10-3 Steepest Ever

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In their latest episode of the VALUE: After Hours Podcast, Morris, Taylor, and Carlisle discuss 10-3 Steepest Ever. Here’s an excerpt from the episode:

Tobias: This is not a whole topic, but the 10:3, the Treasury, the 10:3, either yesterday or Friday was the most inverted it’s been in the data going back to 1982. I get that that’s a short period of time. I don’t know if steepness in the inversion means anything. I don’t know if it’s relevant or not. I just bring this up, because it has been a pretty good predictor of recessions in the past. If you go into a recession, you get a much bigger drawdown in the market. I don’t actually do anything about that trading wise. I just watch it just because it’s like slowing down on the freeway knowing that there’s a big accident further up ahead. I’m not going to do anything, I’m not changing anything. I just know that it’s coming. Anyway, it makes me a little bit nervous, some good buying opportunities when it rolls around.

Alex: I looked at it after you talked about it last week. The only conclusion I came to is that I was very confused by what I was even looking at. I don’t understand most of this stuff very well, but it certainly was confusing/little bit scary to me to see what I was looking at. [chuckles]

Tobias: I don’t know what it does. [crosstalk]

Jake: Is it hard to imagine though, Toby, that there’s–?

Tobias: More slowdown coming?

Jake: Well, is this the most telegraphed recession and market crash in history, if it was to show up? Almost by definition, since everyone knows it’s coming, does that mean it can’t come?

Tobias: The thing is the market’s not off that much. The S&P 500 is only off 12%, 15% since the start of the year.

Jake: That’s fair.

Tobias: Given what’s happened over the last few years with that bubble runup and then on some measures, the most expensive market we’ve ever seen. People can debate the efficacy of Cape, or Tobin’s Q, or those other things. But they do seem to be very, very stretched and they have spent a long period in history below the mean. These things run back more than a hundred years. Maybe we’ve entered a brave new world where margins are more easily managed and capitalism doesn’t compete as ferociously, but it doesn’t feel like that to me.

So, at some stage, margins compress. PEs start looking a little bit stretched, because the earnings are down. Even though the market’s down, it still looks expensive. Maybe there are better opportunities elsewhere. I don’t know how it works. I get that sentiment view too. I don’t talk to anybody who’s not– The average person who I talk to is just like, “Yeah, there’s a big crash coming.” So, that’s not like that’s new news.

Jake: Yes, that’s a real– very [crosstalk] there.

Tobias: It’s not helpful. It’s not helpful at all. There’s not like you can use, there’s a big crash coming to do anything. It shouldn’t change your behavior. The only reason I do it is because I just want to be mentally prepared when it happens. I will get my buy list ready. I know what I’m going to do. And so, when it happens, you don’t get the adrenaline pumping. You’re just going through the plan that you have to buy stuff knowing that– You probably buy something and sell it cheaper, because there’s something that’s better value down there and don’t worry about it, just keep on going through. The worst thing you can do is panic at the bottom and pull all your money out, which is a sin lots and lots of people do it. So, I’m just trying to get my head right before we have a car accident, know what I’m going to do.

Jake: That’s a very good idea, like have your man overboard plan ready to go.

Tobias: Yeah, that’s Mauboussin.

Jake: Don’t wait until you’re in the heat of the moment.

Alex: Yeah, one of the things I struggle with this particular time period is completely understanding that comment and having some sense of normalized economics that might come in if macro is tough. Knowing what normalized is for a lot of the businesses I’m looking at has just become so-

Jake: Really?

Alex: -tough in the past two to three years. For a lot of names or industries that I definitely wouldn’t have predicted at the start of COVID having major headwinds, tailwinds at different times, in some cases, I can’t even explain it today, basically. So, that makes life a little difficult. [chuckles]

Jake: Yeah. COVID feels like we all have to knock 10% off of our circle of competence across the board, basically.

Alex: Yeah.

Jake: Just understanding, being able to predict what industry competitive dynamics look like, I think you got to be really take some of that in in your competence and just recognize that like, “Boy, this is tough right now.”

Tobias: It’s tough to tease out the secure and the cyclical. It’s always tough to tease out the secular and the cyclical, but particularly this time, to what extent will work from home persist and then what knock-on effect does that have for commercial real estate? Very, very high in commercial real estate. And then within that, there’s also a business cycle going on. It’s very, very hard. I don’t know that anybody can figure that out, but it’ll cost you in one way or the other.

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