VALUE: After Hours (S04 E028): Wide Value Spread, Einhorn on Value, Aggregate in Aggregate

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

  • Einhorn – Why Value Is Ripping!
  • Value Spread Very Very Wide
  • The Big Four Basic Key Materials Of The Modern World
  • What Goes Into An Electric Vehicle
  • The Best Way To Rebalance Your Portfolio
  • Tax On Buybacks
  • Why Warren Buffett’s Buying OXY
  • China Dominates The Rare Earth Industry
  • Recession Much Ado About Nothing
  • Contango Yield Curve
  • Meme Stocks Making A Comeback
  • How Financial Engineering Impacts Margins
  • No-One Wants To Buy Upstart’s Loans
  • People Would Rather Keep Their Cars Over Their Homes

You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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Full Transcript:

Tobias: We’re live.

Jake: Sure.

Tobias: It is Value: After Hours. It’s a little bit after the usual starting time, 10:38 on the West Coast, 1:38 on the East Coast. No idea what it is Australian Eastern Standard Time. Sorry, guys.

Jake: [laughs] Too far away. Sorry.

Tobias: It might be 5:30 AM, something like 4:30 AM. What’s happening, fellas? We’ve been off for a little while, Bill, he’s been off for a while.

Bill: Indeed, I have.

Tobias: How’s everybody?

Jake: I missed you, boys.

Bill: I was ready to go last week, but then no one showed up to the room and I was left crying.

Jake: Oh. [violin sound]

Bill: Yes, the world’s smallest violin.

Jake: I had an eventful couple of weeks. Finally got COVID last week. So, that’s fun.

Bill: Yeah. [crosstalk] Congrats indeed.

Tobias: Congrats in a bulletproof.

Jake: Dodged that for two and a half years and then took a little bit on the chin. So, now, I’m superhuman.

Bill: How did it hit you?

Jake: A couple bad nights asleep with slight fever and sweating in my bed that type of thing. headache, aches, but then after that I was pretty much back to normal. But I did my CDC recommended five days of quarantine.

Bill: There you go.

Jake: Wifey took really good care of me. I was like a prisoner, where food would show up at the door, and I would eat it, and I’d leave my tray-

Tobias: [laughs]

Jake: -back at the door.

Tobias: Living the dream.

Jake: Yeah, that’s a real dream. In the kids’ room, by the way, I was isolated on that side of the house. So, that’s fun.

Bill: Nice.

Tobias: Townsville, Craig Yesberg in Townsville says that it is 3:38 AM. I don’t know what you’re doing, mate. It’s way too early.

Bill: Yeah, dude, shoutout to you for showing up.

Tobias: Townsville. Cool. I think that’s lots off– [crosstalk]

Bill: 3:38, this dude tunes in. Ask him. “Hey, Craig, are you drunk or did you wake up for this?”


Tobias: Shift work.

Jake: Oh, boy.

Bill: It’s dope. Good for him, man. I hope we make your morning somewhat enjoyable.

Tobias: Cornwall, Raleigh, Dublin, Nova Scotia, Estonia, what’s up? Caribbean, Altamonte Springs, Florida. You’ve got another Flo Rider down there.

Bill: I always find it odd how there’s that many places with only 10 listeners, but I digress.

Tobias: It used to be 12. Remember, it was 12?

Bill: Yeah.

Tobias: That was fun when it was 12. JT had his 12, 12, 12. I think it was the ghost of 12 past something.

Bill: Help me up. And I tick somebody off, they left me a nasty review on my podcast. So, I guess, we lost them as a listener. We’re down to 11 and then one died.

Tobias: [laughs]

Bill: So, we’re back to 10.

Tobias: Santa Monica, Sweden. Wow. It’s a good spread. Fellas, what have you got up on deck? JT?

Jake: Back due to popular request, we’ve got another how the world really works segment to get into.

Tobias: [laughs] Sperm whale is the most popular request that I’ve seen. [laughs]

Jake: [crosstalk] I’ve been shocked at how much people are liking the Vaclav Smil episode. So, sorry, you’re stuck with a little bit more.

Tobias: Oh, that’s great. Yeah, I’ve got David Einhorn’s Q2 letter. It came out– Einhorn had some nice things to say about value. And a couple little stats from Asness and Alpha Architect on the value spread because I know that everybody likes to see the update.

Jake: [chuckles] Yeah. On what inning are we in, Bill? That’s the other update we need.

Bill: I don’t know.

Tobias: Bill’s been trying to retire it, I think.

Jake: Yeah.

Bill: No, this is a tough– Yeah, this is a tough– [crosstalk]

Jake: Game to call.

Bill: Yeah. The downside is tougher. I’m hoping we power bottomed already.

Jake: We lost Vin Scully. So, we do need a baseball analogy this show.

Bill: Yeah, I don’t know. I’ve been kerfuffled through this one. I’m not sure why I would know now.

Jake: It doesn’t matter.

Bill: But jobs are strong, people are spending everywhere. Guy from Caesars says, “Words can’t describe how good is businesses right now in Vegas.” So, summer session.

Tobias: What do you think that means? Yeah, you got two competing things for people. People still out and about from COVID locked down. Is that still a thing?

Bill: I don’t know.

Tobias: Trouble?

Bill: I think generally we’re all doing things in waves and I think this summer is the wave of getting out. People have already booked things, but I don’t know, man, I spent three weeks on the road. I saw people everywhere. Everywhere it was packed. That’s an actual quote from the CEO of Caesars “Words cannot describe how good our business is right now.” So, it’s funny, because all the experts were like in 2021, well, when you read about what the comps are set up, they were like, “Well, everybody was spending stimulus checks and that’s not going to repeat.” The Guy’s like, “Look, I’m telling you right now, September is comping to September of 2021 from a booking standpoint.” I did like how he said that. “August is seasonally weak as Vegas is slightly less hot than the sun.”

Tobias: [laughs]

Jake: It is hotter [crosstalk]

Bill: [laughs] Yeah. That was pretty fun.

Tobias: It’s not like you going outside.

Bill: Yeah.

Tobias: Let’s be honest. That’s the best thing that could possibly happen. You’re just stuck inside an air-conditioned casino.

Bill: I think he said 90% occupancy regardless. But yeah, it’s interesting. Regionally cited as weak. I think that if you think advertising is a leading indicator, some of the Ad companies seem to be taking it on the chin right now. But all of the coincident and lagging indicator is certainly strong. So, I don’t know. We shall all find out together.

Contango Yield Curve

Tobias: The 10:3, I’ve been watching the yield curve. It’s a very strange shape at the moment, because the 10-year is lower than the two-year, but it’s higher than the three-month. It’s right. It could be through today. Who knows? It might bounce up. I don’t know. But the 20-year and the 30-year, it’s weed kinking.

Jake: What does that mean? [laughs]

Tobias: Well, when it’s in contango, do you use that term when it comes to this — [crosstalk]

Jake: Backwardation I think is the term.

Tobias: Well, it’s normal backwardation. It’s not at the moment in contango. Because three-month and the two-year above the 10-year. But they’re not above the 20-year and the 30-year.

Bill: I got to buy three months, Jesus. I’m leaving money on the table in my– Yeah, too much cash.

Tobias: It’s 3% or something, isn’t it?

Bill: Two and a half.

Tobias: Two and a half.

Bill: You can actually get some yield on that.

Tobias: So, that’s the Cam Harvey’s indicator. 10:3s Cam– That’s really, really close. It could go through any day. It’s been bouncing around right on the line. I’m sure to other people been watching it too, just for a technical that has presaged a lot of other recessions and depressions. But who knows maybe there’s something else going on.

Bill: Yeah.

Recession Much Ado About Nothing

Jake: I was thinking about this the other day. There’s been a lot of arguments about, are we in a recession or what’s the two quarters in a row of negative GDP? Okay, that’s fine. We get hung up on semantics as humans. But nobody’s saying, it’s coming in at 4% or some big number that’s going to help. We’re arguing whether is it plus a half or a minus a half or something. At this point, let’s just say zero and move forward with that.

Tobias: Isn’t it the comp? isn’t the issue that the comp is blown out, so that the next two quarters are–? There’s been a big recovery and then there’s two quarters that are lower than the big recovery. I thought that was the point rather than the exact number.

Jake: Yeah. All I’m saying is it feels much ado about nothing to me.

Tobias: It’s a political thing, right?

Bill: I appreciate your input. That’s very smart take.

Tobias: You get to smack the sitting president. That’s the only point.

Jake: Oh, okay.

Tobias: That’s the only point of it.

Jake: It’s a [crosstalk] problem.

Tobias: It’s a headline that you get to write in the paper. I think that’s the only point. I think it’s– [crosstalk]

Jake: I think it’s recession.

Tobias: Yeah.

Bill: Worst economy ever. Ever.

Jake: Yeah.

Bill: It’s never been this bad before.

Tobias: Everybody in relation to everything, there’s always this representative anchoring, all of these biases, whatever’s happening right now is the worst thing or the best thing that’s ever happened could be true for their life. Who knows? Unlikely.

Jake: Yeah. [crosstalk] luckily.

No-One Wants To Buy Upstart’s Loans

Bill: I thought upstarts call was interesting. I think that people are getting to see that business finally.

Jake: What did they do there?

Bill: Well, they are an AI enabled lending facilitation platform.

Jake: I’m sorry. Sorry, you’re breaking up.

Bill: Yep. That’s right. But what’s interesting is they’re constrained unless they are not seeing the data correctly or they’re frauds. I don’t think the fraud thing. If anybody wants to allege that there’s on them to prove it. They claim their credit models are performing as good or better as they ever have, but the constraint is banks don’t want the paper. I think that what people may not appreciate is when you don’t hold the underwriting on your own balance sheet, you’re beholden to people that want buy the paper.

If you’ve ever worked in a bank going into a recession or the fear of recession, credit departments get very skittish and it seems to me a good way to lose your job is to continue to buy quasi subprime or arguably not rated paper right before a recession, and the recession hits, then the paper doesn’t perform well, and how were you so dumb to be the credit department that allowed the bank to buy that. It’s an interesting development where just a year and a half ago, one of my favorite Twitter personalities, @jonahthejuice, love that, they didn’t hold their own paper. It’s this asset light. Everyone can go everywhere. They can sell it to anybody. Anyone’s going to buy the paper and turns out, you’re as cyclical as your counterparty is willing to buy your loans.

Tobias: yeah, that’s interesting.

Bill: Yeah, it has been an interesting development. Look at slide for their presentation. They’re either lying or their models are performing well. But there’s not the appetite to buy the loans. It’s an interesting development. Now, they’re talking about maybe bringing some of it in house. So, we’ll see how Tech investors feel with financial multiples. I’ll tell you this, it’s not great.

Jake: Yeah.

People Would Rather Keep Their Cars Over Their Homes

Tobias: Tim made the some point last week about, well, the week before about not buying paper, is the Autoline paper? What was the paper that banks weren’t buying? Do you remember, JT?

Jake: Yeah, I think he was talking about subprime auto paper.

Bill: I take that all day long. That’s a good lend. People don’t default on their cars, man.

Jake: I thought people are like taking off right now.

Bill: They might be. But the lesson from the Great Recession– Wall Street can always take lessons too far. So, who knows? But the thing is, people would give in their keys to their house before they turn over the keys to the car, because if you lose your car, you can’t get to work. You actually are permanently impaired. I guess maybe Uber changes that dynamic a little, but I think people keep their car at all costs.

Jake: So, you get a motorhome, got both your bases covered.

Bill: Boom. Boom. Get long camping world– [crosstalk]

Tobias: I think they are a few around.

Bill: I like that.

Tobias: I think there are a few around in the second-hand market there.

Jake: Yeah.

Bill: Yeah, I think so.

Tobias: I think everybody got away and now, they’ve come back and they want to get rid of them.

Jake: Everyone’s like, “RV, that’s awesome. Wait, never mind. I want to go to Hawaii.”

Bill: Yeah, scuttlebutt on that tell– Well, I heard like a month and a half ago is when the brakes got slammed on a supplier to an RV like floors. They do floors. Not so hot as of six weeks ago.

Tobias: I was in Yosemite last week and the drive to Yosemite, I noticed there are a few what so absolutely jam packed with RVs. I don’t know if that’s usual, but it seemed a lot of inventory on the there on the lot– I wasn’t in the– [crosstalk]

Jake: [laughs]

Bill: Yeah, I was driving by camping world seeing and there did appear to be a pretty full lot for camping world.

Jake: Well, gas prices, certainly, don’t help that equation either if you’re trying to-

Tobias: That’s a good point.

Jake: -motor around the US and it’s costing you $1.50 a mile in gas.

Tobias: Yeah.

Bill: Also, nobody fake news me and tell [unintelligible [00:13:41] that I’m out here talking shit on Camping World. I’m not trying to get on his radar.

Tobias: [laughs]

Bill: I got love for Marc. It’s something I don’t need in my life. Camping World has bounced. Bottomed in June like everything. It turns out everything’s just one big rates play.

Tobias: It is funny, isn’t it? Everything just trades same way. We’ve just got– [crosstalk]

Bill: Yeah.

Meme Stocks Making A Comeback

Jake: Yeah. Meme stocks are back, I guess, this week recently. Is that true?

Tobias: AMC, GME. Yeah.

Bill: Did they?

Tobias: Yeah, the big runs.

Jake: Yeah, apparently. It’s all back. [laughs]

Tobias: I saw GME to a hundred bucks a share and then somebody else said, “No, a million bucks a share.”

Bill: Oh, why stop there?

Jake: Something else ripped on the fact that it was on a Reddit board, all that stuff going on again. Yeah, I guess we got to learn these lessons a few times before they stick.

Tobias: There’s always a few [unintelligible [00:14:30] before the bottom.

Bill: I used to think I was too good to accept a meme. But if Reddit wants to meme some names give me– [crosstalk] I can get them some.

Jake: [laughs]

Bill: Not take it anyway. I can get it at this point.

Jake: Yeah, anyway to get these dogs moving, huh?

Bill: [laughs]

Einhorn – Why Value Is Ripping!

Tobias: Let me do some choice lines from Einhorn’s letter.

Jake: Yeah.

Tobias: I tweeted this one out yesterday, but I like this one. “The market is still dominated by the types of investors.” It is germane to what we were just talking about, “Who we described in our year in 2020 letter those that either will not index funds, cannot untrained novice investors, or choose to not valuation different professional investors have valuation as a cornerstone of their investment process. A lot of these investors have had a tough go during the current bear market.” That’s a little bit gratuitous, but I just want to throw that in there anyway.

Jake: [laughs]

Tobias: This is the more interesting line. “We believe that part of the reason value stocks have fared better lately as value investors have suffered a full redemption cycle and is hardly anyone lifted so.” What do you think about that? Is that true? Is that fair?

Bill: I don’t know how you time the bottom.

Jake: Yeah, I think there’s something to that. No, you can’t. But if you were a value conscious, I don’t know what names we want to include in this bucket. But let’s say, whatever it is. And you think it’s worth. You think it’s a 50-cent dollar, which is the reason you’d be holding it. You’re probably not going to get rid of it until you get closer to that.

Tobias: Redeemed.

Jake: Yeah.

Tobias: Closer to value.

Jake: [laughs] Or, redeem, whichever comes first. But yeah, eventually, you run out of redeemers and you run out of those who lost the faith. And that’s I think how you bought them, we just run out of sellers.

Tobias: Well, I think Pzena. I was just talking to you guys before we came on, but Pzena is the stock that I have held. That’s Rich Pzena’s Investment firm, systematic value fund. They’ve got about $50 billion in assets. I thought they were cheap at the start of the year and they traded down 30% with everything else in this sell off. And now, they’ve got to take private, basically, without trading at the start of the year.

I think that it sucks if you hold it, because I don’t think it’s anywhere near for value where it’s going. But I can’t blame them. They’ve been beaten up for so long. That’s why they’re trading where they are. But that’s one of the concerns that I have that you get this and I think we’re starting to see it a little bit. If your valuation buyer, private equity buyer, this is a pretty good market to be hunting around. I’m surprised that there haven’t been more announcements so far.

Jake: Yeah.

Bill: One of the growth your ideas that I like is T. Rowe Price as a stock.

Jake: Because they buy growth your stocks or because–?

Bill: Yeah, you got an asset manager trading at 12 P/E. They’ve got a long, long history of being discipline growth investors. That’s a derivative way to play growth through value lens.

Jake: Yeah, I like that. it might be a good diversifier, if you’re a real value-oriented guy.

Bill: Yeah, and you want some growth exposure, but you don’t want to pay Asinine prices.

Jake: Or, just buy 3x Ark.

Bill: Could do that, could do that.

Tobias: Which way? 3x short or 3x long? Both? [crosstalk] perfectly hedged.

Bill: Yeah, that’s right.

Jake: Both. You can make the argument that that’s probably it’s either going one direction or the other. It can’t stay here. This is the wrong price wherever it is today. [laughs]

Tobias: Ark is up or down but wrong here.

Jake: It’s wrong here. Yeah. [laughs]

Tobias: That’s interesting. I don’t know.

Jake: I don’t know either. I’m just making– [crosstalk]

Bill: Diamond Hill looks– I was just checking that out because that’s another one. They’ve probably outperformed the market over the past year. But their P/E of 10, I don’t know, I guess, it’s where these things trade. I have no idea. I don’t know what I’m talking about. Disregard the words coming out of my mouth.

Jake: [sighs]

Bill: I’m not sure that I buy that the values ripping, because people are getting redeemed. But Einhorn is much smarter than I am. Is he the one that’s on Twitter?

Tobias: I think he said that, “It’s relatively outperforming because the value has already had its full redemption cycle and there’s nobody left to sell.” I think was the point that he was making. Although, that doesn’t seem to be true and the stuff that I hope. There are plenty of souls left.

Jake: [laughs]

Tobias: It turns out that every share is held by somebody who can sell it at any time.

Jake: Who are all these paper hands? [laughs]

Bill: Yeah.

Tobias: We got to get some Diamond hands in the value community. But why would you hold anything? It just goes down. It’s just brutal.

Jake: A lot of ways to lose money.

The Best Way To Rebalance Your Portfolio

Bill: What do you think about rebalancing, Toby?

Tobias: I think it’s very important. I do it all the time.

Jake: [laughs] I’m pro.

Bill: I know, but in your studies and stuff, how did you think about when to rebalance? Because if you’re betting on the value factor, I would think that it depends. Does the stock outperform from one to three years after it falls in the lowest decile? Can you rotate every quarter? How did you think about rebalancing those buckets when you did those studies?

Tobias: On average, there’s a study out there that says this, “It takes five years for the excess performance to disappear, but the bulk of the excess performance is in the first year.” Problem that you have is as you point out before, if that before we came on, but it’s nice owning something, but there’s always something else out there, too. You can be in something that’s run up a little bit de-risk it by taking the position down, allocate to something else. I think that transition is what value is, that buying and selling is what the value factor is. Buy them when they’re too cheap, sell them when they get more expensive or re-bounce the position down and rebuy something else cheap. That’s been a pretty good strategy for a long time. It’s been less good since about mid-2010, but it might have been September 2020. I don’t know. We’ll see.

Value Spread Very Very Wide

Jake: Is that a good segue for the AQR value spread?

Tobias: Yeah, it’s just a very simple chart from Asness. He says that, “It’s at the 98th percentile. Again, global value.” It has been a little bit wider recently, but it’s blown out again. And then Alpha Architect website has the EV/EBIT, but metric that compares the cheapest decile of stocks, the median in the cheapest decile to the median in the total universe. So as Jake pointed out yesterday, we’re comparing the 75th stock to the 750th stock, which seems a little bit arbitrary.

But there are good reasons for doing it. Basically, that spread was wider at July, sorry at June 30. It was 4.15 and it’s come into 4.07 as of July 31, the last month end that we’ve had. But it’s wider than it was in 2000, it’s wider than it was in 2009. Both of those two events followed with very good returns for value. So, that’s what I think. It’s very, very painful to get there, because the blowout means that you’re underperforming. But at some point, that starts closing. If it closes violently is it open and that should mean pretty good returns for value. Gee, it’s been long time waiting for it.

Jake: It’s the [crosstalk] context to that. This is what Wes is doing with that is it’s, you take 1,500 stocks and then you put them in the order of basically cheapest to most expensive and then-

Tobias: On EV/EBIT.

Jake: -on an EV to EBIT bases and then look at basically the 75th cheapest, which is the median of the-

Tobias: Cheap decile.

Jake: -cheapest decile and then look at the 750th stock, which is basically just smack in the middle of the spectrum and compare those two. What it’s saying is that you’re getting roughly four more dollars of EBIT per unit of enterprise value with the cheapest compared to the median one.

Tobias: I think that’s fair. Yeah.

Jake: I’m trying to make it into playing understandable.

Tobias: Four times as much operating earnings as you are at the median.

Jake: Right and that number historically has been around where– it’s not been four. It’s been much lower than that.

Tobias: Yeah, I don’t know. I don’t know what the average is, but the two peaks 2000 and 2009 was something like three handles to be four is very, very wide, much, much wide. You can look at that chart. It’s astronomical. It’s in my Twitter feed.

Jake: Yeah.

Tobias: It’s wide.

How Financial Engineering Impacts Margins

Bill: It’ll be interesting to see some of these cuts that are coming– a lot of these growth companies were overspending and now, the cuts are– I’d be interested to see how the next 12 months plays. You would think that they should show some operating margin expansion over the next 12 months. I’m going to see if that brings in the multiple a little bit or the differential.

Jake: Do you think margins are going to get bigger from where they are right now for S&P 500?

Bill: You would hope so. Otherwise, there’s a problem with a lot of these growth companies. I was thinking about this before.

Jake: Well, there were already at 12%, 13%. That’s astronomical.

Bill: Yeah, I was actually doing dishes thinking pf you the other night.

Jake: [laughs]

Bill: Not in a kinky way.

Jake: Oh, dammit.

Bill: I’m sorry. But one of the things that I was thinking about is, Domino’s Pizza is one example where I think in the past and I might be wrong on this, because I have thoughts, I don’t have empirical data. The best way to live, very ignorant.

Jake: Let’s– [crosstalk]

Bill: Domino’s might have been a public company in the past with the whole system, if we’re rewinding in the 50s. Maybe that’s what they want to be. And now, the franchisor is the public entity and all the shitty margins are in the private markets pushed down to entrepreneurs or whatever. I just wonder how much of it’s just a compositional issue. And then as these capital light businesses have been rewarded with high multiples, how much that’s distorting relative to history, the margin profile on a market cap weighted base.

Jake: Yes. What you’re saying is that a lighter capital, better returns on capital businesses are the ones that end up being public as opposed to owning a bunch of pizza actual, like, brick and mortar of the pizza place.

Bill: Well, certainly, I think they’re the ones that are rewarded with these big multiples. I think financial engineering has really run its course over the past 40 years or so.

Jake: Yeah.

Tobias: Coincidental with interest rates getting squashed all the way to zero.

Bill: Yeah.

Jake: Yeah, it’s funny how those two– [crosstalk]

Bill: And outsourcing. There’s been a lot of things. But I think we shipped a lot of low margins overseas. I think the pandemic has shown how much fragility that can add and I’m sympathetic to the idea that commodities, certainly, after this Inflation Reduction Act can probably catch a nice run here. We’ll see how that all works out.


Bill: Oh, boy.

Tobias: Do you want to do your subject?

Bill: Damn, I’m sorry.

Jake: Sure.

Bill: Well, I think I understand how they’re getting there. I don’t know enough about Pharma. But I think I agree with Medicare negotiating with drug prices. I do think it’s very funny how they’re spending their way off of an oil dependency and calling that inflation reduction. I think that’s rich. That’s politics.

Jake: Yeah, they’re good at framing these things.

Bill: Can you see Ford rose. They raised the price of the F-150, like, 8,500 bucks and I’m pretty sure that’s exactly– [crosstalk]

Tobias: That’s exactly what they are getting.

Bill: Yeah.

Tobias: [laughs]

Jake: Oh, geez.

Tobias: Cynical.

Bill: All right, veggie time.

The Big Four Basic Key Materials Of The Modern World

Jake: Now, do education. All right. This is part 3 in our understanding of the world and this is how the world really works.

Tobias: Has you had to go with financial markets? Because I’ll be interested to hear how that actually worked, too.

Jake: Yeah, that would be nice, wouldn’t it? This segment is on understanding our material world. The first one was on energy, the second one was on food production, and this one is on four basic key materials that build our world. And those are cement, steel, plastics, and ammonia. Now, you might be wondering like, “Hey, what about silicone?” Or, silicone, I should say. Isn’t that what the modern world is built on? Well, Smil says that, “Billions of people could live prosperously without silicone and it’s not an existential constraint on modern civilization like these other four key ingredients.” Just to hit you with some metrics on these.

The 2019 world consumption. Four and a half billion tons of cement, 1.8 billion tons of steel, 370 million tons of plastic, 150 million tons of ammonia. By the way, the mass production, just to tie this back into our previous segments. The mass production of all of these depends heavily on the combustion of fossil fuels about 17% of the world’s primary energy supply goes into creating these four key ingredients and about 25% of all CO2 emissions. The modern world, again, as we’ve been saying over and over again is running on fossil fuels.

Smil says that, “Ammonia is actually the most important of all four of these,” which is a little surprising. And a lot of it is because without it, it would be impossible to feed at least 40% to 50% of the world’s eight-ish billion people. 60% of China’s agriculture is available only due to synthetic ammonia. And so, feeding basically three out of five people in China would not be possible without the production of synthetic ammonia. The global average is around 50%. This huge dependence actually justifies the claim that Haber-Bosch process, which we talked about a little bit before, which was this heating up of key ingredients that then create ammonia. Smil says that, “It’s perhaps the most momentous technical advance in history,” because it allowed our population to get so much bigger.

Let’s jump to plastics then. The synthesis of plastics is basically, you take these small molecules, and they can be bonded together into longer and longer chains and branches, and they make what are called polymers. You take these monomers and turn them into polymers. There are two key monomers, which are ethylene and propylene. They’re basically produced by heating hydrocarbon feedstocks to 750 to 950 degrees Celsius. So, again, huge carbon input to get any kind of heat like that. But their ability to mold these plastics is what makes them so valuable, because we can put them into all kinds of shapes and sizes from thin film to heavy duty pipes, super bottles that you drink out of to massive sturdy waste containers. It’s hugely valuable for us to create the form factors that we need with the thickness and the properties that allow.

Polyethylene accounts for about 20% of the global production of plastics, polypropylene is about 15%, and then polyvinyl chloride, which is PVC pipe, like you guys have heard that before, probably, that’s about 10%. Global production of plastics, 20,000 tons in 1925, 2 million tons in 1950, 150 million tons in 2000, and 370 million tons in 2019. You can see this exponential curve that’s pretty wild.

All right, steel, steel beams can bear loads that are 15 to 30 times higher than granite columns. A steel’s tensile strength is about seven times that of aluminum and its hardness is about four times. It also has a much higher melting point, which is about 1,400 degrees Celsius for steel as opposed to about 660 for aluminum.

Tobias: Does jet fuel burn that?

Jake: [laughs] All right, they are true. Let’s just keep moving here.

Tobias: [laughs]

Jake: Basically, tall buildings, bridges, radio and TV towers, electricity transmission, the big towers that we send the electricity through. Oil and gas production platforms, railroad tracks, ship poles, shipping containers, tools, machinery, boilers, nuclear reactors, oil refineries, those are essentially just a forest of steel. Of course, all the weapons, tanks, and guns, and stuff. Huge part of our world is made up of steel and it’s also actually the largest part by weight of transportation equipment. The average car contains about 900 kilograms of steel, which is about 2,000 pounds. Are we going to run out of steel? Very unlikely.

Iron, which is a huge component of steel is the fourth most abundant element in the Earth’s crust behind oxygen, silicon, and aluminum. The annual production of iron ore is about 250 billion tons. The world’s resources are in excess of 800 billion tons containing about 250 billion tons of ore. Any resource when you look at it, you can do like a resource divided by production calculation to see how much of it do we have versus how much do we produce every year. And that’s more than 300 years’ worth for steel. As opposed to oil, actually, it’s RP is 50 years currently. We’re in good shape.

Interestingly enough, recycled steel actually accounts for about 30% of the total output, 70% in the US, 40% in the EU, and only 12% in China. That could be a place where we might actually save a lot of steel production, would be in China with little bit more recycling. A lot of that probably has to do with the fact that the age of it we were turning over steel from the 20th century. Total energy requirements of global steel production in 2019 was about 6% of all the energy that we harnessed.

All right, next up, concrete. Cement is this indispensable component of concrete, it’s produced by heating basically ground limestone to at least 1,400 degrees, along with some other materials in these large kilns. And so, concrete consists of about 65% to 85% of aggregates which are sands, rocks, things like that, 15% to 20% water, and then the cement is about 15% to 20% of the final mass as well. It’s been the most massively deployed material to create modern civilization. It’s hard, it’s heavy, it’s ready to withstand decades of punishment. And especially, when it’s reinforced with steel, it helps combat the fact that concrete is actually pretty weak against tension. If you twist concrete, it cracks. But if you try to compress it, it doesn’t really withstand that well.

To give you an idea, the Pantheon was completed in 126 CE. That’s 2,000 years ago and it still spans a distance greater than any other structure that’s been made of non-reinforced concrete. Pretty impressive stuff. Today’s best concrete can withstand pressures of up to 100 mega Pascals to give you an idea of how much that is. That’s the equivalent of the weight of an African bull elephant balanced on a coin sideways. So, picture an elephant pushing down on a coin, very small surface area, a lot of weight, pretty impressive.

The most massive concrete structures that we have are dams to give you a sense. The Hoover Dam required 3.4 million cubic meters of concrete and 20,000 tons of reinforcing steel. I didn’t realize this, but the Three Gorges Dam in China is 28 million cubic meters of concrete and 256,000 tons of steel. It’s almost 10x the Hoover Dam, which is pretty damn impressive. See what they did there. Annual cement in America, the consumption rose 10x from 1900 to 1928 up to 30 million tons. It tripled again by the year 2000. The peak was actually in 2005 at $128 million and now, it’s back down to about $100 million.

Now, in China in 1980, less than 80 million tons per year. By 1985, they passed the US. In 2019, the output was 2.2 billion tons. So, it’s just over half of the global total. This is an insane thing. If you take 2018 and 2019 and add them together for China’s production of some of concrete, it was the entire US 20th century total of about 4.4 billion tons. In two years, they did what we did in 100 years. And of course, all of these rely heavily on fossil fuels as we keep beating this drum. It’s especially concerning if you’re living in a place that today has low income and is relatively unmodernized in that you have huge infrastructure needs. That’s how you’re going to get onto the modern economy with having lots of infrastructure. And basically, infrastructure comes from these four key materials. So, unclear how we’re going to be transitioning all this stuff.

What Goes Into An Electric Vehicle

Jake: You guys might have seen some of these before. I think it made the rounds on what actually goes into an electric vehicle. Frankly, it’s daunting. The typical lithium car battery weighs 450 kilograms and in that is 11 kilograms of lithium, 14 grams of cobalt, 27 kilograms of nickel, 40 kilograms of copper, 50 kilograms of graphite, and 181 kilograms of steel, aluminum, and plastic. Well, supplying all of these materials for a single car requires processing about 40 tons of ore. And given how low the concentration is of a lot of these elements, you actually have to extract and process about 225 tons of raw materials per car.

Think about just [laughs] the amount of energy required to process and extract all of these things to create, per car, 225 tons of raw material. Jesus, this is quite a Herculean task. The idea of switching everyone over to electric cars very easily, with the current battery technology, it seems like a pretty daunting task.

Anyway, that’s what your modern world is built out of and hopefully, now, you guys can impress your friends at cocktail parties with some random ass facts. [laughs]

Tobias: How much of that stuff do we have left? Is there any word of the constraints there?

Jake: I think we have most of everything pretty readily available. I think it’s just a matter of, how expensive is it to get it out? That’s the question of every natural resource that you want to capture is. There’s always more, but at what price point. You have to dig deeper for it. You have to process lower quality or to get the same amount of the material that you’re trying to get out of there. Therefore, you have to move more of it through. So, I think it’s always a question– Quantity demanded is always a question of, how much does it cost to get it? Or we just figure out how to mine asteroids and then it’s all good.

Tobias: That does sound a bit easier. What’s the name of the book, JT, for folks playing at home?

Jake: How the World Really Works by Vaclav Smil.

Tobias: “Hydrogen is the key transition fuel of the industry.” I’m not sure what that means. Can you elaborate a little bit? [laughs] Yeah, I don’t know where to go with that, JT. China making 2019-2020, was it they made more than the US–?

Jake: 2018 and 2019.

Bill: 2018 and 2019.

Jake: Yeah.

Bill: 2020, we had a thing going on that slowed all that.

Tobias: 2018 and 2019, they made more than the US made in the 20th century?

Jake: Yeah. Huge, huge highway systems, apartments, dams. They’ve just been building and building.

Tobias: Are they all occupied? So, like there’s ghost cities? Is that real?

Jake: Yeah. I think those are real, the ghost cities.

Bill: Yeah.

Jake: I don’t know. It’s an interesting question. One I struggle with– one way I tried to think about some of these bigger capital allocation questions, because that’s what it is at the end of the day like, “What is getting built and is it providing the goods and services that people actually demand?” The further away the decision is made from the actual customer, I think the greater the chance of an entrepreneurial error being made and a misallocation of capital happening. Let’s say, you’re China and you are building all of this stuff. The idea is that it’s going to be providing all this goods and services for your people.

I think infrastructure has a probably better chance of being on point with what society is demanding. But at what quantity? I don’t know. How quickly? I think, boy, to put that much money or to direct that much resource over that short period of time, I think it really increases your chances of having a misallocation of capital, as opposed to going a little bit more incrementally and seeing like, “Okay, well, what’s the uptake? Why build that 150 of ghost city? We should have stopped it 149. But maybe the people just keep coming off from farms and filling these up, and eventually it works out before they deteriorate? I don’t know. But I do think it is a precarious position.

Tobias: How much of a constraint are those rare Earth materials on making batteries? I heard that they work– Musk talks about mining his own lithium, was it?

Jake: Yeah. I think there’s a lot of different rare Earth that goes into there and in different quantities. Again, I think it’s a cost thing. You can probably find them almost anywhere, but at what concentration. And so, you need a higher concentration to keep the cost down. I think the US is in okay shape there from what I understand. I think China also supposedly has good mining capabilities for rare Earth. But I’m not sure how that fits into the rest of the globe like where else.

To give a sense, I know that Africa has been hardly explored at all when it comes to those kinds of things. The penetration of soil in Africa is woefully underpenetrated relative to other places on Earth, because there hasn’t been anyone in there digging around looking for stuff. So, who knows what like gems might be hiding in there eventually? Maybe there’s entire fields of things we don’t even know about, because no one’s really looked.

China Dominates The Rare Earth Industry

Bill: It’s from JPMorgan. “Outside of lithium, mine supply of critical elements is highly leveraged to China with over 60% market share, the Democratic Republic of Congo dominates cobalt production yada, yada, yada.” Chinese companies now own 15 of the 17 cobalt operations in the DRC and controlled 97% of Indonesian supply. The skimming down the page, it’s not just mining lack of smelting and refining capacity also holds the US back on minerals. Today, China controls 85% of rare Earth refining.”

Jake: While we were cancelling each other and doing whatever the hell here. they we’re off securing all these– [crosstalk]

Bill: Buying up the world.

Jake: Yeah, that’s good to hear.

Bill: Yep. Controlling the midstream of the supply chain has helped the country become the world’s leading producer of electronic cars. I don’t know. It’s going to be interesting. They’ve got a chart here. China, it looks greater than 70% of the world’s graphite, it looks like 40-ish percent of nickel, almost up to 80% of cobalt, and it looks like 70-ish percent of lithium.

Tobias: How hard is ammonia to produce?

Bill: I don’t know.

Jake: I don’t think it’s incredibly hard. Yeah, you have important feedstocks. Natural gas is an important part of it. That’s where the hydrogen part of the ammonia comes from. But it takes energy to do it. You basically have to crack or boil this stuff to really high level to get the ammonia out of it or to concentrate it to create ammonia.

So, I think we’ve got a pretty good handle on how to do that now. We’ve been doing it for a hundred years. But again, it’s a cost thing like how much of your feedstock is costing up? If you’ve seen the price of natural gas in Europe, it’s gotten pretty expensive and that’s probably why Dutch farmers are not too happy right now. Their input costs going up a bunch. It’s always at what costs all of these things, right?

Tax On Buybacks

Tobias: This is a bit of a segue, but did you guys see the– I just saw it on Twitter. But there’s a tax on buybacks.

Bill: Yeah, 1%.

Tobias: How does that work?

Bill: I think it goes in next year and who’s her name? Sinema or whatever from Arizona. She wanted it. They didn’t tax carried interest. They put the 1% tax on buybacks for companies that earn over a billion dollars. I think it is of operating income, but maybe its net income. So, it’s an additional tax on capital.

Tobias: So, carried interest got through and buybacks got taxed.

Bill: Yeah. I do think when you look at the numbers is less offensive, but there’s something very offensive about it that I find.

Jake: Yeah, that’s a very plutocratic type of move there. [laughs] Come on.

Bill: Yeah, I don’t know.

Jake: Does anyone have a good counter argument for the carried interest loophole?

Bill: No.

Tobias: Anyone? With a straight face can make one?

Bill: Yeah, no.

Tobias: The argument, I guess, is something like it becomes long-term capital gains is traded to [crosstalk] capital gains.

Bill: Yeah. But they kick on fees that are earned from effort that’s based on– They get a deal and then they throw in a 1% acquisition fee. I get it, but it’s compensation for work that is rolled into a deal and then taxed at favorable rates. It’s all compensation for your normal course of business activities. That’s the problem.

Tobias: But you should be paying a marginal rate on your fee– your management fee. It’s the carrier that gets the preferential treatment. I’m not trying too hard to defend it. I’d rather see that tax and buybacks. But that’s the argument, I guess.

Bill: Yeah. I don’t know what the– Look, net-net, a 1% tax on buybacks and the Republicans tax package a couple of years ago, you’re still ahead of where you were.

Jake: Yeah.

Bill: They’re only taxing in theory Mature Corporations.

Tobias: They in California.

Bill: Yeah. I just don’t understand this whole taxing buyback thing. It’s delusional to me. But if people want to hammer Walmart and mature companies for buybacks, I guess, go ahead. People are going to end up spending 1% more in the store.

Tobias: Can you do that?

Jake: What?

Tobias: Do they have pressing power like that?

Jake: I think a lot of companies do. Like Bed Bath & Beyond didn’t. They’re going to tax Bed Bath & Beyond. But I think it’s funny because the narrative is like, “Oh, well, they’re buying back all these shares to juice their stock price.” I’d like to see an empirical study that actually shows whether or not buybacks impact share prices. I think for every auto zone, there’s a lot of companies that have gone out and they bought back shares the whole way down.

Tobias: Yeah. The research is that they do most of the buybacks at the top of the market and there are no buybacks at the bottom of the market. It’s rare companies that actually do the buybacks at the right time.

Bill: Yeah.

Jake: Yeah.

Bill: I’m a boomer.

Jake: They got more expensive to–

Bill: So, I actually make dividends anyway.

Jake: They got more expensive to hide your stock-based compensation sent.

Bill: Yeah.

Tobias: Sent tweet.

Bill: But it didn’t even, because the serial deluders are not the ones that are going to get paid or they’re not going to get taxed on some of the dilution because they don’t generate income.

Tobias: Smart.

Jake: Next level.

Bill: Yeah.

Tobias: That it real is. That it real is.

Jake: No profits, no tax.

Bill: That’s right. Yeah. So, it’s [crosstalk] weird.

Jake: The other thing, too, about that is 1%. What are we even doing here? It’s just theatrics.

Tobias: Yeah, it’s [crosstalk].

Bill: Yeah.

Tobias: That’s the brokerage and the acquisition.

Jake: Yeah.

Tobias: [unintelligible [00:49:53] the brokerage, it doesn’t make any difference at all. “Would that change my strategy of going after companies with big buybacks?” No. 1% is not enough to move the needle one way the other. As I said, it’s just brokerage.

Bill: Yeah. I’m not selling anything that’s buying in shares right now because of the 1%. It’s an annoyance, but whatever.

Tobias: “Buybacks didn’t turn out well for Intel or Boeing.” Yeah.

Bill: Yeah. Or, Bed Bath & Beyond, or a ton of companies.

Jake: IBM?

Bill: Yeah.

Tobias: Why did Buffett get that one wrong?

Bill: Probably, because he didn’t know what he was doing.

Jake: [laughs] I’ll let you tell him that.

Bill: Well, he was wrong. That’s fine. That’s what happens. If you’re good at the game, you’re wrong. 40% of the time. 40% came out.

Tobias: All right, here’s a question from the crowd, from Lorenz Müller. Müller, Müller. “What sectors are truly hated in your view except cannabis?” Energy, oil, and gas.

Bill: I don’t know, man, oil and gas got so loved for a while. It was impossible to do anything without hearing about oil and gas. I’m glad that period is over.

Jake: [laughs]

Tobias: It’s still smaller than it has been traditionally as a proportion of the stock market. Total capitalization.

Bill: Yeah.

Jake: Yeah.

Bill: I don’t know that it’s going to revert.

Jake: Boy, I should [crosstalk] on Exxon.

Bill: Anything cyclical– [crosstalk]

Jake: They’ve had some big quarters.

Bill: Yeah.

Why Warren Buffett’s Buying OXY

Tobias: Buffett is betting hard that it is. I’ve seen he’s bought Chevron and he’s bought– He’s still buying OXY.

Jake: OXY.

Bill: He’s going to own the whole thing. OXY is a special situation just isn’t yet, but it is.

Tobias: Why do you think it’s special situation?

Bill: Because he’s going to take it out.

Tobias: But why does he want it?

Jake: Because there’s tons to cashflow.

Bill: I am not really sure. Yeah. I think Charlie has been pretty adamant about wanting to own– thinking that if you can control production and the capital allocation of oil company, and you can restrict how much you’re going to drill over the long-term that’s going to work out okay. The rumor that I heard is that they view this as a real 10-year plus investment. So, if that’s the case, I could see wanting to have fewer people control how much they’re drilling and by fewer, I mean, Berkshire.

Jake: [laughs]

Tobias: That’s time, amigos. We made it.

Bill: No, we started late? That’s a shame. People are going to clamor for more.


Tobias: We’ll leave them wanting more for next week. [laughs]

Jake: Well, [crosstalk] really. [laughs]

Bill: All right.

Tobias: All right, fellas– [crosstalk]

Bill: Well, enjoy the bear market. [violin sound]

Jake: [laughs]

Tobias: Finally, got the soundboard.

Jake: Yes.

Tobias: All right, fellas, see you next week.

Bill: All right. Good show, gents. [applause]

Tobias: There we go.

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