In their latest episode of the VALUE: After Hours Podcast, Bill Brewster, Jake Taylor, and Tobias Carlisle discuss:
- Pending Residential Real Estate Apocalypse
- Would Munger Have Done Equally Well In LA Real Estate?
- Warren Buffett’s Uncanny Ability To Predict The Future
- Stocks In A ‘Death Zone”
- Lessons From Charlie Munger’s DJCO Meeting
- Energy Stocks Screaming Value
- Comparing 40s/70s Inflation To Today
- Expected Returns Stocks vs Bonds
- Food & Energy Shocks
- What To Do With All That Government Debt
- Keep Cash For When The Crash Comes
- Buy On Fundamentals Not Market Timing
- Risk Cannot Be Destroyed, Only Transformed
- Best Twitter Accounts Missives To Oneself
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:
Jake: Real good.
Tobias: This meeting is being livestreamed. What’s up, everybody? There’s nobody listening at this point, but it’s 10–
Tobias: It’s Value: After Hours. I’m Tobias Carlisle. This is Bill Brewster and Jake Taylor. What’s happening, fellas?
Bill: The mouse is running.
Jake: Yes, it is.
Tobias: I upgraded the computer to–
Jake: We can tell.
Bill: Yeah, now it works.
Jake: Yeah, now it works on the third try instead of the fifth try.
Tobias: [laughs] All right, dudes. We’ve got Gulf of Mexico and Townsville. Massachusetts, first in the house.
Jake: There we go.
Tobias: Halifax, Kathmandu. No way.
Jake: What’s the haps in Florida, Billy?
Bill: Just hanging out. I was down in a Miami boat show. My buddy bought a boat, a 25-foot Contender, like a $250,000 discretionary purchase. He has to wait 15 months to get it and they’re delivering one a week. So, some recession.
Jake: Holy cow. What kind of boat is that then? I don’t know.
Bill: It’s like a center console. It’s a Fish Slayer. They are made to kill fish. It’s a pretty cool boat, but there’s no seats or anything like that.
Tobias: Fish apocalypse.
Bill: Yeah. So, it’s not the kind of boat that I would be getting. I like the fishing.
Jake: Can you [crosstalk] anything behind it?
Bill: Oh, yeah, you can. Yeah. You just can’t sit and enjoy it with your wife. I think that’s the one thing that you– [crosstalk]
Jake: That’s why he wanted it. [laughs]
Bill: Perhaps. I don’t know. But he sold his last one for more than he bought it for. So, just buy new boats. Can’t lose money.
Jake: That is investment advice.
Bill: That’s right. So, put a lot in the cart too while you’re at it.
Tobias: How’s everybody feel about this market?
Jake: Me? I don’t know.
Bill: I have no market feelings.
Jake: Kind of boring right now a little bit, isn’t it? Kind of choppy.
Tobias: Bit exciting today.
Bill: What’s happening today?
Tobias: I looked at my little Morningstar panel.
Jake: Yeah. How’s it going?
Tobias: Oh, it was gnarly. It’s down more than 2% across the little squares that I care about. Small in value.
Jake: Not great, Bob.
Tobias: Yeah. National real estate prices. Yeah, I’m spending a lot of time going down some rabbit holes there. A couple of shares. Hoffstein’s on. Yeah, it’s Hoffstein’s– [crosstalk]
Bill: What up, [crosstalk] Hoffstein?
Tobias: A look here. Impending dad. I saw Teslaville. Samson’s on. Jim Hamilton, what’s up? Yeah.
Pending Residential Real Estate Apocalypse
Tobias: I have been going down some rabbit holes on that real estate. I don’t know. I appreciate that I’m feeding my bias when I look at that stuff, but it does seem to me that the data is– I think it’s like a 2007, 2008, 2009 style real estate crash anyway.
Jake: Really? That much?
Tobias: Coming. Yeah, I think so. Coming.
Jake: Wow. Interesting.
Tobias: We’re going down faster than we were in 2008.
Bill: If this is the view, I think you got to have cash. I know that you’re not supposed to market time. I know that I make fun of market timing, but I honestly think if this is the call, go to cash.
Jake: Cash is trash. Haven’t you heard that?
Bill: Not when everything is illiquidity pocket. That’s when you want it the most.
Bill: What’s the probability that any asset that you’re selling that’s quality right now, you look at in the future and you say, “Boy, that was the worst decision in my life to sell that asset”?
Jake: Are you saying that the upside-downside from here doesn’t feel as favorable as at other times in history?
Bill: I think if your view is that housing is going to go down a bunch and you’re worried about the last leg of a bear market down, if you want to change your wealth, that sounds like the time to try to change your wealth. I don’t know. You’ve got to do something different than what people do. I don’t think that staying long, any type of beta is going to save you because in that scenario, theoretically, credit spread should blow out, and the equity risk premium should increase, and you’re basically going to have four sellers. So, if that’s the call, liquidity is the way to win, and then you actually get a step function, and then you can never worry about this again.
Tobias: Well, here’s the thing.
Jake: Get money. [laughs]
Tobias: The 10-year is over 5%. Am I making that up? That’s what I thought. I thought we’d got to–
Jake: Is it that high? I thought it was 2 maybe. Was it?
Jake: What’s the yield curve?
Bill: [crosstalk] two years?
Tobias: It’s almost 4. 3.947.
Jake: Okay. 4.
Tobias: It’s interesting. In October– [crosstalk]
Bill: 2 years for– [crosstalk]
Tobias: It was a bit higher in October at the low. October and low, it got to 4.2 and then it’s come back a little bit from there.
Bill: Six months, 4.8.
Tobias: Which is rationally discounting, you should be paying a little bit more than you were in October 2022, I guess.
Jake: How do you square 90th percentile value spreads with cash? Such a hard one.
Tobias: Well, 2000, clearly that was the time when if you’re looking at market level indicators, you missed the giant trade in value. I don’t think that’s a good idea. I think value is clearly very cheap. But what composition of that basket? There’s a lot of oil and gas in there. Oil and gas have been a drag recently, but I still think– I don’t know. Energy underinvested. What does capital return say about that?
Bill: Well, it says you got to be right longer than the market thinks that you need to be right for. I don’t think that’s a sufficient answer to think the equity is going to work. I think you have to be more right than the market. I think it’s like anything. If people are losing so much money on their house, I don’t know, I find it hard to think that oil demand is going to stick. But I haven’t done any research on how sticky oil demand was through 2008.
Tobias: I saw a stat today, which I thought was interesting. It said that– I retweeted it.
Jake: Price was pretty different though too. 2008, I think we got up to like $150 a barrel. [crosstalk]
Bill: Yeah, forever, oil has underperformed. Yeah, I don’t know. You think? Maybe.
Tobias: This might be an oil-energy derivative. The TSA officers screened 2.5 million people at airport checkpoints yesterday.
Jake: That’s a lot of violations.
Tobias: Yeah, four years ago on the same day, so pre-pandemic, it was 2.3 million. So, it’s up. Not quite a couple of hundred thousand. That’s a material amount.
Jake: Well, we could get into some of this stuff. My segment today is very inflation based. So, I think it ties in with some of this.
Tobias: It feels like people stop talking about inflation a little bit, doesn’t it?
Tobias: It’s not such a hot topic on Twitter anymore anyway.
Jake: Is that right?
Tobias: I think so. Actually, whatever changes they made to Twitter, I find it a little bit harder to use these days noticeably over the last few months.
Jake: Harder to use, you mean not very interesting?
Jake: Yeah? [laughs]
Tobias: I can’t get enough information out of it.
Jake: I agree.
Tobias: I don’t know if it’s because the algorithm favors the threads– [crosstalk]
Jake: Which is a terrible–
Tobias: Yeah. Rather than just the tweets of information. So, people do a lot of threads rather than a lot of one- off tweets, which have got information in them.
Jake: Barf. Yeah.
Bill: It looks like oil was pretty stable– [crosstalk]
Jake: Through that time?
Bill: Yeah, more or less.
Jake: Stable high though, right?
Jake: [laughs] Stable, higher than today.
Bill: Uhhh, stable. It came down a little. I guess, in 2007, it was $86.3 million barrels a day. In 2009, it was $84.3 million barrels a day. That’s pretty stable.
Jake: All right.
Bill: I don’t know how tight you need it. I guess the question that Will Thompson has asked me a number of times is, to anyone that’s like, “Well, oil is going higher,” it seems to me that playing it in the futures market, if you have this really strong view on oil price is a smarter path than doing it in the equity market.
Tobias: That’s not investment advice, by the way. [laughs]
Bill: Yeah. Well, you can get it levered. If you’re right, you are actually right.
Tobias: What about through ETF? Probably better if you run– [crosstalk]
Bill: I don’t know anything– [crosstalk]
Jake: 3x bull oil.
Bill: Yeah, that seems bad.
Tobias: There used to be plenty of– There were little videos that used to do the rounds. This is a long time ago now. But this is 20 plus years ago of the futures traders. Guys used to trade oil and stuff like that. Basically, you’d watch an hour and a half of this guy trading and doing well, and then at the end, it was always vaporized.
Jake: Is that right?
Bill: Sounds about right.
Bill: Traded too big and then that’s all she wrote.
Tobias: Having a bad day, and then bad day gets worse, and six months later, you can’t.
Bill: Good way to do it in options too.
Tobias: All that leverage. Yeah.
Bill: Good trade in options. Remember? You got to be right on the underlying in the option. It’s not the easiest game.
Jake: The only thing worse are the FX guys trading hundred times leverage for currency.
Tobias: At least, it doesn’t [crosstalk] for most part.
Bill: Like Munger.
Would Munger Have Done Equally Well In LA Real Estate?
Tobias: Yeah, Munger [crosstalk] about Daily Journal. Munger made a mistake with Alibaba. Do you think that was a shock to everybody? But then, he said, because it was a retailer and not because CCP. I think we got to the point that it was very, very cheap, but CCP was the limiting factor, right?
Jake: It wasn’t, because it was “goddamn retail business” still.
Tobias: Retail business.
Tobias: Come on.
Bill: I find it interesting how rarely Munger talks about valuation. It is like the very last output of his process. That’s odd.
Tobias: [crosstalk] Buffett.
Bill: Yeah. But some would argue that Buffett’s lucky that he met Munger. I don’t know. Is this because we’ve just seen–? [crosstalk]
Tobias: Munger’s lucky.
Bill: Yeah, you’re probably right. But Charlie probably would have been fairly successful in real estate anyway.
Tobias: No doubt.
Bill: Then, you could say, “Well, you’d just be long levered LA real estate. And any monkey that was living through the time that he was living would have been as rich. He’s just a quality factor bet,” which is possible.
Jake: No way. There’s no way he’d be as rich with that path than the Berkshire path.
Bill: Yeah. I don’t know.
Jake: That wasn’t going up 20% a year like Berkshire was for decades.
Tobias: Still, he got a little leverage in real estate and he clearly likes leverage, so he would have had a little leverage. But there’s– [crosstalk]
Bill: 75% LTV. You’re refi-ing it out all the time. You never pay cash and you can 10.31 at over 50 years of LA real estate. If you own the best real estate in LA, which probably would be his strategy, bet you’re not poor.
Jake: No, you’re not poor, but I don’t think you can get to the same compounding that you got with Berkshire.
Tobias: What did you guys take away from what he said? What was the big takeaway?
Lessons From Charlie Munger’s DJCO Meeting
Jake: There were some colorful descriptions of merger arb and workouts [laughs] that he called– Before I get canceled, I’m just going to say that this is what he said. In fact, he was saying what Benjamin Graham called them, called them Jewish T-Bills.
Jake: Yeah. [laughs]
Bill: Well, he did say that racism has gotten better. So, [crosstalk] can’t expect a 99-year-old white man to be too politically correct all the time.
Jake: The past is a foreign country, right? So, this was a long time ago.
Tobias: How do [crosstalk] about crypto?
Bill: Well, he doesn’t want that.
Jake: You mean crypto shit as he called it or crypto crappo. He had a couple of other colorful names for it. Turns out he might have been somewhat right about most of that stuff, seems like.
Bill: Yeah, there were definitely scams. I have no idea. It’s interesting to me that he’s still holding BYD and he’s still holding Costco. It’s interesting to me that he doesn’t– I mean, he trimmed BYD. He made a case that, what, Daily Journal was not particularly expensive, but he’s not going to go out and buy it. Honestly, my biggest takeaway from him is he thinks 95% of asset managers are delusional. He thinks that it’s a waste of people’s resources and he never talks about valuation.
As someone that listens to Munger, I would feel bad if I didn’t listen to that and look in the mirror, and I still thought that I was the one that should outperform. I came away saying I’m probably delusional.
Tobias: He also said, “Don’t exercise and continue to eat peanut brittle to live to 99.” [crosstalk] Survivorship bias.
Bill: Well, his area of expertise is not– I don’t go to him for exercise advice, nor would I go to him for marriage advice.
Tobias: He’s stayed married, hasn’t he?
Jake: He’s one for two.
Bill: Yeah, to the right woman.
Jake: Pretty long run though with the second one.
Bill: Yeah. Well, she married a rich guy that she knew just wanted to read all day. And I doubt that the facts changed much since [crosstalk] they got married.
Jake and Bill: Yeah.
Jake: She lived until, I think, 2011 or something. You don’t really hear much. I don’t remember him talking about it or it didn’t come up at the Berkshire meetings, but who wants– [crosstalk]
Bill: Probably because he loves one person and it’s him.
Jake: You think Munger loves only himself? That’s what you’re saying?
Bill: Yeah. I don’t think Munger only loves himself. I wouldn’t say it that way. I don’t think that Munger is the type of personality that is going to credit much of his success to his wife. I think that some of the reason that I say that is if you say my kids would think of me as a book with two legs sticking out, to me, that’s not saying I’m someone who prioritizes family time. That’s saying I’m someone who prioritizes me.
Jake: Yeah, that’s fair. I don’t think I was the credit part talking so much, but more or like just nobody asked him about it at the meetings– [crosstalk]
Bill: It’s also never come up. He brings up things he wants to– [crosstalk]
Jake: [crosstalk] You doing okay?
Bill: Well, he brings up things he wants to bring up often.
Jake: Yeah. And he’ll punt on anything he doesn’t want to talk about.
Jake: I thought it was a great meeting though. I thought he was about as spry as I’ve seen him in a decade. I loved hearing the old stories of him and Garen getting into shenanigans. All of it was great. I really enjoyed it.
Bill: What do you take from it? What do you take from him not selling expensive things and not talking about valuation at all?
Tobias: The way that Buffett and Munger run their portfolios is largely this sort of industrialist approach, where you’re not really trading in and out. You’re trying to find things where ultimately, it’s the long-term flows that they generate, which is why they’ve been– Buffett in particular has been an acquirer and a holder rather than a trader. Because that reduces your tax drag. Fewer decisions that you have to make changes the way you analyze positions as they go into the portfolio.
I think Buffett is very, very focused on the valuation, and he’s trying to buy at a sufficient discount to that to give himself a margin of safety. There’s nothing new in that. Everybody knows that. [crosstalk]
Bill: Didn’t he add Apple here?
Tobias: I don’t know.
Jake: I’m not sure.
Bill: I thought I saw that.
Tobias: Conceivable. You don’t know when it happened. If he was adding in October, that might have made sense.
Bill: I guess. Yeah, maybe.
Warren Buffett’s Uncanny Ability To Predict The Future
Tobias: When you look at what is predictive, there’s a lot of luck and beta just in holding pretty good stocks, enough of them over a long enough period of time. But if you’re looking for predictive stuff, it’s very hard to find anything that’s predictive outside of five years. Moats get crossed, valuations don’t matter. Inside of five years, it’s value and it becomes increasingly less relevant as you get to the end of the five years. But there’s nothing really predictive as a metric that goes on much further than that.
I find the work that they do, in some ways, it’s unfathomable how Buffet is getting it so right other than the fact that he has studied the economy so closely and he’s so aware of what’s happening at that. He’s got a better overview than almost anybody else, and by virtue of the fact that he’s getting data from the railways and all of the other businesses too. I don’t know if it’s– I wouldn’t call it inside information, but he’s just aware of it and filing it away.
Jake: I don’t think it’s macro stuff, actually. I think it’s been much more understanding unit economics and microeconomics of businesses and looking at this point, probably tens of thousands of businesses over this entire thing and identifying a handful of them that have something about this business that allows them to earn more than they should, theoretically, in a hypercompetitive world for a long period of time and recognizing this tiny, tiny vanishingly small sliver of them have these advantages, and then just being willing to hold those for a really long time, and earning what the business earns, which Buffett would call investing, and then the other side he would call speculation, which would be hoping to get a higher price for it later from someone else.
Tobias: To be fair though, he’s often buying these things– I agree with that. But he’s also buying these things– say, BNSF, he buys that when it’s just primed to return a whole lot of capital. So, he buys it and de-risks it almost immediately over two or three years. So, he’s got a lot of his cash back and then he just earns what it earns. He brings it up as a mistake. They saw what Geico was playing for clicks on Google. And so, that should have given them a heads-up that Google was a real business that was earning real money.
Jake: Yeah. Worse than that, for years, they said that the most impenetrable moat, if they had to pick any business, would have been a single-newspaper-town newspaper.
Jake: In a lot of ways, Google represents a-
Tobias: Classifieds. Yeah.
Jake: -newspaper for the internet. So, this single town called the internet with a single newspaper in many ways, so it was teed up for them.
Tobias: Even though they didn’t act on that, you can clearly see that he’s thinking. So, he can see how one part of something is happening somewhere and how that’s impacting something else.
Jake: 100%. No, I think you’re right. He recognizes the industry dynamics like you said with the railroad, the consolidation that was happening, less competition, probably prices firming up, better returns on capital likely inbound, all that stuff, I think he’s pretty aware of the cycles and competitive nature of the places where he operates. That’s the key thing too, is that he never goes outside of where he thinks he can understand what the game is.
Tobias: BNSF is another good example of it. Railways were hated for a long time before Buffett did that.
Jake: Oh, they were airlines before airlines.
Tobias: Yeah. Tech stocks in the whenever it was. Was it 20 something? Is that too late? Is it earlier than that? [crosstalk]
Jake: That’s too late. Railroads were like 1880s, 1890s, I think.
Tobias: So, tech stocks then, and then they were fallen angels or there were people buying them as distressed enterprises. Yeah, that’s right. There were tech stocks in Commodore Vanderbilt times, and then they were unpacking the problems from that familiar overbuilding for years and years afterwards, and it was like a distress play. I think that’s why Graham has so much on railway bonds in the first edition of Security Analysis, because that was what was trading then. But until Buffett bought them, they were regarded as being high capex, low-return businesses.
Jake: Yeah. Basically, you had to put money and just stay in place. kind of red queen effect type of businesses.
Tobias: But something evidently has changed. How did he determine that it made that change? He was right. That trade was very similar to the one that he did with– I’m just blanking on it now. Chevron. What’s that?
Tobias: OXY. Well, a lot of the capital came out immediately after he bought it.
Bill: Well, he got to control the capital at BNSF.
Bill: OXY didn’t. Said that they wouldn’t–
Tobias: But he was aware that they were overcapitalized. He was aware the cash was going to come back out.
Tobias: He had made that assessment that whatever he was putting into it, he was getting some very substantial portion back. There was a blog post that somebody wrote. This is a while ago now. It could be– I don’t even know, quite a long time ago now, where they looked at how much had come out initially. It was just jaw dropping how much he’d actually managed to extract from it in the first five years. It was de-risk in the first– [crosstalk]
Jake: Is that right? And then, he was just free rolling after that?
Tobias: I think OXY’s the same. right? He doesn’t control the capital allocation, but–
Jake: He doesn’t directly– [crosstalk]
Tobias: He’s [crosstalk] to the–
Jake: Yeah. [laughs] Here’s a public proclamation of what you’re going to be doing with that capital for the next 10 years. [crosstalk]
Energy Stocks Screaming Value
Tobias: So, oil and gas more cyclical than railways?
Jake: Mm, I don’t know. I guess my answer would be another question would be, over what time frame?
Tobias: Well, over a shorter time frame, oil and gas is more cyclical than railways.
Jake: I would believe so. That sounds right.
Tobias: But you think over a longer term, good growth in energy? Persistent growth in energy?
Jake: Difficult question.
Tobias: That’s what we’re here for, brother.
Jake: Yeah, I’m going to punt on that one. I don’t have a good answer.
Bill: Well, there’s going to be consistent growth in energy. The question is, are the management teams who have never ever been disciplined in the past going to remain disciplined?
Bill: You’re three years after massive goodwill impairments. Maybe that’s the time to buy. Very possible. I don’t think the odds offered today are the odds offered when the impairments came out. I think if you’re saying today, you still want to buy it, then you have to say why you are going to be right longer than the market thinks so. I think that if you think that the price is going to go up, you should look at the futures market, because the equities put a lot of management and a lot of agency costs in between your core thesis and what’s actually going on.
Tobias: You are saying- [crosstalk]
Jake: I have no idea. I’m just saying.
Tobias: -markets rather than the–? Well, that’s been true in gold. Goldminers have not–
Bill: Yeah, because you’ve got people and incentives, and they have to buy new equipment and you don’t know what acquisitions they’re going to do. There’s a thousand things that get in between the direct representation of what you think versus the derivative of what you’re buying.
Jake: Yeah. Amen. A lot of slippage there, potentially.
Bill: Which is not to say the equities can’t work. I just think sometimes equity people come to equity conclusions, because they’re not asking the right questions.
Tobias: Well, trying to express a macro bid in one particular commodity by buying the equities. Yeah, it’s a derivative play on the commodity. So, if you have some sort of macro view on the commodity, you should get the thing that gives you the most direct connection to what you’re trying to express.
Jake: If I was being uncharitable, I would say that some possible of these very long duration growthy bets were in effect often interest rate bets in disguise. If that were the case, then maybe you’d better off just playing treasury market levered up with that kind of stuff, if you really wanted to. If you’re going to make an interest rate bet anyway, maybe it’s a better place to do it, potentially.
Bill: Yeah. Or stay long that and short something else to try to hedge it out. I don’t know. It’s not what I do, but I agree with you. They were uber long duration bets, and if people got out, they made a whole lot of money. Smart move, even if it was dumb.
Tobias: Hard to know when to get out. I know plenty of people who think that there’s lots to come, and so they’re trying to load up. I don’t know.
Bill: Well, we’ll find out who’s right.
Tobias: My screens have started filling up with more energy anyway. I’ve noticed more around.
Jake: Yeah. They’re earning a ton of money. Their ROEs right now are Chevron and Exxon. They’re north of 20, 25.
Bill: Helps when you have a goodwill impairment. It gets the equity down.
Jake: That’s right.
Bill: It’s great. It’s the best way to earn.
Jake: Throw some debt on there too.
Tobias: No, it’s a great way of shaking up sovereign debt too. Just have a little default, come back in with a clean balance sheet.
Jake: Just a touch. Just a little jubilee. [laughs]
Bill: I send a lot of the bad debt to the Fed. Then, the debt market doesn’t have to actually see it, the Fed does. It’s not so bad.
Jake: That’s probably what you had with a lot of stuff, huh?
Tobias: Yeah, there are a few royalty companies around. Thanks, Braden. I’ve had a few guys on the podcast back in the day.
Jake: Yeah. [laughs] Not recently. Should we do some vegetables?
Tobias: Yeah, let’s do it.
Comparing 40s/70s Inflation To Today
Jake: Okay. So, as you know, I’ve been digging into inflation more, and especially the 1970s inflation just because I think it’s an interesting period. I just want to be ready in the event that today’s inflation is not as transitory as maybe everyone is hoping. This piece is based on a research paper that was written by Alan Blinder. If that name sounds a little familiar, he was an econ professor at Princeton. He served on Clinton’s Council of Economic Advisors, and he was the Vice Chair of the Fed in the mid-1990s. So, he’s kind of been around. But this was published in 1982. So, it was shortly thereafter of the 1970s.
My hope was that by going and looking for a little bit more contemporaneous accounts that I might get a little bit more color, a little bit more fidelity as opposed to– The longer the time passes from history, the more chance maybe that there’s some retelling of the narrative of what happened. I don’t know. I was hoping that might be the case. I was going to say, actually, I enjoyed doing these types of reports a little bit more for the show than the ones where I have to pretend to be the authority on sperm whales and [Tobias laughs] spandrels and whatever the hell else. I’m just making stuff up as I’m going. So, this is more fun or a little bit less pedantic, I think.
So, we’ll start off with a little quiz. What do you guys think that the average inflation rate of the decade of the 1970s was per annum?
Tobias: The average–
Jake: Average inflation rate?
Jake: Okay. Billy?
Bill: Yeah, I’d go right around there. Maybe 7.
Jake: All right. Pretty good, fellas. We’re at 6.8, which at the time was very shocking because that was double the long run average before that and triple the rate from the 1950s and 1960s. A little surprising datapoint here, the 1940s actually saw a pretty comparable average to the 1970s at 6.4%.
Tobias: Is that pre or post World War II?
Jake: This is the entirety of the 1940s. So, that would catch pre and post– [crosstalk]
Tobias: Yeah, sorry. Let me try that again.
Jake: The answer is both.
Tobias: [laughs] Yeah. Okay. So, that was potentially wartime inflation, right?
Jake: Yes, very much so. So, what’s often missed in this is that the inflation during the 1970s was uneven around that 6.8% and there was a lot of variance in the price changes of all kinds of different stuff. I think sometimes we’re all guilty of painting with a brush of, “Oh, inflation came in at 6.1%.” Okay, well, that’s this very rolled-up average. But within that is represented a huge, colorful spectrum of different prices moving around and I think sometimes we sort of forget about that. This will be a little bit more germane in a second when we talk about what caused potentially the 1970s.
So, Blinder posits there were basically two inflations. He said that basically, at any given moment, there’s this normal or baseline inflation rate, which is actual inflation rate that gravitates towards fundamental economic forces, so basically, the difference between the growth rates of aggregate demand and aggregate supply. Now, you could see that he’s a macroeconomics guy when he starts talking about aggregate demand and aggregate supply, because I’m not sure, do we really have a good handle on what those numbers even–? [crosstalk]
Tobias: Yeah, I don’t know what those ideas mean, honestly.
Tobias: Or I can’t visualize those ideas.
Jake: Yeah. So, on the demand side, he says the weight of the historical evidence is that the growth rate of money is the dominant factor in the long run. So, this is what Milton Friedman said all along, which was that, “Inflation is always and everywhere a monetary phenomenon.” So, there is some validity of that, is what Blinder is saying. But there’s also these other factors like fiscal policy that influence the growth rate of aggregate demand. On the supply side, the fundamental long run force is the trend rate of change of productivity though occasionally, there’s these abrupt restrictions in aggregate supply. Like supply shocks, they’re called, and that can dominate the supply picture over shorter periods.
Okay. So, he lays blame, the key changes that happened in the 1970s were rapid increases in food and energy prices and run ups in mortgage interest rates. We’ll talk about two little periods that happened. There were two kind of pulses within the 1970s that were caused and we’ll get into these a little bit more. So, 1973, 1974, there were three main culprits of what caused this inflation shock.
The first was a food shock. There was bad weather in the US, and worldwide, and it sent retail food prices soaring plus 20% in 1973, and plus 12% in 1974 for food prices alone. These food prices also got reflected in increase in wages, which results in this upward spiral once it gets going. I did a little bit of my own research on this, because I wanted to think like, “Okay, how does this relate to today? How much does the average US household spend on food then versus now? What’s the intensity of disposable income and food? Maybe that will tell us a little bit more of what we can expect.”
So, in 1960, the average US household spent 17% of disposable income on food. 14% of that was at-home expense, and then the other 3% was eating out. In the 1970s, it was around 14%. So, within 10 years, the concentration of food as your average spend had come down. Today, it’s around 10%. So, 5% at home and 5% eating out. Our general intensity of food today is less than what it was for people in the 1970s. So, even if we had this shock in food, the theoretical impact should probably be a little bit less than what they had in the 1970s.
All right, second up, energy shock. There was a solidification of OPEC in 1973 that led to the quadrupling of oil prices in a couple months. The CPI energy component was plus 26% from September of 1973 to March of 1974. So, you had a short period of time the CPI energy just went through the roof. In 1973, the US petroleum consumption was $17.3 million barrels per day, and the refined petroleum products increased in price by about $5.50 per barrel. So, all this is just giving you a little bit of math about the increase in the US’s oil bill, like an oil tax from OPEC was roughly $35 billion, or at that time was about 2.5% of GNP. So, we had this kind of friction that came on from increased oil prices. In total, that attributed about 3.5 percentage points to an energy shock. So, inflation like three and a half percent of the total– well, 3.5 percentage points of the total inflation was due to energy.
So, then I wanted to go back and rerun. All right, what’s the energy intensity look like back then for the economy versus today? So, in the 1970s, it was 14,000 BTUs per dollar and this is like chain linked to, I think, 2012 dollars. And today, the US energy intensity is about 5,000 BTUs per dollar of GDP, basically. So, less than half– It’s almost cut in two-thirds actually, how much energy is required today to create the same amount of economic productivity.
So, it’s kind of a testament to the efficiencies that we’ve seen, the mix probably from heavy manufacturing more to services, which probably has a lower energy component. All of which would be to say that energy going out of control today in prices may not quite have as much of an impact as it did in the 1970s potentially. That’s a hypothesis.
Then, the last thing for that 1973, 1974 pulse was wage and price controls. So, in 1971, Nixon imposed peacetime mandatory controls over prices and wages with a three-month freeze, they called it. After several phases of this, it was finally ended in 1974. So, Blinder’s research showed that the controls did nothing to the overall inflation. It basically just shifted the timing of it until– that when it ended and then you got this big spike up in wage price inflation.
So, there’s probably a good lesson in there in my mind in when we control the prices of things, like maybe the price of money, are we really just shifting problems or are we actually helping? I don’t know. I’ll leave that to all you armchair economists.
Tobias: So- [crosstalk]
Jake: Yeah, go ahead.
Tobias: Sorry, dude. I don’t want to cut you off. If you got– [crosstalk]
Jake: Oh, we’re still going, baby.
Tobias: Keep going. Because I’m kind of interested, what are we spending more money on now that we weren’t then? But sorry, keep going.
Jake: Yeah, bean burrito, I don’t know.
Food & Energy Shocks
Jake: So, the lifting of these controls caused a spike inflation as prices caught up to where they should have been the whole time without repression. So, 1974 to 1976, so after that spike, it saw the rate of inflation tumble because food price increases had slowed, the OPEC shop wasn’t repeated during that time period, and that extra catch-up time of the end of the price controls was completed. So, 1974, 1976 timeframe, we saw that inflation had come back down under control, and that was the feeling at the time. But then in 1977 to 1980, that period, inflation steadily mounted from 6.8% in 1977 to 14.8% during the first half of 1980. It was over 18% in the first quarter.
So, this one came about then because again, food shocks. We had another bout of rising food prices driven mostly by meat. And then, what happened was that there was a decline in the production of beef at that time, and it was supposed to be offset by increases in pork and chicken. But bad weather, disease, and rising feed input costs led to these high meat prices and caught everyone off guard.
We had another energy shock. This time, political turmoil in Iran led to oil prices jumping. The energy component of the CPI was plus 56% from December of 1978 to March of 1980. So, that time period, you had this another big impulse, upward of CPI pressure. And then, in 1978, the US petroleum usage averaged $18.8 million barrels per day, and the price was pushed up $821 per barrel. So, to go back to that oil tax, like how much was that extra friction, was about $144 billion or 6.5% of GNP. So, pretty big bite, right? You’re going to feel that. This is when we had people lining up or gas shortages. Rationing, where depending on what your license plate number was, you could go, get in line on certain days. Very different world than what we live in today.
Then the third thing that was different than the price controls of that first impulse, this is mortgage interest rates at that time. They were quite stable through 1977 holding at about 9% per annum. By the way, 9%, [laughs] who’s ready for that in your real estate portfolio at 9%? I’ll let you guys guess where prices end up if we have 9% rates. Then, it ran up like a couple more percent from there and it whipsawed around a bunch, and that ended up in 1980 contributing 4.6 percentage points of CPI increase. Just purely basically housing costs.
I’ll cut this down here, because I’m way over time and it’s getting boring. But in general, we saw food prices, energy prices, price controls, and mortgage rates drove inflation and these impulses in the 1970s. When I look at today and if it’s those same potential levers to impact inflation, I’m not totally sure that the economy hasn’t changed to the point where maybe it’s going to be something else is what I’m thinking. Maybe we need to keep our eyes open for what it might be that could hurt us from inflation that would be different than that time period.
Tobias: You think we will rely less on those things now, so an impact in them has less of an impact on the economy or a big move up in them has less of an impact on the economy?
Jake: Theoretically, that makes sense to me. If it’s less of a concentration into the inputs of what it takes to create our economy, then price changes in that flowing through should have less of an impact.
Tobias: The rates now seem to be much, much lower than they were then, but this is– To what extent were the rates–? The rates went up through the 1970s. I remember it being like that. They peak in like 1982, right, something like that?
Jake: Yeah, [crosstalk] rates definitely. What if federal funds rate peak at like 17% or something?
Tobias: Yeah, I thought I was going to say 18%, actually but that just sounded crazy high. If you go from even paying a 9% rate on your house and then 18%, that’s a 50% cut rate roughly.
Jake: Yeah, that’s a lot of interest.
What To Do With All That Government Debt
Tobias: It’s hard to see how we get to there now, because there’s so much government debt. You find out how independent the Fed is then because the Fed will be like the BAJ. It just has to manage the government debt as well.
Jake: Yeah, I don’t know how you eat up so much of the pie and interest expense with the rate at that level. It just seems untenable. I don’t know.
Tobias: What does it take to reset it? What does it take so it doesn’t matter. Like lower house prices, lower stock market price, like lower price on the index?
Jake: To reset all the debt or reset, what, the inflation?
Tobias: If these rates are that high, if inflation is running that high, you can’t have prices where they are. I don’t know.
Bill: Better have cash even though you’re getting hit. But if everything is going to go down 50%, 70%, who cares if you lose 8% a year?
Tobias: Rates were higher in the 1980s, but only 3 to 4 times annual wage, not 10 times like it is now. Yeah. One of the guys that I follow on YouTube, he says San Francisco, the median house price has come off a lot. It was like 1.35% at the peak and it might be under 1% now, but it still compares with the median salary that is $102,000 a year. So, you’re still at ten times the median salary. So, either salary has to go up– [crosstalk]
Jake: That’s a lot. The average for the country, I think, is 3% or something.
Tobias: Yeah, that’s a lot. There’s some interesting demographic change where, as the boomers leave the workforce and generation X has to take over, because there are so many fewer people in generation X than there are boomers, they’re going to have to take on more responsibly bigger roles, and as a result, they’re going to have to get paid more. So, maybe that’s the way that salaries go up. House prices just stagnate for a decade. House prices have already been stagnant for a little while, because at the rate that we’re coming back down, we’re going backwards in time. We’re almost–
Jake: Where are we back to? 2021?
Tobias: We’re not quite pre-pandemic yet. Some markets are getting close to pre-pandemic. Others like California, still got a long way to go. You coming– [crosstalk]
Bill: Part of the reason that some of these businesses may trade at super high multiples– I’m just theorizing. If you look at Costco, their debt is termed out, 2027, 2030, 2032. Pull up Charter. Tell me what that debt trades at if rates are at 20. They will have shorted debt by issuing a ton at the exact right time and they’ll be able to buy it in for pennies on the dollar. If you have a resilient business and you’re thinking of all these things and you’re really worried about a number of outcomes, some of these businesses may have a lot more things at their disposal than–
Bill: I accept that I know so little now that I have no default position other than to assume that the market is not irrational. I think Charlie would tell me to index and just try to articulate why it might make sense, and I think some of this stuff might make a lot of sense. I do not think we’re going to have a great time for investment performance. I don’t see why we’re entitled to it. I haven’t really changed my tune on that in three years.
Jake: Is your default position the fetal position? [laughs]
Keep Cash For When The Crash Comes
Bill: No. I’m not very scared. I own assets. I’m not hyperlevered. I think I own quality stuff. I don’t think that I paid too much. But I probably have endowment bias. What are you going to do? I am going to try to have some sort of cash in case the crash comes. But outside of that, I just sit here and wonder why I do anything active.
Jake: Yeah, that’s fair. I think there are periods of time that behoove you to not get too active. Like, just let the boat go and then you come back with a different set of cards that makes it easier to untangle, easier to figure out what the smart thing to do is. In the meantime, hold something reasonably high-quality, hopefully don’t overpay for it, and just be happy with a smaller return, and not trying to get it all at every step of the game.
Stocks In A ‘Death Zone”
Tobias: This is from John Rotonti, mike Wilson on the death zone. Have you heard this? He’s talking about the low in October versus now.
Tobias: He says, “When stocks started rising in October, they had a much lower valuation with the price to earnings ratio of 15% and an equity risk premium of 270 basis points. So, the equity risk premium is the difference between the expected earnings yield and the yield on safe treasuries higher number. Meaning, that you’re being compensated more for the investments in stocks.” This is me. This is not the article. That equity risk premium has been tested extensively and it’s not predictive at all. [Jake laughs] You’re better off just looking at the absolute return in equities, not adjusted for interest rates, but that’s still– [crosstalk]
Jake: Looking at actual earnings yield, instead of– [crosstalk]
Tobias: That’s the Fed model. Yeah, that’s right. You look at the earnings to– [crosstalk]
Jake: Copying it to treasury difference.
Tobias: Which doesn’t really make any sense, but when you test it, that’s the answer. But it’s still regarded– That’s the Fed model. That’s how they do it.
Tobias: “By December, however, the air started to thin with price to earnings down to 18% and the equity risk premium down to 225 basis points.” He says, “In the last few weeks of the year, we lost many climbers who pushed further ahead in the death zone. [Jake laughs] Investors began to move faster and more energetically talking more confidently about a soft landing in the US economy. As they have reached even higher levels, there is now talk of a no landing scenario, whatever that means. Such are the tricks the death zone plays on the mind, one starts to see and believe in things that don’t exist.”
Jake: That’s a great analogy.
Tobias: Back to Wilson, who says, “The price to earnings ratio is now 18.6%, equity risk premium at 155 basis points. Meaning, we are in the thinnest air of the entire liquidity driven secular bull market that began back in 2009.”
Jake: By the way, that denominator on the price earnings is not going in the favorable direction right now.
Tobias: He says, “The bear market rally that began in October from reasonable prices has turned into a speculative frenzy based on a Fed pause pivot that isn’t coming. Now, I admit that is my bias too. So, I enjoyed that a lot.”
Tobias: That’s how I feel. I felt like the cheap stuff from October through January, but then February has just gone bananas.
Jake: Yeah. By the way, Bill, when you’re talking about termed-out debt, why did we as the US government not issue hundred-year bonds on–? What do you think would have–? [crosstalk]
Tobias: Didn’t Argentina do it?
Jake: Yeah, Australia did.
Tobias: How [crosstalk] get it away?
Jake: [crosstalk] How did we not push out our debt into these super long dated– It probably would have been like a 2% or 3%, I don’t know. But how much smarter would we be looking right now? How pretty would be sitting as opposed to all this debt that’s going to be rolling off in the next whatever? What’s the average now? I think somewhere like five years or something for all the US Treasury complex? Someone correct me if I’m wrong on that, but I think it’s somewhere around there.
Tobias: It’s short-term, all of it is.
Jake: It’s all coming due. It’s not going to be at anywhere near 2% or 3%, I don’t think most likely to be rolled over. What a missed opportunity.
Tobias: It’s crazy, right?
Jake: Look at Berkshire.
Bill: I’m not shocked that Trump’s government didn’t take advantage of that. I don’t think very highly of him as a businessman.
Jake: You would have thought anybody who could get cheap money though, he might have been the guy that would have seen that.
Bill: I suppose. Sorry for triggering some listeners.
Jake: [laughs] Yeah. Well, anyway, sorry to divert us.
Bill: Yeah, I don’t know. Either we’re going to go down or we’re not. But if we do, I think people are going to want cash. I don’t think you want to hide in any risk asset.
Tobias: Yeah. Hard to know.
Jake: Mm. This is bad news for that guy who uses it as his contra, and he’s been heavy in the puts. [laughs]
Bill: That guy’s just giving the market [crosstalk] money. I don’t really care.
Jake: He’s got a lot of cognitive dissonance now.
Tobias: It’s hard to make money on those puts, to be fair.
Bill: Yeah. He won’t. If he makes it once and he does it 30 times, he’ll blow all his money, it’s fine. It’s an inevitability on a long enough time horizon. I hope he’s right once. So, it’ll be a fun ride.
Jake: Yeah, tough game.
Tobias: That’s the problem. Everybody gets the same idea at the same time. The market is overvalued. Therefore, buy puts. Puts are overvalued too. That’s part of the problem.
Bill: Yeah, look, one of the benefits is he benefits from a lot of these yield enhancement strategies that systematically sell calls and puts. So, maybe he actually is buying a structurally mispriced option if it’s some of the front months. But I’m not sure– If he can’t articulate that, then I don’t really care what he has to say.
Buy On Fundamentals Not Market Timing
Tobias: I think if you’ve got good cash flowing assets and you’ve got a management team that is prepared to buy back stock, then you’re going to be okay through this period. You should be looking to buy risk assets. Having said that, I don’t think you want to be in the index. I think you want to be really careful being in big stuff that’s done really well, because that’s just had a cycle that favored it and it’s probably at stretch valuations and we go into a cycle that won’t favor it and the valuations will collapse, which is what happened in the early 2000. It was 15 years of really, really good companies doing really, really well and the stock is going nowhere. Walmart, Microsoft, take your pick.
Bill: Yeah. So, why do you think Munger thinks the index outperforms everybody over the long-term net of fees and net of taxes? It’s not like he doesn’t know this.
Jake: Long time horizon.
Bill: Yeah, [crosstalk] he does.
Tobias: That’s going to be true for most people. Most people are going to be wired to try to sell at the bottom and buy at the top.
Tobias: They’re looking at price action as the way that they’re making decisions rather than trying to buy on fundamentals. I do think that’s an advantage, buying on fundamentals.
Expected Returns Stocks vs Bonds
Jake: Speaking of, interesting little piece out this morning from Verdad on what’s the long run expected return for equities versus bonds and ended up pulling some more data from this researcher named Edward McQuarrie. I wasn’t familiar with him, but the number they came in with was more like 5%, 5% to 6%, basically.
Tobias: Nominal or real?
Jake: Not sure.
Tobias: Probably nominal.
Jake: It’s probably nominal.
Tobias: I saw that chart too. Where did you eyeball the divergence to begin?
Jake: 1942 or something.
Tobias: I thought it was earlier than that, but yeah.
Tobias: Around about that time. Bonds got crushed and equities kept on going.
Jake: Yeah, that’s right. I don’t know. That’s an interesting piece though. I think I’d be wondering about current pension fund projections and what your liabilities actually look like versus your assets out into the future when you’re trying to match these things. If you’re plugging in a 5% versus an 8% or more, that’s a pretty big delta that could leave a reasonably sized hole in your balance sheet, if you were in charge of a pension.
Risk Cannot Be Destroyed, Only Transformed
Tobias: You’ve seen there’s been a few tweet threads going around? I won’t mention the VC fund in particular or the firm in particular.
Jake: Name names, Toby.
Tobias: Well, this was about A16, but I’ve also seen other ones about– It’s a public tweet and I don’t have any view. I don’t have any insight. I’m just relaying what they said. They said that a lot of these VC firms towards the end were raising a lot of funds that they were plowing in very late stage, particularly into things like crypto and so on, which have had massive drawdowns. So, they’re going to look a little bit like Ark, which is public, so people can see what that looks like, where they’re going to be smoked in VC and they haven’t been really investing in early stage.
I know that VC is a little bit more– VC is not angel. It’s not necessarily the first check in the door or the second check in the door. It’s a little bit further down the road than that, but it’s still pretty early stage where they should be in earlier stage companies, not in things that are just about to go public. But their idea was that because returns were so low, they could get into these things that were later staged and about to go public and put in a big check. And so, that was selling that idea to a lot of these pension funds, a lot of the endowments.
Jake: So, you’re saying that outperformance, that part that the pension funds and these large pools of capital were depending upon by having these alternative assets basically might have blown up in their face?
Tobias: Yeah, very much so.
Jake: Just when they put the most money in to hide from public market volatility?
Jake: Oh. As if you can’t necessarily make risk disappear, is this what you’re telling me?
Tobias: We’ve got Corey on here. It can’t be– [crosstalk]
Jake: Corey, what’s the answer here? Come on.
Tobias: It can’t be destroyed.
Tobias: Yeah, I wonder how much of that is going on, because those marks seem to be– I don’t know that there are rules around setting those marks. So, it’s not like it’s completely marked to, but it is still marking your own homework. I disagree with some of the public marks as well.
Jake: [laughs] Yeah. [crosstalk]
Tobias: Of course, that’s why I’m buying. That’s why I’m buying them when I disagree.
Jake: If you didn’t, you are doing it wrong.
Tobias: But then, it does annoy me a little bit that they don’t immediately correct after I buy them.
Tobias: I appreciate it’s going to take a little– You got to have three to five years.
Jake: Cliff Asness made that joke pretty well when he gave the talk at Columbia about like, “Well, I expect it to be inefficient. That’s the whole point of me buying it. But then, how dare it get more inefficient on me once I buy it? This is outrageous.” [laughs]
Tobias: Yeah, that’s how I feel. Exactly right.
Tobias: Hey, Corey is on. “Risk cannot be destroyed, only transformed.” Thank you. Good to have you here, Corey, to correct us like that.
Jake: Sage words.
Tobias: I don’t want ChatGPT. I just want Hoffstein on the other side of a chat window.
Jake: Choff AI.
Tobias: Think about that, Corey. Billion-dollar idea.
Jake: For free. [laughs]
Tobias: I’ll take 3%. That’s all I want. 1% for the idea. So, how are you feeling, guys? Positive?
Jake: Yeah, I think nothing changes here. It’s still the same game that it’s always been, which is, know what you own, try to own reasonably good businesses if you can, don’t overpay for them, lower your expectations, stay within your circle of competence, don’t get too excited. You’re not as smart as the market will make you feel. You’re not as stupid as it will make you feel. And play your own game, ignore the crowd. It’s all the same.
Tobias: That’s good advice.
Jake: More for myself. I’m just telling myself these things, not– [crosstalk]
Tobias: Yeah. No, I’m only talking to myself too.
Jake: This whole podcast, I’m talking to myself. [laughs]
Tobias: Don’t do it.
Best Twitter Accounts Missives To Oneself
Tobias: I do think those are the best Twitter accounts. That’s how to do a good Twitter account. Basically, write to yourself.
Jake: All my quarterly letters are basically just missives to myself of like, “Dude, you know better. You’re about to do something stupid here. Write it up so that you don’t do that.”
Tobias: Yeah, that’s a good idea. Yeah, we haven’t talked about Tesla today. Has it done anything? Had a little recall.
Bill: Who cares?
Tobias: I think it sorted that out over there. Well, it’s the biggest stock in the market. Most highly traded stock in the market. Most highly traded security.
Jake: It is– [crosstalk]
Bill: I’m all set out on a number of topics. That is one of them.
Tobias: Yeah, I just don’t understand it.
Jake: It’s going to be the poster child for something. I don’t know what yet, but for something.
Bill: Yeah, it already is. People have made life-changing wealth if they’ve sold. That is a stock that works or has worked. Does it work from here? Why would I have any insight? I haven’t had any insight that’s worth listening to yet.
Jake: Congrats to those who did though. That’s fair play to them.
Bill: Yeah. I’d much rather put everything in that than some theoretically cheap stock that doesn’t go anywhere.
Bill: That’s a way to actually change your life. Tell me the next one that’s that.
Jake: Oof. Yeah. There’s a whole market full of them. I don’t know if you know this. [laughs]
Tobias: I know a lot of them. It’s my whole strategy.
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