In their latest episode of the VALUE: After Hours Podcast, Bill Brewster, Jake Taylor, and Tobias Carlisle discuss:
- Tera-Caps and Tech Outperformance
- Trend Following Keeps You Out Of The Waterfall
- Michael Mauboussin: What Does a Price-Earnings Multiple Mean?
- Where Have All The Bear Market Hedges Gone?
- Warren Buffett Runs Berkshire Like The Fed
- There’s Nothing New: QE in the Financial Crisis of 33 AD
- The Price Of Time
- Why Warren Buffett Is Buying Energy
- Low Interest Rates Historically Are The Calm Before The Storm
- Interest Helps Eliminate The Industrial Unfit
- Financial Compliance Nonsense
- The Road To Serfdom
- DOJ Antitrust Big Tech
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:
TOBIAS: And we are live. It is Value: After Hours. It’s 10:30 AM on the West Coast, 1:30 PM on the East Coast. Joined as always by Jake Taylor, and Billy Brewster is back.
Tobias: He’s mid-move.
Bill: Yes, I am. I’m under construction. So, I’m going to mute myself for a lot of this.
Jake: Oh, boy.
Bill: But it just went off, so I can think. I might have to take my shirt off. It’s hot, quite hot with the front door off in Florida. [crosstalk]
Tobias: Maybe even hotter if that happens.
Bill: Hey, yo.
Jake: Hit ’em with it.
Bill: Hey, yo.
Tobias: Finally get some views on this podcast.
Jake: Yeah, it’s the Thunder Down Under.
Bill: I’ve never heard that from myself. But I don’t think I’m what’s going to get views. But we’ll see. YouTube might flag it as potentially offensive content.
Jake: Yeah. There’s too much brown sugar in that oatmeal. [laughs]
Bill: Hey, now.
Tobias: I’ve got to do a roundup, fellas.
Jake: Okay. Yeah.
Tobias: Nashville, London, Los Angeles, Nova Scotia, Toronto, Gothenburg, Sweden, Amsterdam, Scotland, Altamonte Springs, Florida, Valencia, what’s up?
Tobias: Kirchheim, Teck. What’s up, fellows? Glad to have everybody join us.
Jake: Yeah, it is warm in California right now.
Bill: Yeah, how hot? I hear it’s hotter than all [unintelligible 00:01:29] get out, as they say.
Jake: Today is forecast to be 115 degrees at my house.
Bill: Oof. No, thank you.
Tobias: 82 for me.
Jake: And I did not move to Phoenix, last time I checked.
Bill: Yeah. No, thank you.
Tobias: [crosstalk] or the sun.
Jake: Oof, it’s a little warm.
Bill: Florida summer’s not so bad this year, relative to the rest.
Tobias: How close are you to the beach?
Bill: We are very close.
Tobias: That’s always helpful.
Jake: That’s nice.
Bill: Where I am, I get a breeze most of the time, which is important.
Tobias: Roman Empire’s checking in. Good.
Tobias: “Offshore Gas Platform, Israel.” That might be the winner. Offshore Gas Platform.
Bill: Nice. Send us some scuttlebutt.
Jake: [chuckles] Or, some energy. I think everyone needs it right now. [laughs]
Bill: That’s right.
Jake: Ship it over to Europe.
Jake: What’s on tap for today, boys? What do we got?
Tobias: I have Chris Leithner.
Jake: Oh. Yeah.
Tobias: He’s a deep value friend of mine, wrote an article over the weekend looking at “Does tech outperform just by virtue of the fact that it’s tech?” No, but he has some interesting stuff. Just we were talking about tera-caps. [crosstalk] [laughter]
Tobias: There was some interesting stuff. You were talking tera-caps. I actually hadn’t heard that term before you use that last week or whenever it was. So, he looked at the tera-caps and he’s got some– He said, “Take these growth rates. Project them forward five years.” We’re going to go and do that exercise again. It’s a Jake [crosstalk] type exercise.
Jake: We got to own the world.
Jake: Oh, all right.
Tobias: And yeah, some interesting– I’ve stopped saying this stuff is impossible, but it’s an interesting thought process. What about you, JT? What do you got?
Jake: Well, we’re going to be unpacking some treasures from Ed Chancellor’s new book, The Price of Time. And it’s going to be a little bit all over the place, because I just went through, and took all my notes out of it, and I’ll just pick and choose some good quotes and some good ideas.
Tobias: Hit them with us.
Jake: Yeah, we’ll bounce around a little bit. It’s not going to be a nice, coherent narrative. Sorry.
Tobias: You’re still reading the hardcover? You like the–
Jake: Yeah, my physical book reader still.
Tobias: You don’t Kindle?
Jake: I love the idea of being able to copy and paste to the Kindle, and it seems a really smart way to do things, and traveling is obviously nice, but I just do not retain the information like I do when I read a hardcover and write it, and then go back through and transcribe out my notes. If the whole point of it is to learn from it, it’s inferior for me going Kindle, even though the wife is not happy about all the books that I have in my office. We had a little conversation about that recently. [laughs]
Tobias: I had to throw a whole lot of them away. I had to throw away 10-
Jake: 10,000 books?
Tobias: -legal boxes of those things and I get them on the Kindle these days, because it’s backlit. It doesn’t wake up the baby sleeping in the room. That’s not a problem for me anymore, but that was the original reason. And now, you can make the text bigger, which is important. I’m on the second to largest text on that.
Jake: Uh-oh. Eyesight’s gone. [laughs]
Bill: So, if I’m looking at your phone on the plane, can I read what you’re [crosstalk] from four rows away?
Jake: It’s on grandma mode.
Tobias: All right. For the reason that I don’t like people looking over my shoulder, I just squint my way through it. But at home, it’s comically big.
Jake: No one’s going to be able to read it. [laughs]
Bill: You should just have your background picture of you in a thong. And then if anybody looks, there’ll be disgusted. Not for being in a thong. We can take a shot at me, not you. Though it would be odd for you to be looking at me every time you locked your phone in that way.
Bill: Anyway, I digress. I think the point of reading books is to signal how many books you’ve read, Jake. That’s the problem. You’re trying to learn.
Jake: Good point.
Bill: Yeah. So, you’re welcome for that.
Jake: Yeah, it’s good.
Bill: I don’t know. I’m going to– [crosstalk]
Jake: I think you might–
Bill: Yeah, that’s true. I’m going to talk a little bit about Mauboussin, Mauboussin– Michael Mauboussin, I should be able to say it by now, but I can’t. I read a paper in January 29th 2014 that circulated on the Twitter machine, and it’s about PE ratios, and then how to think correctly.
Jake: Ooh, I like it. That’s some veggies.
Bill: So, I thought it was a decent– [crosstalk] Yeah, I didn’t think I’d get all that much out of it. And then, I was reading it, I was like, “This is actually pretty good.” Imagine that. He’s way smarter than I am.
Jake: Imagine that the GOAT coming through with a good, nice research paper.
Jake: He’s so prolific at publishing. I don’t know how he does it, honestly.
Bill: I don’t know either. I can’t do anything that consistently for a while.
Tera-Caps and Tech Outperformance
Tobias: Fellas, let me kick it off with these things.
Jake: Yeah, bring it.
Tobias: Because I just have some statistics. It’s not going to take a long time, but it kind of kick us off for a discussion about the assumptions that we’re making. The tera-caps, for people who don’t know, because I didn’t last week and I hadn’t heard that term before, but Apple, Amazon, Microsoft, Meta, and Google.
Bill: May or may not be any more, but yeah.
Tobias: Yeah, that’s fair. But I think it’s still top five or at the time this was done, top five. This is pretty recent, last week or so. So, Apple has grown since– I think this is since listing or since the data– He could find the data to ’85. This is the longest term possible that he could figure it out. The 25-year compound annual growth rate for Apple 22.3%, for Microsoft 25.7%, for Amazon 34.8%. At the size that they currently are, Apple is 11% of GDP, Microsoft is 8.5% of GDP, and Amazon is 5.7%.
If you take those growth rates and you project them forward five years, Apple gets to $7.6 trillion, Microsoft gets to $6.7 trillion, and Amazon gets to $6.3 trillion. Net GDP today is growing at about 3.5%. You project that forward to 2027, so five years forward, it gets $29 and a half trillion in GDP. Which means that those three, the tera-caps will be 70% of GDP. Now, I get the way of comparing a flow against a stock and you’re not allowed do that but it’s just to demonstrate the size of them.
Jake: Starting to talk about some real money there. That’s a lot.
Tobias: Does that mean we’re all just working for one of those five, and everything else like– We’re working for YouTube here, I guess.
Jake: Yeah, good point.
Bill: We are doing that.
Tobias: He makes a point that the valuations aren’t particularly stretched for the top five. But when you project forward relative to the size of the entire stock market or the entire economy, they’re getting a little bit big. Is it possible, is it sustainable? Has size forged its anchor, as Buffett likes to say?
Bill: Well, Buffett’s buying Apple right now. So, I doubt he thinks it does for Apple.
Jake: Is there any concern that, what, I think four out of those five sell advertising as part of their revenue base?
Bill: Yeah, you should be.
Jake: Which is historically been a procyclical business.
Bill: Yeah, I think the pushback, just looking at Apple, 45% of the revenue is in the Americas, it looks like. Hang on, let me get to the right column, 42. 24% in Europe. Got to love the Europe exposure right now. 18.7% in China, 7% in Japan, and 7% in the rest of Asia-Pacific. So, I’m just not sure GDP is quite the right metric.
Tobias: Yeah, that’s fair.
Bill: You’re talking about real global companies here.
Tobias: You could switch it around to gross national product, which would be what US companies earn globally. So, resident companies owned globally.
Tobias: You will find that it’s exactly the same numbers GDP. I don’t know how that works out, but they’re very, very tied together. So, it doesn’t change the analysis much at all.
Bill: Yeah. I guess. Google’s 54% international, 45% US. I don’t know. That would be the only quibble that I have. But I don’t disagree with the thought. This is what we were saying when all the stocks that were frothy, to say the least, I said, “If that group is correct, then they’re basically going to suck up all the economic profit in the US.” I don’t see how the math would work otherwise.
Tobias: The argument for these big five, isn’t that almost literally the argument for this big five being able to sustain the size that they are, that nothing competes with them really like that? When you look at how big they are relative to every other company, all of these companies could go on by themselves on an airline to fly everybody around?
Jake: Airline would never even notice. Those are time– [crosstalk]
Tobias: It wouldn’t notice. Yeah, it wouldn’t notice. The relative size is so much bigger.
Tobias: Is it in fact the case that they have actually extracted all of the economic profit from all these other businesses, because everybody’s compelled to advertise on Google, advertise on Facebook, buy Microsoft products, so on, buy Apple products? Is it fair that they are valued that way?
Bill: I think it’s hard to argue that it’s not fair. If it doesn’t work out, I think you look back and say, “Well, it’s obvious.” But Apple, they fucking take 30% of every transaction that’s digital over their platform and they do it because they can. In retrospect, I think it’s bogus that Microsoft doesn’t get 30% of everything on a PC. What a missed opportunity.
Tobias: Don’t give them any ideas, mate. [laughs]
Bill: As someone that owns a stock-
Tobias: Get a tail on it.
Bill: -I’ll be fine with it. This is garbage that Apple can do this. Not to mention their apps suck now. My buddy was just bitching about Apple Music. Apple Podcast is laughable. But somehow, they just work.
Jake: Yeah, you could make the argument that Excel is undercharged for given how useful that is in the world.
Tobias: Central to the–
Jake: Everything, right? [laughs]
Tobias: It’s like energy. It’s in everything. Yeah.
Jake: Yes, it’s the RuBisCO if we would go back to that segment on–
Bill: But yeah, the service is growth. Just in Apple, you’re looking at 2018, it was $39.7 billion. Today, it’s $68.4 billion and it’s a lot of margin. That’s $47.7 billion of gross profit on $68.4 billion of revenues. There aren’t many businesses historically that have done anything like that, and that own 89% share of American teens, and are going to tax everything that’s built upon them in perpetuity, unless somebody steps in and stops it.
Tobias: [crosstalk] Google is the first company that really makes money. Yeah. I saw a tweet today the amount of money that they’ve spent on lobbying antitrust.
Jake: Oh, yeah. One stat from this price of– [crosstalk]
Tobias: Good ROI.
Jake: We will get to. Yeah, real good ROI.
Tobias: Let’s get segue across this– [crosstalk]
DOJ Antitrust Big Tech
Jake: That’s okay. We don’t have to go all the way. It’s just that 2014, there were zero DOJ antitrust cases filed. And the year after, we had an insane– I forget. We’ll get to the number, but billions and billions of dollars of M&A activity after that. [laughs]
Bill: Yeah, the thing about Apple though is– I don’t know what happens at the App Store. It drives me insane that they’re allowed to do that. But even if you were to file, it’s not a handset issue, because there’s plenty of handsets that people could choose. Like I said, something like 80% of US teens are choosing the iPhone. So, I don’t know that you can argue it’s a hardware issue. Can you decouple the software and the hardware? I don’t know.
Tobias: Where was Microsoft when the DOJ came down on them on the platform, on the desktop market?
Bill: Well, I think what– [crosstalk] Yeah, and they just tried to install a browser. Imagine, they should have taken 30% of everything. What a fucking miss.
Jake: Yeah. [laughs]
Bill: They just weren’t thinking big enough.
Tobias: Because Apple got themselves into that same position, they haven’t? They’re now where Microsoft was. And if they take 30%– [crosstalk]
Bill: It’s complete garbage.
Tobias: If you’re taking a 30% clip of everything that’s going through, you’re painting a big target on you.
Bill: Yeah. It’s not everything, right? It’s just digital goods. But if you’re on Roblox, they get their take no matter– They didn’t develop it. The Twitter, the stupid Super Follow things that I do, I’m on the desktop Twitter 98% of the time. The only thing that Apple is facilitating between me and the users is EasyPay and they’re taking 30%. Visa takes 2%.
Tobias: Why did they let Apple do that? Why do they use Apple and why don’t they use a payment platform?
Bill: Well, they have no choice. Well, because they’re on the app and they want Super Follows through the app. If you’re doing it through the app and it’s a digital experience, Apple gets their take. It’s the greatest toll road ever. It’s ridiculous. Shit, I don’t know, if it continues, but looking at it today, I don’t know how you can say, it’s egregiously valued.
Tobias: So, the risk is regulatory. What about VR? I guess, what’s the other tangential technology, I guess, that moves you off the fine to the next thing?
Bill: Yeah, but they’ve demonstrated a pretty good ability to go out there and copy. They’re not really known as innovators as much as they are really good copiers.
Bill: I don’t know, 4% cashflow yield on Apple looking at 2023 estimates? That can work.
Tobias: It’s not that–
Bill: It’s only 25 times. Eventually, it’ll go into 10, but how big [crosstalk] thesis.
Jake: What would Mauboussin say about that PE?
Bill: I think he’d probably say that you have to think about how long that competitive advantage period is going to exist and what the returns on incremental capital are, and then apply some sort of fade rate, which you can argue whether or not base rates even apply to a business that’s decoupled from base rates for this long. I don’t know that base rates apply to N equals one. How many businesses in history have grown from $143 billion in revenue to $198 billion in revenue in two years?
Jake: The base rate always applies, eventually.
Bill: Yeah, okay. But the when is a very important question.
Tobias: You don’t think these businesses are different? Google was a different business to anything that’s gone before. Microsoft is a different business to anything– Apple, maybe that–
Jake: But is it? I could say that Google is just the combination of multiple businesses that existed before like Yellow Pages.
Tobias: That was a great business.
Jake: Postal service.
Tobias: That’s good business.
Jake: Well, what else? Putting up posters, advertising agencies. I don’t know. Let’s just– [crosstalk]
Jake: Classifieds, sure.
Bill: I don’t know. It’s going to be hard to displace.
Tobias: It’s like they’ve aggregated all of those newspapers all together into one place and their marginal cost is minimal. Those are pretty good businesses.
Bill: Look, eventually, the earnings multiples will be 10 times. But if it’s a trillion-dollar revenue business putting off $300 billion in cash, still got a lot of ways to go. I don’t know.
Jake: That’s a $3 trillion business?
Bill: Yeah, arguably. I don’t know. It maybe– [crosstalk]
Tobias: Well, [crosstalk] stick it in the 10-year and earn three point something percent. So, you’re already ahead of the 10-year and it’s growing, and they’ve got lots of levers that they can pull.
Bill: [crosstalk] I think the thing that’s hard about this is it makes sense. Intuitively, it makes sense. But here, you’ve got Berkshire’s out here– I think we’d all agree, Berkshire knows how to invest. They are buying Apple and Amazon as of recently. So, I don’t know. It makes the game hard.
Tobias: Snowflake. Few other things are in there.
Jake: Yeah. Well, if it was easy, we’d have nothing to talk about.
Tobias: That’s true.
Tobias: Who wants to take it?
Bill: Jake, go ahead. I don’t know, unless you want me to piggyback but I would just say, it actually is a natural segue.
Michael Mauboussin: What Does a Price-Earnings Multiple Mean?
Bill: This paper, it was written January 29th 2014. I’ll send it to Toby, so we can drop it in the show notes. But Mauboussin saying that he used– Here’s another one that I’m going to mess up that I shouldn’t. Damodaran said that an 8% cost of capital is what you should use generally. So, Mauboussin said that the multiple that he was anchoring to is 12 and a half times PE. And basically, steady– [crosstalk]
Jake: Inverse of 8%.
Bill: Yeah. Steady-state value is your NOPAT, so net operating profit after tax normalized divided by the 8% cost to capital plus excess cash. If you want to start using growth, the paper goes on to say that the growth should be growth that delivers more than the cost of capital. Otherwise, the growth isn’t actually adding any value, especially because you’re discounting it back. So, then you’ve got these two components of your steady-state value and then your future value creation, I think one of–
I’m pretty sure I’ve said it in the past. I think expensive in small can work. I think expensive in big is really tough to make work. And the reason that I say that is you’re paying a lot. Your steady-state base that you’re paying for is quite high. So, then you need the future base to grow into the valuation that you’re paying for, and that’s really tough. But as we just talked about, there’s five companies that have proven that thought wrong here for a long time. So, I don’t know, it’s a very interesting paper. He got me hooked when he said–
Jake: Five out of hundreds of thousands.
Bill: Yeah. But they’re also five that could have changed your life.
Bill: I don’t know. It’s arguably, a decent reason to have some exposure to something like that. I don’t know. But based on year end 2013 prices and 2014 consensus earnings estimates, Apple and Edison International, both at a PE of 12.8%. And that’s the hook that I was like, “Oh, that’s interesting.” And then, he goes in to discuss how he breaks down everything. So, I think it’s a great read.
Jake: That is interesting. One, I assume a utility, probably being priced based on people reaching for yield, I think, at that time period, right? Nothing on your bond portfolio. I need something safe. They bid up the price of a utility. That was happening then. Versus another one that I think probably the narrative at that point was that, “This is so big, it can’t grow further than this. Eventually, this has to roll over revenue numbers, and therefore, discount the– fade the multiple on it.”
Jake: So, very, very different stories-
Bill: Some more product stores.
Jake: -coming together this way and meeting at 12.5.
Bill: Yeah, single product story or people going to start to defer iPhones. How many people are still going to upgrade their phone? Look at every other phone company in history, they’ve gone away. So, Apple’s cashflow, return on investment, or on invested capital, it looks like it was 25% versus Edison Internationals was 5% and the– Sorry for the noise. The five-year expected growth rate was 50% for Apple and 7% for Edison. And Apple was net cash and Edison had a healthy amount of debt. So, it’s interesting how the same PE– [crosstalk]
Jake: What’s not to like?
Bill: Yeah, that’s right. I don’t know. That was the hook that got me into it, and then I started reading, and like I said, he’s always good to get people thinking. So, it was one that I would say is probably worth the 20 minutes or so it’ll take to get through.
Tobias: What do you think about the discount rate, that 8%? Is that 2014-
Tobias: -that he proposed that and that was based on the inversion of the PE? Is that how he got there?
Jake: Kind of the other way around, probably. I’m going to guess that that was some weighted average cost of capital calculation with the [crosstalk]
Tobias: Okay. Makes sense.
Bill: Yeah, I don’t know how he did it. But every time that I’ve ever seen him break it down, it seems very– The man has a process. Let’s put it that way. And then, I don’t know how to articulate it.
Warren Buffett Runs Berkshire Like The Fed
Jake: I would also push back that every time they asked Buffett and Munger about cost of capital, they say, “We have no idea what ours is. It’s a stupid concept. We would never even calculate that. Who cares? You should be thinking about opportunity costs, not cost of capital.”
Bill: Yeah. But then the other thing is, didn’t Buffett charge his portfolio companies 15% to use the debt?
Bill: So, he’s got to have some costs– [crosstalk]
Jake: Even more when rates were higher.
Bill: Yeah. I think what they’re probably, actually saying is that we have a cost to capital. But if you ask us to put an equity risk premium and beta weighted, we think that’s all nonsense.
Jake: Buffett runs Berkshire like the Fed should be run, which is all the capital you want, but it’s going to be very expensive to get it.
Tobias: Is that to encourage them to go outside to get the capital elsewhere or is that to encourage them not to use–?
Jake: It’s to encourage them to be judicious in their use of capital from Berkshire.
Bill: Yeah. I think it is also to incentivize going outside, but yeah. The thing is the companies that Buffett’s buying really don’t need that incentive. But if you think about most people, you don’t want to give them an easy way to get capital that’s cheap. It tends to get people fat and lazy.
Tobias: There’s a good question here. “What was Buffett buying in 1973-1974?” We don’t know, dude. Because the letters start in 1977. Was that [crosstalk] partnership?
Jake: No, he had wounded up by then. I think that was the little lull in between. He was still doing stuff. So, BPL had been wound down already.
Jake: But Berkshire was around, and he was working on it, but they were doing– [crosstalk]
Tobias: Hadn’t announced anything yet.
Jake: Yeah. I think he was doing just a lot of smaller private stuff too.
Jake: Well, they bought See’s in ’72, I think? [crosstalk]
Tobias: Yeah. Oh, well, there you go. This answer, just buy See’s Candy. Look out for See’s.
Jake: Yeah, that helps.
Tobias: Let us hope all of you find one. [laughs]
Bill: Yeah, and it’s got to be kind of cheap.
Tobias: Yeah, he wasn’t buying a lot of gold around that time, when that was popular. It was more popular.
Why Warren Buffett Is Buying Energy
Tobias: Not a fan. Now, he is buying energy. Is that a narrowing of the opportunity set or is that–? What’s the energy view, that it’s returning capital? Is that the main thing that he’s grabbed onto?
Jake: I think he likes to see that a management team commit to the cap allocation strategy of a return to their shareholders of a percentage of net income or whatever flow you want to use. You’ve seen him referenced that multiple times, whether it was PetroChina. I think a slide that he talked about for this most recent one with OXY. So, I think he just likes to know like, “I’m getting my money back here sooner than later and anything else good that happens is nice to have. But at least, I know I’m getting my money back pretty quickly.”
Bill: Yeah, I don’t think he’d be doing energy. I don’t think he’d be buying Occidental today if he was a young Buffett. Some of it’s size.
Jake: He can pile a lot of money in there.
Bill: Yeah. I don’t know. I wouldn’t be shocked if he was doing one of these Holdco. A lot of guys at capital camp are doing this. I could see him doing something like that, where you’re buying cheap industrials trying to suck the equity out through refinancing and rolling it up.
Jake: I do find it funny when Buffett laughs at all of us about, how easy it was for him to get in or out of something like volume wise like, “Oh, I couldn’t believe I was able to punch out of the airlines so easily.”
Tobias: [laughs] Yeah, that was– [crosstalk]
Jake: Basically, just rubbing it in all of our faces in a discreet way.[laughter]
Tobias: That was funny.
Jake: Yeah. I think he said something similar in the last meeting about OXY, surprised how much money he could get into it so easily.
Bill: He wasn’t right on the airlines.
Tobias: Corrected the error though. Makes mistakes but corrected the error, just like no wrong punch out bye.
Bill: Well, I’m saying when he punched out.
Tobias: Oh, he punched out — Well, he’s not measuring by stock price performance. He is measuring the quality of the business right there.
Tobias: The thesis was, everybody’s going to compete in a more gentlemanly fashion than they have in the past rather than undercutting each other and having the massive capital investments in new plans and running it whenever a new competitor comes in, because somebody else fails to get cheap planes and they compete on nothing. They’re not going to do that anymore, because the slots are fixed. And then, it turns out that the business is massively cyclical. You can just shut down the entire world. This business don’t work. So, I think he changed his mind.
The Price Of Time
Jake: Yeah, who knew? All right, shall we bang out some Chancellor?
Tobias: Let’s do it.
Jake: All right. Let’s see. This is The Price of Time by Edward Chancellor and it’s all about interest rates. So, the history of interest rates and then especially a focus on what’s happened in the last 10 years.
Tobias: See how that same chart that shows that interest rates have come down since 6000. BC, when some king went to another king, some amount of money for 60%?
Jake: Yeah, of course, he does.
Tobias: And now, it’s zero. So, therefore, interest rates, you can just draw a straight line all the way– [crosstalk]
Jake: I have five millennia of interest rates.
Tobias: There we go.
Jake: It’s page one.
Jake: [laughs] He goes through and really starts it off in a very much Austrian economics sort of mindset, as far as I can tell. He’s referencing Henry Hazlitt and economics in one lesson about, “How often it is that we as humans have this tendency to only look at the immediate effects of a policy and not look at all of the effects for everyone? We focus on one special group, and we ignore what happens to everyone else and including the secondary unintended consequences?” This book could have been called Unintended Consequences, basically. Some of the historical things are really interesting. He says that “Mesopotamians charging interest on loans before they discovered how to put wheels on a cart.”
Jake: We’ve had we’ve had interest and debt basically, since before we had wheels. The Latin for interest actually connotates the concept of fertility and money is derived from the word for like a flock. And capital actually comes from like head of cattle. So, these word etymologies, they’re all based in farming and things that are growing on their own, like, there’s fertility to it.
Finance Was Born In The Shades Of Sanctity
Another interesting observation. The finance was born in the shades of sanctity and that was because like religious temples were some of the biggest providers of loans early on. A lot of that I think has to do with trust in a system. You figured maybe the temple wasn’t going to screw you over, I don’t know. There were regular debt crises throughout history, especially Mesopotamian history. Even every 50 years, they’d proclaim a debt jubilee and basically, write off all of the debts.
There’s Nothing New: QE in the Financial Crisis of 33 AD
Jake: Interesting fact. The first experiment and quantitative easing was in AD 33, when a banking crisis erupted and emperor, Tiberius decided to lend out the imperial treasure free of interest to all of the patrician families. That’s another thread that runs throughout this book is that there is absolutely nothing new under the sun, as far as what we’ve been doing, what the expectation should have been as to where this was going to lead. Everything turned up to 11 is basically, the underlying message.
Low Interest Rates Historically Are The Calm Before The Storm
Another little bit sobering thought is that the very low interest rates appear to be a calm before a storm, historically. In Neo-Babylonian, the rates on silver dropped not long after that Babylonia fell to the Persians. 18th century, Holland saw rates drop not long before that the Dutch Republic was overrun by revolutionary France. Time after time, low rates are this eye of the hurricane that then just shit happens after that.
Another thing that we probably should have predicted. When emperor, Augustus, who was one right before Tiberius, he flooded Rome with treasurer. Interest rates dropped and the house prices rose in Rome. All these same things that we’re seeing have happened. Irving Fisher, who was an economist in 1930s has a nice quote in here about, “Interest is human impatience crystallized into a market rate.” So, a lot of it has to do with the time value of money and how do you coordinate the action and the economics through time. And that’s one of the jobs that the interest rates it does.
He goes into Böhm-Bawerk, who was an Austrian economist talking about how the decline in the rate of interest leads to the adoption of more roundabout or time-consuming methods of production. The lower the interest rate, the more that we put the emphasis on future goods as opposed to now, which makes me wonder like, “Is this how we ended up with shortages today,” is that we had all these low rates that then led people into these very futuristic thinking of, let’s build spaceships for space tourism as opposed to like, “Well hey, shit, we might need some energy between then and now.” So, we under invested in a lot of basic things that–
David Einhorn has talked about this right before, like, all these basic industries were starved of capital, because we had these very futuristic. And interest rates that are artificially low push entrepreneurs into that thinking, because of the time value of money.
He goes into a bunch about John Law and all of the craziness that that guy was able to execute through the Mississippi bubble, which is, probably, deserves its own segment at some point.
It goes into Richard Cantillon, who if we remember was the one who had this idea of Cantillon effects. But Cantillon said that when a national bank turns on the printing press and buys up government debt, the newly created money is initially trapped within the financial system, where it inflates financial assets rather than consumer prices and only slowly seeps out into the wider economy. Boy, if that doesn’t describe the last 10 years– [crosstalk]
Tobias: Yeah. Even loss five.
Jake: Cantillon in writing in 1700s, all this stuff is just nothing new.
A lot of stuff on Walter Bagehot, I think is how you say his name, B-A-G-E-H-O-T. And this was a guy that was born into a banking family, worked as a as a banker, and then became the editor of The Economist in the 1860s, all the way up until his death in 1877. And he had some great quotes about, “The good times of high prices almost always engender much fraud.” You hear Chanos saying that we’re living in a golden age of fraud right now.
Another one. “Bad business takes time to grow, especially bad lending business, which is the most dangerous, because when discovered, it saps credit and destroys the spring of industry.” This idea of financialization of the economy leading to this reckless investment that then destroys the actual industrial output.
Another great one was that John Buell, which was like John Q. Public in Britain at that time. John Buell can stand a great deal, but he cannot stand 2%. Another quote like, “People won’t take 2%. They won’t bear the loss of income. Instead, they invest their careful savings in something impossible. “A canal to Camacho, which is a place in Russia, a railway to watch it, a plan for animating the Dead Sea, a corporation for shipping skates to the torrid zone, which is almost like ice skates into hell.
He had several of these kinds of jokes about how basically, people can’t withstand this low 2% return. Its yield chasing, basically. That’s what he was talking about. In some of them, he made jokes about people investing in a wheel for perpetual motion. And then another one was, for an undertaking, which shall in due time be revealed, which is basically early SPACs, right?
Jake: He’s talking about like, “Well, we don’t know what this business is going to do yet. But we’re going to put money in here, so we can go by it and figure out what it’s going to do.
” Let’s scroll down a little bit. He goes in quotes, a lot of like William White from the Bank of International Settlements. He was this guy that was one of the truth speakers at 10 years ago, especially. And basically, he’s just pointing out all the unintended consequences of low rates and what happens.
Interest Helps Eliminate The Industrial Unfit
And actually, low rates be getting low rates after that. And a lot of that has to do with this zombie company argument where this really interest helps the natural selection of less competent employers and inferior processes. And so, “Interest helps eliminate the industrial unfit” is how he says it.
And so, the productive forces of the community are better utilized when we have higher rates. And so, one thing he points out that is, the default rate on US junk bonds after the GFC was half of what the average of previous downturns was. We basically kept a bunch of companies on life support through cheap debt in which the zombies then, because they glob up the system and don’t let it find a healthy equilibrium, they keep rates low after that.
You see that in Japan, this very sclerosis that has set in over so much time. It’s shocking.
He gets into the US Forest Service firefighting. Before 1934, I didn’t realize this. But they only would fight manmade fires before 1934. And then after that, they had this policy called the 10 a.m. policy, which was “Every fire has to be out by 10 a.m. next morning.” And so, of course, as we all know, that built up into these– The fires keep getting bigger and bigger and more destructive, and the analogies are obvious as to the fighting fires in our financial forests.
Like I’d mentioned before, 2014, the DOJ file, not a single antitrust case. The next year, global mergers top $5 trillion, half of that in the US. And actually, the number of US companies listed has haved from 1996 to 2016. So, we’ve seen this huge consolidation. Pretty rough on private equity. He says that, “No set of individuals benefited more from the Feds easy money than the buyout barons. None were less deserving.” [laughs] Let’s see. Let’s the good stuff here.
This is interesting. In 1899, the President of Equitable Life, which is an insurance company asked all the respected financiers of that time period, the future course of long-term rates. And yields at that point in 1899 had been falling for decades, similar to where we might find ourselves today. All 69 responses that he got said, it was basically going to be lower for longer. And they were all wrong.
The bond bull market had already ended and US Treasury yields rose for decades after that. So, these turns in the bond market occur very infrequently. But when they do, they last for decades at a time. The question may be, where are we at? We don’t know if we’re in one of those, but it looks a little bit that way, if you look at the chart. [chuckles]
Really rough on China, actually. He talks a lot about how much just the expansion of credit has been there. The one interesting thing about international banking rules, so like, Basel, all that. Basel I in 1988, 30 pages. Basel III in 2011, 616 pages. We’ve just seen this complexity of just insane amounts.
Hyman Minsky pointed out in the 1930s that, “The financial innovation is really just like a code word for the intention to get around regulation that was put in during the last crisis.” And so, actually, he made it’s comparable to the Maginot Line in France, which was this huge wall and structure that was built to keep the Germans from invading France again. And basically, the Germans just went right around it. So, basically, all the financial innovation is just to get around the Maginot Line of the previous regulations.
The Road To Serfdom
Last thing we’ll get into is, he talks about The Road to Serfdom, which was Hayek’s famous treatise on too much government intervention and where that leads. And so, I’m going to quote this last little bit. “So far, each step that we have taken on this new Road to Serfdom has been incremental and justified on the grounds of expediency. Little thought has been given to the general direction in which we’ve been traveling. We’ve blundered to use Hayek’s term into greater government control of the economy. And the more we blunder, the more the system appears to fail, which in turn justifies further interventions.”
So, lots of good stuff in this book. I was joking before we started that it reads a little bit like if you had just been following Zero Hedge for the last 10 years of all the stories that are in it, but then applied some academic rigor to it. But if you’re of an Austrian bent, and if you liked the history of finance, and Chancellor’s, probably the best financial historian alive today, I think. That’s probably a fair argument. So, check it out.
Tobias: Yeah. Devil Take the Hindmost is one of the best books I’ve read.
Tobias: I’ve bought the new one, but I haven’t read it yet. Yeah, that was great. Thanks, JT.
Jake: Yeah. Sorry, it went on a little longer than I was– Actually, I’ve only hit about half the things that I’ve written down. So. [laughs]
Tobias: No, we need it. We got 15 minutes to go here. We might need to come back to those.
Jake: Yeah. [chuckles] And I’m not going back. [laughs]
Tobias: Do you think that the unintended consequences stuff, do you think that these consequences– Everybody knows what happens, if it’s just that they say. The crisis right now is so important that we’ll just take these consequences when they– That’s future. That’s a problem in the future. That’s not a problem now.
Jake: Give me chaste, but not yet.
Tobias: And now, we have the–
Jake: Bigger problems?
Tobias: Now, we have the unintended consequences. So, now, we’ll just deal with those with more interventions now. Solve that problem down the road.
Jake: It’s quite possible that reset is the only actual out for this. I don’t know. I don’t know what that looks like exactly. I try not to think about it too much, because it’s scary. But you just look at how the puzzle pieces all fit together and it’s like, I don’t know how you ever get off of this road without just cathartic tear down and rebuild in a new image.
Tobias: You keep on kicking the can. You put the problem up to the next level of government and then eventually get to the point where you blow up, because there’s no one above you to bail you out.
Jake: We need an alien, a line of credit to Mars or something. [laughs]
Bill: What’s so bad about the road we’re on?
Jake: [sighs] Ah, well, I would say that Chancellor would say that, “It leads to the realization that there was a lot of very unproductive investment that will need to be liquidated or the change hands and that’s very painful. The further that we fight that the less growth we have, and the less growth we have, the more likely we are to probably be at each other’s throats, historically.” So, there’s just a lot of fragility in a zero-sum pie not growing world, I think.
Bill: So, we need to shrink the pie drastically to accelerate all of the social unrest to then get to the other side that is better, hopefully.
Jake: I guess, it’s the amount of pain that were collectively willing to endure.
Tobias: But there’s two things going on that are interesting.
Bill: I’m not willing to accelerate that pain. Fuck that.
Tobias: There’s two things going on. There’s the actual productive capacity. The stuff that we make and we incrementally better at that all the time. But then there’s the financialization of it, which in some senses– [crosstalk]
Jake: There’s claims to all of that stuff.
Tobias: Potentially unnecessary, right? It’s the financialization of it that deranges the incentives of people who are in the system where that– one of my favorite rough valuation measures is that Tobin’s Q, which is replacement value of assets versus the market value of the assets. And if it’s constantly at this premium to replacement value, you’re incentivized to be participating financially, rolling stuff up and doing stock market maneuvers instead of going and building stuff. That’s what actually takes us forward.
Bill: I don’t know that that’s true. Why wouldn’t you be incentivized to start the thing and flip it to the guy that’s rolling it up?
Jake: [chuckles] Well, let me give you another Chancellor quote here. “The trouble is that soaring asset prices don’t make a nation any richer. They only produce the illusion of wealth. Investors enjoy capital gains when asset prices rise, but any immediate gains are offset by lower investment returns going forward.” And so, he says that in late 2018, US household wealth had reached $100 trillion, a sum equivalent to five times US GDP. By contrast, household wealth in the postwar decades averaged just three and a half times GDP. So, we’ve basically just pumped up the claims on the wealth, but that’s not actually real wealth. Production capacity is probably more aligned with what wealth is.
Bill: I guess. I don’t know. I got to read this and maybe try to talk to him.
Jake: You should. He’d be great for Business Brew.
Bill: I guess, I get it, but I also don’t. For all the bitching, we just shut down the world and got to the other side pretty okay. Now, whether or not that was the right idea, people are free to disagree on. I’m not going to sit here and say government’s perfect. And we probably, almost certainly overstimulated on the back end. I don’t know. If you can actually shut down an economy and avoid a collapse, that’s a pretty compelling reason for me to say that maybe we have learned a little bit from the past. Now, we will see if we can slow down inflation. And if there’s runaway inflation, and destitution, and famine, then I’m wrong. But I think if there’s a reset of wealth, I just– [crosstalk]
Tobias: I think there is global famine going on at the moment, isn’t there?
Tobias: There’s certainly some energy problems in Europe.
Jake: Leading to the shutdown of productive capacity and farming yields.
Bill: But I don’t think that was a rates issue. I don’t think rates are the reason that people didn’t invest in energy. I don’t buy that. I just think people have gotten waxed for so long that no one wanted to invest in energy. If anything, rates are the reason for the shale boom that then led to a bunch of stuff.
Jake: Well, wouldn’t you say though that those low rates that led to the shale boom are the instability that was created by low rates for that industry?
Bill: I guess. I don’t know. Maybe. But if you don’t have the shale boom, then what? Oil is at $130 and then maybe we have more deep wells, like water wells. So, now, we’re just getting there. But I don’t know. It took 10 years. We had a whole lot of consumer surplus in the middle. If you believe in the time value of assets and money, that’s probably a rational thing to do.
Trend Following Keeps You Out Of The Waterfall
Tobias: There’s a good response. “Every day I get a little more weighted toward trend following. I don’t want to be long equity and I don’t want to think about all this doom and gloom. Just ride the trend wherever it goes.”
Bill: Not a bad idea.
Tobias: There’s a lot too it statistically– [crosstalk]
Bill: I’d rather a CTA. [crosstalk] have a CTA. They’d be well at times.
Tobias: You could do it with anything. Using any of those like the 2000 data study and out of different asset classes seem to work pretty well over a long period of time. I don’t think it always does. It doesn’t work well in periods of time, ironically, what we’ve just gone through, because there’s a lot of whipsaws to get people in and out.
Bill: Yeah. I just think you got to ask yourself, “If I get out of the strategy, I’m running and I get into some trend following and I get whipsawed, am I going to be okay with that?” Because that I think the way that those return streams are characterized is a lot of small losses followed by a big run. Is that fair?
Tobias: Yeah, I think that’s what they’re aiming for. You could look at Japan as an example. If you implemented some trend following on the Nikkei, you got pulled out– You would have stayed in the market all the way to the very top, even though you knew it was hundred times CAPE, you knew it was too expensive and you’re desperately trying to get out. You’re just waiting for it to cross over.
Jake: You got out pretty reasonably good timing then for that?
Tobias: You did. You did. Because then it proceeded down so far and then the– [crosstalk]
Jake: Still going. [laughs]
Tobias: Well, it proceeded down so far. That was ’92 and here we are. It didn’t cross over or I’m not sure if it even has. It was below for so long and it got you back in at the bottom. You’ve not performed as well since the bottom in Japan, but relative to how much loss you didn’t take from the top, you’re still ahead. I think that’s the thesis for a lot of the trend following. It keeps you out of the waterfall. I don’t think– [crosstalk]
Bill: Yeah. You got to think about the times that you want to do it right. Yeah, that’s right, because you can get gapped and screwed on stuff like that.
Tobias: That moves around too much.
Bill: Yeah, on an index. If I did something like that, I’d probably do a 50-day, 200-day because you don’t want to do 30 and 10. Then you’re just trading all the time.
Tobias: All of them get whipsawed. All of them get in and out at the wrong time. Corey Hoffstein and the ReSolve guys– Sorry, I’m just blanking a little bit on what they currently call themselves [unintelligible 00:52:33]. I’m sorry, I don’t know what they’re currently trading under. But they don’t look at– [crosstalk]
Jake: Adam Butler.
Tobias: Adam Butler. Yeah, Adam Butler, it’s true. They look at the agnostics. They just say, “Use all of them. Put a small amount of capital in each and pull it out.” Because they’re all going to be– [crosstalk]
Bill: Oh, that makes some sense.
Tobias: So, you’re never in or out. It’s not binary.
Bill: Yeah. That way if you’re high off of crossover or something, maybe some of the shorter ones get you in and– Yeah, huh, okay. That sounds logical.
Tobias: No, It’s just now it’s getting more complex, because you’ve got however many buckets you decide, however many moving averages you decide, that’s one.
Bill: Yeah. How many markets are you going to do it on?
Tobias: Equity strategy has 10 buckets for trading SPY.
Jake: Yeah. One underlying.
Tobias: Now, you’ve got thousands of portfolios tracking just– Probably, it works. You can do it with the computer. It’s just hard to build.
Bill: Yeah, you’d want it on commodities too, I would think, if you really want to be diversified. You don’t just want to have it on one market.
Tobias: So, I hope that you’re in something all the time.
Bill: Yeah. So, good luck with that idea.
Tobias: [laughs] Yes, you can do it.
Bill: I actually don’t think it’s a bad idea.
Financial Compliance Nonsense
Tobias: I think that’s what Corey and Adam do. I think they’ve got something out there. ROMO. ROMO, I forget what they ended up calling the ETF. I don’t know if I can say that tickers.
Jake: Oh, God, we just got fined. [laughs]
Bill: The regulation around financial marketing is ridiculous. I understand that you got to protect people from shysters, but the inability to talk about a product is nuts.
Tobias: The marketing rule is one thing. But there’s also, all this stuff that goes on at the backend. They’ve got guys in there thinking about how to make your life harder all the time. That’s all they do. [crosstalk] compliance.
Bill: Meanwhile, Cathie Wood can say, “We have 70% forward returns or some nonsense like that.” She’s trash there.
Tobias: Don’t know how she did that one.
Jake: That’s what the models show.
Bill: Yeah, that’s crazy. Meanwhile, worried about dropping into some ETF ticker in a legitimate nuanced discussion, fucking stupid. Anyway– [crosstalk]
Tobias: Well, if someone’s talking about your own, then you’re not able to correct something’s wrong in that discussion. You can’t correct– [crosstalk]
Jake: You can’t even say anything?
Tobias: No, you can’t participate.
Bill: Oh, that’s wild. So, I could go out and spread fake news about yours and you can’t even jump in and be like, “That’s not correct”?
Tobias: That’s it.
Bill: Wow. Smart.
Jake: What are we even doing here? [laughs]
Bill: Smart. Oh, that’s a good example of when governments go wrong.
Jake: You need some financial innovation to get around that.
Tobias: Billy, were you here for the– [crosstalk]?
Bill: Blockchain solves this.
Where Have All The Bear Market Hedges Gone?
Tobias: Blockchain does solve this. Were you here for the Eye of the– We were talking about the eye of the storm. Was it last week or was it the week before?
Bill: Yeah, I thought it was two weeks ago, wasn’t it?
Tobias: Do you guys think we’re still in eye of the storm or have we moved out the other side? Because it seems to me, there’s a little bit of vol around.
Jake: Will you quit reading my journal?
Bill: Yeah, I have no idea.
Tobias: Because if we were going to see, if this was like a mega bear, we’re nine months in if we measure it from the start of the year, mega bears run 18 months, two years. We’re coming into the back half, which will mean we’re going to see some waterfalls sometime.
Jake: Two-thirds of that now.
Tobias: This is the nasty period if we’re into it.
Jake: It just seems really hard to imagine though, because it seems the most obvious– [crosstalk]
Tobias: Everybody feels that way.
Jake: Everybody knows this is about to happen.
Jake: So, can it happen if everyone knows it’s about to happen?
Jake: I don’t know.
Tobias: I don’t know. I don’t think so.
Jake: And I don’t think so either.
Tobias: And every time I look at how you hedge it, all the hedges are bananas expensive, because everybody knows that it’s going to happen, which means that I think it doesn’t happen. And yet– [crosstalk]
Jake: And yet, how does it not happen if you push rates to– I don’t know, whatever, 6%?
Tobias: Well, that’s the thing that does it, right?
Jake: What’s cost capital? 8%?
Tobias: [crosstalk] you just automatically plug in 10 years ago and then since 10 years ago, I don’t know. [crosstalk]
Jake: Zero after that. It’s zero.
Tobias: 10-year plus some margin?
Jake: Well, yeah, I don’t know.
Tobias: I did some testing in a falling market like we had. I haven’t looked at this in a few years. But in the falling market that we had, paying up to the 10-year was perfectly fine at any point in time. You’ve been bailed out at every single point.
Jake: Well, here’s something that’s interesting. I don’t think I ever really quite put together, but he was talking about financial repression. And between 1945 and 1980, interest rates in the US and the UK average -3.5% in real terms. So, that created an annual subsidy to the US government equivalent to 20% of tax revenues, thanks to the lowered interest expense. And so, due to that repression, the US national debt relative to GDP declined by 75%.
So, we were able to basically de-lever by having negative real yields for a long period of time. Now, as you know from Buffett’s study that he did over 17-year time periods, there were some rough time periods in there for investors. So, I don’t know. Even if you do solve the problem by inflating your way out of it, that doesn’t mean that you’re going to have a good experience as an investor necessarily.
Tobias: Brian says, “If there’s a way for it to happen where none of the hedges work, that’s how it will happen.” Yeah, I agree. That’s how it’s going to happen.
Jake: Well, that’s yeah. That’s the tail risk issue that you have if it’s– [crosstalk]
Tobias: It threads the tail risk. It just never triggers the– the VIX never gets that high.
Jake: Never spikes VIX high enough to pay you out.
Tobias: It just slides. It slides slowly. Slow-motion crash.
Jake: The old man in the bathtub. [laughs]
Tobias: I think we’ve only had a fourth rally of this decline so far.
Tobias: 2007-2009 was 17 or 18. So, it’s fairly early days there.
Tobias: Maybe we [unintelligible 00:58:43]. I don’t know.
Tobias: You just got to be in the tera-caps and you’d be okay.
Jake: That’s what we figured out. It all come full circle.
Tobias: Just get back in the tera-caps.
Bill: Well, the problem is-
Jake: The water’s fine.
Bill: -if it’s economic driven and commodities driven, I don’t think that not being an– I don’t know man. You’re going to have to be really good. Small isn’t going to save you, that I’m uncertain of. Small is going to get shellacked on a business result basis. But the multiple maybe helps you. But I don’t know, man, I haven’t seen one piece of evidence in my life that thinks that when shit gets messed up, the small guy wins.
Tobias: And on that cheery note, that’s time. We did it, amigos.
Jake: Ooh, [laughs] we made it.
Tobias: We made it. [crosstalk] Next week, we’re going to be at a conference and we’re going to be trying to do it live from the conference. It is going to be starting a little bit late. I think we’re at 11:10 West Coast.
Bill: Are we Tuesday or Monday? What are we?
Jake: We’re Tuesday.
Bill: Nice. They bumped us to Tuesday?
Jake: Yeah. We’ll see if we’re able to– [crosstalk]
Bill: They were able to bump us. We asked and they gave what we wanted.
Jake: That’s right.
Bill: Because they respect us.
Tobias: Brown M&M’s in the rider.
Jake: Yes. We’ll see if we’ll be able to execute it live.
Bill: I want blue– [crosstalk]
Tobias: It’s possible we’ll won’t be able to. And we’ll have to tape delay or something, but we’ll see.
Tobias: We’ll try and figure it out.
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