In their latest episode of the VALUE: After Hours Podcast, Porter Collins, Vincent Daniel, Jake Taylor, and Tobias Carlisle discuss:
- The Catalyst That Will Break The Market
- Real Estate Predictions 2023
- Just Buy The 2-Year At 5%
- What Drives Investment Returns?
- Find Opportunities By Overcoming Socialism Risk
- Bearish To Bullish Reversals
- This Is A Long Slow Train Wreck
- The Debt Ceiling Problem No One Is Talking About
- We’re Bullish On Energy
- Market Is As Inefficient As We’ve Ever Seen
- Some Stocks Can Stay Undervalued For A Long Time
- The Two Positives In The Economy Right Now
- Liquidity Heat-Seeks The Crap Stocks
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Full Transcript
Tobias: Preparing to stream live. We are live. It’s Value: After Hours. It’s a special edition. It’s a foursquare. We’re like CNBC. The scarier the markets get, the more people we put on the screen. We got legends, Porter Collins and Vinny Daniel, along with Jake Taylor and myself, Tobias Carlisle. Welcome. How is everybody?
Porter: Well, we’re good. Ready to talk some Value: During Hours here. It’s pretty good.
Tobias: [laughs]
Jake: Yeah.
Porter: Can’t complain.
Jake: It’s During Hours–
Tobias: Now, I have to change that name. Sometimes– [crosstalk]
Jake: It doesn’t make sense. Don’t worry about it.
Vincent: The late-night shows do the same thing. They tape it at, what, 05:30, 06:00 clock?
Jake: Yeah, good point.
Porter: Maybe it’s for the Aussies. Who knows?
Vincent: Yeah.
Jake: Yeah, it’s 04:00 in the morning there.
Porter: Yeah.
Tobias: I forget exactly when we spoke to you guys last, but I don’t think a great deal has changed other than we’ve had a little bit of a junk rally by Q4 last year through to, maybe a month ago. Do you feel like we’re still in full on rally mode or are we sort of correcting a little bit here?
Porter: First of all, I think we did it last fall. It was one of our favorite podcasts we’ve done with you guys. It’s kind of fun to talk stocks and get a little geeky on some stuff, which we love doing.
Tobias: Awesome.
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Bearish To Bullish Reversals
Porter: I feel like the junk rallies, we’ve had it. I’m not necessarily bearish stocks here. I think this is just a big chop festival for a while, because you talk to everybody and no one has any idea what’s going on. You have a lot of conflicting data of CPI, PPI, jobs data, leading, lagging. And so, no one quite knows what to do. So, I think you’re not going to break out of this range until people have a better sense of what’s going on. And junk definitely had a nice little rally. All the losers from last year all rallied.
When you go through stock by stock, there are a lot of interesting opportunities and some of these charts look pretty good. We’re a subscriber to Carter Worth, and he put out a bearish to bullish reversals, which is our favorite chart pattern. Or bullish to bearish.
Either one, we like both of them, but these long bases where something’s changed. I’m not going to do it, go ahead and buy Square or Roku, but those two stocks are definitely in there. I’m not going to buy those two stocks. But there’s also a couple of the steel names, Cleveland-Cliffs and US steel. You think about where– because of the China reopening, steel prices can do pretty well and these stocks are dirt cheap, the balance sheets are good. And so, I think there’s definitely– if you’re a stock picker and you like to use your brain and there’s a lot of stuff to do.
Vincent: I would say, in terms of overall markets, I’m really not that definitive right now simply because so much of market movements in the near term is based upon things and brains and factors that the four of us don’t really care to adhere to, but it is what it is and it moves markets in a material manner. The one thing that does feel done and mainly, because I think the Fed put the lid on it is, if you’re not of the belief that the Fed is going to be cutting rates in 2023 and early 2024, we’ll see if that stands, but for now, the answer is a definitive no. A lot of these meme stocks are going to struggle, I think, because they need stupid liquidity to really work.
I feel particularly for the names that we play in, if the two-year stays high and stays tight, their access to funding of every type, whether it’s inflows coming into the stocks or more importantly, funding to fund their businesses, they’re just struggling mightily. The cost of capital is too high. So, that’s where I feel like that’s done in terms of the market. And hopefully– and when I say hopefully, because I actually think it would be a cleansing process, we start to see some of these really unwind in the form of bankruptcies. That would actually, I think, be pretty good for the market.
Liquidity Heat-Seeks The Crap Stocks
As for the rest of the market, I’m an agreement reporter. I think there’s a lot of stuff to do. I also think there’s a lot of stuff you should just simply avoid, because it’s just too hard to fight parts of the liquidity machine. It’s just not worth it, long or short. We were joking around before this came out, when liquidity hits the market, it always heat-seeks to the crap that we typically don’t like.
Jake: [laughs]
Vincent: It’s just true. It never goes to that coal company that you own, but it does go to Nvidia. So, my view is, “All right, as overvalued as I think Nvidia is,” and we take our shots from time to time, “Don’t play big,” because the personality of it just doesn’t go with our brains and the way it works.
Tobias: I saw a tweet today. Nvidia is at 80 times EV/EBITDA. That’s expensive. It’s rallied from five times, I think, about a decade ago. So, there’s been a lot of multiple expansion in that rally.
Porter: It’s not a young company either. It’s a fairly mature company. I won’t do it. I will never pay that type of money for something.
Jake: You think that these liquidities are a kneejerk that buy-the-dip sort of Pavlovian response to like, “Well, look how much it’s down? Therefore, it must be cheap.” Because there’s not more work really being done often, I wonder.
Vincent: Well, that’s our issue is that, [laughs] when you look at some of these charts and they’re down a lot. And then, you actually do look at some of the fundamentals and you’re like, “Oh, crap. This is really expensive.”
Jake: This is still expensive.
Vincent: I can’t touch this. Yet, I know there’s a whole wall of people that, whether from it’s a technical basis, whether it’s a rate of change and whatever metrics they’re using, are going to view it very differently than us. So, I think Square fits in that bucket, Porter, right?
Porter: Yeah, I agree. In that bucket– I believe Sonos was in that bucket of it looking like a bearish and bullish reversal. I looked at the stock and it’s 20 times earnings and I go, “You know what? That’s okay. I don’t hate it.” But Square at– well, use adjusted all– [crosstalk]
Jake: [crosstalk] Infinity times– [laughs]
Porter: Yeah, infinity times adjusted, or gap earnings, but 50 times adjusted. So, there’s still a lot of normalization to occur. Whether we’ll ever normalize again, God only knows at this point.
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Tobias: When you see the confusion and the chop, do you think that’s a result of just confusion of leading and lagging indicators? Because there are indicators like– I think the 10:3 has been quite predictive. There’s eight instances since Cam Harvey published his paper. It was pretty predictive before then. It’s been pretty predictive since it flipped in, whenever it was, October last year, and it’s been as inverted as it’s ever been before. It’s as steep as it’s ever been before, and yet, we’re still debating it– we’re in March now, we’re still talking about it’s still more inverted than it’s been at any other point in time other than the last few months.
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Real Estate Predictions 2023
Porter: Let’s stick to what we’re good at. You think about interest rates, mortgages, autos, all this stuff, and with where rates are, there’s just not going to be a lot of activity in big ticket items. Houses, there’s nothing going on. We can touch on this. Auto prices are up, the volumes still aren’t there, and it’s just more expensive to do all this stuff. So, I think if you take the housing as a massive pillar of the economy, there’s just not a lot of growth or decline, I think. I think the prices haven’t come down enough to see the velocity.
Again, there’s still not a lot of inventory out there. I think there’s the whole foreclosure issue, which we never really fixed post-COVID. So, that’s one of the reasons the inventory is still so low. I don’t think we’re going to go anywhere until this is resolved. Either price or a lot of time or rates come down, and I don’t see any of that changing right now.
Vincent: Yeah. To me, I’m speaking to friends who are looking in the real estate market. So, let’s extend the housing market to just overall real estate in general, including office, as well as multifamily, and the malls, and the strip malls. Nothing’s moving. Very little, if anything, is moving, there’s just no velocity. What I think occurred for the housing market specifically, let’s call it from October up until, say, February, is let’s keep it simple.
The 10-year rate dropped 100 basis points, which created incremental activity relative to what was happening in October. And then, if you add this little complexity layer that on a seasonally adjusted factor, two or three homes, and I’m speaking in hyperbole, selling in December, just nationally, that’s it. And maybe went to four or five homes because a few additional homes sold because rates went down 100 basis points. Of course, we seasonally adjust that, annualize that, and all of a sudden, it looks like the housing market is back. The reality is that the majority of homes are sold between March and August.
And this gets back, Tobias, your leading indicators, but I view these as all leading indicators of activity and I think it’s going to come in absent changes in rates and softer than expected over the next few months. Exactly when? I can’t time it, but I think you’re going to start to see it more and more come through the data, I would think.
Jake: Well, unless you’re just totally over the barrel and have to move, why would you change your 3% interest rate for a 7% now? It’s kind of unthinkable.
Vincent: But on the commercial real estate side, your issue is you’re probably underwater. If you have a 10-year fixed mortgage, same thing applies. Even if you’re underwater, you’re probably going to sweat it out. But heaven forbid, if you have some form of bullet maturity coming your way or your principals do, that’s a problem. It’s a problem for the banks and it’s a problem for the people who own the property.
Porter: It’s a much bigger issue if you’re in places with variable mortgages like Canada, or UK, or Australia.
Tobias: Australia.
Porter: It’s a real problem. So, I would assume that those central banks cannot be as aggressive as what the Fed is doing. If you look at some of these house prices to income, and debt to real estate property values, it’s just so far off the charts in those places that I think that the risk of total calamity is much, much higher than it is in the US. And so, we’re going to be in a really tough period here.
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The Two Positives In The Economy Right Now
Vincent: I do want to throw a bullish thing in there, because we started, of course, being super duper bearish. There are two positive dynamics to this economy right now. For what it’s worth, and I think they’re quite powerful. One is the COLA adjustments to Social Security increase by 8%ight to 10%. That’s a cohort that just goes out. If there’s more money to spend, it’s disposable income and they’re spending money, I think it’s one of the reasons you’re probably seeing better consumer spending data than the average. If we probably broke it out by demographic, my guess is the elders in our societies have more money to spend.
The other thing is, I don’t think it is no longer stealth capex cycle happening with the Inflation Reduction Act. The desire to have so much tax incentives associated with buying everything, solar, wind, or anything that reduces CO2 emissions, there’s got to be some tremendous equipment being purchased, which is helping the economy as well.
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This Is A Long Slow Train Wreck
Tobias: Did you touch on office before, Vinny? Because one of the stories that I have a little bit of trouble– I remember 2000 and after 2000, the dotcom bust– There were websites like Fucked Company and there were all of these– There was a lot of commentary about the collapse in Silicon Valley. I don’t feel like there has been as much commentary. There’s none of those sorts of sites around now or I don’t know about them. I saw an office in San Francisco. I thought occupancy was down like 35% year on year or something like that, which is– That’s a full-blown crash.
Porter: There was a bank we were short at the time called Greater Bay Bancorp. They were eventually forced to sell to Wells Fargo, just because the commercial real estate market was so bad there. This time, office is terrible. I’m actually in one office deal in California, and they can’t get price increases, and everything is lower. Everyone’s trying to fill occupancy and there’s a ton of vacant space. So, I think it’s a massive, massive problem. The banks are going to do their best to TDR, troubled default restructuring.
Jake: Extend and pretend.
Porter: Or debt restructuring. Yeah, they’re going to extend and pretend. Yeah, it’s exactly what they’re going to do. That’s the only thing they can do because the bank doesn’t want to own all this real estate, and they’re probably going to be forced to on the margin. You can see it. The delinquencies all are starting to pile up, but it’s not a disaster yet. But almost every day, it seems like there’s a CMBS problem. The Twitter building, Elon is not paying his debt and that went into bankruptcy. And so, it’s all over the place.
Tobias: I saw a statistic that something like commuting is still down like 50% from– or it’s only just got back to 50% from where it was pre-pandemic, I’m guessing. And so, part of that is secular because there seem to be a lot more people working from home. But part of that is also cyclical. We’ve come to the end of a really long extended bull market and we’re seeing this collapse. I’m surprised that it hasn’t leaked through to office space more. Is it just so sticky and so slow that it takes– You got a lease. Your lease runs until when it ends, and then you can really only think about it. Then, it’s only at the margin that you’re seeing the turnover.
Vincent: The answer is yes. I think the real estate market, unlike running a fund of publicly traded securities, you’re told every day how great you are and how much you suck, right?
Jake: [laughs]
Tobias: More of the latter.
Jake: Yeah. [laughs]
Vincent: [crosstalk] But the beauty of that, particularly, if it’s in private equity pools, they haven’t marked a lot of that stuff yet to what we would view as proper marks. We were on a podcast a few weeks ago, and I said, “I wouldn’t own in the private market or even the public markets for that matter, a corporate office, like if something came across our desk, I wouldn’t look at it unless I had unlevered double-digit cap rates on current NOI. I would do current EBITDA because I would want the GNA expense included in that if it’s publicly traded,” nice little game that the public guys play. When you do the cap rate math of any of the stuff that’s out there right now, you’re just not there yet.
Now maybe, Tobias, I’m kind of in your camp that everything is too expensive to me, and whenever I look at something, I want it cheaper. But I don’t think you’re asking a lot for a double-digit cap rate on what is potentially a secular decline in the underlying trends.
Porter: It’s a long, slow train wreck here.
Tobias: Yeah.
—
Porter: The only way to fix it is lower rates and that’s just problematic at this point.
Tobias: It doesn’t seem to be on the cards at all, does it, lower rates? There was some possibility, I think, in January it sounded like– Well, they had a 25-basis point increase rather than whatever they had estimated, 50 basis points or something like that. But now it’s going to turn– [crosstalk]
Porter: Not when Home Depot is raising wages 7%.
Tobias: Yeah. Well, that’s right.
Jake: Yeah, starting to get structural with the inflation.
Vincent: But to play counter for a second, if you guys are right that the leading indicators are if what I just said, on the leading indicators, it actually come to fruition in terms of rolling through the economy, maybe, perhaps, we will get lower rates in six to nine months.
Tobias: Ah, yeah.
Porter: The real question about the labor market is something changed post-COVID. Did all these boomers retire and you have a structural shortage of people being able to do the labor and we’ve had no immigration for, whatever, five years now? You’ve a real structural shortage in labor of doings. There’s still “help wanted” signs all over the place.
One of the point I wanted to make is that pre-2008, real estate was a very, very local market. You had the Texas S&L collapse and you had a different New England real estate bust. And so, I think now you’re going to see more and more of regionalized problems.
If you just look at the growth in– I’m here in Texas. Or, in Florida. It’s just so much greater than everywhere else. There was a headline out the other day about California budget deficits, and I’m sure New York is in the same place. You’re going to really see this bifurcation all throughout the United States. All of us have been talking about this for so long, but there’s only so long you can run huge structural deficits, especially on the state level.
And so, I just think if you go back to what we’re good at, we used to do a lot of, is trade regional banks. Back in the day or even today, you can pocket where there’s a lot more growth and, sell short where there’s no growth or issues or any kind of asset quality issues. That’s why I think you’re going to see more and more as this kind of cycle just continues to chop along until we figure out what’s going on.
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Tobias: Michael Cantor is, I think he’s an economist. I follow him on Twitter. He has this HOPE thesis where he says housing goes first and then it’s orders– What is it? Profitability, JT? [laughs]
Jake: Yeah. [laughs]
Tobias: I don’t really care so much about what the middle is, because you just got to know the H at the start. That’s when you start getting worried. And then, the E at the end is employment. That’s when you stop worrying. That’s the bottom. When employment finally cracks, that tends to be close to the bottom of the cycle and the top of the cycle. So, the fact that we’ve got very tight employment here at the moment, to me, that doesn’t say that’s a contraindicator. To me, that says you just got to keep on waiting until you get to that point where the E cracks.
Porter: But it does hurt the issue because right now, rates are the real issue, where historically, rates haven’t really been the issue. The issue is high rates here and you can’t cut rates until employment rolls over. Again, this economy is hyper financialized economy. Look at the US. $32 trillion in debt. We’re going to have problems and we’re running, again back to the bear case, which I know Vinny wanted to get bullish on me for a second, but–
Vincent: [laughs]
Jake: [unintelligible [00:21:41] him of that.
[laughter]
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Just Buy The 2-Year At 5%
Porter: You run these structural deficits for so long, how long can you do it for? Right now, you’re seeing a crowding out. Heck, I want to buy the two-year at 5% too. I don’t know. We’re worried about chop fest. The queues are down 115 bips today. Why not just own the two-year? I think you’re seeing more and more and more of that, of people saying, “Screw this volatility. I’m just going to own the two-year.”
Vincent: The two-year– [crosstalk]
Tobias: Yeah, vol [crosstalk] since that’s been possible. Sorry.
Jake: Yeah.
Vincent: Oh, yeah. The two-year and shorter duration is the best risk-adjusted asset on the board. That doesn’t sell well in asset management community, [Jake laughs] because it’s just not– And I’m telling you, it sells even worse in bank land because the value add of a bank has always been the low-cost deposits and now, they’re competing against an alternative investment vehicle that has equally compelling default risk characteristics.
But yeah. Maybe it’s because we’re market participants and we’re looking at daily marks, but this stuff just takes time. I’ll admit it’s probably taken a little bit longer than I thought it would just in terms of the slowdown. There are, as we were saying, offsets. But if you believe the way we do is that we’re overly indebted and highly financialized, eventually these higher rates are going to take its toll. They have already, but I mean it really take its toll.
Porter: Everybody just gave their thesis on our bank short. We don’t have a lot of them. We have a handful of bank shorts on the portfolio. Their percentage of, they call them DDAs, which is checking account deposits where you’re earning zero is the highest it’s been really ever. If you r evert to any sort of mean, and you go from zero to the go-to deposit rate or the two-year rate, which is 5%, it’s a big difference, and that really crimps your margin. Especially, if you’re an inverted yield curve, it’s just not a great place for the banks.
Jake: Yeah.
Porter: Asset quality is not getting any better and growth stinks. So, I don’t understand, besides being maybe optically cheap, what’s the bull case for the banking system right now? There’s just not a good one.
Jake: Yeah, they went long cheap and they’re borrowing short now, expensive.
Vincent: Yeah.
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We’re Bullish On Energy
Tobias: What about energy? How do you guys feel about energy? We had that classic chart from just about every other commodity out there where it’s run up and it’s run back down again. But structurally, cyclically– Cyclically, it says one thing. Secularly, it says another, I think.
Porter: I think that you have to take the three standard deviation warm winter into account here, and that’s the reason gas prices went from $10 to $2. At $2, I said it last week on Danny’s podcast, it’s probably bottomed. At $2, it’s at or close to being bottomed there, just given the fact that these LNG export facilities are going to open up, and you won’t have a structurally– this degree of warm winter, and maybe you do have a warm summer, and all that type of stuff.
I think if you look at the energy stuff, the consumption continues to roll along. There’s really no problem with the demand. And so, I think that we stay higher for longer. I think the bottom is in for at $70 or wherever it hit is probably the bottom for oil, and we stay higher than that.
Vincent: I’m really hoping you’re right, Porter.
Jake: [laughs]
Vincent: I think you nailed it in terms of in the near term, there’s a lot of headwinds coming your way. The first 30, 40 minutes, we talked about slower economic growth. That has an issue and associated with potential issue with the demand or probably not as much as markets would believe.
But the long term for us, it’s hard not to be bullish energy. Forget about valuation for a second, which is in your favor, but we just have undersupplied the things that we need on a global basis for 10 to 15 years in exchange for a new method of fueling ourselves which, for now, costs significantly more than what we’ve been using. I’m talking about solar, wind, and all of the renewables. And so, you can’t really get rid of what you had before and you just did not invest in it. So, the supply demand dynamics long-term are extremely favorable.
Porter: I’m going to rebut on the part where you said, the economy stinks. Well, stock prices stink. They’re not cheap, I don’t think, but the economy is ticking along. And especially, if you think about China reopening, and it’s been closed for three years, the biggest economy in the world, I think there’s going to be more demand than the bears think. And so, therefore, I think that we’ve seen the bottom here in oil, I want to say. You’ve also had the SPR draws and they’ve been big.
Jake: Yeah. [crosstalk]
Porter: They’ve done a lot to structure [crosstalk] to tamp down the prices of these commodities. And so, we’ll see where it goes from here.
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Market Is As Inefficient As We’ve Ever Seen
Tobias: What do you think about using the SPF to manipulate the energy prices lower?
Jake: For a mid-term election?
Porter: I’ll have, probably, a differentiated take on this. It worked pretty well.
Jake: It did work well.
Porter: They sold, I don’t know how many barrels they sold, but for what they sold, they took down the entire curve and lowered the energy prices for the entire world based on what they did. And so, I can’t crush them for doing that. We’ll see about the future, but I don’t have a problem with what they did.
Vincent: I think it’s politically par for the course. Why would we be shocked that a politician used an advantage to win an election? It’s bipartisan, right? Porter and I say this a lot. We could get angry all we want about market structure and things, but no one, and I mean no one’s going to listen to us or care. And so, as a result, just play with the cards that you’re dealt. That card being dealt seems quite normal. It would be abnormal if a politician said, “No, you know what? I’m not going to do that. That is wrong and that is going to put society at potential risk for a two standard deviation event.” That would be the outlier to me.
Jake: Yeah.
Porter: This is why the stock market, [Jake [laughs] it should not be like in an economics class, because the stock market is so much more than spreadsheets, numbers, and all that type of stuff. You add in the political elements, the geopolitical elements, the psychology and fear and greed elements, it just stirs it around to much more than a simple numbers game. That’s the part that we love. It drives us bananas most of the time, but we love it.
Jake: [laughs] I heard Cliff Asness talk about– He was lamenting the fact that– he admits that the market is inefficient and that’s what’s providing the opportunity. But then once he buys it, he wants the market to get efficient [Tobias laughs] right away for him. But often, it goes the other direction on you and then you lose your mind about it.
Porter: We’ve been making the argument that the market is as inefficient as we’ve ever seen it.
Vincent: Yeah.
Jake: Even more than like early or late 90s or [crosstalk]?
Porter: Passive flows are really-
Jake: Distorted the structure.
Porter: -distorted markets. You have a buyer who doesn’t care about fundamentals. The 60% buyer doesn’t care.
Vincent: Also, add in the very large vol-targeting mandate component of the market, where there’s so much capital that trades on volatility levels and levered based upon that. It creates distortions that I don’t think existed way back when, or not in the size that it does today.
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Tobias: This is a related question, and you might have answered it. But what do you make of the–? Last year, we were down variously. I think we were down 25% at one point. We were we down as much as– [crosstalk]
Porter: Some of that. Yeah.
Tobias: Volatility really just didn’t do much at all last year and it stayed low.
Jake: Like an old man getting into the bathtub.
Tobias: [laughs]
Porter: [laughs] I actually think– we were talking about this. Probably, the reason why really no one has changed their tune in terms of their views and opinions of the market. Remember in prior cycles, I remember during the Great Recession, and then going back even before that, the dotcom bubble, people were scared of markets. For right or wrong, and it’s very possible, so far, be it’s working out for them. No one’s scared that markets can go down and you can lose value of your wealth, unlike prior cycles where people were very apprehensive of it.
Porter: And I can’t blame them, Vinny.
Vincent: No, and that’s the point. How can you blame them? They’ve seen time and time again. When they’re the ones that sell, the string pullers then pull the strings, increase the liquidity a massive size, and the people who bought at the bottom benefit.
Porter: They’re going to do it again. You can’t pull this out. The market goes down, whatever goes down, and they’re in there. Luke Gromen has made the argument that it’s of national security to keep the S&P up. I can’t dispute him on that. It’s depressing, but whatever.
Jake: Interesting thought.
Tobias: Is it controllable to that extent?
Vincent: Probably, but at the end of the day, no.
Porter: They can.
Vincent: But from here to now, yes. Let’s rewind the clock. Everyone has said to us what the Fed wants. Who the hell knows whether this is what they really want? Is for the markets to crash, something to break. The markets go down to 3,200, 3,400 and then they can reset and be more dovish. Well, you did get a crash in October of 2022. We just don’t really think about it. We had two crashes, but they were different. One was the UK effectively was defaulting.
Tobias: That’s the April, the earlier one?
Vincent: That’s the October of 2022. At the same time, I think the yen went to 150 and you were losing that currency. How did they just suddenly get better? That was the Fed and the global central banks and their magic wand behind the scenes. So, they got their crash, they just didn’t like it. It was too much of a crash, and they had to go and support markets. Since that time, you saw a surge in liquidity on a relative basis up until, say, about two, three weeks ago. So, it’s not surprise– which we played that, but it’s not surprised markets did materially better during that time frame.
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Porter: We keep on saying this is going to be a chop fest. If you look at the S&P, it’s been flat since last May, flat since July, flat since September, flat since November, flat since February. It’s done nothing. It goes up and down, and everybody’s confused. And so, the valuation will fix itself. Probably through time, as these companies grow into it, and we hate the valuation of certain names, they’re just going to grow into themselves. And so, that’s my bull case.
[laughter]
Jake: Yeah. Sideways. [laughs]
Tobias: Sideways for longer.
Jake: Smooth, sideways for a decade.
Porter: Yeah, exactly.
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The Catalyst That Will Break The Market
Tobias: That doesn’t bother me so much as a value guy, because I think there’s a lot of cheap value stuff around. So, I’m happy hunting in the value stuff and just buying and selling and trying to find the stuff that’s buying back stock, pretty good cash flow. So, if the market goes sideways for a long time, I don’t really have a dog in the fight. I just note that every single big crash, take the last two, for example, 2000-2002, 2007-2009, you would have been seeing exactly the same thing at about this point, which is about a little bit over a year into it. We’ve not done that much. Nothing much has really happened. It was that back third that really saw the carnage.
I think that people would say in the last one though, that was the Lehman moment and it was after that, we really had the– do you need a catalyst like that for this one? If so, what do you think it is?
Porter: You always do. You need a giant rug pull of liquidity.
Tobias: Fear.
Porter: When you have a giant rug pull of liquidity, that’s what 2008 was. The 2008 probably wouldn’t have gone down but for a giant rug pull of liquidity. You’re just not seeing it in this market. One of the reasons that you’re not seeing the commercial real estate collapse is because there’s no giant rug pull of liquidity. The banks are kind of massaging it, they’re extending the cycle, the Fed is doing the same thing. And so, unless you see a massive bank issue or something else– Think back to what Vinny said about the UK. That was the liquidity issue. They went, “Holy shit. We can’t do this,” and they plugged the hole.
Vincent: This time around also, think about Credit Suisse. That was a controlled event. But that’s a pretty big bank to have what happened. I think probably the risk that is underappreciated and it’s hard to really handicap or underwrite it is the geopolitical risk. It seems like the human brain more and more, I guess, with the advent of social media is, when something happens, it’s in the immediate front part of your brain for a week and a half and for the war, is probably a little bit longer than that, which is sad. But now no one talks about it. There’s still incredible geopolitical risk globally. It doesn’t seem to be going away. So, that would be maybe the potential rug pull that brings the latter third of this down [unintelligible 00:37:37].
Porter: I got bullish for like a second when I thought that last couple of weeks that there could be some grand compromise between Ukraine and Russia. Russia can’t keep doing this. I don’t know, we’ll see. None of us are smart enough to figure this one out at this point.
Tobias: I don’t even know which way it goes when that happens.
Jake: Yeah. [laughs]
Tobias: I think sometimes, you get one of those catalysts, and the catalyst– I don’t think that the market isn’t cheap enough to have a– You have a short-term rally, might last a quarter or 10 weeks or something like that. But then, ultimately, there needs to be some sort of reset to the system.
—
Some Stocks Can Stay Undervalued For A Long Time
Porter: Tobias, I’ll ask you a question. So, we’re full subscribers into The Acquirer’s Multiple thesis of, “You buy good companies at reasonable prices.” What takes the market to figure some of this stuff out? I look at GM in that bucket every single time I look. Maybe it belongs in there, I don’t know. Maybe Tesla belongs in there too. That’s a whole different issue.
[laughter]
Tobias: My observation is that things can stay undervalued for very long periods of time, like five years, six years, and vice versa. I think it can be overvalued for very long periods of time. I think it’s funny when you’re reconstituting portfolios, like on a quarterly basis, how long something can stay in there. You’ve had this like–
I’m a long-term holder of this thing, when really, I’m reevaluating it every quarter to see whether it gets left in or taken out again. I don’t know. It takes a long time for sentiment to change about things. But it is funny. I’ve seen a few cycles now. I remember dotcom, some of those names that were flying high, and the original dotcom. Then, how cringeworthy they were subsequently. Remember when it was like the China commodity, the super cycle?
Vincent: Yeah.
Tobias: That was a good time to be a value investor, particularly a deep value investor. But then, that reversed as well. All of those names that we were flying high through that period of time were cringeworthy.
Porter: There’s a couple of stocks that it’s in The Acquirer’s Multiple that we own. We own some of these met coal names, Met Warrior Coal, which is HCC and AMR. I don’t know, if you own that or not, but post-COVID and when coal prices went crazy, these stocks really rerated. I’m looking at AMR here. They went from close to $0 to $170. And so, that’s a pretty good move.
But it’s now, it being digested for the past, I would call it, 16 months. It’s chopped and been flat. Met coal prices went down. But as China started to reopen, they’ve started to reaccelerate. You look at these stocks that are roughly one and a half times EBITDA net cash, special dividends, regular dividends, buying back stock. Maybe it just takes a little bit of time. These stocks have finally surpassed their COVID highs. Maybe it just takes a little time. I don’t know. I don’t think [crosstalk] speak about names. I’m giving you the bullish case on some of these things.
Tobias: The best example is Dillard’s, DDS. It wasn’t my position, but– [crosstalk]
Jake: Weschler.
Tobias: Was it Weschler? Yes.
Jake: Yeah.
Tobias: He held it and held it for eight years or whatever it was, and it went nowhere for the first seven years and 40 weeks or something, or seven years. And then the last year, it turned his entire holding period into a 30% CAGR over the– [crosstalk]
Jake: They get 10x-ed over two years from there.
Tobias: I just think that’s what happens. I remember distinctly looking at about 2015, a lot of the names that had been dotcom darlings, stuff like Microsoft and some of those other stocks, they had been performing phenomenally under the hood, but they really hadn’t done anything for so long that there was no volatility– [crosstalk]
Jake: Stock price wise.
Tobias: Stock price wise, yeah. You could buy leaps in them and the leaps had no vol. The underlying look pretty good. All you had to do was have some movement over two years. But I remember thinking as I was buying those, “They haven’t done anything for 15. Why would they do anything over the next 2?” But at some point, you got to pull the trigger on that stuff.
Vincent: That’s why we’re big believers in subscribing that duration is probably one of our competitive advantages, all of us, when I’m looking at it. Because the names, like you said that we own, we have no idea when they’re going to start to work or not. You’re right. You have to re-underwrite them every quarter to make sure that the underlying trends are pretty much where you think they are. The thing that you think is cheap is actually cheap relative to the cash flows that are coming out the door. But I can’t tell you when they’re going to work, because the flows don’t come to us on a daily basis. But if it is what it is, eventually, these things can be rocket shipped in a material way like Dillard’s, you just don’t know when.
Tobias: The big risk is that you take a number. That’s what I hate. But sorry, Porter
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Find Opportunities By Overcoming Socialism Risk
Porter: No, another example we were talking about this earlier is Petrobras, which is the Brazilian oil and gas giant. the stock has basically done nothing since 2013. It’s sort of chopped around. But if you look at in terms of how much money they made last year, they made more than Tesla, Nvidia, and Visa combined. The market cap is $65 billion at this point, and the market cap of those three stocks is $1.7 trillion.
In the meantime, I’m getting paid a 25% dividend in Petrobras. People will say, “Well, that’s an emerging market stock. They got socialism risk.” My counterpoint would be, we have socialism riskier too. [Jake laughs]
We have other risks as well. I will take my chances on margin of safety here with that stock than buying the S&P. Maybe I’m wrong, but I’m going to earn a 25% dividend in the near term. And so, I just don’t think there’s no one doing that same strategy that we are. We’re a hedge fund and an odd hedge funds at that. But I think just people’s perception of risk and reward is just funny in terms of they can’t miss the upside, they can’t miss the upside. So, they just keep in the S&P.
—
Thematic Investing
Tobias: I’ve got a question in the sidebar about your process. How do you source ideas? How do you prove them up? How do you size them? Can you talk a little bit about that?
Porter: Sure. Part of the sourcing for us are names you already know and have known forever. That’s usually in our wheelhouse of– Think about in the financials. You’re just looking at your screen, I’m doing it right now and knowing where– You know the names so intimately well. The other thing we do very much so is we’re very much thematic investors. So, we believe in underlying fundamental themes, and where we think the world is going over the next, say, 3 to 5 to 10 years. And then, we try to find stocks that fit that framework.
Then on top of that, we also layer in a bunch of screens that we do. We subscribe to Bloomberg. And a bunch of screens that we do that’s set up that start highlighting things that screen cheap or quite frankly, screen expensive. And then, that’s the first layer of the process. And then, they also have to prefer them to marry with our underlying fundamental theme so everything is in sync as to how we’re thinking. So, we could put a trade on because it looks cheap, but I don’t have a lot of staying power, but I don’t believe in the underlying business.
Tobias: To what extent are you using technicals when you’re buying and selling?
Porter: It’s part of the process. I wouldn’t say– we would never buy or short of stock exclusively on technicals. I gave the example of Carter Worth’s screen of bearish to bullish reversals. It’s one of our favorites and the inverse of that, he has a list of 25 names or maybe it’s 100 names. We’ll look in there, and two or three will pop out to us. I’m like, “Yeah, that’s kind of interesting.” And we’ll do work on that. That’s a way of saying, “Hey–” We always worry about flows. I think we’re very good at finding the E, but PE, the multiple price you pay, that’s the harder part.
But if you can find something in a decent technical trend and a fundamentals you like, and we like to marry the two because obviously, we love pissing in the wind, but you’d rather not be pissing into the wind. You have a nice gale force tailwind behind you and you can buy stuff like that. So, I think it’s part of the process. Technical charting is very subjective. And so, we pay a couple of people that actually know what they’re doing rather than us guessing and drawing lines and stuff like that.
Tobias: How are they making that assessment that’s moving from bearish to bullish?
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How To Find Multi-Baggers
Vincent: Carter actually, probably taught us the art of technical analysis. What I think you want in a technician, to me, what I like about is that their brain is very agnostic to fundamentals. The best ones just look at a chart and make a decision. That seems very foreign to us, but you kind of want that, because you don’t want a bias. You don’t want any form of– You want a different opinion. So, a bearish or bullish reversal, and we’ve seemed to have married our views of the world with that more than other technical patterns, is the stock just stops going down and it’s trying to crest and– Every time it goes down, it’s bought and every time it goes down, it’s bought.
More important in the back door from a fundamental perspective, we see a rate of change in the fundamental theme that we think is justifying exactly what is happening to the stock. And we’ve always felt like we were, interestingly enough, three to six months ahead of the technicians in terms of seeing the fundamental inflection. If we’re right, they just can’t see it in the technical levels yet, but it’s coming.
Porter: If you think about it, as we’ve gotten older, we have our elephant gun out more so than we have our sniper rifle. And so, we look for big trends where we can– If the stock is down 50% or something like that, and the technicals have bottomed and maybe the fundamentals have bottomed, you only need one or two inflections in the business model or something happens.
And its boom and the stock has the juice to go. If you think about it from an Acquirer’s Multiple standpoint, the valuations are there too. So, you have this really interesting stock that has a big margin of safety, great balance sheet, decent ROE. We were just talking about GM. What finally takes GM to the next level? It graduates from The Acquirer’s Multiple list. You finally sell and you rebalance into something new.
We’re buying a company, meeting with a company tomorrow, and we always tell them like, “You do not want us on your shareholders list.”
Tobias: [laughs]
Porter: Because you know if– [crosstalk]
Jake: [laughs] You’ve bottomed out– [crosstalk]
Tobias: Things are going really badly, if– [crosstalk]
Porter: Yeah, you’ve got them like, “You’ve done something wrong.”
Porter: “Two years from now, if we’re at the top of your shareholders list, something went wrong.”
Porter: Yes. There was this great bank called Flagstar, and it was a Michigan-based bank, and they’d done everything wrong. And so, we were buying in 2011 and 2010 and 2012, and the stock had pennies in the dollar. We had a new CEO. Vinny and I would yell at him all the time, and Vinny said the same thing. He’s like, “We better not be at the top of your shareholders list in two years.” It worked. It was a great multi bagger stock.
There’s another stock called AerCap, which we post GFC. We had owned $9. We were like one of the top three holders. No one knew what it was. And then finally, it was trading for BLOW Book. Things were terrible. They made a couple of different acquisitions and finally, stock’s like $70 now. We sold it a long time ago, of course, but those are the things that we like to look at, and where they can be multi baggers.
Not to say that we wouldn’t own a Home Depot and a compounder. But for a big, long institutional holder, that’s great. Or Buffet, he’s just going to sit on some of these compounders. Hedge funds don’t do that. They like to move their money quicker.
—
What Drives Investment Returns?
Jake: I saw this great chart recently that was showing– It’s called What Drives Investment Returns? It’s just like time spectrum. It was, over one quarter, it was sentiment change. One year, multiple change. 2 to 5 years, cycle and industry. 5 to 10 years, return on incremental invested capital. And then, 10 plus years, people and culture. And so, just knowing which game you’re playing on that and where are you trying to optimize your process, I think, is like half the battle of this.
Porter: Yes.
Vincent: You bring up a great point for us. Management teams and really feeling uncomfortable with the management team, particularly industries where there’s not just the underlying tailwinds, makes a material difference. I could go back to– You talk about our reserves in the back of our head of names that we like. There are like four or five really world-class CEOs in financial services land in midcap bill, where if the stocks ever got to the levels, we almost just go out and buy them knowing that the management team is still there and then just pick up a phone and call them.
I’ll give you one of them. We’re not involved in it now, but PFSI is this small midcap mortgage bank, so a monoline mortgage bank. The guy who runs it is spectacular, but it’s a mortgage bank. It’s a deep cyclical. So, you just sit there, and it sits on your screen, and you just wait until it gets to evaluation. Then once it does, you start buying it and then you pick up the phone like, “It’s the Grim Reaper. I’m back.”
[laughter]
Vincent: They own your stock again. But yeah, I’m a big subscriber of getting to know management teams over the course of the cycle and their actions suggesting that you really should be looking at this thing, even if it’s just on your watchlist.
Porter: That’s a great example. The stock, last year, got down to $40 as everyone’s like, “Oh, mortgage cycle is going to suck.” Of course, it’s going to suck. But at that point, we were like, “It’s just too cheap here. At $40, we bought it.” Stock went up and– If you probably talked to the CEO right now, you’d probably say, “Yeah, this is not that good and stock is $60. So, at $60, we’re not going to play. I’m not going to short it here, but I’d rather buy it back at $40.” It’s coming. [chuckles]
—
Tobias: Let’s do some speculation for the last five minutes.
Porter: Sure. Good. We’re good at that.
Jake: Yeah. [laughs]
Tobias: What cracks this market and where do we go for the rest of the year?
Vincent: Absent the geopolitical risk that we talked about.
Porter: I don’t think the earnings are going to come in as good as people think they are. I think you’re going to have probably more margin pressure. The earnings for the most part in Q1, they weren’t great. I have an obsession with Tesla, but the earnings weren’t good. The stock still went up, because the fanboys bought it and they believed in, whatever, out year thing. In general, they weren’t great. I was looking at Costco. Costco is the same thing as Home Depot. The unit volume is not really there, and it’s been price. And so, what happens when price is not as–? It’s not 9% nominal anymore. It’s half that. And so, the earnings growth is just not as good.
Vincent: I got a weird one and I’m not sure if I even believe it, but–
Jake: Even better.
—
The Debt Ceiling Problem No One Is Talking About
Vincent: We got out of our heads this whole debt ceiling issue. No one talks about it anymore.
Tobias: It just resolved so quickly. It’s like theater.
Vincent: Well, Tobias, it did not resolve itself-
[laughter]
Vincent: -at all. It’s just out there in June, July- [crosstalk]
Porter: It’s gotten worse.
Vincent: Yes, and in August. It’s just out there and we’re relying on tax receipts coming in, so that it’s not a June event, it’s more of an August event as some analysts last night told me. It’s in the Republicans– I’m not getting political. I’m just thinking as a political– [crosstalk]
Tobias: Strategically.
Jake: Right. Strategically, the Republicans need a win here of some sort. I was watching the testimony today of Powell and all that, and all the Republicans were banging the drum on [unintelligible 00:56:27] fiscal deficits and the like. If that gets hairy, that could crack the market. I don’t believe there’s going to be compromised because it’s such a big issue. But let’s fast forward the clock that it is resolved.
Then, what’s the first thing the US government has to do is issue tremendous amounts of debt, which sucks liquidity out of the system. Someone has to buy that debt. And so, if we’re issuing debt, absent QE, which I don’t think we’ll have, that’s a negative liquidity draining moment for markets. So, I think that debt ceiling is going to be a very interesting volatile time for markets. They resolve it and yes, the markets go up, kind of similar to end of a war, but it’s the aftereffects that I think become quite interesting.
Jake: Who buys that debt if not the Fed though? Anywhere rates that make any sense.
Porter: It’s the four of us. We’re buying the two-year treasurer.
Tobias: That’s right. [laughs]
Porter: We’re finding it– [crosstalk]
Jake: No.
Vincent: Not the long bond though, Porter.
Jake: Yeah.
Porter: But they’re funding everything tight anyway.
Vincent: Yeah. I also think that you might see changes in bank laws and financial regulation to relax leverage levels, the SLR ratio.
Porter: You’re crowding out. The problem is we’re crowding out. The whole thing about– I go back to our days of reading the papers on QE and portfolio balanced channel. His whole idea of QE is he wanted people out on the risk curve. And right now, it’s the reverse of that, is that the two-year treasury is 5% and it’s telling you, “Hey, idiot, don’t buy the S&P. Park it here for two years at 5%.” I’ll argue against myself. The inflation rate is probably higher than that. So, on real raises, you’re losing money.
Vincent: That’s why you do short duration, because someone said, “Well, what do you do in a year when you get your money back?” They’re like, “Well, what if rates are–” And I don’t believe this. “What if rates are 6%, 6.5%?” I’ll roll it. If they’re not, then I’ll just figure out what to do with the cash afterwards and I earn 5%.” So, I probably lead on that is that that’s probably the best thing people can do with their money. [crosstalk]
Porter: Especially if you are a boomer. We have so many retirees and they’re all sitting there saying, “Well, heck, I don’t want to lose my money. I’ve gotten killed for so long. I probably didn’t own go-go tech stocks.” They were probably in stupid value stocks.
Tobias: [laughs]
Porter: They can finally say, “Hey, I can sit here in cash and not worry.”
Vincent: By the way, I just noticed, we were in about an hour and 15, 20 minutes, which, by the way, this is great. I truly enjoy doing this. We didn’t talk once about gold. Not once, which is amazing to me.
Tobias: Do you have a view? Do you want to do it? Do you want to give a 30-second gold?
Jake: [laughs]
Vincent: I think at the end of the day, there has to be some form of a standard that restructures fiscal responsibility across the globe somehow, some way. I don’t know, if it’s gold, but I just don’t think you can run chronic structural fiscal deficits for 50, 75, 100 years. It doesn’t make sense to me.
Tobias: You’re the one talking about politicians earlier saying that you’ve never met one who–
Jake: Yeah.
Tobias: You did the right thing, they do the– [crosstalk]
Jake: Do you eventually run out of the next generations that they can’t do it.
Tobias: Yeah, that’s a great line.
Jake: [laughs]
Tobias: Whose was that? Who said that?
Jake: Oh, It was like some– [crosstalk] Remy is like a libertarian. He does these songs. Anyway, it was hilarious.
Porter: Warren’s out there today. She was banging the drum for him to cut rates so she can spend more. Both parties do it well. They both spend. I don’t see how they’re going to cut– They can’t cut spending. They can’t.
Tobias: It’s baked in.
Jake: It’s baked in. What id– [crosstalk]
Vincent: If it’s baked in– okay, let’s roll with this. If it’s baked in, then what’s coming next?
Porter: More debt.
Jake: Inflation.
Vincent: Someone’s got to buy this debt.
Tobias: We all look like Japan eventually, right? It’s the BOJ stepping in. When you get that question, it’ll be the Fed. We’ll get a crash, the market will fall, the cut rate’s hard. It won’t make any difference, rates will go down, they’ll step into the market, they’ll liquefy everything. And then at some point, when we reach the bottom, we’ll take off like a rocket ship again. So, make sure you’re fully invested.
Vincent: [laughs]
Tobias: As you could have guessed, Vincent is a very proud Italian man. In our yearend letter, we had Sylvester Stallone’s Rocky and Rocky IV. The theme was No Easy Way Out.
Vincent: It’s just for editorial purposes, because this might go global, Italian-American.
Porter: Okay. Yeah.
[laughter]
Vincent: We’re probably [crosstalk] proud Italian man. So, yes. But yeah.
Tobias: Well, thanks, gents. We’ve bumped up against time. Vinny Daniel, Porter Collins, Seawolf Capital.
Porter: Good stuff, guys.
Tobias: Thanks for coming on. I hope you’ll be back on again in the future.
Vincent: Awesome. Thank you.
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