget that all of this stuff in the market, all these things we talk about, it has impact on real people and their lives, and what happens to them, and obviously, Bill, you’re probably very painfully aware of the real impact that some of this shit has. I think that if you’re listening to this podcast right now, if you’re willing to be down in the weeds with us and in a lot of the minutia and jargon that we use, you’re probably already pretty sophisticated, and I wouldn’t be surprised if a lot of people look up to you in a financial sense and in an investment sense. I have to believe that you’re probably a leader in a lot of ways, maybe even if you don’t realize it, and people ask for your advice and opinions.

I think whenever the next market crash does happen, who knows when, but it’s going to happen at some point, this is just how this works, there are going to be real people who are hurt and I think that all of us, and you, as a listener as well, I would really ask that you think about your role in being a helper there, in being a leader, and stepping up and helping the people who might be psychologically damaged by it, who might take extreme actions if the unfortunate things do happen. At a minimum, I think there’s the potential of a whole generation perhaps who will lose out on investing in the market and owning businesses, and a lot of the good that can come from that. I think that our society is strongest when we have a lot of participation in the ownership of the businesses. We have a lot of buy in, we have that–

I think that actually leads to a lot more egalitarian outcomes than as opposed to a few people owning all of the assets in a society. We saw that. That happened during after the Great Depression. There was a whole generation of people who swore off equities after they sat on the hot stove. I think that you’d be doing a huge service to your fellow human if you stepped up whenever that next thing does happen, and check in on people, and just make sure that– Do what you can to help and I think the three of us will hopefully be doing that and helping, but I would say our listeners have just as much of a right to do that, and are probably just as equipped to do it as we are. So, that’s a little PSA/sermon for today, and maybe next week, I’ll come back with something with sperm whales instead. [laughs]

Separate Yourself From Your Returns

Tobias: What’s the secret to doing it? Is it separating yourself out from the returns? The part of the problem is that we are going to lose real money through this next bust-up. So, it is going to potentially dire if you’re not taking out now. If you have more than you can afford to lose in the market now, then now’s a good time to rectify that situation.

Jake: Yeah, and I would say that, I just like when I look at my IRA and I say, “Well, 30ish percent of this is not actually mine. That’s Uncle Sam’s. He’s just the silent partner in it.” So, I adjust my net worth downward mentally a little bit. You can look at an extended market in the same way and say like, “A lot of this is maybe not actually my real wealth. Just because the most recent mark to market was pretty high on this, it doesn’t mean I’m actually as rich as I might think I am.” Maybe a little bit of mental adjustments now, when you’re in the high periods, and likewise the ownership of businesses during low periods. We haven’t had a lot of those in the last decade, but when they do happen, your ownership is probably worth more than what the last trade thinks it was worth, and you have to adjust upward a little bit of what your true wealth is. It’s classic Chapter 8 and 20 from Intelligent Investor, Mr. Market, not instructing you as to the worth of your holdings, but instead as a partner that is there to take advantage of when you can.

Dealing With Drawdowns

Tobias: As Meb Faber points out, there’s only two states in the market. You’re either at an all-time high or you’re drawing down. And you’re not at an all-time high very often, which means most of the time you’re drawing down. So, you’ve just got to get used to being in a drawdown and sometimes, it’s deeper than otherwise is.

Bill: Is that what Meb says? That’s how he frames it?

Tobias: He said it. He said you’re at an all-time high or you’re drawing down most of the time if you’re not at an all-time high.

Bill: Yeah, I like that. I like that a thing about that. Dude, I’ve talked about him before. This is why– I mean, it’s not why, but it’s one of the things that I really respect about Mike Mitchell. He was excited when things are going well, but he wasn’t overly excited when I talked to him, and then he’s had a correction, I think if you look at the stock price, and you think about his portfolio, you can figure out his correction and when I talked to him, he’s the same guy. It’s amazing. The ability to not be impacted by that kind of volatility, I think, is a major superpower. I don’t think a lot of people have it.

Tobias: Virtually impossible.

Bill: What?

Tobias: It’s virtually impossible.

Bill: Yeah. So, I think a good thing to really take account of and it’s always better to do it at highs, but is to say, “Okay, well, what do I really want to risk here?” like you guys said, and then, “Is my asset allocation reflective of what my true risk tolerance is?” I think that’s a very important conversation that people should be having with themselves, not during a drawdown or at all times highs always. I think that’s a really important. Probably, the most important thing and then the stock picking is probably quite a bit secondary to your overall actual results.

Jake: I was going to maybe even lead us in a little love and kindness meditation after this because that is actually one of the, I think, great ways to get out of your own head and recognize that there everyone else just wants to be happy, and healthy, and do well just like you do. I’m not going to do that because I decided that would have been a little cheesy, but do yourself a favor and just find a five-minute love and kindness meditation, and listen to it, and see if it doesn’t make you feel better and feel a little bit more connected to your fellow man and just recognize that we’re all just trouser wearing apes who are trying to do the best that we can every day.

Tobias: Was that a love and kindness medication? That sounds really good.

Jake: Yeah. That was a Freudian slip maybe because it is kind of medication.

Bill: Yeah. I found some medication for that last night. Thank you, California.

Jake: [laughs]

Energy Prices Spike

Tobias: Do you guys want to take some questions? I think there’s some good stuff in here that we should talk about a little bit. What about the energy spike? What are the current views on how to play it? Is this something for value to outperforming– likely I think that draws some value for our performance if you’re in energy.

Jake: Build a time machine, go back to when the prices were–

Tobias: You think it’s over?

Jake: -the negative and realize that probably wasn’t going to last.

Tobias: Yeah. What’s your oil–[crosstalk]

Bill: Yeah. Here’s the thing though. That was the time to buy and now, I see generalist interest in oil. That makes me very, very nervous. Very nervous.

Jake: Yeah, in fairness, I saw something recently that capex is still way off for the industry. So, there might have gotten a little religion. This could be a sustainable thing. This is like our extinction topic that we talked about before– [crosstalk]

Bill: You think oil guys aren’t going to drill for oil?

Jake: I think [crosstalk] take a while is what I’m saying.

Tobias: Yeah.

Jake: The price can go crazy places in the meantime. It’s not like flipping a light switch exactly. There’s a little bit of lead time.

Bill: Yeah. I guess that this is the thing that I get caught up on. One, I don’t understand the industry and I think it’s an industry where generalists just go to die. So, that inherently, from an outside view perspective, gives me a little bit of concern. Two, you’re not buying one year of cash flow. It’s one thing if these things are priced at two times cash flow and you think you’re going to get the cash back, I get it. But they’re not and then in years five, six, seven, eight, you’re relying on them not to expand again, and I don’t know, maybe that will happen because maybe all this ESG has made them fully untouchable. I’m inherently attracted to that argument because fuck ESG. But outside of that, there’s not a reason that I am.

Tobias: Good comment here. Oil and gas guys aren’t drilling yet. I own an energy business talking to these guys every day. When you when you think about the last oil energy spike, that’s what was happening right there.

Jake: Was that 2014? That was last time– [crosstalk]

Tobias: It might be as long as it goes then. It just felt like everybody had a– they had some share in a syndicate that was going to go and drill a well somewhere. I don’t think we’re quite at that– we’re not at the mania point yet. I still think we’re very early innings for oil and gas. The problem is that it’s a commodity. I’ve got no idea where that’s going. I think you pointed out last time, JT, that oil and gas prices spiked that you think that was one of the– There’s a theory that was one of the things that spiked the 2007 market when that went down.

Jake: I have a friend who thinks that, that oil running up to whatever it did 150 or something popped the 2008 bubble. I don’t know. I don’t understand the linkage of and the mechanics of why that might be, but it’s an interesting theory.

Bill: I don’t know that I would buy that it’s causal, but I think when you have that much leverage and housing is slowing down, then it might have been the incremental thing with that much debt, they kind of pricked the bubble. I guess in retrospect, it was subjectively a bubble. So, you can say that. But maybe certainly a cause or a correlated factor.

Jake: What do you think that is, just the mopping up of disposable income from the average person when their energy costs spike like that?

Tobias: I would say inputs into finished goods.

Jake: It is kind of the prime mover of all humanity really in a lot of ways.

Tobias: It’s hard to tell how expensive it is because I’m in California. Every time I fill up my tank, I do that thing where my eyes come out of my head. It’s the biggest number I have ever seen every single time.

Jake: Yeah, it’s a good thing–

Bill: [laughs]

Jake: –you can mortgage your house so easily, so you can fill up your gas tanks.

Tobias: Can’t drive a car anymore. We’re just going to start at the top of the hill and then roll it down.

Jake: Jesus.

Tobias: Yeah, oil and gas, little love for oil and gas here, I don’t think.

Bill: Dude, I’m at my boy’s house, and until this dude is bullish on oil and gas, I’m not bullish on oil and gas, and that’s just how my mind works.

Tobias: Why is he not?

Bill: He doesn’t like that other people like the idea of owning the stocks. He’s just like, “This is how generalists always get screwed. I like oil stocks when nobody wants to touch them. Right now, all I see is that [crosstalk] to buy.”

Tobias: Was that a year ago?

Bill: What?

Tobias: Was that a year ago when it went negative?

Bill: Yeah, he was buying a little bit when it was negative.

Counterintuitive Investment Ideas

Tobias: What are obvious counterintuitive ideas at the moment if it’s not oil and gas? I don’t think there’s anything obvious. If you guys have got good obvious ideas, throw them in, but I think that everything’s got hair on it.

Jake: If it was obvious, it wouldn’t be that good of an idea. [laughs]

Tobias: Well, that’s true. That’s fair.

Bill: What he and I talked about, and I don’t even want to say this out loud, because God forbid, somebody actually thinks it’s a good idea, but some of these mining companies, they’ve been really beat up, especially, the goldminers. I don’t know. It’s a terrible business though. There’s so much merit in saying just from first principles, is this what you want to own for the long term? I’d probably be like, “No.” But that’s why there’s opportunity. It’s just I’m not sure I’m the one that’s going to figure out how to exploit the opportunity in that particular market.

Tobias: Videogame publishers look stupid cheap. I’ve seen a few of them in the screens. What’s the reason for that? It’s a fragmenting market.

Jake: Spiritual opium? I don’t know.

Bill: What? The videogames?

Tobias: Well, it’s a big bump, an unusual last 12 months or last 18 months and so, they’re just normalizing back to where they’re going to be.

Bill: I don’t know. You had culture problems. What was it, Take-Two or was it Activision? I don’t know. I’m not dialed in enough to have an informed opinion there.

Tobias: You can’t let that hold you back.

Jake: [laughs] Yeah, exactly. [crosstalk]

Tobias: This is a podcast, sir.

Jake: [laughs]

Prem Watsa’s 10 Year Record

Tobias: Does Prem Watsa’s bad track record in the last 10 years justify Fairfax trading at 0.8% of book value?

Jake: Oh, yeah.

Bill: Point what percent?


Tobias: I don’t think there was a percent there. It was just 0.8% of book value.

Jake: I think all insurance assets are financially repressed at the moment by low interest rates. So really, It’s on the insurance to underwrite that it’s profitable to not lose money because you’re not going to make it up on the returns of the float at today’s interest rate environment. So, Fairfax, I think, has done a reasonably good job of their underwriting for especially the last five years. Then obviously, if you’re in low-yielding instruments like a bunch of bonds, it’s going to be tough to do much on the flip side. So, I like it, if you’re thinking about– and this is true of all the insurance companies really. But I like it as, if you wanted to place a bet on interest rate changes to the upward, I would say there’s a lot of latent earning power in insurance companies that could be realized.

Tobias: Do you get the same thing from commodities? Is higher interest rates going to help commodities? Is that the whole value cycle, just interest rates too low?

Jake: Yeah, possibly. [laughs] They’re all interconnected that way. It’s like cash flows today versus cash flows far out into the future are also affected by that same interest rate equation. So, I don’t know. The whole thing’s a goddamn interest rate play at this point of the cycle, I guess.

Tobias: Yeah, value just boils down to where’s the 10-year. It’s like talking to Chris Cole. It’s like everything is either long or short volatility. It doesn’t really matter what it does.

Jake: I know. It’s sort of frustrated that that’s been largely true.

Tobias: Any thoughts on The Outsiders’ CEO, Bill Stiritz, at Post Holdings? He’s a good investor. No, we don’t have any.

Jake: What I’ve seen of him, it seems like he thinks for himself which is what you’re really looking for. But I don’t know enough about the individual moves other than what I’ve read in The Outsiders which is what, I don’t know, 10 years old now. So, I’m sure he’s still been operating smartly, but I haven’t really kept a close eye on it myself.

Bill: Yeah. Will Thorndike probably thought more about this answer than I did. So, I’m just going to roll with him.

Tobias: What about tobacco?

Bill: It is a good business. You can smoke it.

Jake: [laughs]

Tobias: Do you still hold tobacco?

Bill: I don’t. I thought there was a little bit of opportunity cost in there– [crosstalk]

Tobias: Not win-win-win enough.

Bill: So, I don’t know what I sold it to buy. I’m not opposed to tobacco. I think tobacco makes sense. I like the yield. I think it makes sense as a bond alternative. You’ve got terminal value risk, but that’s existed for a long time in that business and they tend to be able to price their way out of it.

Tobias: I think this is an interesting trend to all the disruptors like Bonobos, I don’t even know how to say it, Warby Parker, Casper, etc., getting back into bricks and mortar retail, and Amazon too. Wasn’t physical retail supposed to be dead? The cheap retail stocks, certainly, some cheap–

Bill: It’s all omnichannel.

Tobias: Omnichannel.

Jake: I know of one cheap retail stock which is Sears, [laughs] which earlier today traded for, I believe, two cents a share. If you can buy it but it’s under that security issue at the moment where– [crosstalk]

Tobias: It’s at the queue at the end.

Jake: Yeah. No, well, not the queue. Well, they’re under restriction at the moment with– You basically–

Tobias: You can’t buy it.

Jake: -in finding a brokerage that would let you buy it.

Tobias: Yeah. You can only sell it. That’s a weird– [crosstalk]

Bill: Sorry, dude. I didn’t mean to cut you off. I was just thinking that– [crosstalk]

You Can’t Buy OTC Stocks

Tobias: It’s just a weird thing. If I’ve done that with all of the OTC stocks as well, sell them, you can’t buy them anymore. What’s that do to the market? How does anybody get access to that stuff now? You’ve got to find a chop shop somewhere that’ll let you do it.

Jake: I guess, I don’t know. There was one day, I think it was last week where Sears opened literally at a 10th of a cent, it was a full 99% down for that day. But then it went back up to 18 cents during that same trading session. It is just all over the place on tiny volumes. If there was ever a time to be invoking the grain of salt index, which is if we’re you remember the– Look at the total amount of volume relative to the change in market cap and then decide whether you that that’s a reasonable mark to use for your personal ownership of a stock, this is high up on the grain of salt index.

Tobias: What happens if there– you’re only allowed to sell. Who’s on the other side of the transaction?

Jake: Sharks.

Tobias: How are they executing that? How are they getting–?

Jake: I don’t know. But I’ve got to find a brokerage so I can buy for a 10th of a penny, these lottery tickets.

Omnichannel Retail

Bill: Anyway, on the retail thing, I don’t think that omnichannel is a new thought. I think that a lot of good retailers have demonstrated that a physical presence is an important component of what they’re offering, and I would suggest– Some dude did a deck on Restoration Hardware. It was very well done. One of the smartest guys I’ve ever seen. I don’t know, Sullimar Capital Group or something like that, that websites got it. Also, that guy’s not actually that smart. But Williams Sonoma is another good example of– [crosstalk]

Jake: Didn’t he sell Restoration Hardware?

Bill: What?

Jake: Didn’t he sell Restoration Hardware [crosstalk]?

Bill: Shut up. I don’t want to talk about it.

Jake: [laughs]

Bill: I don’t want to talk about it. But anyway, Williams Sonoma, my beloved Cornerstone brands are opening up some stores. I do think Warby Parker is one. Lululemon is a good example. I just think you need good retail experiences and I think that the retail story got a little bit over its skis because America overbuilt so much mall space, and a lot of the boxes were shitty. So, shitty retail sucks and then it turns into retail sucks, but that’s not really true. That’s how I see that.

Tobias: Why bail on Restoration Hardware?

Bill: Can people just let me just not talk about this?

Jake: Yeah. Just kick the guy when he is down.

Tobias: Sorry, dude.

Bill: It was April of 2020, and I was not convinced that they were going to generate sufficient cash flow to pay back their debt, and Gary said that they were going to use cash on hand, and I didn’t first see one of the biggest explosions in furniture selling, and I wish I had credit card data, and I’d like to never talk about it again. It really hurts. It’s up 7x since I sold. So, let’s just all move on.

$CROX Up 100%+ YTD

Tobias: Ouch. There’s a few businesses like that. What’s up with Crocs? Why is Crocs running so high?

Jake: Have you ever worn them, bro?

Bill: Because it fucking dope and kids love them.

Tobias: Yeah, I don’t wear them, but I wear other stupid shit.

Jake: [laughs]

Tobias: So, it’s not like I’m too good for them or anything like that. I just don’t.

Bill: Dude, my youngest, if you try to take him outside without his Crocs shoes on, you are going to get screamed at.

Jake: [laughs] Really. He’s hardcore, huh?

Bill: Yeah, and he doesn’t even have– they have these little buttons that kids put on the crocs to make them their own. He doesn’t even have that, but he is down to ride in his Crocs shoes.

Tobias: that’s another stuff that’s gone absolutely bananas over the last 12 months. It was like a there’s another net-net super cheap.

Jake: Obvious winner. [laughs]

Tobias: Yeah. Fashion.

Jake: Not a fad, not a hula hoop.

Tobias: Well, it’s come back. It was a fad for a while and then, [unintelligible 00:57:37] was in there as well, and [unintelligible 00:57:33] haven’t come back, the Crocs have.

Jake: Tough game.

Tobias: Indeed.

$CRI Trading Flat YTD

Bill: I wonder how Carter’s is trading, the baby clothing company. If you believe the demographics, they should do pretty well, and that’s like– I’ve just gone through a lot of Carter’s clothes in my day.

Tobias: What do you like about Carter’s? I don’t know anything about them.

Bill: I don’t love anything about it, but it’s reasonably priced stuff that a child can poop in and you’re not going to kill yourself for throwing it out and it’s kind of cute.

Tobias: Oh, it’s for kids.

Jake: Just basically like Old Navy. [laughs]

Tobias: [laughs] For the workspace.

Jake: Yeah.

Tobias: All right, folks. I think we’re running out of ideas here. So, we’re going to pull it.

Bill: We can talk about baby poop if you’d like. That would not be good though. So, we should pull it.

Tobias: I’m out of that business now. Thank God.

Bill: Yeah, as am I. If I look a little flushed, it’s because I earned it last night. So, I’m happy to be out in California partying a little, but also, I need some water and rest.

Jake: [laughs] And an IV.

Bill: Yeah.

Tobias: All right. Dude–

Bill: Good to see old friends.

Tobias: We’ll be back same time next week. See you then.

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