In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Joshua Young discuss:
Here are the headings in plain text without numbers:
- Oil vs. Human Ingenuity: Can Innovation Prevent an Energy Crisis?
- Oil & Gas Cycles: Market Trends, Innovation, and Investment Opportunities
- Investing as a Game of Chicken: Valuation vs. Patience in Market Cycles
- 10 Philosophical Razors to Sharpen Your Thinking and Cut Through the Noise
- Value Investing Sentiment: Is the Market Finally Turning?
- The Shale Revolution’s Impact: Oil Prices, Inflation, and the U.S. Economy
- Oil as an Economic Indicator: Recession Risks, Price Cycles, and Market Mispricing
- Energy Intensity, Reindustrialization, and Oil’s Role in the Economy
- Shiller PE, Market Cycles, and the Magnificent Seven: Are We Overvalued?
- Stock Market Rotation: Is Capital on a Hair Trigger for the Next Big Shift?
- Trading vs. Investing: Do Noise Traders Influence Real Asset Values?
- Bitcoin: Digital Cash or Speculative Asset? The Case for and Against
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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Transcript
Tobias: We are live. This is Value: After Hours. Joined as always by my cohost, Jake Taylor. I’m Tobias Carlisle. Our special guest today is Joshua Young of Bison Interests. He’s the founder and managing partner. It’s an oil and gas public equity investor. How are you, Josh?
Joshua: I’m good. How are you?
Jake: Welcome.
Tobias: Tell us a little bit about Bison Interests.
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Oil & Gas Investing: Cycles, Small Caps, and Surviving the Downturn
Joshua: Sure. So, we launched in 2015. The thought was that after the oil price crash in 2014, capital had fled the public markets and was being directed into the private markets in oil and gas. I guess also a broad private equity boom was going on there. And so, we thought we’d go buy some small caps at a low valuation, and that buying value with catalysts would yield outperformance over time.
And so, we were right about the outperformance relative to small caps and relative to oil and gas stocks. We were wrong that oil and gas stocks would go up over the following decade. And so, our benchmark is PSCE, which is the small cap ETF. I think it’s down something like 75% from when we started, and we’re up somewhat.
Again, none of this is an offer or solicitation recommendation or anything like that. But that’s what we do. We try to just find value priced oil and gas stocks. And then, actually, one time I joined the board of a company, and became chairman and replaced the board and replaced the management team and sold it and did real well versus the other companies in that area. And that was a Canadian small cap.
Jake: So, when Your benchmark’s down 70%, this is like the– What’s that meme where the guy’s [crosstalk] fighting the third place? [chuckles] He’s celebrating on the podium, but he’s in third.
Joshua: Yeah. Good performance relatively, and you’re still massively lagging. The reason to talk now and the reason that things are interesting, is that historically, cyclicals underperform for parts of the cycle and then they massively outperform. There’s the broad cyclicals and then there’s specific niches, and oil is probably one of the biggest of those niches.
What historically happens, is in almost every cycle, you have such extreme outperformance in the up part of the cycle that you lure in enough capital to be able to get over investment and crash the market and so on in that niche. And so, you need to have that period of massive outperformance over a multi-year period. You need enough capital to get a capital cycle to lead to that destruction.
And so, we haven’t really had that. We had a couple years that were okay, 2021, 2022, but we’re, what, 15 years, 16 years into this down cycle that started in 2014 and so– Sorry, 11 years into that. And so, at some point, you’re going to need a material upcycle. Small ap’s, when they’ve done this poorly historically, they’ve done really well in cyclical upcycles. And that’s theory.
And then, with almost no one actually picking any of these stocks and with it dead and seeing disgust and concern and [chuckles] various other things when you tell people this is what you, that’s-
[laughter]Joshua: -very exciting as an active manager in the space.
Jake: Well, fair play to you for surviving, and sticking around and staying the course. You get a gold star in my book for that.
Joshua: Actually, I got better than a gold star. I’ll show you– [Jake chuckles] I got to go to Vienna recently, and they gave me a little oil drum with a little– I don’t know which country it’s from, but from OPEC, they had me come out and meet with them and– Yeah, so, that was pretty recent. Then, of course, they dumped oil on the market right after.
Jake: [laughs] Just killed you. [laughs]
Joshua: Yeah. But at least, I got a little plastic oil drum.
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Oil & Gas Cycles: Market Trends, Innovation, and Investment Opportunities
Tobias: Yeah, I think small and micro– More generally, not just oil and gas, although there’s a big oil and gas component to the cyclicals that I look at, it’s looking more value and better value than I’ve seen in a long time. I think they’re looking very, very interesting and healthy at this point. But let’s talk specifically about oil and gas. For folks who are tourists in the oil and gas sector, maybe give us a little–
Jake: Like, history of the last 15 years or something?
Tobias: Yeah. Where are we going. Where are we and where we are going.
Joshua: Sure. So, what historically has happened, is you’d have a down cycle which would last for a while, typically around the discovery of one or more large fields, and you’d have development of those fields, typically, development costs were quite low. Way back when you’d have 1,000 rigs all on just one little area all right next to each other, and then as things progressed and there were better rules on these things, you’d have fewer rigs and more efficient development of fields.
That’s the down cycle is you have a discovery and you flood the market. And then, as those fields run out, you have a big upcycle that induces enough exploration and delineation to be able to crash the market again. And so, we had this big discovery which was a little different from what we experienced historically in the US with innovation from an engineering perspective for shale.
That really kicked off in 2010 or so, the innovations. It took a few years for it to get big enough to crash the market in, let’s say, 2014, 2015. And so, we’ve been in this really prolonged down cycle for oil and for natural gas because of this engineering innovation and because of the roughly 10 million barrels a day of production growth from the US, from Canada, from a couple other unconventional basins and then also a little bit of innovation around deepwater development, which has provided the rest of that marginal, let’s say, 10 million barrels a day of production.
And so, we’re at the tail end of that. There hasn’t really been much exploration or innovation outside of shale and outside of, to a much lesser extent deepwater drilling. And so, I think it’s getting really interesting. We’re seeing it already on the gas side where gas prices are higher, but the rig count isn’t up much and production has flattened out. And then, on the oil side too, there hasn’t really been much oil production growth for the last couple of years in the US, and either we’re at a geologic limit or we just need higher prices to get that next set of developments. So, very high level, that’s where we’re at and where we sit.
Just from a narrative perspective, every cycle at the bottom, people say, “Oh, it’s done and it’s over and you can’t invest in that and it’s trash and it’s terrible.” They come up with all kinds of, “There’s moralistic stuff, there’s economic stuff. Buffett would say this about airlines, but I’m sure, they would say it about oil companies too.” Like, “Oh, capitalism would have been better if they shot the Wright Brothers out of the sky.”
Jake: Yeah.
Joshua: So, anyway, that’s where we’re at. I think we’re very close to if we’re not at a bottom for the cycle because of the similarities to other bottoms as well as what we’ve seen with the production trajectory. And then, there’s weird narratives on demand every cycle. The reality is that demand for oil has grown by about 1% a year globally for 40 years other than COVID. Independent of narratives on electric vehicles, various other things.
And then, for natural gas demand is booming and supply is not. And parallel markets, some wells produce both oil and gas, some just produce one or the other. And so, that’s I think where we’re at in the cycle.
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The Shale Revolution’s Impact: Oil Prices, Inflation, and the U.S. Economy
Jake: It’s an interesting counterfactual to imagine a history where we didn’t get shale at all or it was stayed like too hard or technologically. I don’t know, imagine $150 oil for the 2010’s period. What would that have meant for inflation, what would that have meant for what the federal funds rate looks like, how much can you juice the economy, how much can you borrow as the US government? There’s all these knock-on effects of imagining $150 oil for a decade. Quite interesting, actually. Like, maybe one of the bigger untalked about historical influences.
Joshua: Yeah. I think if you think about the US economic miracle over the last couple of decades, almost all of it is explained by low prices for electricity and chemicals for natural gas, as well as substantial incremental revenue and capital expenditures for oil and for gas. So, it’s not just the higher oil where maybe you’d have $250 oil, because if you look at how ridiculous it’s been that you have oil prices at 20-year lows, but eggs or cars or other physical things that are similar and cyclical in a lot of respects are five times more expensive than they were, let’s say, in 2007.
So, in addition to that, which would have really changed the world quite a bit, you would have had $10 or $15 or something dollar natural gas without gas shale. And that would be a very, very different world with very different winners.
Jake: It’s $4 today, right, roughly–
Joshua: Yeah, like $4.50. But it was $2 for a while and I think an average of $3 for the last 10 years or something like that. And so, we’ve really benefited a lot. We’ve spent hundreds of billions of dollars invested in the US which people think, “Oh, it goes into the ground.” But the reality is most of that money is labor, and then parts and equipment that’s built and replaced and repaired.
This is where I’ll just touch on it just very briefly. If baby drill would work, it would be amazing for the US. But suppressing the price and encouraging OPEC and others to produce is massively negative for the US economy. This is very, very big positive effect, very rapid recycle of cash that’s invested in drilling for oil or gas wells, especially on the shale side. It’s been, I think actually quite depressing for the US economy in the last couple years as the rig count has fallen and as production has flattened out, both for oil and natural gas.
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Oil Price Cycles: From $130 Brent to $66 – What It Means for Production and Supply
Tobias: Before we came on, I had pulled up the oil price. It looked to me like it topped out in– Before we came on, I said to Josh, it was May 2022. And he said, no, it was June 7th, 2022. I think it was like $124.50 was the number I saw. But what was the number, Josh? Do you know?
Joshua: I think that was probably WTI. I think Brent was like $130 or $132, something like that. I should know the exact number. I know the day better than I know the exact Brent– [crosstalk]
Jake: It was negative like a year before that? Is that accurate?
Joshua: Yeah, 24 months before it.
Jake: Yeah. Okay, so, two years before. It’s wild.
Tobias: So, where are we now? We’re about 70 bucks, $66, something like that?
Joshua: Yeah, $66.
Jake: Is there a lot of production that is reasonably at least earning a cost of capital at $66?
Joshua: No. So, there’s two questions. [Jake laughs] There’s like–
Jake: [crosstalk] I asked [laughs]
Joshua: Yeah. What breaks even on OpEx, which most production on right now is profitable from a pure just lifting cost and operating cost perspective. The companies are making money on existing production. But the funny thing about it and the thing that makes it so powerful from a potential cyclical perspective, is that most of this production that’s grown in the past decade is ultra-high decline rate. The first-year wells, they decline 70% plus. Even in your fifth year, sixth year, you’re still talking about 20% to 25% annual declines on the production. So, the overall base for US production is declining something like 40% a year. So, it’s not just the OpEx. You want the full cycle, you want the CapEx.
Frankly, these days, you also want to count the inventory cost, because a lot of the companies are having to reinvest a lot to replace their development inventory. And so, that break-even is probably closer to $90 WTI. The evidence of that is that the rig count has fallen. If you look back to 2022, it grew for a few months after oil peaked and then it started to fall. The oil and gas rig count, I believe is down somewhere in the 30% to 40% range since then. So, that’s displaying we’re in supply destruction territory from a pricing perspective.
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Oil Price Cycles: From Supply Destruction to $150+? Market Trends & Forecasts
Tobias: So, when you see that, where do you– I mean, if we need to get back to $90, just to see break even, what’s the prospects for that in the short to medium term?
Joshua: So, one of the biggest overhangs on the market has been OPEC with their spare capacity. And so, we think OPEC has about three million barrels a day of spare capacity and the market thinks that it has about six million barrels a day of spare capacity. Unofficially, let’s just say that that’s not really an OPEC number. That’s an OPEC member number. And the OPEC guys might agree with us more than [laughs] they agree with their member countries, but that’s not official and they don’t have a specific– They don’t provide numbers that they say they can’t verify.
And so, as that production comes on, that’s been what the market’s been reacting negatively to, as it comes back on and that spare capacity number falls, you could end up seeing prices rise a lot to the extent that inventories don’t rise. The EIA just came out and the EIA has been pretty pessimistic on oil and bearish and so on for the last number of years. They showed over a million barrel a day supply deficit for February.
And so, if that’s true, and again, we’ll see– These short-term numbers are very difficult to get right. People have strong views on them and they’re almost always wrong. Whether they’re vendors or government officials or like traders, they all have very strong views. It’s helpful to say, “Okay, hey, I’m not exactly sure but y’all have a 90% error rate, so I’ll just discount all this heavily and say, ‘Hey, this is what it looks like.’”
It looks like we’re in a deficit even with the recent additions from OPEC. I think as that spare capacity clears without flooding the market, we’re set up for potentially, I don’t think we go like evenly from 66 or whatever to 90. I think we clear at some price, I’m not sure exactly where, and then go way higher when we don’t see the supply response that everyone’s expecting.
The scary part about balancing the market is OPEC was there to balance the market. As their oil comes on and as there’s less spare capacity, there’s not really a lot of precedent for oil or for other cyclicals to hit a medium Goldilocks type price. They typically go from supply destruction pricing to demand destruction pricing and they swing. So, we’re in a glut right now. It’s a weird glut, because the [chuckles] inventories are declining, but we’re going to go from glut to consensus deficit, and that would be a $150, $200, whatever dollar price type environment, at least on an inflation adjusted basis.
Jake: One thing that’s always impressed me or I found odd is the– On the total production and consumption, the price moves on to me, what seemed like very small differences as a percentage basis of that total. It seems like it’s all run really tightly as far as a stock and flow system looks. I don’t know, if you could help us visualize that or if you’ve thought about that in ways that might explain that better than I just did.
Joshua: Sure. So, the best model I’ve come up with for that is actually from Morgan Stanley. They published this statistical– I think, Toby, you’ll like this quite a bit. They have a dispersion of prices over time, and it’s like a frequency chart. Basically, oil prices hang out either in supply destruction territory or demand destruction territory. They’re almost never in the middle.
Jake: But they were equilibrium
Joshua: Almost never. Yeah. And so, we’re in this very weird position for the last couple of years where we’re hanging out in equilibrium. It was leaning towards supply destruction, because the rig count was falling, but it wasn’t catastrophic. And so, you see this– It’s a bimodal price condition, essentially. You’re either supply destruction or demand destruction almost never in that Goldilocks type situation.
And so, what you’re observing is the market being in a big degree of uncertainty and being in an unstable price situation. And so, that middle ground that we found ourselves in for the last couple of years, it was very unstable, and that’s where I think there was so much debate and so much contentiousness because the question was, hey, is this 2014 and we’re about to see another three million barrels a day of shale or offshore or whatever and you’re going to see the price collapse, or is it 2003 and you’re about to see prices rise a lot for the next 10 years? So that’s, I think, the real debate and that’s why you’re seeing that tension.
Honestly, there’s a negative correlation between a lot of these short-term statistics and price movements. That’s the best explanation I can come up with, is just that you’re like zoomed in way too much and there’s really this much bigger battle going on. The reality is that honestly, I think the bears have won in the sense that we are in supply destruction territory. At $66 right now, inflation adjusted, you’re talking about $40 from 2007. And so, we’re there. Or, $50 from 2017. But you have policymakers and other folks that are looking at it thinking, oh, this price is high, not factoring in the crazy inflation and everything else, including labor and steel and other stuff that goes into it. And so, anyway, I think that’s what’s going on.
It’s a great question. People don’t really talk about it. But the problem is, hey, what happens if you’re into supply destruction territory already? Its volatile, but in there. Is it more likely that you stay there or gets worse, or is it more likely that over time that gets worked off and you end up going much higher? Where to next? My view is where to next is much higher, but there could be some pain in between now and there.
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Oil as an Economic Indicator: Recession Risks, Price Cycles, and Market Mispricing
Tobias: Oil and gas as a economic indicator where if it gets to– It seems in the past where oil and gas has spiked, that’s led to a slowdown in the economy, and then either as a consequence of that or because the economy slows down and oil and gas prices tend to follow suit. If we’re going into some recession here, how do you feel over the shorter to medium term in relation to oil and gas prices?
Joshua: Yes. So, there was a famous commenter who I won’t call out by name, who would talk about how the oil market always cleared based on the current situation and not the forward expectation. And that’s changed. That commenter was a famous oil bull and actually now is bearish, which is very exciting to me. [Jake chuckles] I just want to see this capitulation come in. We named our firm, Bison. We’re just going to face through this.
Jake: Yeah, last man standing.
Joshua: Yeah, we’re going to face through this. But man, seeing multiple competitors that either represent themselves as bullish or whatever, or these various pundits that were super bullish at $130 and now have fully capitulated and whatever. Anyway, the theory is that these things clear on current expectations.
The reality is that with a giant paper market and a much smaller physical market, the oil market’s big but the paper market for oil is enormous, there’s a lot of room for forward expectations to get priced in. There’s a very cogent argument that you already have a pretty bad US recession and a moderate global recession priced into oil at current prices versus current oil inventory levels and current supply demand deficits.
So, again, it’s very wonky and some of this stuff is often wrong, whatever, but there is a pretty good argument that you’re, let’s say, $10 to $20 mispriced too low right now and that positioning is so extremely negative. There’s like what you can see and there’s what you can’t see and the position you can’t see is even worse than what you can in the CFTC data and various other stuff.
And so, I think we’re in a weird position because of that forward looking spot price for oil which again shouldn’t happen, but is. To me, that’s very exciting. Because again, you’re– You’ve gotten pushed into this supply destruction territory, but the fundamentals are actually, you should be pricing demand destruction, not supply destruction because you’re under supplied in the market.
Then, again, like your cushion from OPEC and so on is diminishing right now potentially pretty rapidly, and so that’s where again to me, it’s very– It’s not just that I’ve owned this stuff for a while and want it to go up. It’s fine. If it’s going to go down first and then up, I’ll survive. We own very, very cheap stocks that I think are mispriced even at lower commodity prices than today, and so we’ll be fine. But I think the setup from the market and the level of capitulation as well as positioning is way too negative. I think as it just normalizes, there’s room for it to go crazy. And again, a lot of that is just where the price is versus where the current economic reality seems to be.
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Energy Intensity, Reindustrialization, and Oil’s Role in the Economy
Jake: I could see that as a signal decaying over the time as the energy intensity of the economy comes down as well. Services just require less energy than manufacturing.
Tobias: Is that the case? Has the energy intensity of the economy come down?
Joshua: It has, but it makes you wonder about [chuckles] what’s left. So, some of it–
Jake: We’re all making burritos and financing everything. That’s the-
Tobias: Podcast.
Jake: Podcast. [laughs]
Joshua: Yeah. Exactly. Podcasts aren’t very– we’re doing this virtually. If I flew out to LA to do this, then it would be a little more oil intensive, but we’re not. So, yeah, I think re-industrialization, which we’re seeing now in Europe, at least, they’re talking to the talk on that. And then, Trump and Canada, various other places, re-industrialization breaking trade is bad, but re-industrialization is very, very energy intensive.
I think in the next downturn, we’re going to see just how real some of this economic activity that we’re measuring is. I try to avoid being super bearish, but it is the American miracle has been wonderful. But some of these numbers are funny and there are whole asset classes that have no cash flow and no fundamentals, and there’s giant amounts of money that’s supposedly been created or whatever, and economic growth associated with things that have no– They’re just computer things. They are there. So, that aspect I think might go away. It might be that the energy intensity of the economy has never fallen. It’s just been that were measuring some of the wrong things.
Jake: Yeah, I could buy that argument, for sure.
Tobias: How does the new administration’s policy impact the oil and gas market as we go forward? I haven’t followed it closely. It’s not a political comment. I’m just interested from a business perspective.
Joshua: Yeah. It’s bipolar, let’s say.
Jake: Well, it changes every 45 minutes.
Tobias: That’s why I haven’t been paying that much attention. [Jake laughs]
Joshua: Yeah. If this is recorded whenever someone’s listening to this at some point in the-
Jake: Yeah, it started to stale.
Joshua: -future, it’s going to be different than what we’re saying.
Tobias: Tomorrow.
Joshua: I think uncertainty suppresses economic activity. It suppresses investment. And so, I think generally that comment is negative. That said, deregulation and lower taxes or lower whatever should in theory beneficial. And then tariffs, if the goal is to actually lower global barriers to trade, that’s really positive. If the goal is Smoot-Hawley style, 1930s, suppression of trade, then that would be really, really bad. And so, again, I don’t think we know.
I think we know that even just the energy policies are bipolar, inconsistent and disappointing. I will say, I had really high expectations of the folks that came in to run energy policy and they’ve massively underwhelmed. And so, hopefully, they deliver but massively underwhelmed. These are people very successful in the private sector, and frankly they could be making a lot more money and not embarrassing themselves if they went back to that. It’s just very odd to see people agree totally, like, what is the word, the clown themselves or whatever [Jake laughs] for what end. Bipolar policy doesn’t yield any positive results.
So, again, I’ll get off the soapbox, but it’s very weird. It is concerning short-term from an economic perspective, because uncertainty does suppress economic activity. That being said, I think the fundamentals for oil and gas are powerful enough that we may overwhelm some of this policy uncertainty and policy failures very shortly.
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Oil vs. Human Ingenuity: Can Innovation Prevent an Energy Crisis?
Jake: Josh, what would be the counterargument to the thesis that being long-term long oil and gas is being short human ingenuity?
Joshua: I think it sounds really good, because in the last decade–
Jake: That’s why I said it [crosstalk] [laughs]
Joshua: Yeah. Because in the last decade, we saw human ingenuity crash the price and crash the gas price and keep it low. We’re seeing maybe the failure of human ingenuity as supply disappoints. At least, on the gas side, prices rise. Gas was the first mover on shale. It came way sooner than oil. Oil’s way harder. So, if you’re seeing price rise, you’re seeing supply disappoint, you’re seeing core exhaustion in these fields on the gas side, I don’t know why you’d think that you’re not going to see it even more so on the oil side.
So, anyway, I don’t know, there’s these weird sound bites and it’s great for selling subscriptions or whatever. But there’s a reality, which is that one hand, there’s human ingenuity. On the other side, there’s Malthusian scarcity, and we’ve balanced that very well as a species over our modern era. I’m not saying that we won’t be able to solve very high oil prices, but the history is that you need those price spikes in order to incent the investment and time and ingenuity to be able to get to another period of low prices.
The fact that that’s so popular and such a common conception itself is a good indicator that we’re about to experience a period of much higher prices and concern around the ability to innovate out of them.
Jake: It does feel like we’ve landed a few Hail Mary’s over time of– The Green Revolution, the productive output of agriculture from all of our various methods that we use, like huge productivity increases there to the point like, we could feed eight billion people. That was a real question mark for a long time. And then, shale. I put in the same thing of like we landed a Hail Mary. But this expectation that you’re always going to keep landing Hail Mary’s as a species, that might actually be a little bit of a dangerous idea that we’ve all generally accepted.
Joshua: Yeah. I think it’s not that we won’t. It’s that we won’t consistently. And that these Hail Mary’s are the result of enormous amounts of money and time. And so, when you deprive the money by going through a multi-year downturn, then you end up increasing the odds of experiencing a period of shortages. We’ve seen this on agriculture, we’ve seen this in other commodities. That’s what it means for a thing to be cyclical, is that you don’t end up–
We haven’t solved agriculture, we’ve improved productivity, but we also have various challenges associated with it. I don’t think we’ve solved oil and gas either. We’ve improved productivity for a period, found some good resources and then I think there’s some risks around that and those risks increase.
Our base thesis was, hey, there wasn’t enough exploration or delineation going on even back in 2015. And this problem would just compound over time. And so, we’ve seen it compound over time, and we see it as a way worse problem now than it was in 2015. There’s almost no one going and doing anything about it. And so, as you only discover 10% or 20% or so of the reserves that you produce in a year, eventually, you run out of those reserves and then what do you do. It’s not that there’s not that oil there or that ingenuity, you just are going to experience a period of too high prices and too much focus on the thing just like we experienced a long period of arguably too low prices and too little focus.
So, it’s not we can’t do it. It’s not that it’s going to be horrible forever. It’s just, hey, what is it like the good times lead to weak men, and weak men lead to bad times and the bad times lead to strong men sort of circularity. So, it’s similar for cyclical. So, it’s not impossible. We’re not going to have peak oil or anything like that, but we will require another reinvestment cycle. We haven’t had it. I believe in human ingenuity, but also, we need high prices and focus in order to be able to get that.
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Tobias: Hey, Josh– Josh has to run. We’re going to stay on and do Jake’s veggies and go around the horn. So, Joshua Young of Bison Interests, thanks very much.
Jake: [crosstalk] have you back Josh-
Joshua: Thanks for having me.
Jake: -and get some more of your thoughts.
Joshua: Yeah, absolutely. Thanks for having me on. You guys have a great podcast. Have a good one.
Tobias: Thanks, Josh. All right, folks. Let me just give a shoutout. Boise. Cleveland. Bethesda. Max in Valparaiso. How are you? Bendigo. Up early. Milton Keynes. Toronto x2. San Rafael, California. Brandon, Mississippi. Tallahassee. Tomball, Texas. We appreciate it, Tyler. Bremerton, Helsinki, Camas, Nar Nar Goon, that’s not a real place, Les. Les Whynin. Nokia, Finland, Jupiter, Jupiter 2. Lucky guys. San Diego. London. Zagreb, Croatia. Albion. Gothenburg, Sweden. Antwerp, Belgian. Madeira Island, Portugal. Kennesaw, Georgia. Cincinnati. This is a good spread. Amazing. Karachi, Pakistan.
Jake: Wow. All right, enough of this tomfoolery.
Tobias: Hang on, I’ve got to get this last one out. [Jake laughs] Zevenbergschen Hoek.
Jake: He’ll read anything, folks.
Tobias: The Netherlands. Almost natural. [Jake laughs] I skipped over one that might get us cancelled.
Jake: Okay. That’s too bad.
Tobias: You have to check in and see which one I skipped over. Nashville. JT, hit us with the veggies.
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10 Philosophical Razors to Sharpen Your Thinking and Cut Through the Noise
Jake: Yes, sir. Today, we’re going to be discussing philosophical razors. And so, we’ll start out by saying–
Tobias: Occam’s.?
Jake: So, that’s going to be number one. But let’s not bury the lead, Toby.
Tobias: Sorry. Sorry.
Jake: So, have you ever found yourself stuck in a debate, tangled in a web of confusion, overwhelmed by the complexities of life? And is it me, or does it seem like there actually is a lot more bullshit in the world these days that you have to sort through?
Today, we’re going to be sharpening our minds with some powerful intellectual tools, which we’ll call philosophical razors. These 10 principles, if you will, help us slice through the nonsense, avoid logic traps, and ideally, at the end of the day, make better decisions. So, let’s kick things off with Toby’s favorite, Occam’s razor, the most famous.
William of Ockham was a 14th century Franciscan friar, logician and theologian. He often found himself in trouble with the church, because he had these radical ideas about simplicity and philosophy and theology. And sometimes they say that like every profession is a conspiracy against the laity. When you try to make things too simple, that’s why all the religious stuff was written in Latin. So, he was forced to flee Bavaria and then he spent his later years writing. And so, his principle, as everybody already knows, is–
Tobias: Can I have a go, see if I can remember it? So, I think it should be stated as prefer the explanation that assumes the least.
Jake: Sure?
Tobias: Give me the–
Jake: Well, I’m not giving his exact writing here. I’m translating it. But the simplest answer is likely the correct one.
Tobias: You didn’t read it in the original Latin, JT?
Jake: Yeah, exactly. [Jake laughs] So, let’s just do a little example. Picture this. Your TV suddenly stops working. The reason, it’s unplugged or maybe the power’s out or wait for it, the government has hacked into your living room to make sure that you’re not watching the wrong news source. Now, which of these seems more likely? Probably, the simplest explanation is usually the correct one. And Occam’s razor reminds us not to overcomplicate things.
So, let’s go to number two. This is Hanlon’s razor. That is, never attribute to malice that which can adequately be explained by stupidity. Unlike most philosophers on our list, Hanlon wasn’t a famous academic, he wasn’t a scientist. He was an ordinary guy who submitted this phrase to a joke book in the 1980s, and apparently, it stuck. It’s actually gained worldwide recognition. It’s often compared to Napoleon had said at one point that, “Incompetence is more common than conspiracy.” It pretty much rhymes with that.
I think also one’s a little bit reminded there of the fundamental attribution error from psychology, which is that we often judge others harshly based on their actions without taking into account the situation that they’re in. When it’s us, when we’re the ones who mess up, it was the circumstances it’s not that we’re a bad person. So, next time, someone cuts you off in traffic, maybe they’re just distracted and they’re not like a supreme A hole.
Next up is Hitchen’s razor, “What can be asserted without evidence can be dismissed without evidence.” Christopher Hitchens was a journalist, intellectual, fierce debater, actually pretty clever, funny guy to listen argue with people, if you like that kind of thing. He spent most of his career challenging political propaganda, religious dogma, and arguing that extraordinary claims require strong evidence. This is really a skepticisms razor.
So, imagine that Toby tells us that he has a pet dragon in his garage and we asked to see it. He says, “Oh, it’s invisible.” Well, according to Hitchen’s razor, we don’t need to waste our time just proving that there’s not a dragon in there, because he hasn’t really given us much evidence. We can just move on. So, no evidence, no belief, big time saver.
Closely related to that is Popper’s falsifiability principle, which is basically for a theory to be truly scientific, it has to be falsifiable. So, Popper was an Austrian-British philosopher of science. He was frustrated at the time by the way that Marxist theories and Freudian psychology could twist any outcome to fit their claims. And so, he sought a clear way to distinguish real science from, what he called, pseudoscience. His solution was falsifiability.
So, basically, if it can’t be tested and potentially proven wrong, it’s not science, it’s pseudoscience. So, for instance, the claim that crystals heal diseases, let’s say, how do we test that? We can’t. So, it isn’t really much of a scientific claim. I’ll leave placebo effect out of that for now.
All right. Next up is Sagan’s standard, “Extraordinary claims require extraordinary evidence.” This is related to Hitchen’s razor. But Carl Sagan was a renowned astrophysicist, science communicator, author all around pretty awesome guy. He spent his career promoting critical thinking and scientific skepticism. Let’s say that if Toby tells us that he saw a UFO, should we believe him based on some blurry photo? Sagan would say no. If the claim is very extraordinary, then we need the evidence to be just as impressive.
Next up, Brandolini’s law. This is the bullshit asymmetry principle. Alberto Brandolini was an Italian programmer, and he coined this principle in 2013 after seeing how easily misinformation spreads online. So, he recognized the struggle of fighting falsehoods in an era of rapid digital communication. Really misinformation is the hydra of the internet, like cut off one head and two more grow in its place. So, I think in AI world, now with generated content that we’re going into, I think this is going to go into overdrive. Honestly, I’m not really sure what we do about that. [chuckles]
Next up is Goodhart’s law. This is when a measure becomes a target, it fails. Charles Goodhart was a British economist. He worked with the Bank of England. He observed that when people manipulate metrics to meet goals, the metric itself starts to lose meaning. So, when numbers– [crosstalk]
Tobias: Inflation.
Jake: Yeah, exactly. [chuckles] Dot plots, whatever. So, at one-point in India, there was a policy aimed to reduce the cobra population during the British rule, and they paid people for each dead snake. Well, it backfired when people began breeding the cobras to collect this bounty. And then, ultimately, it led to an increase in the cobra population. Once the program was discontinued and everyone just released all the cobras that they’d farmed. Oh, man. Basically, that’s government intervention in a nutshell.
All right. Next up, Sturgeon’s Law, which states that 90% of everything is crap. Theodore Sturgeon was a science fiction writer who noticed that while most things in any field are mediocre, there’s always a few shining examples of something that’s excellent. So, most movies, most books, most TV shows, they’re pretty mediocre. And 90% of it is crap, but the remaining 10% is pure gold. And so, we want to be selective.
Next up is Tesler’s Law. T-E-S-L-E-R. This is that complexity is conserved. Larry Tesler was a pioneering computer scientist. He worked at Xerox, Parc, P-A-R-C, and Apple. He was passionate about making computers more user friendly. He even coined the term user interface. So, his law states that making things simple for users increases the complexity behind the scenes.
So, think about your smartphone. A toddler can use it and scroll through and do all amazing things, it’s so intuitive. But behind the scenes of that slick interface is this labyrinth of extreme engineering hardware, complicated coding. So, you can’t really hide it. I think risk is also– I’ve heard Corey Hoffstein talk about this quite a bit, that “Risk can’t really be destroyed. It can only be transmogrified or moved or converted into some other form.” I think the same thing is true of complexity.
Perhaps, the funniest one that we’re going to wrap up with is Cunningham’s Law, which is the best way to get the right answer is to post the wrong one on the internet. Ward Cunningham was an American programmer. He created the first wiki, which laid the foundation later for Wikipedia. He noticed that people correct misinformation more eagerly than they provide correct information when they’re unprompted. So, if you post that Toronto is the capital of Canada online, within seconds, people will rush to correct you that that’s not correct. So, weird but very effective way to get information.
So, in conclusion, these philosophical razors are tools to help you sharpen your thinking, avoid logical traps and perhaps, clear up some confusion and use these principles to stay clear headed when possible, and handle misinformation, extraordinary claims, complex decisions in a world that’s increasingly full of bullshit.
Tobias: Good one, JT. How did you find that list of razors?
Jake: I asked the ChatGPT gods to help me fill out. I knew several of them, but they help for mapping out the space quite well.
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Shiller PE, Market Cycles, and the Magnificent Seven: Are We Overvalued?
Tobias: Let’s use Cunningham’s Law to see if we can figure out what’s happening in the market. You guys feel free to just let us know what the true answers are. How far down is the market now? We down 5%, down or more than that, S&P 500?
Jake: Off of the all-time highs?
Tobias: That was directed to the hive mind, but if you’ve got answer there.
Jake: I think 9% ish, looks like. That’s an eyeballed.
Tobias: Correction. At 10%?
Jake: Yeah. NASDAQ at 12% or 13% or something.
Tobias: Gets us down to about 37% on the Shiller PE.
Jake: Takes you all the way back to–
Tobias: September. Last year.
Jake: Yeah. Three weeks ago. No. [laughs]
Tobias: What do you think? Do you have any views on– There’s an argument that Shiller PE is less useful as a metric for determining the level of the market, because the Magnificent Seven over earn and they’re not oil and gas companies which previously was the heaviest in them and obviously much more cyclical. So, Shiller PE no longer a useful metric. Part of the proof of that, is that since it was published in 1996, it’s traded the entire time above that. How do you feel?
Jake: Yeah, there’s some good arguments. I think one needs to look at margins to perhaps make some adjustments to– When you went from 6% margins to, now we’re at 11.5% or so– Corporate America is just earning a lot these days. They’ve taken a huge a bigger chunk of the total GDP pie for itself. Now, that describes what’s happened and then what part little bit harder to say. Perhaps, they–
Tobias: When I say the Shiller PE, I said the Shiller PE is wrong, you say “Yes, it’s overstating.” It’s actually more expensive than it looks, because margins are much wider than that. And you prefer Hussman’s approach where he says, “If you adjust, it looks like it’s as expensive as it’s ever been.”
Jake: I tend to want to lean on reversion to the mean at an unhealthy clip. And so, if you do that and visualize the world going back to normal things, like normal valuations, normal interest rates, normal tax rates, normal interest expense paid, normal profit margins, normal share of labor per capita in GDP terms, all those things are all push you back in the other direction. I think you just have to be a little bit careful anytime you’re pretty far out against. It’s not a market call. There’s absolutely nothing written in stone that we can’t go to Japan type of euphoria.
Tobias: Japan got to 100 times. China got to 100 times.
Jake: We’re way below that.
Tobias: The highest the US ever got is 44 times in April 2000.
===
Investing as a Game of Chicken: Valuation vs. Patience in Market Cycles
Jake: Yeah. So, that’s still north of here as well. One thing I have been thinking about that is kind of, I don’t know what to make of it, but I find like when I’m out on my walks, this is what comes into my head. I think about like the investment game as being sometimes like a game of chicken, especially the professional version. So, who has more courage in their conviction? The investment manager and their backing LP base, their customer base, who hold onto something like Costco, let’s say it’s 60 times earnings. They have to worry about that going to 20 times earnings while they’re earning the underlying ROE of Costco, okay?
Or, is it the more value conscious manager and their LP base who have to wait around forever for Costco to eventually come back to that maybe more reasonable price of 20 times earnings. They stay patient long enough for that to happen. So, if you try to boil that down into something a little more pithy, it’s like either you’re brave enough to hold your nose on valuation or patient enough to hold your breath on the timing. Sometimes it’s like this tug of war of like who has more conviction in their beliefs, which I don’t know, I’m not sure what to make of that, but that’s what I think about while I’m out walking around. [chuckles]
Tobias: I like that frame. Yeah, so, it’s courage on both sides.
Jake: It takes courage on both sides. Both will be right over I think various time periods, but who capitulates first. The guy who’s worried about it going and he punches out, or is it the guy that had to wait around and all the LPs left, because you weren’t doing anything and it’s swing you bum.
===
Stock Market Rotation: Is Capital on a Hair Trigger for the Next Big Shift?
Tobias: What do you think about the divergence between– There’s clearly Magnificent Seven and a handful of other stocks have vastly outperformed. If you back them out of the market, then the rest of the market looks like Europe.
Jake: You’re saying that the crashes here is just not evenly distributed yet?
Tobias: Yeah, something like that. I think it’s interesting that small cap’s topped out in April 2022, June 2022, somewhere around there. Oil and gas topped out around June 2022. And so, I don’t know what that falling prices. Maybe just got ahead of itself there or maybe it’s an indication of underlying weakness in those small and micro. That certainly looks like in the earnings of those small and micro.
Jake: I don’t know. I think it’s interesting to imagine– I don’t know how you measure this, but how much capital is on a hair trigger that wants to rotate out of what’s been working, and then has now recently not been working and into something that might be working more. So, for instance, this year to date, Mag 7, not great so far. But European stocks have done pretty well in this first whatever three months, two months of the year.
How much capital then is on the edge, the hair trigger of wanting to bail out of what’s not working and jump over to what is working? Either programmatically, because it’s a momentum strategy or just the natural human inclination of like, “Well, this horse has gotten tired. I’m going to jump off of it and get onto the next horse that’s getting ready to go.” I think it’s a pretty big chunk of capital that might be that. So, all which is to say that the rotations might actually be quite dramatic as well if you have a lot of capital that’s all trying to chase into whatever’s been working recently.
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Trading vs. Investing: Do Noise Traders Influence Real Asset Values?
Tobias: It’s hard to know to what extent the noise traders make much difference one way or the other. I feel like to a large extent the noise traders, you can noise trade in crypto in all the meme coins, all the shit coins.
Jake: Sure.
Tobias: Does that really impact anything anywhere else if that little corner of the market is feeding on itself?
Jake: Yeah, it’s interesting. I don’t know, because– At the end of the day, whatever asset it is, the full lifetime cash produced by it and returned to shareholders is what it’s actually worth. That’s where the real value is created.
Now, people can get over on each other based on clever buying and selling along that path of eventual distributions of cash. So, something like the crypto complex. My understanding is that it’s mostly you just have to get over on the clever buying and selling. There’s not really some distribution that’s going to, if you just bought and held it forever, that you would earn– like an apartment complex that you know is going to give you some return on your capital over time as people are paying for a roof over their heads.
Well, all right, now when people get excited and put a lot of money in there, that allows others to perhaps take money out and then go put that somewhere else. So, the way that the money fungibly moves around all over the place, I think it gets quite difficult to wrap your mind around, like, what are the second and third order effects of bubbles forming and popping and capital moving around and being destroyed? Created on margin, created in people thinking that they’re more rich than they actually are based on mark to market things and then maybe their consumption patterns go up and that gooses the economy. It’s all just one damn thing after another in economics. [laughs] You can’t take one piece of the spider web out and analyze it very well, because it’s so interconnected.
===
Bitcoin: Digital Cash or Speculative Asset? The Case for and Against
Tobias: Bitcoin’s a funny one. All of the cryptos is funny to me, because the argument is its cash, it’s digital cash, in which case, if you listen to a traditional financial planner, they would say, you don’t want to hold too much cash, because over time, you can look at the long-term returns to cash. They’re negatives.
Jake: Not great, Bob.
Tobias: Not great, Bob. So, if we say, “Okay, well it’s cash,” maybe it’s a better form of cash because maybe–
Jake: It goes up into the right?
Tobias: Well, it seems to the prices so far, but part of that is speculation. But there’s also an argument that you can’t inflate it the way most currencies are inflated. So, there’s a limit on whatever it is 21 million bitcoin [crosstalk] You shoot the dollar.
Jake: Mm-hmm. It’s a cool idea that you could cross a border with the billion dollars in your head. That’s interesting.
Tobias: Yeah.
Jake: Whereas a billion dollars’ worth of gold in your prison wallet-
Tobias: [crosstalk] move.
Jake: -is a little bit– it’s probably going to be a little harder to walk across the border.
Tobias: There are Spanish galleons out there. We tried it in the past. It was hard.
Jake: Yeah. Yeah, that is hard.
Tobias: I don’t know if you can fly it or not. Probably expensive. It doesn’t make me want to hold it necessarily. If I accept the argument that it’s cash, then okay, that’s fine, then I want a small allocation to it. You guys feel free to jump in and tell us where we’re wrong. I don’t know what happened to the guy who was very bullish MicroStrategy. MicroStrategy’s gone the other way since then– Yeah, digital scarcity. That’s the argument for it.
Jake: Yeah. But aren’t they making a million of them every day? You read these stories of some-
Tobias: Yeah. That’s the main– [crosstalk]
Jake: -14-year-old kid that like puts out his own little poop coin or whatever and talks it up in a Discord, and everyone jumps in when the price goes up, he takes 20 grand out of it and the whole thing collapses. Like, what did we accomplish as a species here? [laughs]
Tobias: I like this one. It’s good framing for crypto and bitcoin is it’s a global gambling game with 100% payout ratio. Yeah.
Jake: Sure. But then that assumes it– Again, this is a zero-sum game. You have to get over on people, you have to be clever in your buying and you’re selling. I’m not attracted to games like that, to be honest. I want to be part of win-win, long-term productive capacity for humanity type of situations and not, can I get over on the next guy.
===
Tobias: It seems like there’s a lot of gamble to me in this market. There’s gambling apps everywhere. Everybody gambles on everything. I was at Vegas last week, an Australian–
Jake: I bet I can get you to gamble before the end of the show.
Tobias: Oh, yeah?
Jake: Yeah. [laughs]
Tobias: All right.
Jake: I’ll take that 10:1 up.
Tobias: [laughs]
Jake: Sorry.
Tobias: I was talking to a younger guy and I said like, “Do you gamble?” He said, “Oh, not much.” He showed me his app and he’s like, “I’ve got–” He had like three bets on for that game and it was like who scores first,-
Jake: Yeah. Over under-
Tobias: -who wins. Yeah. Yeah. Yeah.
Jake: I’ll prop bet stuff.
Tobias: I was like, “That’s funny that in his framing, that’s not much.” Maybe it wasn’t much money.
Jake: What does that do for your dopamine part of your brain when you were just like a constant bet on at all times? That can’t be good for the human animal.
Tobias: Well, they know that people log into their accounts at 03:00 AM or 04:00 AM and they’re set up to give you a little reward if you do that.
Jake: Oh, my God.
Tobias: Little dopamine hit if you do that. Speaking of which, there’s a possibility that the NASDAQ introduces 24-hour trading.
Jake: That’s a horrible, horrible idea.
Tobias: Is it?
Jake: For what purpose?
Tobias: But why not? I have to buy some shit at 03:00 AM in the morning. What am I going to do?
Jake: That’s usually when the best decision making is happening, right, for–
Tobias: That’s why all of that long form advertising on television, that’s why that made so much money, because people were prepared to sit there and let you advertise to them for an hour at a stretch.
Jake: I think it folded up now, but there was a market that was intended to be long-term oriented. Like, it got rid of all the high frequency trading it had–
Tobias: Yeah. What happened to that?
Jake: I think it folded up.
Tobias: Long-term stock market?
Jake: Yeah, something like that. I think it might have folded up. But that’s a shame, because that was a credit to our species. I don’t think 24-hour trading is a credit.
Tobias: But then, there are other markets in the world, there are other time zones in the world, they can trade on NASDAQ during their business hours.
Jake: Sure. Fair enough.
Tobias: We got someone in from Cronulla. I’ll give them a shoutout, because they wanted a shoutout. [Jake chuckles] I watched the sharks in Vegas.
===
Value Investing Sentiment: Is the Market Finally Turning?
Tobias: Let’s talk value for a little bit. How do you feel? Give me some good feelings about value.
Jake: Yeah. You want some confirmation bias?
Tobias: Give me some confirmation bias. From what you’re seeing, do you think that– Give me the temperature, the sentiment of value guys you talked to.
Jake: Have you seen any Vietnam vet? You see Jacob’s Ladder. [laughs] Oh, no.
Tobias: Optimistic about the portfolios. I feel pretty good about the portfolios. I can see the rebalance coming up and I felt like late 2020, when everything had ripped and value hadn’t really moved and I could see that nothing really had to happen.
Jake: Yeah.
Tobias: You didn’t need the multiple expansion for the returns to be quite good. I thought the embedded growth and flows– [crosstalk]
Jake: I’ll make one observation, is that for a lot of the international value guys, the underlying businesses have done reasonably well, where you can say like, “Yeah, that was a decent business to be a part of over this time period that you’ve held it.” The multiples have gone the other direction in such a way that it really occludes the results of the manager and makes them look like they don’t know what they’re doing.
I think that this too shall pass when it comes to those type of contractions and multiples. And eventually, the business results at the very, very end of the day will outweigh it, but you just have to be patient and keep doing what you’re doing.
So, I think in general, there’s a little bit more pounding of the table I think right now for like, “Hey, our business results have been pretty good. I know it doesn’t look like it in our NAV’s that we’re reporting.” But that’s probably not the worst setup that you can imagine for a value guy.
===
Tobias: Yeah. Yeah, I tend to agree. Well, folks, I think we’ve come to the end of the show. JT, good effort as always. You want to plug Journalytic? I’ll plug it for you. Journalytic.com. I use it. It’s great.
Jake: Yeah. Thank you. Yeah, I don’t want to get too far ahead of, but there’s some really cool stuff in the works right now behind the scenes for more there. I think it’s going to be pretty special. I’ve been using an early beta version of it that it’s more team oriented and less of a solo player version. A lot of the AI stuff I’ve been working on to bring that to the table is like, it’s going to be pretty kick ass. So, I’m excited about that. But I don’t want to let the cat out of the bag too early here. But stay tuned.
Tobias: I always get asked what young investors should do to learn to better investors. And I always say, write down what you’re doing, so that when you revisit it three to five years hence, you have an idea why you were doing something. And Journalytic is very good for that. I still use it that way. I put down my positions, guess which ones are going to outperform and which ones weren’t, which ones won’t, and find out after the fact that I still don’t know which ones are going to do which, and so I should stick to doing it the way I’m doing it, which is quantitatively.
Jake: The feedback loops are so fiendishly long that the human brain is not good at tying together cause and effect on that long of an interval. That’s not the environment that we evolved in. We’re much more like, “Oh, hit your head on that branch. It hurts right now.” [chuckles] You want to have a tool like a technology that helps you to close that feedback loop, and you have to write things down in order to do that. It’s so easy to trick yourself into revisionist history of what you thought at the time.
When you go back and read some of the things that you actually did write down, you’re like, “Is this the same guy? [Tobias laughs] What the hell’s going on here? Someone in here tampering with it? There’s no way. That guy’s an idiot.” I think you always want to look back and feel like you were an idiot, because otherwise you’re probably not really making progress.
Tobias: Good stuff. And if there are any independent RIAs out there and you’d like to talk about how value can help your portfolios, then give me a DM, or a tweet or an email. I’m available on lots of different services. Just wolf at me, and I’ll have it and I’m available for a chat.
Jake: Hmm. Let’s go.
Tobias: All right, everybody. We’ll see you next week. Same bat time, same bat channel. Same bat time, bat–
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