VALUE: After Hours (S04 E027): Small Value is Quality, Energy in Food, Financials and the Consumer

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In their latest episode of the VALUE: After Hours Podcast, Tim Travis, Jake Taylor, and Tobias Carlisle discuss:

  • The Trillion Dollar Question For All Investors
  • Signs We’re In A Recession
  • Inflation Is Class Warfare
  • Insane Amount Of Energy Required To Put Food On A Plate
  • Small Value Is Quality
  • Markets Have An Imperfect Discounting Mechanism
  • 1/3 Of The World’s Food Supply Ends Up As Waste
  • Commodities Plunging
  • The Causal Linkage Between Energy Prices And Food Costs
  • Is The Worst Over For Bond Performance?
  • The Future Of Buy Now/Pay Later
  • This Market Similar To The Tech Bubble
  • Subprime Auto Loan ‘Crisis’ Is Just Hype
  • 10 Year-3 Month Treasury Yield Collapsing
  • When Parties To Collusions Cheat
  • The Impact Of Europe’s Crazy Natural Gas Prices

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: All right, preparing to livestream. Its Value: After Hours. I’m Tobias Carlisle. I’m joined as always by Jake Taylor, but we’ve got a new face, Tim Travis. How are you, Tim? Where are you? What’s happening?

Tim: I’m good. I’m in Orange County, Coto de Caza is the area. So, a beautiful day and exciting day in the market. So, thanks for having me. guys. I appreciate it.

Tobias: Pleasure. You run a value firm and you got to focus on financials and options. Is that fair?

Tim: We don’t focus specifically on financials, but we do have a lot of them because they’re tilted towards value, especially of late. But yeah, we typically carry 15 to 20 positions and then we concentrate obviously, on the top ideas and then we’ll intertwine option strategies like covered calls and cash secured puts. No speculative buying of options or anything like that. But to enhance the income and reduce risk. So, especially with where interest rates were and where bonds were yielding going into this year, that strategy helped create yield and a little bit of protection from the way that the market’s fallen.

Tobias: What to do with the option speculation over the last few years do for you? Was it good or was it bad?

Tim: It was pretty good in general. Because I think it perked up pricing with volatility on call options, especially. We were able to sell calls and get a little bit more premium than historically. But there were some bad ones, too. We were long discovery before they had the merger and that was one of those that got caught up in the Archegos. And so, the stock was trading at 25 or something like that.

I think we had covered calls at maybe 35. I don’t know if you guys remember it, but I believe that stock went to $105 or something insane. And so, it’s tough, because you’re in a covered call and you’re up, you’re making money, but you can’t really exit it unless you want to be basically short the stock, if you keep your option. So, I had never had an experience like that. You’ll get exercised from time to time, but that was an extreme example.

Tobias: You’re still ahead in that scenario.

Tim: Yeah.

Tobias: You’re just hedged out and you just don’t participate.

Tim: Exactly. You still make money, but you just don’t get the bananas money that I was making until it blew up.

Jake: [laughs]

Tim: Yeah.

Tobias: What’s happening, JT? You’re back from your trips?

Jake: Back from my trips, back home, happy to be home. Yeah, it was good. Went to Denver or Vail, and then to Michigan to visit some family and live that lake life for a little while-

Tobias: [laughs]

Jake: -and then back to reality here. Back to the grind.

Gluts Always Follow Shortages

Tobias: What’s your take on what the markets are doing at the moment? That’s the question, mate. Go on.

Jake: Yeah. [laughs] Seems like down seems to be the answer right now. I don’t know. I think we’re seeing a little bit of things that we’ve talked about on the show before. But the reflexivity of the economy starting to catch up a little bit with what the market might have been sniffing out for the last six months. Walmart just had a big surprising print with, was it, Tim, you’re saying that the revenue was–? [crosstalk]

Tim: Yeah, revenue was up.

Jake: That’s okay.

Tim: Revenue was up. I think it was actually exceeding guidance, but operating margins were way down. So, the mix is terrible.

Jake: Inventories exploding-

Tim: Exactly.

Jake: -which a year ago would have sounded insane, if you had said that. I think a year from now, inventories, there’s going to be a glut, right? No one would have believed you.

Tobias: Isn’t Taleb says, “Gluts follow shortages? Gluts always follow shortages, shortages never follow gluts.”

Tim: Unless maybe you’re in oil or natural gas in the current environment. That’s what’s interesting is. Historically, that’s what would have happened is, they’d be drilling wherever they could. But it’s just not really happening yet. So, we’ll see if that develops again.

Tobias: Is it a regulatory issue, they’re not drilling or is it just no big [crosstalk]?

Tim: That’s a big part of it. I think that they’ve learned a little bit of a lesson. They don’t want to sabotage. They’re making so much money. They haven’t made money like this in a really long time. They’re not really that incentivized and they know at some point the war will end and those prices could drop it. We’ve seen it in 2008, energy prices were holding up really well and then it just collapsed and we’ve seen it a few times a last decade.

Tobias: Is that an economy wide thing is—Energy’s in the input. So, the energy, a slight drop off in demand means that prices collapse? Is that what drivers had an early tell?

Energy Prices Can Drop Fast

Tim: I think it’s almost the late tell to some extent. If you remember, 2008, so much of the market was going down, but Energy held up for a lot longer. I believe it wasn’t until really later in that year when Lehman– and I’m not looking at a chart or anything. But from what I recall, before Energy prices really, really, really started capitulating fast. I forget what the year was, 2015, maybe. Yeah, I remember it was the day after Thanksgiving when OPEC said that they were going to increase the amount that they were drilling and a lot of those stocks were down 30% and it just kept going down, down, down. So, it can happen fast once a change occurs.

When Parties To Collusions Cheat

Jake: Well, there’s a bit of a game theory with any cartel, where the reward to cheating is so strong that eventually one of them will defect. That’s true of every single– Anytime that there’s a shortage and people are trying to collude to keep the prices up. Eventually, someone will cheat on that and you’ll end up with– Then that drives the behavior downward. Now, everyone’s standing on their tippy toes, the parade, right?

Tobias: OPEC was the organization that I was taught as the example of that phenomenon in– [crosstalk]

Tim: Exactly. I was just thinking the exact same thing. I remember it was– they termed it as a paper tiger. I don’t know. They don’t seem too much like a paper tiger at this point. [laughs]

Tobias: Someone always defects.

Tim: Yeah.

Jake: Someone always defects, but surprising–

The Impact Of Europe’s Crazy Natural Gas Prices

Jake: I don’t know if you guys have seen natural gas prices, especially in Europe lately.

Tim: Oh, it’s crazy.

Jake: Oh, my God. I remember in early mid-2000s, I was working a lot more in natural gas area and it was like $2 or $3 an MMBtu. And now, over there, it’s $50.

Tobias: Wow. Energy is a luxury good.

Jake: Oh, my God. It’s quite remarkable.

Tim: What they’re talking about, honestly, doesn’t get enough attention. They’re talking about basically shelving industries during the peak winter months, so just allocating to the hospitals and to consumers and shelving whole industries. And of course, in Germany, that’s the lifeblood of the economy. So, I’d expect there to be a lot more pressure to end the war between now and then because that’d be a huge blow to Europe.

Jake: Well, we’ll get into this during the veggie segment when we’re talking about food, but natural gas is a really important feedstock input into our food production. So, we’ll unpack that in a little bit.

10 Year-3 Month Treasury Yield Collapsing

Tobias: I’ve been keeping an eye on the Cam Harvey 10-year three months. That’s collapsing. The 10-2, 10-year, two-year is the one that everybody quotes all the time. I don’t really know why this is because the Cam Harvey wanted to 10-3. But 10-2 and negative. Everybody knows that. It’s been negative twice. [laughs] It predicted the COVID crash and then it’s gone negative again.

Jake: It’s a virologist?


Tobias: It’s amazing. And then, so, 10-3 seems that– I don’t know. Anyway, 10-3 is collapsing and I think it’ll go negative in the next week, probably. From the trajectory, it could be tomorrow from the way that it’s falling.

Tim: Yeah.

Jake: If we change the definition of recession, do you really have a recession?

Signs We’re In A Recession

Tobias: That’s important. I thought about that a little bit. Do you think that they have a point in the sense that we have had two years of funny comps high and now, we’re going to have two years of just getting–? When Shopify announced all of its layoffs, that chart that they shared which showed, it’s got a dotted line of internet adoption and that’s got these two years where it spikes vertical, and then it captures– It looks like it’s trending back to that dotted line. Do you think that that’s true of what’s happened economy wide that we got this run up? And then, now, we’re just drifting back to the longer-term trend. And so, that’s going to count as two quarters of negative growth in which case that’s the technical definition of a recession rather, but they’ve got an argument that it’s not legitimate. What do you think?

Tim: I think the real argument was the last two years sugar high legitimate.

Tobias: Yeah.

Tim: Because on a real basis and this leads into my topic a little bit. On a real basis, it’s not even close. It is a recession for sure. Because wages, even though they are increasing and we have full employment, the inflation is far exceeding that. You’re seeing it. When we get into the breakdown of some of the earnings reports, which I’ll get into. I’ll show you exactly where that is. But I think by all means we’re in a recession whether or not they want to classify it as one. I also think that the growth we saw the last year and a half was really a sugar high, obviously, bolstered by stimulus. I wouldn’t view that as legitimate growth.

Tobias: How do you feel, JT? Is it recession or is it just funny comps?

Jake: These are such complex systems that to try to draw them down into– [crosstalk]

Tobias: This is a podcast, sir. This is exactly what we do.

Jake: To distill it down into something so simple from something so complex, I feel like is a bit of a fool’s errand.

Tobias: But after that– [crosstalk]

Shopify Lays Off 10% Of Its Workforce

Jake: Having said that– [laughs] Well, let me back it up a little bit. I think and maybe this is a good to draw on Shopify or Reese this morning announced that they’re going to lay off 10% of their workforce. One way of looking at that—Toby Lutke showed a graph that showed the penetration of ecommerce and you have this nice little trendline going, and then all of a sudden, it jets upward during the pandemic, and then it drifts back down towards the trendline, which probably, we should expect more often in the world.

But something to think of there is that, Toby as an entrepreneur got inputs from his environment that he needed to expand more because of this big ramp up. And so, it was a misallocation of capital. I think he would admit now that he hired on so many people and now, they have to fix that by right sizing the company. And so, you can imagine that that happens not only in Shopify, but all over the place where there was a misallocation of capital from the wrong signals being sent to all the entrepreneurs as to what do people want, what are the demand for goods and services.

The more money you print and pump into a system, the greater the chance, I think you have it a misallocation of capital. We have to reap those seeds that we sowed for, I don’t know, for a while. To imagine that you can do that much intervention and not have to pay the piper at some point in a reasonable amount. I think it’s probably wishful thinking.

Tobias: I thought that was a very good letter, just a little bit of a side trick, but I thought that was a very good letter. He admits exactly that mistake. He said, “They had to make a bet and they bet that it would bring forward that adoption by or that penetration by five or 10 years.” It looks like that bet was wrong. And so, they’re letting 10% of the workforce go. But I thought it was about the most humane one of those letters that I’ve ever seen. I thought he did a pretty good job there. I got a lot of respect for Toby and I liked Shopify a lot. I don’t know what the right price is for Shopify, but it’s something that I would like to own. I just don’t want to be the one who has to pick the right trust and buy it at.

Tim: Yeah, it’s got a lot of bulls, especially with the sell off for sure. I was looking at it today just to see. Yeah, it’s a tough pill for guys like you and I to swallow, but I could do really well. Who knows? I think, Jake, touching on your point.

This Market Similar To The Tech Bubble

I think there’s a lot of similarities to the tech bubble. You saw it with valuations. It wasn’t as extreme. But a lot of that investment that occurred back then, even though the stocks went down 90%, that accelerated investment ended up laying out the infrastructure for what we have today in a lot of ways.

I think you’ll see similar stuff coming out of this and you know who ultimately paid the price? Shopify shareholders that bought at high levels and that funded a lot of stock-based compensation. They’re the bag holders in that scenario. The company, I look, they still have a lot of cash on the balance sheet, they’ll easily make it. But yeah, it shows you got to be careful what price you pay for something.

Tobias: I saw that phenomenon a little bit. Before I was an investor, I was working at telecommunications fiber optic company that came up out of the Wasteland that fiber optic turned into after all that money was spent. They were measured on how much they put in the ground. They’re incentivized just to get as much capital as they possibly could and turn that into cable in the ground and then the demand just wasn’t there. And so, the company that I worked for had a reason after all of that and they had built and their metric was, can we build each link profitably? So, they do a lot better doing that. I sometimes wonder how much of that is investment for the future? How much of it is just completely wasted?

Tim: Yeah. For smarter people than me, I don’t know.

Small Value Is Quality

Tobias: Yeah. I don’t know the answer, either. My topic was that the Jeff Weiner whose Wisdom Tree has a great Twitter account, had a great tweet about the amount of return on equity in the value portfolios versus the return on equity for the growth portfolios and he said, “As far back as Wisdom Tree data goes, which is pre-2000, anyway.” But you’re looking at this 2000 types.

One of the things that Jake and I’ve talked about before on this podcast is, in early 2000, the return on equity of the value portfolios was better than the return on equity of the growth portfolios, which seems to suggest that the value portfolio should have been trading at a premium to the growth portfolios. But they obviously weren’t. They were trading at a discount. That was some of the conditions that created the run for value in the early 2000s.

And now, we’re looking at similar things. Just universe is the Russell 2000. He says, “Russell 2000 value now has a higher return on equity than Russell 2000 growth.” What’s the reason for that? Is it just energy and financials having a good run?

Tim: I would assume so. If you look at 2000. A lot of the stuff that was really good for value were like homebuilders, insurance companies. That’s when Berkshire had a huge run, and Fairfax had a huge run, Markel. I think that you do have a lot of smaller financials in that index that are still profitable, unlike a lot of the companies probably losing money. Then, of course, energy miners, the ones that are posting huge ROEs with the boom in commodities would be my guess.

The Trillion Dollar Question For All Investors

Jake: I think the trillion-dollar question for all investors at this point is, how sustainable are these returns on capital for the more cyclical businesses? Is the market fading them too hard or not hard enough? If you knew the answer to that, you would be a very wealthy man in five years, I think.

Tobias: That really is the trillion-dollar question is that what happened in the early 2000s, too? People just didn’t believe that oil, and gas, and minerals commodities were worth investing in. So, it took a long time. Then three, or four, or five years into it, people forgotten all of the fear of commodities of the cyclical to know that absolutely piling into them right at the very top of the cycle.

Tim: That’s exactly what happened. My first job out of college, I wasn’t there long, but it was Vanguard. But that was 2004. I remember seeing the flows going into energy and it was huge. But you’ve got to remember. Energy was a total dog in the 90s. The returns that they were posting were huge and I felt like, “Oh, man, people are chasing performance.” But this was 2004, 2005.

Jake: Yeah, few more years.

Tim: A few more years. Yeah, I think that’s an interesting phenomenon that does occur for sure. I think that is what happened.

Tobias: If you’re fundamentally driven that’s always what happens. You’re always two years too early and then you feel like an idiot for first, what, for the entire two years, I guess.

Tim: For value [crosstalk] you feel like an idiot for a decade.


Tobias: Yeah.

Markets Have An Imperfect Discounting Mechanism

Jake: I think a similar thing happened in 2000s with retail, where there was some pretty reasonable big box retail companies that were earning pretty good money during that time period. But everyone had this narrative that the Amazons of the world were coming and we’re going to eat their lunch. They were probably right, but it just took much, much longer for it to play out. Those companies can earn for a long time. And so, the market getting ahead of itself in discounting that allowed there to be a lot of meat left for the person buying when everyone thought, “Well, this is a dead end.”

Tobias: Solo Prosperity says, “I track a Profitable Universe and it excludes Financials/Energy and even in 2000, Cheap had higher quality than Expensive. So, it doesn’t think it was a sector thing.” Solo had a look at this for me when I posted this last week.

Jake: Oh, good.

Tim: Yeah. We’d have to look at the components, I think. It’s always like what’s the definition of value for someone? What’s the definition of growth? At particular times, it just depends on how that’s being defined.

S&P500 Is Now 85% Of The Index

Tobias: Yeah, those big indexes aren’t much help. I think I saw the S&P 500 value is now 85% of the index that doesn’t leave a lot outside the index.

Tim: Wow.

Tobias: I don’t know what’s in it. I think that– [crosstalk]

Jake: Say what? Run that by me, again.

Tobias: 85% by number, maybe. Maybe by valuation, maybe they split it by value, by market cap.

Jake: So, they’re saying the S&P 500 value just only excludes the highest 15% of most– [crosstalk]

Tobias: I guess so. Yeah, that’s the other half.

Jake: Okay. No comprendo. [laughs]

Tobias: Well, I guess, if you’re doing it by count, you’re always going to have value as being a very, very small component of the index, where there’s not much market capitalization in value. So, you have to split it by market cap. In order to achieve that, you’re going to get a count that’s like 85% in value, 15% in growth.

Jake: Fair enough.

Tobias: I don’t know how they define it anymore. Those definitions don’t make much sense to me.

Tim: Yeah.

Jake: Yeah.

Tim: I don’t spend a lot of time thinking about them like that myself. I’m more focused more on the micro aspect of it.

Tobias: The funny thing is, though, it does drive on a day-to-day basis. It drives the portfolio, I think. You can look at the movement of which is a Michael Green argument. But the big index do seem to have an outsized influence on the components.

Tim: Totally. The Russell is actually I think, very much highly correlated with value. For the last couple years, I would say, there’s a pretty good correlation. It definitely worked against us in 2020, when value really underperformed a lot by growth. But yeah, we see it this year, too. The days when value really has a good day, the Russell’s usually up quite a bit.

Jake: Toby, how was your anti-Ark correlation? Is that still holding strong?

Tobias: Well, it’s less now that I’m not short.

Jake: Oh, okay. Yeah.

Tobias: But I was basically short Ark for a long time there. That didn’t work and then it did work.

Jake: [laughs]

Tobias: And then I stopped.

Jake: Okay.

Tobias: Tim, do you want to take a chop at your topic?

Is The Worst Over For Bond Performance?

Tim: Yeah. Sure. We’re about two weeks into earnings. And so, a lot of the financials have reported. I thought it’d be interesting to get a view on credit and the consumer. And so, starting with the good news, the quote from Jamie Dimon, basically paraphrasing him, but almost precisely what he said. He said, “Commercial credit has never been better in our lifetimes.” And so, I think that’s interesting. I think a lot of the companies that I follow closely, they turned out their debt, they took advantage of low interest rates, they have relatively conservative leverage ratios. And so, higher rates aren’t a huge deal for them at this point in time. We had low rates for so long that there really was the opportunity to do that and at pretty good duration, too. I thought that was interesting.

And then another aspect of that is, when you look at the triple-C bonds, the highest of the high yields, the last few years, even last decade, a lot of them are Energy and there still are some in Energy. But if you think about it, those companies are making more money than they have in quite some time. I think that’s another reason why that’s less of an issue this year and that’s hugely positive for the banks, especially the big banks, the Citi groups in the world, the JPMorgan’s. Commercial credit is not going to be a huge deal in this recession in my opinion. When you look at– [crosstalk]

Jake: Tim, can we do a quick detour on that with–?

Tim: Yeah, of course.

Jake: I’m just thinking like the total pie of economic value created and who gets to win and lose in this is going to be somewhat divided by equity and debt. If management executes good cap allocation on the debt front, let’s say, they get long terms cheap debt, it feels like that would be positive accrual for equity holders. But therefore, we have to lighten the scale somewhere else. If you’re the debt holders, does that mean that that was Pozo debt to be selling and underwriting?

Tim: Well, it’s a good point. I saw today, I think Bloomberg had the article or a note, the Journal did. But the amount of negative yielding debt is down 87% from the highs. I think it’s at $2 trillion now. I think it was $20 trillion or something like that going into the year.

Jake: How about real?

Tim: Yeah, exactly. Exactly. If you’re buying a bond, as long as that bond is not defaulting, they’re losing money. That’s why the 60:40 portfolios are doing terribly. I always thought it was crazy when people do Monte Carlo simulations. It’s always like the bonds outperform when the equities are doing bad and you get a positive trend there. It’s like not always. Not when you’re starting at zero interest rates going way higher. So, I think that’s a good point. But I don’t think it would be too severe. I think in my opinion, we’ve probably seen the worst for bond performance.

Jake: Okay.

Inflation Is Class Warfare

Tobias: Can we ask you a slightly different question just before we keep going? If commercial credit is not going to be an issue going into a recession, then what do you think will be the issue in this–? Can we have a recession without commercial credit being impacted?

Tim: I think it’s going to be interesting. I think you’re going to have a bifurcated consumer and I think we’re already seeing that. On a real basis, they’re going to be impacted by the inflation and their wages not growing as fast as inflation in a way more serious way. I think you saw that with Walmart. People are spending more money. If you look at credit card spending, it’s all high double digits for all of the banks like, 20%– 18% year over year and quarter over quarter.

Jake: Yikes.

Tim: But there’s a mix, where it’s like, “Okay, if I can only afford gas and food, I’m going to cut back on clothes expenditures that I don’t necessarily need.” And so, I think that that’s really what you’re seeing. It’s unfortunate, of course. But very, very much a bifurcated economy for Ally Financial, which is a company we follow closely and have positions in. Credit is still way better than it was pre-pandemic. Even though, charge offs are up a bit and delinquencies are up a bit from last year when you had all the stimulus, it’s still far superior to 2019. People still have more money in their savings accounts.

But where they are seeing more rapid degradation is on the lower end, which seems pretty rational. They’re mostly prime auto, but the subprime securitizations, they’re seeing degradation as well. So, definitely like the millennials, the Generation Z, they might have been off a little that they can chew in some of these really expensive automobile payments. I think that’s a trend you’ll see continue.

Jake: This is why Rudy would say that, “Inflation is class warfare.”

Tim: 100%, it is. It absolutely is. Yeah. When you look at credit, for instance, like JPMorgan, they still predict that consumer credit charge offs are going to be less than 2%. So, that’s still a really low number. And now, they’re able to tighten up on underwriting and things like that. I just don’t think this is going to be a credit led recession. I think there’re similarities to 2000. In that there you had the NASDAQ down 80%, you had the other indices down quite a bit. But the actual recession wasn’t that steep. And so, knock on wood, hopefully, we see a situation like that. That would probably be a positive scenario if that were to occur.

Jake: Need to get that up. We got to get another bubble going to pull us out of this. Housing bubble took help for it.

Tobias: We’re in the everything bubble. So, what’s left?

Jake: Oh, shit. What’s left on the table? [laughs]

Commodities Plunging

Tim: Well, commodities are plunging. Commodities outside of the energy space have come down a lot. You think if it weren’t for the war, I think you’d see probably the Energy prices going down, too. And so, you’d probably see the Fed loosening up a bit on terms after this meeting. I think that could be a catalyst where that really reduces the inflationary pressures, if there is a resolution. It doesn’t look like there’s going to be soon. But I think that that would be one of the bullish things that could occur.

Jake: Hmm.

Tobias: We’re now say, seven, eight months into the drawdown and we’ve got to resolve it one way or the other. We either just turn around here on a dime and we go back to all-time highs or we get a big flush before that happens. What’s the trigger for big flush or a recovery?

Jake: Do we have to have that or can we go middle ground where you just muddle for a few years?

Tobias: They usually end in some sort of selling crescendo, don’t they? Has anything sort of petered out?

Tim: Well, I think the big– [crosstalk]

Tobias: [crosstalk] Japan maybe.

Tim: No, that would be a bad situation for sure. Yes, sovereign debt is the nightmare. Because the debt levels are so high. I remember when that emerged in 2011 and then Draghi said, “We’ll do whatever is necessary.” [crosstalk]

Tobias: Whatever it takes. That’s a 10-year anniversary of “Whatever it takes.”

Jake: Exactly. Yeah.

Jake: Is it double down on that?

Tim: 11-year.

Tobias: It’s 11. Okay.

Tim: Yeah. It could be something like that. But the other side, I guess, if I was going to put my optimist’s hat on, you could almost say that that occurred with crypto. If we’re comparing this to 2000, a tech driven bubble, I know it’s the everything bubble, but let’s just talk about that. You’ve seen multiple huge made off crypto collapses. And so, now, you’ve got some consolidation occurring in that industry. When you look on a micro basis, stocks like Netflix, Coinbase, even profitable companies like Facebook, Google, they’re down pretty substantially. Google, Apple, Microsoft, they’re all down 20%, I believe, at least a little bit over that. So, they’ve taken a hit.

When you look at stuff like the banks, for instance, a lot of these are trading at five- or six-times earnings and you’re like, “Okay, well, we’re going into a recession.” But you have way higher net interest margins. They’re growing their biggest revenue line item by 15% or 20%. And then they have CECL accounting, which basically, you have to reserve for total losses on the life of the loans. So, that kind of upfronts a lot of those credit losses, you’re going to see and you’re still going to see changes in. Of course, it’s volatile. But they’re still being conservative on their loan loss reserves, stemming from the pandemic and the lockdowns. And so, they’re still going to be really profitable. You’re not going to see the major, major multibillion dollar losses in the financial crisis. I still think that there’s a little PTSD from that for people. And that’s why they always sell off every time there’s [crosstalk] smoke.

Consumer Sentiment At All Time Low

Tobias: Sure. But then, does that make it more like the early 2000s, where there was really no credit crisis. it was more overvaluation collapsing back down to more normal valuation. One of the things that I think it argues for being closer to the bottom than not and I’m pretty bearish, but this is one of the things that we’re looking at. I can’t really square it with anything else to look at is the sentiment across everything is just so bad. Every sentiment indicator, whether it’s the consumer, whether it’s the AAII, the American Association of Independent Investors, all of those things, all those sentiment indicators are lower than they’ve been at any other point in time, lower than the 2007 credit crisis, lower than any March 2020. People are very, very upset.

Tim: Oh, without a doubt. Without a doubt. There’re people that are reading those newsletters where, “Okay, the market is going to take a 50% hit” and reacting to that there is a lot of pessimism which you normally see in bear markets like this. I feel most people think we’re not close to the lows. I agree with you. I think that that would be something that gives a little bit of optimism for me, at least, unless you see.

We went to Las Vegas, we’ve been to Disneyland, we went to the fair, people are spending money. Everything is as crowded as I’ve ever seen and that’s filtering in in the data. Credit card’s spendings way up. Even at Walmart, people are spending money, people have jobs.

You’re not going to default on your loans. You’re going to pay as much as you can, while you have a job. The tech companies are laying people off. Those are usually high net worth type people that have easily transferable skills. It still sucks. But most, I don’t want to say real economy. That’s diluted at this point. But many companies, many industries are still hiring. So, we’ll see. There’re jobs available and so we’ll see how long that lasts.

Jake: Yeah.

Tobias: Macro stuff.

Jake: It is.


Tobias: Do you want to do yours, JT?

Energy In Food

Jake: Sure. Yeah. Two weeks ago, we did Vaclav Smil, his book and we talked about energy. And this now, we’re going to be pulling some stuff from a different chapter in his book that’s on food. It’s surprising actually to me, I didn’t realize this, but how interrelated those two things are, but we’ll get into the details here. First thing is, if you imagine foraging instead of farming in a relatively arid environment, it would require about 100 square kilometers to support a family.

And so, if you imagine the Earth’s total planimetric land area like flat land area is about 149 million square kilometers. If you just like back into the math as to how many families could be supported, if we all tried to be foragers, instead of having farming, it’s one and a half million families, which is pretty far south of our current population of seven or whatever it is, now, billion. So, that’s a little bit untenable. [laughs]

The Modern World Is Eradicating Malnutrition

Now, so, the UN estimates that the worldwide share of undernourished people decreased from 65% in 1950 down to 25% in 1970, and now, it’s down to just 9% in 2019. We’ve had this miracle of eradicating malnutrition. 1950, it was like two and three people were malnourished on Earth. And now, it’s down to one in 11. That’s a pretty dramatic improvement in the quality of life. Pretty remarkable. Now, where did that come from?

Combustion of liquid fuels for transportation feels like it’s the most important thing, gas for your car. But the modern world’s most important and fundamentally existential dependence is really on the fossil fuels and their use of food production for all of us. We simply could not harvest enough abundance in a predictable manner without having fossil fuels and electricity to do it.

Tobias: Is it fertilizer? What does it go into?

Jake: Oh, it’s everything. Fertilizer’s part of it, but we’ll get into some–.

Tobias: Farm equipment.

Jake: Yeah, it’s everything.

Tobias: Okay.

Jake: It’s like seed to your mouth or farm to fork, I guess…


Jake: In the last two centuries, the human labor component to produce a kilogram–

Tobias: Oh, no. Back into the– Wait, mate. Wait. Stop, stop, stop…

Tobias: You have gone back into the 12 matrix, except this time, it’s gram.


Tim: Like he is spinning a record.

Tobias: He got the 12, 12, 12 going last week. I don’t know what that is. Is that a Zoom feature?

Tim: I don’t know.

Tobias: [laughs]

Jake: I’m glad it’s not mine.

Tobias: Lay down a beat on top of that. This is the Metaverse, yet. Here we go. Let’s see. Come back, JT. Yeah, the Illuminati got him. That’s right.

Tim: [chuckles] What he was saying was too controversial apparently.

Tobias: Yeah, it was, it was.


Tobias: I had to cut. 12 grams, Jake Taylor wrapped it album. That’s it.

Tim: [laughs]

Tobias: How is inflation class warfare? Oh, here we go. That’s good before I have to answer that question.

Tim: [laughs]

Tobias: Gram, gram, gram.

Jake: Seriously? God, dang it.

Tobias: You are back. The gram is gone.

Tim: Back.

Jake: We got a short Zoom or something. This thing is, it’s not working.

Tobias: Yeah.

Jake: I don’t know. I keep getting stuck in these weird loops, huh?

Tobias: Too controversial.

Jake: [laughs] so, it is. All right, so, back to what we’re saying. In the last two centuries, the labor component for producing one kilogram of American wheat went from 10 minutes’ worth of labor time down to two seconds. So, we’ve become incredibly efficient, which then allowed us to go from– 83% of our population in 1800 were farmers. And now, it’s down to less than 2%. That allowed us then to become– We can all be podcasters now, instead of being of being farmers.

Tobias: Learn to code.

Jake: Learn to code, yeah. The limiting element always in the production of food, in growing food was nitrogen. It’s a very key ingredient for photosynthesis. And so, people would use manure, animal or human for introducing nitrogen back into the soil, so that it would be able to grow, increase the yield of the plant. Well, in the 19th century, they got higher crop yields by going to Chile.

Chile actually had these deposits of this thing. They called it white gold, because it was so valuable and they would export it all over the world and there were wars fought in Chile over this. But then in 1909, these two guys named, the two German scientists, Fritz Haber and Carl Bosch. They invented this process that created artificial ammonium, which is a source of nitrogen then that they can use in fertilizers.

This was a huge breakthrough for us to be able to increase the yields of all of our farming. If these two guys didn’t do this, it’s possible that the amount of starvation on Earth, if we tried to have the same population would be off the charts. These guys are actually like heroes that probably no one is really heard of. The Haber-Bosch process that they invented is still used today. It takes, though, 1% to 2% of the entire global energy is required to run this process to create the ammonia that we need for our fertilizer. Natural gas is a key input of the Haber– That’s where the hydrogen comes from to create the ammonia is from natural gas. So, this synthetic fertilizer provides over half of the 210 megatons that we use in total for fertilizer. It’s incredible that we’ve been able to do this. But it takes tons of energy to do it.

Insane Amount Of Energy Required To Put Food On A Plate

Give you a little sense of, Smil breaks down like what certain food types require, like, how much diesel and how much energy is required to create this. One kilogram of Great Plains wheat requires 100 milliliters of diesel to produce. That’s about half of a US cup. Imagine like that’s how much. One kilogram of sourdough loaf of bread takes about 250 milliliters. It’s about like one entire cup of diesel. One American chicken, like, one kilogram of edible meat of a chicken requires about three kilograms of grain corn, which then the feed costs alone are about anywhere from 150 to 750 milliliters. And then if you add in retailing, storing, home refrigeration, and cooking, basically all of the energy required to put the chicken onto your plate requires 350 milliliters of crude oil. So, it’s almost basically half a bottle of wine of diesels required to put that chicken on your plate.

Now, actually, it’s pretty comparable to bread, which is why the price per pound of chicken and the price per pound of bread are pretty close together. Then a tomato that is bought in Scandinavian market that’s grown in Spain, which is pretty common. Foods grown somewhere, shipped somewhere else to be consumed. One tomato requires about 650 milliliters of diesel per kilogram. Almost a full bottle of wine of diesel is required to put tomatoes on your plate if they’re transported. Even worse than that, seafood is, the stunning 700 milliliters per kilogram. And a wild shrimp and lobster, if you are caught and all the packaging, everything is more like 10 liters per kilogram. Like an order of magnitude difference. So, that’s why seafood is so expensive. It has a really high energy input to get it onto your plate.

The direct energy usage in the US is about 1% of all the energy that we use is for the production of food. But after adding, and processing, marketing, packaging, transportation, wholesale, retail, storage prep, the grand total is closer to 20% of our energy goes towards food production. In a big component, one of the ways that we might actually be able to fix this and help ourselves is food waste. We waste per capita, the amount of calories that are created are, it’s somewhere like between 3,500 and 4,000 kcals, kilocalories. But the consumption requirements are almost half of that. We call it between 2,000 and 2,500 depending on what your size is.

Tobias: If you are cutting or bulking.

1/3 Of The World’s Food Supply Ends Up As Waste

Jake: Yeah, if you’re in a bulking phase. [laughs] Basically, we lose almost half of all the crops, the fruits, the vegetables, about a third of all fish, 30% of cereals, 20% of meat and dairy products. If you sum it all together, about a third of the world’s food supply basically ends up as waste. If we can do things to improve that, we can actually pretty dramatically reduce the amount of energy required. I’m going to close by a really great quote that Smil has in here. “We will be eating transformed fossil fuels, be it as loaves of bread or as fishes for decades to come.”

The amount of energy required and this is again, we were saying to get all of society off of fossil fuels, which is going to require an incredible amount of time, and ingenuity, and discipline to get off of fossil fuels that provide all the food for us and to not have an existential crisis is going to require a crazy amount of time, and ingenuity, and effort. If you’re trying to cut fossil fuels to zero, you’re basically saying like, “I’m okay with starving a billion people or more.” You don’t really hear him phrase it that way. But that’s the hard economic reality of it.

The Causal Linkage Between Energy Prices And Food Costs

Tobias: So, two questions. One is, spiking energy prices in Germany. Does that then have a knock-on effect? That was pretty sobering. All of those statistics that said is, what trouble is Germany in with energy prices going where they are?

Jake: Well, I think just the general, any energy price input costs going up is going to be it, because food is such an energy intensive, good to produce, it’s going to have impact. Rising food prices are the true guillotine risk. All the Arab Spring, any of that stuff came– The precedent of that was rising food prices. That’s when people get pissed and start taking to the streets is when food gets too expensive. So, I feel it has to have some impact eventually. You can’t hide food costs.

Tobias: I read that the Egyptian pharaohs, “You’re a great pharaoh when the Nile was up, because that produced a lot of food.” Then you could build monuments, which are basically gigantic wastes of– [crosstalk]

Jake: Of the food, like, converted right into your prestige. [laughs]

Tobias: Of human power, to build gigantic pyramids and then when the waters receded, and you couldn’t make as much food, then you got your head taken off, and new dynasty got there to run. So, yeah, that’s been at risk for a long time.

Tim: JT, let me ask you. So, based on your research, are you optimistic about the policies in the Netherlands and Canada to reduce nitrogen by 30%?

Jake: I just don’t know, if we have any way to replace that to keep the productivity up. I think that seems foolish to me.

Tim: Yeah, I think a lot of people think that. It’s interesting, because you’re breaking down the numbers and you’re exactly right. There’s so much food that goes to waste. We’re all guilty of it and it’s like, “All right, maybe spending a little more time on that might not be the worst idea.”

Jake: I think all of these big problems that we face, there’s no silver bullet for any of them. There’re no easy answers. It’s a lot of little hard trade off answers and solutions that we’re going to have to figure out how to work with together to make happen, if we’re going to get through it, I think.

Tobias: You just tend not to confront them until you have to. If you look at a tech company as a microcosm of the broader economy, when they’re making lots and lots of money, there’s foosball tables, and air pods where you can sleep and meditate. But then when the rubber hits the road, all of that stuff goes out. Not work from home anymore. Everybody’s in the office and you get there before your manager and you leave after your manager or don’t come in tomorrow.

Tim: It’s true.

Jake: It’s amazing how the balances of power can shift so rapidly, huh?

Tobias: Sorry, dude.

The Future Of Food Is Bugs

Tim: Did Smil get into bugs at all? Because it seems like celebrities and the World Economic Forum, they’re now starting to push the bugs.

Jake: He does not get into that. Although, I can’t remember, it’s probably a couple of months ago, we talked about this on the show about– I think we talked about it. I don’t know. A lot of stuff blends together for me anymore. But we talked about how if you grew up eating bugs, then that was a cultural and social norm that actually your wiring would be okay with it. But if you didn’t, the chances of you ever being okay with it are incredibly small. I think they’re going to have a really hard time forcing that on to non-bug eating historically populations.

Tobias: I think they transform it. They take all the cricket protein and they turn it into a chocolate bar and you’re like, “Well, I eat chocolate bars.”

Jake: I don’t think of that.

Tim: I saw Robert Downey Jr. was pitching that.

Tobias: He’s got a cricket chocolate bar?

Tim: It was like a protein powder, basically. It was on the Colbert show. I didn’t watch the show. I just saw the highlights of it. But yeah, it’s like a tasteless. I didn’t see either of them taste it. I don’t know if it wasn’t just in my clip. But yeah, I don’t think that’s for me, personally.

Tobias: Fear factor for every meal. Thanks, Tim. [laughs]

Jake: Fear factor.


Tobias: Yeah, Joe Rogan was way ahead on that one, huh?

Tim: No kidding.

Tobias: Yeah. I’m going to try not to eat the bugs, but who knows?

Jake: You’re going to eat the bugs and you’re going to like it, sir.

Tobias: Yeah. That’s what. I’m going to get a t-shirt. If we get nuclear power, do I still have to eat the bugs? Because I’m a big fan of nuclear power. [laughs]

Jake: Less bugs. Yeah, if you’re willing to.

Tobias: Few bugs.

Jake: [laughs]

Tobias: “Bugs are probably already in our food as a food additive. McDonald’s doesn’t have to tell us what’s in their food.” Interesting.

Jake: Well, I think if I remember right, there’s certain thresholds that if you stay below a certain percentage of bug, then it’s okay. They don’t have to say anything.

Tobias: Pfft. [unintelligible [00:50:23] percent bug, don’t have to tell you.

Jake: It’s always been that way.

Tobias: It’s not material.

Jake: Yeah, non-material bug amount.

Tobias: I just want to know what proportion McDonald’s food is actually food. Because it doesn’t have it seems to break down. Even now, I’m astonished that it doesn’t break down. My kids dropped a few McDonald’s fries and burgers under the seats. I didn’t even know that. Months later, I found them and they still look pretty good, honestly, not that I tried them. They didn’t break down.

Tim: Yeah, a little bit of bugs isn’t– I think it’s just like the coordinated, I would almost say coercion of it. That is the most alarming thing. If it’s eaten as like a delicacy or whatever, it’s not a big deal. I’ve been drinking wine outside and had a bug in there and it’s not a huge deal.

Tobias: You drink that much?

Tim: I’m not going to pour out a good glass of wine. Yeah, the coercion of it and is not too attractive.

Tobias: “All processed food will have insects.” Yeah, it’s probably right. Probably come up with a technical name for the protein and you just won’t know. You have to look for the– [crosstalk]

Jake: Soylent? Soylent green?

Tobias: Yeah. Exactly. Right.

Jake: Oh, boy.

Tim: On a different subject-

Tobias: Please.

The Future Of Buy Now/Pay Later

Tim: -I was just going to mention that I was reading a conference call today this morning from my errands, which is a lease to own retailer. You’re dealing lower end of the spectrum there. What they’re seeing is that people aren’t renewing their leases on the TVs, the furniture, the appliances, as much. Obviously, you’re stuck with a lot of bills and you have to make decisions on what you’re cutting.

Defaults are up quite a bit for them. People just aren’t returning this stuff. It’s not like a 2008 type situation by any means. They’re still profitable on the EBITDA basis. But it’s goes to the point that we were talking about where on the lower end, you’re going to feel inflation a lot more heavily and you probably don’t have the equity exposure, which might be good this year.

Or, the equity in real estate and stuff like that. I just think that there’s a lot of micro data from the companies that are coming out, which really says that. In general, honestly, credit’s pretty good. For the consumer in general, most of the people that are really, they’re lending to are doing pretty well. I’ll be curious how they’ll buy now, pay now or pay later.

Tobias: Yeah, that’s what I was going to say, too.

Jake: Yeah. Buy now, pay never.

Tim: Yeah. People use those for gasoline. You know what I mean? I don’t know. I think you’d see material degradation there early on in the cycle.

Tobias: Yeah. Matt Hansen brought “Rent-a-center, Lease to own: Rent-a-center looking super cheap on surface.” Yeah, I’ve seen a few of those stocks around, too. I wonder about that buy now, pay later, too. I looked at those pretty closely, because there’s one in Australia that went public and had a huge run. They require, I think about a third of the price upfront, a quarter or a third of the price upfront. And then there are repayments on the remaining sum plus a fee. It’s always struck me as one of those things that’s going to look really good in a healthy economy and really ugly in a bad economy.

Tim: Yeah. You get volumes. It’s easy to– [crosstalk]

Jake: [chuckles] Easy to sell.

Tim: Yeah, easy to sell. Well, to me, Upstart’s one of the most interesting stories because that was the most glamorous tech momentum plays and they were profitable, too. It wasn’t like, “Oh, losing money.” It’s a former Google guy running it and then that’s stock. It’s got to be down 85%, 90%. And now, they’re seeing that demand for their originations is down quite a bit. That’s one of the companies that– I like aspects of the business, but that’s when I’m watching closely. I’ll also be watching like a firm. Lending Club, which is a stock I like quite a bit. It’ll be interesting to see how this is filtering to them.

Subprime Auto Loan ‘Crisis’ Is Just Hype

Tobias: When you said there originations are down, what does that mean? I would have thought that in a market like this they soar or is it– [crosstalk]

Jake: Probably, cut people off. I would–

Tim: Well, a lot of it for them is-

Tobias: Clothing and stuff like that.

Tim: -things. There’ll be banks or funds will buy some of the securitizations that they originate. Because they’re like a location where they’re originating. If you want to grow your loans, you could buy some from upstart, so that they’ll sell that. And right now, credit markets are pretty much frozen for a lot of securitizations. We saw that in the bank data. Capital markets bank debt issuances and SPAC issuances. That was all very minimal this quarter. People just aren’t as anxious for those types of originations. Credit is not following the algorithms to the same extent that it has. It outperformed the last couple of years with credit really doing so well with the stimulus and everything. And now, people are like, “Okay, well, it’s not doing that now. Is it going to get a lot worse?” So, they’re just a little more cautious on what they bring onto their balance sheets.

Tobias: So, where’s the bottleneck? It’s not Upstart’s demand from its customers. It’s the secondary purchaser of those loans, who doesn’t want to take on those loans.

Tim: From my understanding, that’s the issue right now is that there’s not as much demand there. Obviously, if credit conditions are weaker, you’re going to demand more yield. And so, that could impact originations. What I thought was interesting with Ally, which is a company I know better. Their loan origination yield went up pretty substantial. I want to say, I think it was 75 basis points on retail auto, something like that. They’re originating at 8% and their net charge offs are only 54 basis points on retail auto. It really depends. But I think that they’re actually getting a lot of their originations. I think companies like Carvana, which used to access the securitization markets, they can’t really do that as much. So, they’re selling more of their loans to companies like Ally, which are willing to take them at the appropriate margins.

Tobias: How does that make you feel for Ally?

Tim: Good. They’re strong underwriters. Even in the Great Recession, auto credit held up a lot better than mortgages. People are working and so, they need that. What’s a little different here is that the loans are way higher, because cars are so expensive now, even on the used side.

Jake: What do you about these like 96 or I don’t know, 200 month [laughs] auto loans?

Tim: Yeah, you got to look at who’s doing what. There’re definitely some irresponsible lenders and there’re more responsible lenders. I know for Ally, for instance. When they’re underwriting, their pricing in the substantial declines in used auto pricing. What’s good about that industry is, they can recover the automobiles quickly and then they have all the auction platforms to get maximum value from it. It’s not like a house where it’s like, you could be depending on your state, you could be in basically litigation for years. I think it’s attractive business, especially when you’re getting the yield. If they weren’t getting the yield, I’d be a little more worried. But they are. So, I think, I can’t see a scenario where they won’t still be quite profitable.

Jake: What if you could vertically integrate this whole process for yourself by buying car part as well?

Tobias: [laughs]

Tim: Possibly.

Tobias: You put that in an ETF, give it a good ticker. Vertically integrated autos.

Tim: Yeah. People love predicting the [crosstalk] disaster. The next financial crisis with auto and I think it’s a little bit different of an industry. There’s not the same dynamics that made the financial crisis what it was with mortgages, and with the CDOs, and all that stuff. It’s a very different ballgame. Even if used car prices go down, it is far from cataclysmic for responsible people.

Tobias: People aren’t speculating cars, I guess so.

Jake: No. Exactly. You don’t buy. You don’t have– [crosstalk]

Tobias: Flipping them. Unless you flipping them to Carvana.

Jake: I was going to say, Rick’s hospitality employees buying five or six cars to speculate, like, they did with houses.

Tobias: To flip them.

Tim: Oh, yeah.

Tobias: Well, thanks very much for joining us this week, Tim. Great job.

Jake: Oh, thanks, Tim.

Tim: Oh, thanks, guys. It was fun. I appreciate you having me.

Tobias: I’m going to be off next week. I’m going to be in a region with no internet or very– [crosstalk]

Jake: Australia?


Tobias: No, I’m going to be near Yosemite.

Jake: Oh, sweet.

Tobias: Yeah. So, we’ll be back the week after that. But always good to see you guys and look forward to seeing it then. You guys want to sign off?

Jake: Cheers, everybody.

Tobias: If folks want to get in contact with you, Tim, how do they do that?

Tim: They can do it at is our website.

Jake: Is that five W’s?

Tim: Yeah, exactly, exactly.

Jake: Okay.

Tim: And then, I think my Twitter handle is @timtravisvalue, I believe.

Tobias: Cool. Good stuff. All right, thanks.

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