You're listening to Teip starting this week, introducing a new mastermind group called Investing Mastermind at every quarter a team up with Tobias Carlisle, West Gray and Jack Taylor to talk about what we see in the financial markets right now. Today, we're discussing how why Catherwood and ETFs are moving the stock market. We're talking about why it's too simplistic to say that low interest rates are good for stocks. And we're also looking at whether or not the Shilpi is a valid measure of the stock market.
We'll talk about that and much more. You definitely don't want to miss out on this one.
You are listening to the investor's podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors podcast, I'm your host, it brought us in and what a lineup that we have here today. Toby Carlisle was Gray and Jake Taylor are joining me for Investing Mastermind Group here in Q1.
It's always great to speak with you and even better to speak to all of you of the same time. So welcome to the show Giants.
Thanks for having us. Likewise. Thanks to. So I'm sure the audience are really going to enjoy this conversation and what you guys see in the financial markets right now, Toby Wes and I wrote a book a very long time ago, and now it's almost a decade since it came out.
And that's a pretty good explanation of sort of the underlying process, which is like the screen, basically. And then I do a few of the things on top of that. I just think the most interesting thing in the market at the moment is Kathy Ward and ETFs. You might remember in the early dotcom days, there was this fund called Janus and they had great performance and they got great flows like a lot of flows as a result. And they were focused on smaller illiquid tech names.
So Janus had these great flows into these very illiquid stocks and they got great performance as a result. And that was probably then driving up the performance of those stocks. There's been a similar argument made about Arek that they tend to focus on smaller nonprofitable tech stocks and Ocasek sort of gigantically big over the last few years. It's now sort of the third or fourth biggest ETF shop out there and then flows now that go into these small illiquid tech stocks, sort of they control the prices of these tech stocks, had this little wobble over the last few days, and that's caused some redemptions for them, which is may cause them to do some selling as well.
They also have a big exposure to Tesla. So I just think that that's the driver of the market at the moment, is potentially getting some redemptions and having to sell out of some of those stocks, which will push down those names. And they're very sort of beholden to what Tesla does. Tesla's a much bigger stock, but it's still quite volatile, hasn't made a great deal of money. And so there's some risk that it creates this sort of cascade of selling and gets caught in it.
And then I don't know what that does to the rest of the market. It seems to me that there's a lot of money in Tesla and that it's fairly new money and a little bit sensitive to what happens. Others say something on that, because it relates to our business a little bit, we have a momentum fund that traffics in a lot of the names that ARC funds as a complex trades in. I've definitely noticed a correlation in day to day, up and down all around with respect to our funds, which has actually been really cool the last couple of months.
But the last couple of days it's been pretty painful. I don't know if it's actually true, but it certainly seems to be the case that our fund flows are driving a lot of demand and supply shocks in these kind of tech firms. I don't know how big of an issue it is as a broader marketplace, though, but certainly the case in that narrow sector of the marketplace that somebody sprung a leak over the last year as its flows are just amazing.
It's been it covers up a lot of money and then it redeploys it because the active funds that are redeployed immediately into the market as they see fit. And there's been this weird little wobble over the last few days with some of the the frothy high tech names have pulled back. So has Tesla. And SORT has shifted its portfolio mix a little bit from it's taking it away from some of those more illiquid names. And it's moved a little bit more into Tesla, which might make it a little bit more liquid.
But the holdings in some of these companies are kind of it's extraordinary how much of the company is sort of in the 20 percent plus range in some of these companies. How is this going to play out, like whenever you own that much of a company and I don't know if you are that familiar with Ark, what's the plan? How can they ever get out, especially for some of the smaller names, I guess, where there's just not enough liquidity?
Well, I think it's a perfectly legitimate strategy and you guys do this, too, so I'm not criticizing too much, but it's a perfectly legitimate strategy to buy something when it's very illiquid and plan selling it when it becomes more liquid or much less liquid, which is what tends to happen. People don't sell when stocks are down low because they they want to get out. They sell typically because they have to get at somebody sort of you know, they've got redemptions or they need the money somewhere else to leave it.
They've got a margin line or something like that because they know they're undervalued. So so there's no liquidity when you're trying to buy some of these beaten up names. Not that their names have beaten up their names ahead. I'm just saying as a value, you're always trying to buy business and then you're sort of hoping that down the road a year or two or three or five, whatever, at some point the thing that you're buying sort of comes back into fashion and people want to pay a higher multiple for it.
And typically that's when you see a little liquidity and you can probably ask was about the research into liquidity as a factor? I think that that's the idea, isn't it? Was that the less liquid it is, it's typically better returns from a less liquid stocks than more liquid stocks. You want to be buying illiquid and selling liquid. That's right, Vanger has a fund that does it in a single room called Zebra Technologies. It's started by some group of academics that specifically targets that factor and kind of makes sense.
You should earn extra for buying things that are in the. But to get in and out of. But that doesn't solve the problem for you, if you kind of forced and I don't know what they do in that scenario. I think that it's going to be tough to get out. All right, guys, so another thing I want to talk about is whether or not you accused the 13 filings in your investment approach and you're sitting out there not completely sure what a 13 filing is.
It's a quarterly report filed to the SEC. If you control more than one hundred million dollars in assets, it's something that institutional investment managers have to do. Jake, let's start with you. For 13, I use it as a screening tool. It's a place to look for ideas. The vast majority of the time when I kick the tires on something that I look at, it doesn't make any sense to me. And that's OK. You don't have to understand everything.
But every once in a while there'll be an idea that I'll find that is worth digging into more. And those make up for all the other times where it's a fool's errand. I think one of the biggest problems that I think I see in that when people are kind of 13 cloners, if you will, it's really easy to clone the portfolio, but it's really hard to clone the conviction. And the conviction doesn't come until you've actually done some of the work yourself.
You know, if you wanted to sort of quantify or use a common approach to it and a 13, like I think has written about this, a fair amount of favor, you can do that. And I think that probably works over a long period of time. But the periods of time where it doesn't work, I bet, are really hard to get through because you just don't have the conviction to to hold in there. The other thing I would say is that you have to be really careful about who you choose to follow in the space because some people turn over their portfolios in such a way that that information, by the time it comes out, might be really stale.
It might not look like their portfolio at all. So there are you can figure out who the ones are, who are the long term holders, and those tend to be better places to look. That's been my experience. You can see all of the portfolio there because you can't see international holdings and you can't see shorts that they have on which you might be looking at half of arbitrage or something like that, and you can't see any option positions that they have on.
So you're getting one picture of the portfolio, the other. That's a weird one. And I think I learned this from May when I wrote this book, was that you shouldn't buy the biggest holding because that's that's the one that's run up the most. I think. But as you say, we've done our own research on this because we've always had big family offices ask about the strategy. And to your point, Toby, the irony is you don't want to actually conviction wait in accordance with how the actual managers Wadham you generally want to own, like, their smaller, tiny positions that are that's where they get the most mojo.
It's not usually their biggest position, typically because of like tracking your concerns or capital allocation concerns or other things that are actually unrelated to how much actual conviction and more related, arguably with the incentives of asset management business. How do you find this? I think I heard somebody say that recently that they look for the weird holding in the portfolio that doesn't make sense and that their argument was that some analysts is pushed really hard to get this sentiment stick a little bit of it in.
Yeah, I think that's one approach. I mean, the other challenge, obviously, to Jake's point, and this is one that no one's convincing me of, is how do you pick your baseball players? Who's on the team? It's one thing to go pick their stocks, but it's most important to find out who the hell is going to be your baseball players. And then they hit home runs or not. This is going to be familiar enough with the with the philosophy that you like.
So, you know, it's easy to climb Buffett because we all kind of know his philosophy pretty well. And there's a whole lot of Buffett type dudes out there who I'm reasonably comfortable probably that some tech guy. So you could look if you get comfortable with it, I can't get comfortable with it, that process. But if you are that kind of investor, then you can probably figure it out. So now that you bring up Buffett, let's just say that he would be all better, so he bought a position for him.
I don't know if you want to define that's a big position. He put in eight point six billion. Verizon, the thing you put around three billion and Chevron. Do you guys have any thoughts on those topics? Berkshire's 13, if you have to be a little bit more careful with now that he has lieutenants who are managing bigger sums of money, so you don't really necessarily know if it's Buffett, then you have to understand their process. They don't really talk much and they're pretty quiet.
So it's not quite as clear that that was Buffett anymore. That's just something to keep an eye on. Let's take a quick break and hear from Susan.
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I've got a position at Amazon, although I did at one stage, which is sort of it was optically expensive. I had to look at it at the time I put it on and I couldn't kind of figure it out. And then a year ago, maybe they put the position on in Barrick Gold. And I know from running a blog that if you put Buffett and Gold in the headline of a post, it's going to go bananas. And I think every other news outlet in the States knows that as well.
In the world knows that. And so that was like a headline for a long time. It was this tiny little position and then it got sold out in the latest thirty minutes. And I didn't hear anybody say anything about that at all. It was like that just didn't happen. It didn't exist. What about Snowflake, too? Very kind of out of character for what you would expect from or Akshaya. Yes, you were talking about it before, that you dig into some of the data on those filings.
Could you talk a bit more about that?
Well, there's always outperformance because generally, to Toby's point, when people pick their baseball players, they focus on people that have performed well after the fact.
So obviously, if you CN holdings of people that you choose as your baseball players, you usually choose baseball players that have hit home runs, not necessarily those that strike out all the time. So obviously, the back tests are incredible. The city, which is a danger in the first place. But then so then the empirical question is, OK, great, we know they all work, but how do we extract the most quote unquote, alpha or kind of ride the coattail value from looking at these 13 positions?
And I think the broad idea is do not weigh them in accordance to how they weigh them. And if anything, if you're going to do it equal weight to things. Again, I'm like I'm like Toby at this point. I gave up stockpicking. So I always think through Courtland's I would just go grab the baseball players and just take the ones I like the best and equate all their positions not in accordance with their conviction, where Jake might have a little better qualitative insights and he may do a different approach.
But I just thought about that through the lens of if I were going to try to clone these people to extract the most benefit efficiently and without thinking too hard. That's basically the conclusion of all the work we did. You can also use the services that show when somebody is buying or selling and if it's someone who tends to hold for a very long period of time, then it probably doesn't matter if you're a quarter or so behind when they're buying something else, when you get the guys who are trading all the time in and out.
It's a snapshot of chaos every quarter. And you don't know what's happened in the days or weeks since or before. It's kind of useless trying to clean those guys and you just taking a snapshot of the entire portfolio and not what they actually trading. The other thing we did was we talked about it in our book tokenized book back in the day, then we formally looked at it. You can also look at these names and 13 F's and then map them back to like their fundamental factor characteristics.
And the question is like, OK, well, if they have 13 conviction and they happen to look good on whatever you like, value, quality, whatever the heck it is, that's certainly an additive measure at the margin. Like you want to want to do a 13 F name, but then also identify that it has low moment and it's a total piece of junk and it's like the most expensive stock in the world. That's not a great idea, but using 13 F is like potential marginal contributor to like a factor portfolio.
I want to tell someone that's a bad idea. That seems reasonable to me. One other point that I think is is important is I will often kind of bias towards managers who I know have an activist bent because then there are other levers to be going on at the corporate level that can make a difference. And it's not necessarily just a sort of passive holding. Yeah, going to this, I was so excited about asking that question, I'm really happy you guys are setting me straight.
So I do want to say for the record, though, to think it was Toby's point about how much the trader if not it was Jake, I would say that if you do that, someone who is really interesting to follow would be someone like Mohnish Pabrai. He doesn't trade a lot. Sometimes he could even go yes, in between. And he has a huge international portfolio and not a lot of US stocks. And like he used to say, there's a thousand reasons why people sell stock, but there's typically just one reason why they buy a stock.
And I think that's definite upheaval for him. But I can easily see why that might not be applicable for everyone else. And we shouldn't fall into that trap. I remember I was speaking to Bill Miller about this and, you know, well, prepared as it was, I was going into debt to Rome and talking about different picks. And and one of the first thing he said was just like, hey, dude, that's how you're supposed to look at it.
We have different funds with different aims. And this is just a summation of all them together. And we have different strategies for that's really just me in the sense if you look at what I do and I would say that's correct for Bill Miller's fund, I wouldn't necessarily say it's the same thing if you're looking at money or guy for that matter. I think we have a very different approach where it makes a lot more sense to go in and see not only what they bought, but you can also reverse engineer and see what's price to buy something at, which could also give you some help in terms of of conviction.
So another guy I would like to to talk about here is, is Ray D'Alessio. And this is a quote from Ray Dalio that we talked quite a lot about here on the show. I think even mentioning doing the last mastermind group meeting we had here with Tobey Bass. And it's a quote from Idalia where he said that in these current market conditions, you have to diversify into many different asset classes, currencies and countries for market conditions like these. And so one of the things I wanted to talk about specifically here is equities.
That is what we know most of our listeners are really interested in. That is equities. And many of them are not looking at individual stock picks. A lot of them are thinking perhaps in a bit more traditional portfolio sense. I mean, the percent of my portfolio should I hold in stocks giving the market conditions. So let me try and ask you guys that same question. So what do you do personally and perhaps more importantly, starting with how do you think about this question of market conditions like these?
How big a percentage of equities should I hold? Personally, it's easier for me to answer this question because I put my exact money and percentages into the same thing that I do with my clients, so this is what we execute as well for the firm. I have a little bit more discretion than Wes and Toby. Obviously, sometimes I'm jealous of their sort of tying themselves to the mass. I think it's very smart, actually, because I can just go round and round in circles in my head, especially where we are right now.
And I'm sure every time period feels like it's the hardest time period to be an investor. But right now there are such large tides in the marketplace and in the world, really, that it's a really difficult time to figure out asset allocation. Maybe this is just my own shortfalls and having too much discretion. But, you know, when I think about the world, I feel like tale's have gotten quite a bit fatter than they were at previous times.
And what I mean by that is the very extreme outcomes that we might expect in a given year or five years. So, for instance, on one side, I can make a pretty convincing argument that markets are too expensive, that we have too much debt, and that we should expect a lot of maybe debt deflation. We could have tremendous amount of bankruptcies potentially. There's so many zombie companies. Right. The other thing, too, is you have technology that's pulling down the prices of things in a pretty extreme way as technology is accelerating.
You look at the price of a TV from nineteen ninety seven to today, it's ninety five percent less than it was. There's a saying that everything in the long run is a toaster and you could maybe make the argument that everything in the long run is a TV and that technology wants to do more with less. And if that's the case then that's incredibly deflationary, in which case I think you want to actually own quite a bit of cash and so that you have money to put to work.
If a market was to correct really hard, you want the optionality on that deflation. OK, so that's on one side. On the other side, we have tremendous amount of stimulus money printing, government intervention, perhaps indexation that kind of never lets the market correct. That's one theory. In that instance, maybe rates are lower forever. Who knows? You really need to own businesses at that point, especially if we see a tremendous amount of inflation.
Right. Your cash is going to be a terrible thing when it comes to that part of the equities owning businesses. For me, I kind of have two two prongs that I approach from that. I'm looking to just buy things that are unloved, cheap, kind of misunderstood assets or industries. And then on the other side by companies that I, I know the team who's running it to the point where I think it's a very antifragile bet on their capital allocation.
So if things go really wrong, like I know they're going to be making a bunch of smart moves on my behalf as an owner that's trying to protect my downside. So we have this incredible rainbow of how the future might unfold. And I'm just trying to be the least wrong across that whole rainbow. It's really hard to do right now because the the tails are so fat. You're doing things that look very contradictory. That's a really long winded answer to how I'm thinking about it right now.
And like I said, I'm a little jealous of these two other guys who maybe don't have to think about that much stuff as much and just execute the strategy that I think is very smart, what they're doing and they get to maybe sleep a little easier. I don't know. You guys can tell me if that's true or not, but I spent a lot of time going around and around in my head on walks about what the heck are we going to get in the next five years?
I agree with Jake, the level of brain damage potential here is infinite, so you generally don't want to walk around the world with a lot of brain damage. So I try to avoid that. I just focus on things you can control taxes, fees and diversification. And I'm going to channel some inner Jack Bogle here. But I think that equities globally diversified. And if you can handle the tracking error, buying the cheaper ones and buying the stronger ones is generally a pretty good evergreen bet.
If you've got long 10, 20 year horizon and the only reason you would ever add in things that pay you nothing like bonds. And if they do pay you, they pay you an income which is tax inefficient. So you give half of it back to the government is if you have an extreme risk aversion problem and or you have liquidity risk, like you might need capital at a certain point and there's no other way to get around it. So for me personally, I'm I'm all in all the time global equities.
And then we use some fancy things like Toby does, too, like we'll try and follow the beta risk a little. But in general, I think it's fine to just have a huge amount of equity risk if you've got the capacity to hold it for 10, 20 years and you can either cut your operating costs as an individual or you can work harder to make more money. But burning your capital on things that pay you zero, anything they do pay is got to go to a fund manager.
The government. That just seems like a bad idea to me. I like stocks. W could you talk a bit more about global equities and one thing I wanted to talk about is when you look at Vanguard, for instance, and you see how they do their global stock market, there is a disconnect between GDP and the allocation. So the baseline is like, hey, let's just allocate like an indexer and buy them in their market cap weights, right?
So that's like roughly, let's say 50 percent us 40 percent DEVE 10 percent M plus or minus whatever. I think that's a fine place to start is a baseline because you can do it really cheap, really efficient, and you can deal with the things I mentioned up front that you could control fees and taxes because you can go by VTE or something like that if you want to get fancy and you want to do it in an evidence based way, there's probably arguments that you can use components of value and momentum.
So if, let's say, a certain country like M, I'm making this up, let's say the P on M is 10 and the P on US stocks is five hundred. I'm not going to shame someone who's targeting higher expected returns if they tilt more towards M to the extent they can handle the potential swing in the short run. Nor would I fault someone who also looked at relative strength. So someone that just kind of shifted based on momentum. So M is is outperforming the US stocks over the past year.
They want to take a bit more towards the momentum. Great. I think those are two tactical ideas where you can manage, again, the taxes and the fees of engaging in that activity make a lot of sense. Otherwise you should just probably do the market cap roughly diversification thing and you probably shouldn't it be all in on the US. Frankly, even I know Buffett talks about that. This seems like a bad risk management. Yeah, and I just want to say for the listener out there, if you're like this cool west dude, he came all with all his death m thing, correct me if I'm wrong.
Wesseh or so def that would be developed markets. Yeah.
Like Europe, Japan and then Iran would be like all the people on the fringes, arguably like Philippines, Thailand, Brazil, like kind of the up and comers would be generically called emerging markets I guess. So, Toby, now everyone's looking at you. So what's the case for being 100 percent in equities right now? That's a personal question, I think, for a lot of people, depending on where they are in this cycle. I am personally young enough that I think that it's okay for me to be fully exposed to equities and particularly when implemented.
I do it long, short in a mid cap, large cap universe and long only in a small universe. The two things that I manage, both us focus so on at the moment, all I think about is the US. When I look at the US, some sort of a joke that really, really hard, it's been kind of baffling to me as a value guy for a very extended period of time that the market seems to be extremely expensive, that these stocks are sort of they're a little bit rich to the long run may now.
But they're not I don't think that they're anywhere near this. If you look at a Dessau breakdown, take the French data. So can French as part of the former French. Came up with all the factors that was just discussed. Many of the factors it was was discussing, discussing before they can French publishers all its data on his website. You can pull it down and take a look at it yourself. But basically they break down on a cash flow basis because you're not allowed to talk about trust anymore because it's such a dead factor.
But let's talk about cash for it, because that's sort of acceptable. He breaks them down into all of these different. He breaks it down into thirds, fits into ten, ten buckets. The most expensive bucket is as expensive as it has ever been. It may be exceeding. I can't remember exactly, but I think it might have exceeded two thousand now on that basis. And the cheap stuff is it's expensive relative to its long run. Maybe it's nowhere near as overvalued as the as the really expensive stuff.
The problem is that that's been true for an extended period of time. It's just the difference between the two has just kept on widening and widening. That's unusual. And could be some problem with the way that we're accounting for this stuff. It could be a change in the underlying business, the nature of businesses, that we're sort of more tech focused now rather than more heavy industry. Or it might just be plain old kind of speculation in the market and that these things happen every now and again, that people get too excited about new technologies and they pay too much for them.
That sucks all of the money away from the other parts of the market. And then at some point there's a reckoning. So if you look at cyclically adjusted P, it's kind of very unpopular at the moment because it tells everybody that the market's really expensive and hasn't been particularly predictive for an extended period of time. And it's not over sort of short periods of time. But all you can say, looking at the Cape at the moment, is that the forward returns look pretty low.
And when you get that kind of market low returns, it's often accompanied by a lot of volatility. So it kind of getting the worst of both worlds terrible returns and likely a lot of the likelihood of a big draw down increases through that period of time. So I personally like to have I've got to get some shorts on in the market that are short, junky, overvalued stuff that has broken down momentum. And I just try to get long, cheap, strong stuff that generates lots of cash flows through a bust.
I prefer stocks at buyback stock. So if they go down, they get a better opportunity to buy back stock. It's great if they stay cheap, they just keep on buying back more stock. The intrinsic value gets concentrated. And you hope that if they go through a big bust, it's the stuff that's more sensitive but much more expensive, more speculative, heavily levered stuff that gets dinged up more. And so that sort of protects the portfolio through something like that.
So I'm one hundred percent exposed to the US market, but I do it in that way for basically a long time with small and micro, which is, you know, if the market rips small and micro does pretty well, small and micro valley sort of keeps up with it at the moment. But I think over the long run, small and micro value will outperform. And then if it gets really beaten up, then a long shot should provide less of a draw down and then the broader market.
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And so it's a very public metric. I'm sort of curious to hear your thoughts on that, because whenever you when if you look at the ratio and we make sure to link to that here in the show notes, it goes back to call it eighteen seventy. Right. So it looks like it's a very, very long time serious. So it should be somewhat able to predict what's going to happen because it's, after all, looking at the valuations.
And then the same time you'll probably hear people arguing that, well, we at the very end of a long term interest rate cycle. So how much can we use? That's historical data, especially considering that it's not just a question of interest rate being as low as they are right now. It's also a question of what will they be in the future. And I guess there is a consensus in the modern era right now that it's probably going to stay there for some time.
And you have people like Ridell, you're saying, well, P of 50 might be applicable. I think he was talking more about conventional PE, not necessarily about the Cape here, but he was saying because of the low interest rates. So what are your thoughts on that, Jake? I find Kate to be very compelling as an idea. I mean, I like the smoothing over a 10 year time period. We're currently in the thirty five times neighborhood, which is pretty rich on the the data set.
I think I got up to forty four times in ninety nine, but Japan in nineteen eighty seven I think got up to what, sixty six times or something like that. And before that it had not been over twenty five. I find it to be very logical but as a timing mechanism I don't think it has a lot of it. Can't do a lot for you, although maybe you make the argument that maybe we should just have the wrong timelines when we're thinking about these things.
I saw this study that that looked at starting cap ratio and then how did that perform over the next one year, five year, 10 year and 20 year and the one year? It is just a complete scatter plot, like the distribution is all over the place. There is no there's no value to it at all. By the time you got to a five year, it starts to tighten up along the line that looks like tells you like, hey, this the cheaper the starting, the better the returns.
And then over the ten year, it was actually pretty marketed like it tightens up quite a bit. There's a lot of value to it. So if you are thinking in five to ten year increments, I think the cap is very useful. But if you're like most investors, I think these days you're thinking quarter to quarter. It doesn't really tell you anything. It's not going to help you there. What's interesting is that over the by the time you get out to the 15 or 20 year mark, that slope of cheaper starting price to return actually starts to flatten out.
And I think that has to do with you've had 20 years from a good starting point of cheap. The quality of whatever it was starts to then be what dictates how it turns out, maybe like a return on equity instead of just starting price. So which sort of matches what I think you would expect if you were being logical about it? I find it very interesting, but not very useful. What the Cape ratio doesn't really change anything I do strategically or tactically, but it's definitely interesting to think about.
Sure. I'm basically in the same boat as well, so I kind of watch it and it makes me feel sick when I watch it, when I see how hard it doesn't impact how I invest in the market. The problem that you have is that I think that Japan, I think got to a hundred times. I might be wrong about that, but that's my recollection, that it got to 100 times. China got to 100 times. So the US at forty four times at the peak of the dotcom bubble wasn't really trying.
It could have gone up two and a half times to really ring the bell. And the fact that something I think David Einhorn's got a great line where he says something like the fact that something's two times overvalued is no less silly than something that three times overvalued, five times overvalued. I just have to look at something like Tesla. I think that Tesla could be 20 times overvalued. And I would have said it was insane at 10 times overvalued. So it doubled from there.
And it's gone up 10 times over the last year. So it definitely the wrong person to be asking about that kind of stuff. Jay, why don't you go ahead and then pick your topic? Oh, well, I just very selfishly, since I had two guys who are kind of quantitatively minded writing a terrific book together, quantitative value, I wanted to know for myself if you guys had any thoughts about sort of the future of what looks like however you define it, your definition.
But I mean, is it unique data sets? Is it a guy or machine learning? Is it a better thin slicing of factors? Is it I don't know something else, maybe even like a return to basics like much maligned price to book. Like, if everyone thinks it's crap, does that mean it might start working again? Curious to hear two experts talk about it. I have a respect for the behavioral errors that we all make in the markets, particularly when we're stressed and we're typically stressed at the times when you need most, which is when the market's down a lot and you should be behaving in a particular way.
So I think that the description that you gave it started me tying my hands to the mask. That's really what I have tried to do. I wrote a book with with got the benefit of Wes's insights into all that stuff and then said, that's a really good approach. I'm going to do that and then I'm not going to mess with it at all. And so I told myself to the mass and I kind of implement the strategy without fear or favour as to where the world goes after that or where it's already gone, which is a better man to ask about that.
So I would say I would break to break it into two pieces, how will that stuff affect the business of Quent? I think I'll have dramatic effects in the sense that you got to pretend like you're doing something if you want to get paid extra fees. So I think people will do a lot of this activity, add complexity, add whatever as part of a sales pitch. But that's the whole game of like, how do I get like some sort of information advantage before Joe Blow's supercomputer versus Susie supercomputer?
I don't know if that's really a great long term game to win in, but I know it's a great game for people to sell and people continue to do that. I know a lot about it. I don't know a lot about it, but I deal with a lot of people and we hire a lot of people that I'm less open to letting them explore their crazy ideas to try to beat the brain dead versions of these models. But no one's convinced me that they actually add any real value beyond just marketing stuff.
And I'm much more in the camp of Toby where in the end, like fundamentals matter, it's humans buying and selling in the marketplace. The only edge you really have is just being less human and less crazy. And to the extent you can rely on systems to minimize that behavioral baggage, I think that's evergreen. So I don't think all this stuff matters for that component. It's just follow your system and tie herself to the mast and you'll probably be OK if you don't screw things up.
And if you buy sales pitch about how the the random forests triple levered Zimbabwes swap machine learning algorithm is going to add value to your portfolio, you're going to get the fund manager rich, but I can work out too well for you. That's my basic take on all the craziness and complexity out there. I think one of the big risks for guys, for fund managers and people investing with fund managers is when fund managers get behind a little bit, they start changing what they're doing.
So they drift a little bit. And it's very tempting in this market in particular, if you're going to drift into a more growthy kind of style, because that's been what has been working for about the last five years probably. And it's been accelerating. It's been getting the distance between the two has been getting wider and wider. And so at some stage, you just sort of can't take the pain anymore. And you want to jump into something that just to take the pain away for a moment, I would 100 percent do that.
I just know that the moment that I personally do that, the whole game is over and it will reverse course and go back to where I should have been in the first place. So I just keep that in my mind that the only thing you can do to outperform is to do those things that deviate from performance. You have to sort of stand apart from the crowd if you hope to outperform, if you're not prepared to do that and you just want to get the market return and just go and buy the market and just don't worry about it.
But I sort of flatter myself that if we if I stick closely enough to a good value strategy, it will eventually turn around and outperform. There's been no evidence of that so far, though, I should say.
I think what Toby is saying is very, very important because a lot of times when you when you see people that have like the machine learning model that works or this model or my value is bigger than your value or whatever the heck people are out there saying a lot of times when you actually forensically look at, well, what is this thing doing? It's implicitly adding stuff that has been winning. So like, oh, well, you know, your value strategy is not Tobi's value strategy.
It's actually different. This is half like high momentum or like intense quality buying. And no kidding. It outperforms like hardcore Toby strategy because it's fundamentally different. It's not better. It's just different. And most of the time, especially, people like machine learning space because they can't really understand what their systems are doing. They're indirectly catching dynamically different factors that have worked. So it looks better on the back tests, but now you have to have high reliance on that system being able to regime shift in a robust way, like, OK, yeah, you switch from deep value to deep value, but with a lot more momentum or whatever it is.
That's awesome because it back tests better. But do you think your machine learning algorithm is going to be able to robustly time that the next time? I just wanted value to become momentum so I don't have to change.
Yeah. There you go. Yeah. That's a good question. What do you guys think of the sort of value rotation thesis that may or may not ever come to pass, in which case maybe value does become momentum? I might just die of pleasure if that happens, I never should have experienced it. It's been I've only been in investing sort of professionally, semi professionally since 2010. So it's been a long kind of hole since then for hasn't really caught any massive outperformance since then.
It sort of was a phenomenon of the early 2000s. And I'm embarrassed that I sort of I'm a momentum value guy. Like I jumped on the bandwagon after I'd been working and now it's like, you know, this a great paper by Mikhail Semenov. Or he says it's like it's the worst drawdown in two hundred years of value. It certainly feels that way. And he's basing that across the book. And we the books for many friends these days.
But I sort of think that at some stage and when I look at the portfolios as a value guy, if I roll up the portfolio and I look at my portfolio compared to the market, I think on every metric it's cheaper. On every metric, it's growing faster on every metric, and it's got a higher dividend yield. And so I think it's something like that's the sort of stock that I would buy expecting that stock to outperform. I think at some stage that happens.
It's just there's a lot of momentum in this market at the moment. There's a lot of tech momentum in this market at the moment, and that will persist until it goes away. And there's really nothing you can say about a. I'm kind of with Toby, like I had bad timing, I was a value investor in early two thousands and I mix that up for scale. And then after the fact, I realized, like, oh, can you actually time the value premium?
My opinion is not really unless you got lucky to start stockpicking and you happen to have a value philosophy around two thousand. You think it's amazing strategy. You try to systematically can I predict when the premium is going to outperform the next premium? That seems unclear to me, but I do like it as a strategic allocation because to Toby's point, gravity should matter at some point. Cash flows, all that stuff. In theory, fundamentals should matter. But markets, as we're seeing and you've seen throughout the history of the world, sentiment, animal spirits, a lot of times matter a lot more than gravity.
That's just the nature of the beast, I guess. Charlie Munger has a really something I think about a lot, a quote about this, and he said that sometimes stocks will trade on the value of their use of cash flow and as a as of actual business, and sometimes they will trade as Rembrandts. There are markets where it's a Rembrandt and there are markets where it's the use of the cash flow. And I think just recognizing kind of what market are you in a Rembrandt market right now helps you to be a little bit more patient.
As a discretionary value guy, Jake, what do you think it takes for the family to sort of start working or are we already there? I don't know, I mean, there's been so many head fakes, it makes it you just don't even want to whisper it for fear that it would disappear on you. Right. But I mean, I agree. I think the the question that I struggle with is, does it happen because it's a crash across everything?
And then maybe what was value, like you said earlier, is not historically against the cheapest decile, the most absolute lay-up cheap that it's ever been. It's sort of middling as far as the historical data set of how cheap the cheapest is. Does that get a little bit cheaper and everything else kind of catches down, in which case that's where I like having some cash on hand for that kind of scenario. But if the doors close, it sure would hurt to miss that value rotation when you have been waiting for it for so long.
And I think this is where to me, I, I try to keep absolute value in my mind and not just relative value. I see a lot of I would call slippage in what someone thinks is cheap based on well, it's cheap compared to this other thing today that is not cheap at all. Whereas if you go and try to use a little bit longer term kind of historical, was this cheap relative to all of the opportunity sets that have existed in time, the pickings get quite a bit slimmer, but I think you're a little bit more disciplined about what you buy.
The problem is, writes Fred, I was just randomly watching some of the I think it was Bloomberg has some tiles on the TV last night after everybody had gone to bed. My first discussion of the Deutsche Bank, like, is one of the heads of economics or something like that. And I was talking to him about the right sprey argument that low rates justify high valuations like I've never really been able to was so fastness. You're welcome. Was just missing you, too.
Yeah, yeah, yeah. I know they're looking a lot dumber. And then I talk to Cliff and he said something like, I think that I can show like I can brute force a connection. And he was going to write a paper to that effect. But like at least little blog post clips, perspectives, but it never did or it hasn't come out yet. And then I just I just looked at the case against interest rates like this, just eyeballing it.
You can see interest rates start high and like nineteen eighty and had low as they have been now. And then you have a decade through that peak since 2000. And there's another little bump in 2007 and there's another little bump today. And that doesn't make any sense at all, just looking at interest rates. So that's not that's not helpful in the Deutsche Bank. I pointed out like that had low interest rates in Japan and they've had low interest rates in Europe and they got low multiples in both of those countries.
So I have no idea anything that I used to know. I don't know anymore. The confusion stems from just the DCF math and the problem that interest rates are highly correlated with cash flow growth. And so so the issue is all else equal. You have low interest rates. Obviously, stocks are cheap. However, if low interest rates are also highly correlated with poor cash flows, well, now it is this not all else equal. So the issue is if the value stocks, cash flow growth is coming down and the discount rate is going down, it's hard to assess whether it's good or bad for value, which is why empirically you see no relationship, because when interest rates are going down, it's huge because it means there's poor cash flow opportunity sets.
And same thing when interest rates are going up. Well, if that's indicative of real cash flow growth, maybe that's good. It's just the intuition of all else equal or the assumption of all this equals what I think trips people up on that logical trap of interest rates mean you can pay one hundred times for stocks. Well, not really, unless you're an idiot. That doesn't make logical sense at all. You've got to stay. What's the cash flow growth profile?
Chris Call this morning tweeted that if interest rates rise to the level that they were pre 2008, like around that time frame, 50 percent of corporate profits would disappear into interest expense. And then if you think about if government had that exact same kind of dynamic, the load to pay that interest expense would also go up, which then theoretically would mean there's more taxes due, which would also probably put a crimp into how much pie is left over as as a business owner, we can't afford to have rates go up at all from these prices without, I think, some pretty severe damage.
See, those kind of comments, though, are an all else equal argument, right, because the problem with that logic is what would cause interest rates to go up, especially real interest rates? Well, probably real economic growth, a real price power or something. So to the extent that the corporations we go from like current rates and it goes up to 10, well, there's probably going to be a fundamental economic reason for that. And a lot of that could I'm not saying this is the case, but it could be the case.
It's because their economic profits and free cash flow growth is a really good profile, which means that it would kind of offset, like the scare story that the kind of insurance salesman story, her buddy, Chris's insurance salesman. Basically, this is an insurance sell story, which may or may not be true, but a lot of times things in extremes tend to mean revert naturally. And so you don't want to be too scared of them, I think.
Hey, guys, so one thing I wanted to talk to you about here today is these so-called 17 year cycles and so they're not always 17 years.
I do want to say that for the record, but they're sort of like being famous in the value investing community because the saying goes that, you know, you've got to have a somewhat bull market for 17 years and then it's going to be flat and then you're going to have another 10 years. And we're really talking like long stretches. So it's not going to be like a bull market every single year and then flat for 70 years straight. Obviously, that's not going to be the case.
But perhaps the most famous one would be from nineteen sixty five. And you had 17 years and then from the early 80s and up to nineteen ninety nine, you had another 17 years and the market went fifteen point one percent from the early 80s. And then you had 12 years with around zero percent and then the past nine years you had nine point eight percent. So some might be thinking about that. And then though, if this is this is horrible to try and extrapolate and be like, oh, yeah, that's been going on for like nine years and it's around 17.
So it's probably going to run for another eight years. That's not so much my point. The reason why I'm saying this is that I was watching a video with Monness papyri the other day and he was talking about these cycles and in reference to being a value investor and looking at the market, trying to find compounders, that being one strategy and then the other strategy being he was really trying to find like really cheap bargains that would then go to the intrinsic value of, say, two or three years like those two.
I wouldn't insist on the opposing way of thinking, but it is like two different ways of looking at that stock investing. And so his point was that there might be paraphrasing here. We're speaking with Monness your next month. So he probably set me straight. But his point was that you would have compounders in bull markets. That's what you should focus especially on. And then whenever you are entering a territory of call it flat magots, that's when and where you're going to look for really, really cheap companies that would then revert to the intrinsic value.
Do you think that has any kind of validity thinking about those cycles like that?
Jake, you want to go first? Yeah, thanks for letting me take the easy ones. I mean, I do find it interesting that Buffett has written about this before when he is generally kind of macro and like bigger market agnostic. But he's pointed this out multiple times, these 17 year cycles. I don't know if it is a generational thing, that it's sort of an emergent property of a new generation has to learn the same lessons over again. I don't know if it's interest rate changes that kind of like maybe move on some of these cycles.
I don't have a lot of let's just say that's not a big part of my process. I try to simplify it a little bit more of are there things that as a business owner make sense to me to buy that I think I'm getting a good deal on it? Whether that means if I'm classifying how I think Mohnish is a 50 cent dollar that is going to rerate from a 50 cents to a dollar, or is it a compounder where I want to own it for a long time to the point where the multiples entering and exiting don't matter as much as the return on equity along the ownership.
And I personally am drawn or to the 50 cent dollar approach just as a I think it's I like to have that edge always. And I'm I'm not as confident in my ability to predict a business and the business's ability to earn 20 percent return on equity for 20 years. I think that's really hard to do. I think it's much harder to do than people think it is right now.
The article that Buffett wrote where he was comparing two periods that were about 17 years, I think it was kind of I don't know that there was anything special about the number of the years. I think he was just saying, if we look at the last 17 years, interest rates went from a low number to a high number and the stock market did this. And if we look at the preceding period, interest rates went from the reverse and the market was sort of flat for that period.
And that inspired the of Katznelson to use the to use K sort of divide the market up into these periods with the tailwind, some sideways markets and basically sideways markets. The market starts at a very high valuation on a case basis, and it's sort of drifting sideways with lots of volatility in the interim. And it sort of doesn't really go anywhere for extended periods of time, like 13, 15, 17, something like that. Those periods of time I've tried to reconstruct those charts using Kape.
It's really hard to find the bottom like this. No, there's no way you can really do that. Quantitative what you have to kind of you have to know where the Cape is and then go through and identify the load. It's in the charts. It's not an easy thing to do. It's not something that you can just tell a computer to do because there are lots of these little bull markets and bear market. I don't know what you call them, like two or three or five year bull and bear markets where the market does this little round trips and sometimes it goes on and it's not clear where the low of the cyclically adjusted P is in that market.
It's not clear to me whether how you divide the two. So they're just really hard to identify, I would say. So if you know prospectively that you're going into one of these regimes, it may make more sense to do one thing over another. But I don't think you ever know prospectively what regime you're going into. You kind of just get the opportunity set that you have in front of you and then you have to decide what you're going to do.
And so the solution that is both sort of come up with is to go and test a whole lot of different test one model through a whole lot of different regimes and see which model sort of did the best without any foreknowledge. And there are periods when it does really badly and periods where it does okay. And you sort of come out at the end with with some reasonable performance. And when you when you look at the model that we created, it draws a lot.
And what Buffett says, one of the things that looks for is, does it have pretty good margins that indicates that the company has some pricing power, they are stable, that they are growing, and then you buy it cheaply. Is it not too heavily? It's a whole lot of there's a whole lot of criteria that you look at to make sure this is a safe business. This is a good business. It's earning lots of money and it's pretty cheap if you do that over time, some of those companies are going to turn into compounds and some of those companies are just going to rewrite and get sold out of the portfolio.
I think it's incredibly difficult to predict prospectively which one of them is going to be a compound and which one is like I talk about this all the time because Microsoft has been a great performer over the last decade. But I remember vividly going to the value investing Congress and hearing people pitching Microsoft at the time and Microsoft at the time. It's like twenty eleven, twelve, thirteen. Hadn't gone anywhere since two thousand. Was this received kind of common wisdom that Steve Ballmer didn't really know what he was doing and Microsoft had had its first year of revenue dropping and then they had this new guy in this session, Adella, and everybody's like, well, where's this thing going?
Like what's the and here you are like ten years later, almost ten years later, Microsoft's got this absolute software as a service. Satya Nadella is a genius. I think part of it is it came from a low valuation. Part of it is that they have done some amazing things in that business as usual, which is just didn't exist before. That's a multi, multi billion dollar business. I think it's really, really hard to predict. I think the things that you can predict is safe right now based on its balance sheet, like it's not going to get put that way.
You can identify all the. The things that will blow it up, make sure they're not there and is it cheap because if it's too expensive, you can lose money that way, too. Does it have some pricing power at the moment? Yes, it does. If you put all those things together, good things can happen. Also, there are lots of donuts. Some of that good fun stuff like that want to cook for five years. It's down 99 percent, just like on balance over the portfolio.
If you have enough positions, you do get pretty good performance out of it. That's my naive approach to the market. I see these guys running great arguments for positions and I'm like, that's a brilliant insight. That's really great. It's just that I can't do it. And I suspect about whether they can do the one thing that I have done, I just want to find stuff you can hold for like this, go as far back in the dataset as you can and then buy stuff and see how long can hold it for how long you get the outperformance.
And I've just then tried to fit different. What is the thing that predicts the performance of these things? And it's not I can never find any quality metric that gives you any that works that period. The only thing that I've ever found is the starting price relative to a fundamental and it almost doesn't matter which fundamental. If it's cheap, that's your best bet about performance over an extended period of time. We did that God study on our affairs from it, that Regis, you get like the five year winners and it's I ran a bunch of factor regressions and try to do it.
Tobey's saying, like, hey, can we reverse engineer out these winners? And literally, you can't you get Beda, obviously, because you're buying stocks, but there's no momentum value. There's no obvious characteristic set to identify, like long term, quote unquote, like five year looking ahead winners. You just got to know. But to totally point the hell out of knowing that the new Microsoft CEO would have turned up from a not many people. To be fair, there were people pitching at the value investing Congress, but their thesis was, it's cheap, it's like an 11 percent free cash you.
That was the payoff. Not this is a compound that it's going to be taking over the world over the next decade.
This is not Google. All right. What a fantastic discussion. Thank you so much for taking the time to join this massive discussion here today. I'd like to give all of you the opportunity to tell the audience where they can learn more about you. Yes. Why don't we go ahead and start with you. Just Alaf architect, Dotcom, follow the blog, follow us on Twitter. The investing side, Farnam Street Dotcom is our firm, and then it'll be an idea, along with Bill Brewster value after hours once a week, it's supposed to be more for entertainment than necessarily investment purposes.
And then I guess on Twitter at Farnam Jake one. You can hear more more complaining about the underperformance of the house with Jessica Lynch when I wrote a book a long time ago, I want to tell you that and I've got some other books in that. So if you search my name and Amazon and I run Acquirer's multiple dot com and acquirer's funds, dot com better the two sites we can kind of follow along with if you want to do it yourself.
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