In their latest episode of the VALUE: After Hours Podcast, Bill Brewster, Jake Taylor, and Tobias Carlisle discuss:
- Value Undervalued
- ‘New Technology’ And Its Diminishing Law of Returns
- Antagonistic Pleiotropy: Short-Term Genius/Long-Term Bust
- Fragility In Commodity Prices
- Monte Carlo Simulation Strategy
- Worm Capital – Tesla On Path To Dominate S&P 500 By 2030
- Ten-Year Treasury Vertical
- How Cobweb Theory Affects Markets
- Stellantis NV $STLA Cheap
- Time To Buy Domino’s Pizza $DPZ
- Einhorn’s Latest Letter
- One Way To Avoid Getting Wiped Out!
- U.S Continues To Subsidize Housing
- The Interest Rate Boogeyman
- Which Direction Is The Market Elevator Going?
- Inflation To Run Hotter
- Bubbles Are Rational
- Homebuyers Running Out Of Options
- When You Have No Circle of Competence
- Berkshire Meetup
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:
Bill: At Auburn, is hilarious. Hey, we live.
Jake: We live.
Tobias: We’re live.
Jake: What time is it around the world, Toby?
Tobias: It is 10:30 AM West Coast, 1:30 PM East Coast, I think 3:30 AM Australian Eastern Standard Time, 5:30 PM UTC. I looked it up. It’s going to be true for a few months and then it’ll changes again. It’s Value: After Hours joined by– [crosstalk]
Bill: 7:30 AM, my time.
Jake: Ooh, stills on the Hawaii time right now.
Tobias: It’s not so bad. It’s living.
Bill: Well, the problem is I’m currently in Florida.
Tobias: What about your kids? What time for them?
Jake: Yeah, kids.
Bill: I was not nice to them last night.
Jake: Are they waking up at noon?
Bill: No, you know four-year-olds. You know how they just whine, and whine, and whine, and whine. Well, after 19 and a half hours of traveling, no sleep, I wasn’t having it and I probably could have been more compassionate. Oh, well. One of a long list of mistakes.
Tobias: Townsville, Queensland in the house. Wow, Prince of Island, Alaska.
Bill: There we go.
Tobias: Casuarina prison in Perth. Good to see you, Stuey. Nashville. Nice.
Bill: The Alaskan fan is tuning in to figure out what he’s going to do or she. Shouldn’t assume it to he with all oil money.
Jake: It’s a he?
Jake: [laughs] We know our demographic here. Come on.
Bill: Statistically speaking, you’re right.
Bill: It could be the outlier. This couple women that listen, shoutout to y’all. Thank you.
Tobias: [crosstalk] a couple.
Bill: Yeah. Well, I think there’s four.
Bill: So, 40% of the fans.
Jake: 40%, that’s pretty good.
Bill: That’s not bad. Not bad.
Tobias: Big numbers.
Jake: Big– [laughs] Big league. What’s on top for today, boys?
Tobias: Yeah. The one thing that I saw a tweet from Cliff Asness about interest rates jacking up and the theory was super low interest rates, what keeps the stock market up and that interest rates are up and stock markets still up. So, we’ve debunked that one, too.
Ten-Year Treasury Vertical
Tobias: When I had a look at the 10-year, the 10 year’s at 2.9.
Bill: It’s going higher.
Tobias: I remember what it went through, too.
Bill: Yeah, I think quick.
Tobias: Over the last decade, it’s been over 3 on two occasions. It’s not just over 3, like 3.07, 3.06 in 2013 and 2018 and then it rapidly got stomped on after that. I don’t know if this is like– The Feds decided that three is as high as it can go or if it was just something that’s what happens. But anyway, it’s interesting. Interesting to see what’s going to happen.
Bill: What did Dudley say yesterday? I thought he said three and a half is where the short-term rank should be.
Jake: That’s the magic number.
Bill: No, well, I know– [crosstalk]
Tobias: What do they say for short-term? What are they calling short-term? That’s not 10-year, right?
Bill: I don’t know. I’m trying to figure it out, because there are a bunch of tweets and I’m trying to go to the actual source.
Which Direction Is The Market Elevator Going?
Jake: Speaking of funny tweets about that, I think Morgan Housel had one about, he’s like, “If you told someone in 2011 that mortgage rates were at 5%, they would say, “Wow, how’d they get down that low?”‘
Jake: It’s not always what floor of the elevator you’re on. It is which direction is the elevator going off in.
Tobias: Yeah. What direction is the elevator going in? Going up?
Jake: Pent house, apparently. [laughs]
Tobias: Yeah, I don’t know.
Bill: Why is this so hard to figure out? You want the short thesis on Google? I typed in Dudley FOMC speech, it wasn’t at the FOMC. So, maybe that’s on me. But I can’t get what I need if– This is not good.
Tobias: Stockholm, what’s happening? Nashville, Abu Dhabi. We got a pretty good spread.
Jake: It’s worldwide.
Tobias: Eastern Germany.
Bill: He did mention speaking in the elevator that he thought the economy had a long way to go.
Tobias: Which way?
Tobias: Up or down?
Jake: Good question. Unclear.
Inflation To Run Hotter
Tobias: It’s hard to see inflation. The last print from inflation was 8.5%. I’m pretty bearish inflation is whatever. But it’s hard to see inflation maintain at that rate for– We’re all set on fire at that rate. It’s got to come down from there. But it’s still going to be high.
Jake: What if you shut down the world’s factory in the form of China and COVID? What’s that do for your inflation predictions?
Tobias: Yeah, I have to withdraw it at that point.
Tobias: Some of these things are just too terrible to think about, I think. Just have to hope they don’t happen.
Bill: Well, it’s happening, though. I don’t think that Hopium gets you out of this.
Tobias: Well, then inflation is going to run a lot hotter.
Bill: Yeah, or it doesn’t. One of the two.
Einhorn’s Latest Letter
Tobias: Well, I didn’t read all of Einhorn’s letter. I just saw his Q1 letter came out April 19th. So, that’s today and I just started reading it before he came on. He says, “The markets are predicting 5.3% inflation through the end of the year.”
Jake: What does that mean? Looking at Treasury futures or something?
Tobias: Yeah. I can’t remember exactly. But there’s some instrument that will give you the market’s prediction. But he said the market was predicting 3.5% a year ago.
Tobias: So, the markets not going to be right. 5.3% is pretty hot.
Jake: That is hot.
When You Have No Circle of Competence
Bill: It’s all a matter why, I guess. I don’t know. I don’t know anything. Dennis Hong said, “His circle of competence he defines as his ability to predict an accurate statistical range.” I’m pretty sure that’s what he said, and I got to thinking about that, and I determined I have no circles of competence.
Jake: It’s hard.
Bill: No, I’m not kidding. I don’t think I have any.
Jake: Well, I mean that’s not true. Your entire life you point preventing probabilistic predictions about.
Bill: I can’t fucking predict accurately tomorrow.
Jake: Well, yeah.
Bill: I’m almost certain the Sun will come up.
Jake: There you go.
Bill: That’s one area of competence that I have.
Jake: We can build off of that.
Bill: Yeah. So, I got that going for me.
Tobias: The Earth will continue to turn.
Bill: Or, if it doesn’t, it doesn’t matter.
Tobias: You got bigger problems.
Bill: That’s right. Yeah, I’m not even kidding. I really, I thought about that and I was like, “I don’t–” [crosstalk]
Tobias: Here’s another thing like, “Sun coming up, Earth continues to turn, value spread continues to blow out. Value spread at all-time highs.”
So, this is from the Alpha Architect website. I pulled it up last week just because I was interested to see– because the end of every month, they update the data. And so, the spread now is wider than– [crosstalk]
Jake: You just have a little calendar reminder that says, “Self-flagellation”? [laughs]
Tobias: Oh, it’s just like, “What am I underperforming? Let me go have a quick look.”
Tobias: The data goes back to 1992. The spread is wider now than at any other point in the data including– [crosstalk]
Jake: You keep telling me that every time we talk about it.
Tobias: This is how you get there, though. It keeps on going up. But the significance, now, well through 19– This is measured on EBIT to total enterprise value since 1992 monthly, year end, US domestic stock. It is now wider than it has been at any point in the data by a very wide margin, including 2000 and 2007 or 2009, whenever the little peak was through there. And then it’s now extended over the EAFE data as well, which I didn’t think was going to happen. Because the US markets has been quite strong. So, it’s been everything outside of the US has been suffering in comparison, but it’s now extended past that as well. It’s crazy.
Jake: That’s really surprising to me. I would have thought that top decile has been blown out now in a lot of ways, wouldn’t you?
Tobias: In this, because it includes energy?
Jake: Let me use a better word than blown up. No, the most expensive decile would have been beaten up enough to not have such a widespread.
Tobias: Yes. The significance of this spread is, it’s the value spread relative to the market.
Jake: Oh, okay. So, it’s only from halfway to downward then. Not the top and the bottom.
Tobias: Because it’s EBIT rather than book or other measures of value, it’s not going to include a lot of energy. So, the spread in there, they’re saying it’s like a yield on– [crosstalk]
Jake: Yeah, it’s a flow– [crosstalk]
Tobias: The yield is like 15.5% across that decile versus it was 4 I think for the market, which is very significant. Anyway, I think that continues to be a pretty good opportunity getting better every month.
Bill: Lot cyclicals in that, right?
Tobias: Must be. Yeah.
Jake: No one’s buying it.
The Interest Rate Boogeyman
Bill: I think everybody’s scared, man. Not of everything, obviously. Somebody’s laughing out there that like, “Oh, that’s a stupid comment. Look at how expensive everything is.” Well, I get that, but I don’t– There’s not too much bullish sentiment out there and I don’t see a lot of people being like, “We’re going to be fine through these rates hikes.” There’re a lot of people that are like, “Well, what are rates going to do to everything?” There’s a big boogeyman that I think people are looking at. I just said that that my circle of competence is zero, right?
Tobias: What’s the Boogeyman? What’s the– [crosstalk]
Bill: Their rates are going to kill everything.
Jake: You know what’s weird about that, though, is that, you see the bull and bear AAII sentiment and its super bearish right now, right? And yet, exposures, I think are still pretty heavily tilted to equities. People are just saying it, but then I think that they’re not backing it up with their money. So, I don’t know.
Tobias: Is that auto investment into– [crosstalk]
Bill: I think a lot of it is.
Jake: It could be.
Bill: I think a lot of it is.
Tobias: It’s probably a good thing that people even if they feel one way, they’re still doing the other.
Talk Bearish, Act Bullish, Get Rich!
Bill: Yeah. What did Mike say on the Twitter machine? “Talk bearish, act bullish, get rich.”
U.S Continues To Subsidize Housing
Jake: That is maybe what’s happening. It feels like I don’t know. A lot of this stuff is– I feel the data sets of it are pretty noisy. So, it’s hard to really write a good narrative out of it.
Bill: I think that there’s legitimate concern around if the Fed– If mortgage rates trickle through the housing cycle, typically, housing will lead economic cycles. So, you just haven’t seen in the data yet and it’s coming.
Tobias: What is housing lead the economic cycle?
Bill: It’s got a huge multiplier effect, man. There’s a ton of labor that’s directly employed by housing and they spend quickly. The laborers tend not to be people that are saving as much. They’re spending most of their raises. You get a lot of transitory labor into and out of construction, I think. You get a lot of like–
Bill: Maybe somebody would be in a restaurant, and now they’re in construction, and then I think you probably have some refi impacts and wealth effect. I don’t know. The wealth effect’s a little funky, though, because typically I don’t think and I haven’t really looked at this. Maybe 2007 changes, but that would be the only time like really sales velocity decreases. When housing hits a tough patch, price don’t tend to come down that much, because most people just don’t sell.
Tobias: Yeah, that was the question, that was the point that I was going to make or the question I was going to ask that. Typically, what I see or what tends to happen is that, the stock market crashes and it takes the property market, real estate market another year before it bottoms, because it’s the less liquid market. It takes longer to clear.
Bill: Yeah, well, now if you’ve locked your rates in, I don’t know that people are eager to sell.
Jake: Yeah. I was trying to figure out is someone ever going to come up with a– Or, let’s say that rates do and especially, if this is true that the Fed wants to get out of the mortgage market and if that’s the case, boy, I have to imagine rates could be a quite a bit higher. Imagine we have this scenario where people want to move and they have good reason to move, but no one wants to give up their mortgage.
Would we almost need another product or something that would allow you to keep that same mortgage and transfer it or in some kind of escrow? I don’t know exactly how it could work, but it seems that might be a business that would make some sense. This mortgage comes with the house and you just assume the whole thing and you’re going to assume someone else’s that’s also lower.
Bill: Yeah, I don’t think there’s been too many assumptions of mortgages clauses. Mortgages are interesting, right? Because when you buy them, if you’re long the mortgage debt, when rates go down, people refi you and your duration shortens, you are in the– [crosstalk]
Jake: Yeah, you’re on the wrong end of a call option there.
Bill: Yeah, you’re always on the wrong end, though. Because if you bought them, too– [crosstalk]
Tobias: As the lender, the borrower was got the right side of that, right? The lender’s got the bad side. That’s what you see.
Bill: Yeah. Because the buyer always has the option to put it to the lender. And then if you bought it pack of mortgages when they were at 2.9 or whatever, if you have any duration in that, it’s going to get extended if mortgage rates go to 6. I’m sure people make money buying that stuff, but I don’t fully understand how outside of levering it and hoping.
Tobias: Fixed rate mortgage just as the standard is, I’ve never encountered that before in Australia. You could get a fixed rate for five years, but you pay a premium for it. What I understood was that you never get the fixed rate, because you always pay over a full mortgage, you always pay lower rates at the variable rate, because you don’t have to pay the premium. So, the US has Fannie Mae and all of these other government GSEs or whatever they call that lend to that market, because they wouldn’t do it. Otherwise, it’s non-commercial.
Jake: Yeah, we subsidize our housing market considerably relative to other countries.
Bill: Yeah. I think it’s a reasonably decent policy, but that’s not a well thought out comment.
Jake: You’re right. I think there’s something about homeownership and skin in the game, and your community, and giving a shit about that you’re a member there, and some stabilities. I’m pretty anti-meddling in human affairs by government. But in this instance, I’m not sure it’s that bad.
Bill: When you want an asset liability match, you don’t want a long-dated asset that all of a sudden, you’ve got some crash and a bunch of people have to refi their five-year debt. You’re like, “Fuck.”
Tobias: Well, that’s what happened in 2007.
Jake: Yeah, [crosstalk] on arms.
Bill: Yeah. I don’t think we’ve gotten to the point, where credit conditions have been super loose, yet. I think the underwriting is still quite good on average. We may be getting there if rates go up, people may start to look at more exotic debt products. But to date, I don’t think that’s a real risk, yet.
Tobias: I didn’t finish this part of Einhorn’s letter, but Einhorn was writing about the homebuilders in particular and he said, “The reason that they’re cheap, because people were scared of a 2007, 2008, 2009 type scenario.” He said, “He didn’t think that was likely, because they’d been such a huge underinvestment and lending was much stricter.” But I literally that was what I was reading before I jumped on here. I haven’t finished it, yet. So, there may be a curveball by the end of it. There may be a punchline that is different to that.
Jake: Yeah, psych.
Tobias: But I think that that’s interesting from Einhorn.
Bill: Yeah, no, I think that’s probably right.
Tobias: Because Einhorn was very bearish. He was short all that stuff through seven at nine. So, I tend to listen to him a little bit on that.
Bill: Yeah, well, I don’t think you can look at the data and think we’re going to have a big housing crash. You may have an illiquidity bubble. That’s a big problem, but I just don’t think–
Tobias: The problem with this stuff though is that it’s never really predictable beforehand. I don’t think so either. But when it happens, we’ll revisit this in four years’ time, people are like, “They had no idea.” You pull– [crosstalk]
Bill: Well, if you have some catastrophic event and all of a sudden, but then you’re just going to have illiquidity, right?
Homebuyers Running Out Of Options
Bill: I guess, then the homebuilders have to complete all these houses that they’ve started, but have not completed and they’re sitting on a bunch of inventory that’s high cost, because they paid up for the land, and they paid up for the materials, and now you got no bidders. I guess that’s possible, but I think if you’re going to make that argument, you really have a lot of burden of proof on you outside of I feel this is going to happen.
Tobias: I don’t disagree. I own a lot of home builders. So, I like that argument, too. But just like to aerate the other side, too.
Bill: I have no circle of competence. So, I don’t even know what I’m talking about.
Jake: What do HELOCS look like right now? I thought I saw a chart that there’s been a fair amount of money taken out in the last few years.
Bill: Yeah, there have been a ton of reifies.
Jake: Which then, that has to be pretty stimulative for the rest of goods and services. I don’t know. It did got away or you have to pay some of that back, and now, all of a sudden like, “Oh, boy, we have a little bit less demand for all this other stuff.”
Bill: Yeah. Look, I think you can make a valid argument that you believe that demand is temporarily too high and we’ve pulled forward a lot of it. When things slow, we’re going into recession and– Okay, but I guess, haven’t we proven the fact that we can overstimulate the economy if we need to?
Tobias: How many times can you do that?
Bill: That’s the problems.
Tobias: How many times can you give the kids another coke when it’s late at night before they crash anyway?
Bill: I have no idea, man.
Jake: The Cola, okay.
Tobias: I got a good comment. “New buyer incentives (pool, landscaping, rate buy down) happen before developers drop prices. Watch for the homeowner incentives to appear. That will signal the top.” I saw something that there were a large–
Bill: Hang on. Repeat that Please.
Tobias: New buyer incentives happen before developers drop prices. So, they start offering free stuff before prices come down. But that’s the harbinger for something bad is going to happen. I did see that the number of speculative homes was high. This is developers, who’ve bought and developed the place or refurbished the place to flip it. That was– [crosstalk]
Bill: Yeah, but that’s because there is no fucking inventory. Days on market or savage–
Tobias: Yeah, it’s low as it’s ever been.
Bill: This is straight out of Logan. But he’s right. It’s savagely unhealthy. We’re not more than a month after I was talking to my buddy, who’s a buyer’s agent. Shoutout to Jason Dalby in Denver. If you need a house, buy it from Jason. Actually, don’t because he probably won’t rep you. He straight up was like, “I don’t do buyers right now. I cannot do it, because I can’t write an offer that’s aggressive enough.” He doesn’t feel right repping a buyer and basically saying, “We’ll pay whatever you want with whatever terms you want, and there’s no cap on this, and it’s cash only.” Those are the kind of offers that are getting accepted. That’s insanity.
Bill: It’s like slowing that a little makes sense to me.
Tobias: For sure.
Jake: This too shall pass.
Bill: But I don’t know. If you slow that, does that mean catastrophe or does it just mean that you’re slowing something a little? I don’t know.
Tobias: It’s hard to tell right the margins of the thing dictate what we see that’s the marginal buyer and seller getting together. But it doesn’t necessarily speak for the bulk, where 2007, 2008, 2009 seem to be a lot– There’s just so much speculation out there, because I don’t think there was that much speculation of there’s just not a lot of liquidity. It’s like just jacking up prices.
Bill: Yeah, the one thing that I do think that people get a little fast and loose with is, people are like, “Oh, well, there’s a lot of cash buyers.” What is really a cash offer? I guess you back it up with some proof of funds, but it’s not really cash. Unless you’re showing somebody a bank account, that segregated funds that is actually cash.
Tobias: It’s just not subject to finance, isn’t that all means?
Bill: That’s correct. Yeah.
Tobias: You just got the financing already lined up?
Bill: Yeah. And I just think that people associate cash with true cash, that’s not equities, and it has nowhere to go.
Jake: This is a schmuck’s full of money.
Bill: Yeah, that’s right. I think it’s just shorthand for we’ll get it done whatever we have to do, which works unless there’s a big correction.
Fragility In Commodity Prices
Tobias: “How long until we think the supply chain starts to heal? We’ll build more homes, and that’ll slow the craze.” I don’t know. A while, a few years. It takes a while to build home.
Bill: Yeah, well, I think there are a couple things on this. I don’t know why anyone would listen to me. I have no circle of competence and I’ve been way wrong on this.
Bill: I think the supply chain has been getting better, but to Jake’s point, now, you’ve got China coming offline. Let’s talk about lumber, something that’s never been discussed on this podcast. Do we think that Russia coming offline is good for aggregate lumber supply?
Tobias: We get a little lumber from Russia?
Bill: They got a lot of natural resources. It’s probably not an incrementally good thing. Do we think that the Ukraine being destroyed– [crosstalk]
Tobias: What about Canada coming of?
Bill: Wait, Ukraine being destroyed and having all those people fleeing, does that create any housing demand? You got to put them somewhere. You probably have to build something. It’s hard for it to be an– [crosstalk]
Jake: Yes, for Poland. I don’t know about the US.
Bill: Yeah, no, I’m not saying the US. But it’s a global market, right?
Bill: I accepted somewhat local, because it’s heavy to ship. Then we go to this side of the world, you’ve got huge housing shortages, days on market is, I don’t know, 30 [crosstalk] today?
Jake: Measured in hours. [laughs]
Bill: Yeah. Housing starts have been over one-six forever. Completions is the problem. Canada, it’s hard to argue that the west side of Canada is getting competitive. You got all this stuff in the southeast that can maybe come online, but how are you going to get the labor to actually get this mill done and to actually get the truckers to move it around. I don’t know. We’ll see.
Jake: Are you saying that there’s fragility in some of our systems that we’ve erected over the last–?
Bill: Yeah, I will say that smarter people than me think lumber at 300 is more probable in the summer than lumber at 800. I wouldn’t be shocked if we have a sell off. But if lumber goes to 300, I don’t know what it looks like after that. Because presumably, some people are going to get knocked out of production, which is all a long-winded way of saying. I think that housing starts, completions are almost built in for a while, I think, unless builders just shut it down, which is possible. But I don’t think it’s probable.
Tobias: It’s been funny looking at the daily chart of some commodity that’s gone absolutely bananas on Twitter. It was milk today. Milk has shot straight up.
Tobias: I don’t know why milk would be.
How Cobweb Theory Affects Markets
Jake: Well, there’s this idea in economics called cobweb effects and what it is that, if there’s a lag at all in supply or demand how it shifts, then you’ll see the price move pretty dramatically, and it almost ends up making almost looks like a cobweb like a spider would build.
Tobias: Overcorrecting? Trying correct to the– [crosstalk]
Jake: Yeah, there is overcorrection. Supply, if you can’t put it on right away when demand is there, you’re going to have a price change, and then eventually, it catches up and overshoots, and now, it moves back the other direction. Equilibrium is only a thing that you just move through occasionally.
Jake: I would expect more volatility and all this stuff than less. Even if it goes lower, maybe it goes lower, harder and it goes back the other direction, I think the stability is the rare occurrence and that this type of fluctuation is probably more than norm.
Tobias: I mean that run up in the 10-year, that’s an incredible ramp. Every time I check in, I expect that to have broken, but it’s still ramping up. I remember we were talking about going through two that was this year, wasn’t it?
Jake: It’s two weeks ago. [laughs] Oh.
Tobias: JT, you want to do your– I couldn’t even pronounce it.
Bill: Oh, do not. We something. The Bullard, the presentation, I think is worth looking at. You can find that, I’m pretty sure it’s stlouisfed.org. I had one more thing. Fuck it, doesn’t matter.
Jake: We’ll get back to it.
Bill: Yeah. Oh, my buddy is at trade oil. They say that there’s a lot less liquidity in the market right now. And I just wonder if there’s some combination of a lack of liquidity plus, some people that are– [crosstalk]
Jake: What does that mean? Supply for–
Bill: Just like traders.
Bubbles Are Rational
Bill: My buddy said that, “It’s so algo driven now that if he puts in an actual bid, he can watch the entire market respond to his bid.” Now, he’s trading like a super niche product. It’s TAS, which is traded settlement. It’s only 30 minutes of the day that he trades every day, but he is a specialist in that market. He was just saying that, “There’s a lot less liquidity than he’s ever seen in his career.”
I wonder if that’s going on a lot of places and then if it is, I was listening to Soros speak about reflexivity and he said that like, “Bubbles, he actually thinks are very rational,” because if you think a bubble is coming, the rational thing to do is pile in and make a bunch of money. I wonder if some of these spikes are– I just don’t know how much of it’s like. People that see market structure issues, and they’re exploiting them, and they can just push the market much further, much faster than they used to be able to.
Jake: Because of the lack of depth to it?
Bill: Yeah. If you have some access to leverage or something and you just know that you can pound the book, I would probably do it if I knew how. I don’t and I have no circle, I have a square.
Jake: Square of competence? [laughs]
Tobias: Or, take a Hedron of confidence.
Bill: Anyway, that’s all I got.
Antagonistic Pleiotropy: Short-Term Genius/Long-Term Bust
Jake: All right. Veggies for today are this concept called antagonistic pleiotropy. It sounds very complicated. It’s not as complicated as it sounds, but where it came from is that, there’s been a lot of talk I feel lately and this is what happens during any regime change, I think. There’s a lot of talk about like, “Oh, everyone needs to evolve with the changing times as an investor.” That sounds right, doesn’t it?” Oh, of course, you need to evolve and keep up with everything. But evolve is an interesting choice of words for this, because what do you guys think about when you think of evolution? What’s the phrase that comes to mind?
Tobias: Survival of the fittest?
Bill: I just think a style drift in this case.
Bill: All I hear is underperformance.
Jake: Yeah. Don’t spoil the punchline.
Jake: No, but Toby’s right that survival of the fittest is often what’s thought of, but that’s actually wrong. It’s wrong because it’s more about reproduction and passing on your genes. Imagine any organism that is living for centuries, but doesn’t reproduce, it’s effectively, evolutionarily invisible at that point.
Survival is not necessarily what matters in this. The difference between survival and reproduction can be shown with this antagonistic pleiotropy, which I will just call AP to shorten it for the rest of the segment. One, because it’s hard to say and two, because we don’t have time for that. So, AP, it comes from Greek actually, which means more and turning. It means multiple paths in a way. AP, it comes from traits that increase your productive fitness at the expense, though, of later in life like decreasing lifespan.
A classic example would be in primates, your prostate in a primate, which we are primates has increased metabolic rate. How that helps you be more reproductive is that, that actually increases sperm motility. But it comes with the downside of later in life that higher metabolic rate will create more incidence of cancer. You passed it on into the future, but it’s not good for you in your survival of the fittest.
Another classic example would be salmon, who swim upstream, this epic journey to spawn, and then they die. Another one actually is Huntington’s disease, where people with Huntington’s disease actually have a lower incidence of cancer when they’re younger than average and actually, have higher fecundity, which is better breeding, like, have more kids. But it comes at the cost later this genetic mutation causes neurodegenerative diseases later in life that are actually pretty horrific.
Basically, we have increased fitness in the short run, but that same expression, genetic expression causes a compromised long term. I did a little just playing around with return streams over, let’s say, a 30-year period of your investment horizon. I did a thing, where, let’s say that you had Hall of Fame returns 30% a year for four years and every fifth year, you had a minus 70%. You just got the shit kicked out of you.
I think that there are some people, who follow this strategy that is very high variance. When you are winning, you look like a genius. You’re killing it. When it doesn’t work out, you get absolutely monkey hammered. What ends up happening then is, if you do this four good years, one bad year, and you play that out for 30 years, a 30/70 up and down. You actually end up your 30, you’re down 60% total. It’s pretty rough. If the further that it would go actually, the further you would go down this curve toward zero.
Now, contrast that with Style B, which was 5% upside every year and a 10% drawdown. Much tighter ranges of variance. By the year of 30, you’re up 71%. It’s not you crushed it for a 30-year period, cumulative 71% is not much.
However, you made it much, much farther into it. I think you would probably have been fired well before if you were running that 30 up, 70 down time period. Now, you might be saying like, “Well, every five years, that’s unrealistic.” You’re not going to get clobbered every five years. I did another little run that was 25% per year for nine years and then down 80% on that 10th year.
You look like a genius for long stretches of time and then you get hammered every 10 years, you have a bad year. That turned into a cumulative 230% by the end of 30 years. Not too shabby. It’s okay. However, contrast that with Style B, which I would say is probably maybe more, like, I think Buffett has tried to run most of his career which is 8% upside, especially as he’s gotten bigger, but let me preface that. 8% upside, 9 out of 10 years, so, pretty modest ambitions, I would say. And 20% downside of that 10th year. You end up with a 309% total return over that 30 years.
You end up pretty materially outperforming this other higher variance strategy. This has been called variance drain in other contexts.
I think what it shows is that there are certain strategies that can make you short term look like very successful and do really well, but long term, you’re going to end up paying for it a little bit in the way that antagonistic pleiotropy applies.
I would say that, we may be seeing that little bit of a turning point and that maybe we had that period, where the first four to 10 years or whatever, four to nine years were where it was like, shoot the lights out type of strategies worked really well to go back to Bill’s point about style drift. Is it really time to be evolving more towards that or maybe still being a little bit more down the center, smaller variants is still maybe a smart thing to do? That’s up to you and your own personality, but just at least know what you’re doing.
Tobias: When you’re constructing that, is there some significance about the size of the up year versus the size of the down year?
Jake: Well, the bigger the up year, the bigger the down year that you can afford to still not–
Tobias: But are they in the same scale? Is the five down to the 20, the same as a 25 to 80? Whatever the case maybe?
Jake: Well, you can play around with different– Sorry– [crosstalk]
One Way To Avoid Getting Wiped Out!
Bill: Down 80 is bad. You pretty much wiped out?
Jake: Down 80 is bad.
Bill: I don’t think we talked about what happens though, if I increase my Twitter follower account during those up 25 years, and then I launch some Substack products, and maybe hold some conferences, and then maybe I’m in an LP structure, and then I have fun, too, and I say, I just had a bad year, and I’m about to get ready to go again, I get my two and 20 maybe-
Jake: I’ve learned all my lessons from before.
Bill: -or just my 06/20 on the first, you can get pretty rich in that first strategy.
Tobias: John Merriweather did it three times.
Bill: Yeah. So, LPs may not. But the GP can make it out pretty well.
Jake: That’s right.
Bill: He’s got to be good at sales.
Jake: If you’re a good salesman, well, that’s what I was going to say that-
Bill: That’s right.
Jake: -you can have multiple bites of that apple.
Monte Carlo Simulation Strategy
Tobias: The book, Concentrated Investing, I built this little Monte Carlo simulation of the different bet sizing, so, you can have reverse Martingale like a fixed sum of your book that you bet regardless of what happens or you have Kelly or half-Kelly, right?
Tobias: And I built it, so that it would give me thousand runs and then I can refresh, it would give me another thousand runs. I played with a lot over a few days after I built it. It was amazing how on average over the full set and I collected all of them into a chart which is in the book. You definitely do better with Kelly.
Tobias: But it’s amazing how many times you run it with Kelly. When I say, you run it once, it’s a thousand trades in sequence over probably a lifetime. It’s amazing how many times, even though, you know that it’s the bit of strategy on average over the full set, how many times it underperforms, it was a little bit humbling watching it run actually, I was like this is– That makes me a little bit nervous.
Jake: Implicitly, Kelly is the median expected version of that, right? It looks very good, but you can end up on either end of that median.
Tobias: Right. And half-Kelly’s no better. It looks to me like it calling for– [crosstalk]
Jake: Half-Kelly just squeezes the lower and higher levels together, right?
Tobias: Kelly is supposed to be the optimal return for risk and half-Kelly is supposed to be some half of the volatility, but you must be truncating your return more, because it’s not optimal. It’s definitionally not optimal. But it’s still–
Jake: Chop some of the downside part off, right?
Jake: And lowers the whole structure.
Tobias: It just lowers the return. Yeah. In some ways, it’s that example that you gave. It’s a 30% versus 80% or 5% versus 10%.
Tobias: And that’s why I was just wondering if you’re influencing the results a little bit by choosing a ratio that was favorable to it, but it doesn’t help in the runs that I looked at.
Jake: Yeah. This was effectively a very simple Monte Carlo that was pre-prescribed over a 30-year horizon, where you’d have, whatever four or five drawdowns over that 30 years.
Tobias: The drawdowns really do kill you, because it’s hard to compound back from that.
Jake: Dude, there’s so hard to get out of. They’re legitimately difficult.
Tobias: You do have to survive. It’s the big bounce up the other side that was worth being there for if you can [unintelligible [00:40:20], you don’t want to be pulling out. I met so many people over the last 10 years, who had sold out in 2009 at the bottom.
Jake: I think this is almost impossible to overcome if you’re an allocator, who’s picking managers and you’re going to go– It’s so hard not to just go whatever the hot hand has looked like, right? And then–
Tobias: What else are you judging it on? What, they’re telling everybody sounds the same?
Jake: I know. Difficult, though. [laughs]
Tobias: You’ll look at the return and the returns are just randomous.
Jake: Well, this guy’s smart. He’s been crushing it lately.
‘New Technology’ And Its Diminishing Law of Returns
Tobias: Ark is a classic example. I look at that portfolio as it stands, I think that’s a scary portfolio to hold.
Bill: I look at that. It has some pretty good 60% forward.
Jake: [laughs] And increasing.
Bill: That’s right. Everyday.
Tobias: Somebody did the analysis, where she started at 40, or 20, or something like that in the investment– [crosstalk]
Bill: Yeah, 40.
Tobias: They just calculated down, and then looked at it, and they said actually, 50% is less aggressive from here than 20% close from where she said it the first time around. It’s under [unintelligible [00:41:28] interview with her and then one of the comments underneath is a good one.
Jake: And even there’s multiple compression in there? That’s what she said?
Bill: Yeah. Well, there’s been some already.
Tobias: Last time I looked at, I think the multiples were too heroic relative to the market but the underlines is still pretty ugly. There’s not a lot of the revenues are filtering down, but bottom line. But maybe that changes, maybe it’ll hit an inflection point. I don’t know.
Bill: I tell you what, if the revenues are filtering down to the bottom line, then there’s no way it does 60% forward, because then there’s not enough reinvestment opportunities.
Jake: I don’t know how you can look at every other technological revolution that’s happened in humanity and assume that there’s going to be all of this profit available for you out in the future, and that you’re going to be able to pick the winners of that. Airplanes, radios, TVs, the list is endless of awesome world changing technology and yet, the ability to make money from these giant revolutions has just been really almost impossible.
Tobias: Yeah. Can you see it coming and switch from one to the next one?
Jake: [laughs] I don’t know. But if you’re doing any destination analysis of like, what is the competitive structure of this industry look like in year 2037.
Bill: Winner take all, baby.
Jake: Every single one?
Jake: It’s all profit.
Bill: You just got to define the niche, right?
Jake: Everyone’s going to have 80% profit margins out in the future?
Bill: Except for the old-world companies that are generating cash– [crosstalk]
Jake: Except for all those hosers that– Yeah.
Worm Capital – Tesla On Path To Dominate S&P 500 By 2030
Tobias: There’s a presentation doing the rounds that predicts Tesla will be a very significant part of the S&P 500 in 2030.
Bill: Is that the guys from Worm?
Tobias: I wasn’t going to name them, but yeah, that’s one.
Bill: They put it out. You can name them.
Tobias: I didn’t get all the way through it, because the PE– [crosstalk]
Bill: They are quite good. I liked them as analysts. It’s not rude.
Tobias: I couldn’t get to the part, where I couldn’t find the substance of it. I went through the first dozen pages or so and I couldn’t find what– I just saw the claims. I didn’t see the supporting information.
Bill: Look, the Gigafactory all that stuff, it’s super interesting. It may work and if it does, that’d be sweet. I think I said to you guys when Ho Nam, he said, “If the US looks like Silicon Valley, Tesla’s going to have a huge market share.” The only thing that I would say back to that is, if the US looks like where I live F150s, their electric one are going to dominate. So, I don’t know.
Maybe the West Coast, East Coast arbitrage thing is real and maybe it does it again. I don’t understand why Mercedes, the EQS doesn’t just look like an S class. It baffles me why they made the front look like it does. Maybe someday they’ll figure it out, maybe they won’t. But yeah, I don’t know. It’s possible. I don’t even know how to assess the odds of anything. So, who am I?
Jake: [laughs] This isn’t tough.
Tobias: Well, I think you don’t have to necessarily assess the odds of it happening. You just have to find a place, where you’re getting a bet that predicts that it won’t happen and then you just have to take the bet the other side. You just trying to find a way to shape the bet, so you’re getting some free optionality in a bet. I don’t think that Tesla’s got thousand bucks as free optionality. I think you’re almost assuming that it happens at that point.
Bill: Well, I think they would argue that part of why it can go a lot higher, just because there’s people like us that don’t think you can.
Jake: That’s fair.
Bill: It’s the overhang. I don’t know.
Tobias: The valuation works if you can get 50% growth a year to 2030. I fully acknowledge that. If Tesla can do 50% a year until 2030, then it’s undervalued here. It’s 50% undervalued.
Bill: Yeah, they can maybe do it. What kind of multiple do you put at the end of it?
Tobias: I was just assuming terminal of normal 5% for 10 years. I just put in a normal terminal.
Bill: Yeah, but 20 times, we’re going to argue on a car manufacturer. Although, I guess, it’s a car manufacturer that has a monopoly– [crosstalk]
Stellantis NV $STLA Cheap
Tobias: You can get Stellantis that’s about two turns at the moment.
Bill: Yeah. I don’t know. I have no idea.
Tobias: Stellantis was the cheapest thing in my screen like five years ago, something like that. I bought some leaps– [crosstalk]
Jake: Yeah. How that worked out?
Tobias: They did work out okay, actually.
Tobias: It’s back now. The leaps have expired. So, maybe one more time around.
Jake: Is it cheaper to buy it in XOR? Also, I think there might be the case.
Tobias: Cheaper to buy it in–
Tobias: Oh, I see. Yeah, possibly.
Bill: Then you can get their capital allocation without paying some tax on it, too. That’s the nice thing about hold codes, even though, they traded discounts.
Tobias: Yeah. Did they always trade discounts?
Bill: I think they should. Ah, come on.
Bill: I’m sorry. I’m looking after the dog and the dog is not cooperating at the moment.
Jake: He looks like he’s being a good boy when I saw him.
Jake: Oh, she. Sorry.
Bill: She’s getting huge and she hasn’t stopped chewing.
Tobias: Getting lots of calls to feature the face. Well, there she is.[laughter]
Tobias: Research statistic.
Jake: She’s behind the curtain right now. [laughs]
Tobias: Where are you on the index funds, Bill? We need an update?
Bill: Well, I have no circle of competence. So, indexing would be a smart idea. Honestly, part of the reason that I don’t is just like get some embedded tax consequences to switching, which I know is not a great reason to not do something, but it’s also not that fun to– I was talking about that Microsoft position. Just paying 15% to get out of it on a company that I think I like, but clearly, don’t understand.
Jake: Harder to get your mind around it. Yeah.
Tobias: Incrementally over time. So, it’s not all or nothing.
Jake: That’s true.
Bill: Yeah, the other side of that, too, is I know, tax rates only go down. But one day they may go up. So, 15% is not the craziest tax rate to have to pay.
Jake: Yeah, that’s a good question. At the capital gains level and at the corporate level, the ability of corporate America to keep a bigger chunk of the pie creation than probably almost any time in history for in the US. Does that stay this direction or does that revert to some mean when you’re running trillion-dollar deficits? Just print it, who cares?
Bill: Well, here is the thing, though. I wish I had longer data. I’ll look this up. But so much of taxes is payroll and withholding tax receipts that is. Maybe there is an argument. I don’t know. Maybe that argument of lower corporate taxes isn’t the craziest thing in the world. But certainly, lower than they’ve been in a long time. Let’s put it that way.
Jake: We got time for some questions, TC?
Bill: Anything to add, Toby?
Tobias: Hit us some questions. No, I don’t know. Gee. I live in California, sir.
Jake: You’re just used to taking it right in the shorts.
Tobias: Yesterday was Tax Day. So, I’m is still recovering from that.
Jake: Yeah. You in the shower just crying?
Tobias: Oh, quarterly.
Jake: By the way, Berkshire update. We should probably throw that out there, huh?
Tobias: Oh, yeah. What are we doing? We’re going to be there. Maybe watching around.
Jake: We’re going to be there. I think probably, tell me if you guys think this is right, but probably, Saturday afternoon after the meeting, find somewhere to post up, and then tweet it out, and have people come hang out. Does that sound good?
Tobias: Yeah, that’s probably what we’ll do.
Bill: Saturday, when?
Jake: Just after the meeting.
Tobias: After the meeting.
Jake: I don’t know. Whatever. Three or four– or something.
Tobias: In the afternoon.
Bill: Yeah, I don’t know. Follow the Twitter machine. The Twitter machine will tell you.
Tobias: I thought across the road at the– The walk bridge across, there’s a bar at the bottom that walk bridge. That was that was pretty fun last time.
Jake: The Hilton?
Tobias: The Hilton.
Bill: Yeah, that is fun.
Tobias: When I was there, but I don’t know what time it was.
Bill: it is packed. Well, we were there in the middle of the second half of the meeting.
Tobias: It’s pretty quiet while I was there.
Bill: Yeah. I like hanging out there. I don’t go to the meeting, either. So, that helps.
Jake: [laughs] Well, I will be at the meeting, because it’s my– [crosstalk]
Bill: I will not.
Tobias: [crosstalk] the first half of the meeting.
Tobias: Probably, won’t get back after lunch.
Bill: I’ll go for the video, and then I will look at everyone that woke up at 4:30, and I will say, “I hope that this was worth your day sitting here,” and then I– [crosstalk]
Jake: They you go take a nap– [crosstalk]
Bill: No, I don’t take a nap. Sometimes, I watch it, but I just don’t– Actually, I do have a spot that I go to there. So, I may be there for some of it, but then I ended up leaving. I will not disclose that spot.
Bill: Not– [crosstalk] hell.
Tobias: If you’re truly interested in what they’re saying, the best way to watch it is the Yahoo feed from the comfort of your own home. But if you have– [crosstalk]
Bill: Yeah, then you actually can hear something.
Tobias: You got to be out and about.
Bill: Plus, if somebody asked some silly question, I don’t have to sit there and listen to it. Well, Warren and Charlie think, “Great, this kind of question, again.”
Jake: I don’t know, man.
Tobias: I just liked the way they– They’re usually pretty polite about the way they re-answer to the question.
Jake: I want that full sensory experience of being there. I want to soak it all in.
Bill: You want to smell Warren and Charlie?
Jake: I want it all. I want as much sensory information as I can pour it in.
Bill: Weird, but okay. I respect that.
Time To Buy Domino’s Pizza $DPZ
Tobias: I bought some Domino’s Pizza in the stock.
Jake: Is it tasty?
Tobias: Not the– [crosstalk] I buy the pizza all the time.
Tobias: I like it as a position just so, everybody knows I’m wrong. It’s surprisingly the small– [crosstalk]
Jake: How did that get into the screen?
Bill: This is the question that I was going to ask. You should explain that, I think.
Bill: Well, how it got into the screen.
Tobias: I have adjusted some of the things in there for what they earn and that’s one of the ones that pops up, because consistent over on its assets.
Bill: So, ROA helps it out.
Tobias: Yeah, return on assets, but yeah. Basically, same thing. It’s just been incredibly consistent. If you’re trying to feed a family of five, which I am, it’s the cheapest thing out there. Even though, I think it’s probably getting beaten up, because it got too expensive and I think it’s also getting beaten up, because grain weight has grown up, and that’s a big input for it.
Jake: They already had huge margins though, didn’t they? Are they– [crosstalk]
Bill: [unintelligible [00:53:25].
Tobias: It’s also the stock. It’s just the stock.
Bill: Yeah, I think it’s getting beaten up because people think, “Well, what’s the– [crosstalk]
Tobias: Pandemic’s over.
Bill: No, it’s the front year free cashflow yield.
Tobias: I don’t know. It’s top of my head.
Bill: Yeah, I bet its rates go up. I don’t know. I bet it has some inverse rate. Everything does.
Tobias: I don’t think it’s going anywhere anyway. I don’t think it’s disappearing anytime soon.
Bill: Hell no. It’s not. Domino’s is dope.
Tobias: I’m often shocked at the scale of these businesses. It’s $1.6 billion in assets and a $14 billion market cap last summer look like. It’s basically neighborhood Cafe these days.
Bill: Yeah, well, $522 million of free cashflow according to the machine.
Tobias: And they buyback a lot of stock. That’s the other thing I like about it.
Jake: Ah, that’s probably what triggered it.
Tobias: That’s always my– [crosstalk] Yeah.
Jake: That gets Toby, [crosstalk]
Tobias: That does get me excited. Same reason I bought HBQ, which the big filler rolled into recently.
Jake: It’s right.
Tobias: It’s actually been performing okay. It’s been consistently cheap the entire time I’ve held it, but it’s done okay which that’s unusual in my portfolio.
Jake: Yeah, that’s great. If it can stay cheap for a buyback and do okay for you, that’s not a bad place to live.
Tobias: Yeah. That’s the Tootsie Roll versus IBM.
Jake: You can make– [crosstalk]
Tobias: Remember that Motley Fool ad that used to run?
Tobias: They had the maker of Tootsie Roll versus IBM for some extended period of time. Tootsie Rolls consistent repurchases of stock has been very good at it.
Jake: They’re saying that, with Tootsie Roll was better than IBM then?
Tobias: It outperformed. Yeah. Because even IBM grew really quickly. Tootsie Roll bought back really cheaply the whole way through. Motley Fool ran that ad for years, and years, and years. They probably retired 10 years ago, but it’s fresh in my mind. I love those buybacks.
Jake: At the right price.
Tobias: Yeah, at the right– I like material buybacks, because I think it tells you that it’s undervalued, it tells you that management’s doing the right thing. Buybacks to support option issuance less interested in.
Jake: Yeah, that’s not as cool.
Bill: I like the idea of variable dividends.
Tobias: What’s that?
Jake: It’s actually thinking for yourself before deciding how much money to pay out?
Jake: As a manager.
Jake: Special [crosstalk] something like that.
Bill: I know that the argument for buybacks is, if you don’t like the price that they’re buying back, you can just sell back proportionately and create your own synthetic dividend. I guess that that makes some sense to me. But maybe that’s the answer. Maybe I should shut up.
Tobias: Well, you get long-term capital gains, too, on your little dividend sales versus being taxed at your marginal rate for the dividend.
Tobias: And you can time it for whenever you want. You don’t want it in one year, you don’t have to take it. You want it in another year, you can take it.
Bill: Yeah, it’s certainly accepted as superior.
Tobias: You just mean in terms of like the comments treated like a preference, and they have to hit that dividend sum, and then they have to ratchet at 5%, and they keep on doing that. So, they become dividend champions or whatever they call them.
Bill: Yeah, and I think some dividend people would say, “Well, that’s a good thing, because it focuses companies on allocation of capital.” But I don’t know. Sometimes, I just want the cash back. I’m kind of old school in that way. But I guess, then I could sell.
Tobias: I’ll say that for Tesla. They found a way to reinvest at a very high rate for an extended period of time and that’s a big, big business relative to a lot of other things around. So, he’s doing a good job there. You just paying a lot for it.
Bill: Yeah. Well, there’s only one Elon.
Jake: Dog’s chewing on the curtain back there.
Bill: I’m aware. She’s going to destroy it. It’s paper anyway.
Jake: Oh, [laughs]
Tobias: I think we’ve done it, dudes. We’ve made it.
Jake: We’ve made it. All right, well, I guess, we’ll see everybody in Omaha then, huh?
Tobias: Yeah. So, next week, I think we’re going to take a break for a week and then–
Jake: Travel break?
Tobias: Yeah. Get some travel and we’ll be back the week after that. I think we’ll be doing– Is it Omaha, the week after that?
Bill: It’s, what, May 2nd?
Jake: Omaha is– [crosstalk]
Tobias: We’re doing our book report on Omaha?
Jake: Yeah, it’ll be a Berkshire extravaganza.
Tobias: All right. Sounds good.
Bill: Yeah. All right.
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