In This Episode
On the heels of the 10-year anniversary of the March 2009 stock market nadir, Dan sums up how things looked when the S&P 500 bottomed out at 666 at the dark days of that crisis, how things look a decade later, and why investors should keep a two-word phrase at the top of their minds: “Cycles matter.”
Now, with the stock market up double digits since December, Dan has been thinking hard about the best way to judge the valuation of the overall market. His surprising conclusion is that 95% of the time it doesn’t matter how expensive the overall market has become – with two exceptions.
As always, Dan sticks to his motto when assessing markets: “We don’t predict, we prepare.”
He then welcomes this week’s guest to the show. Jeffrey W. Ross, MD retired in 2017 from a successful first career as a fellowship-trained Interventional Radiologist and a board-certified Diagnostic Radiologist. The previous Secretary/Treasurer of Colorado Springs Radiologists, P.C., Dr. Ross also sat on the Board of Directors as co-owner of Penrad Imaging in Colorado Springs, CO.
He is now the CEO and managing director of Vailshire Capital Management, which he founded in 2013 with the motto of heling clients “Live well and invest wisely.”
His investing philosophy, value investing with a focus on momentum as well, prompts the comment from Dan, “Well from that description, I sure wish I’d been you for the next 10 years instead of me.”
Jeff is full of insights for why the greatest investing legends of all time – Buffett, Einhorn, Ackman, and others – have been lagging their usual returns over the last 10 years, as well as what’s changed, and what’s next.
0:45: Dan gets right into his weekly rant. “If most investors understood what I’m about to tell you… investors would be at zero risk of being caught up in moments like the Dot.com peak of 2007, the housing peak of 2007… but we clearly need to talk about it.”
2:47: What does a Roman poet have to teach us about modern markets? Dan quotes the ancient Roman poet Horace cited in Benjamin Graham’s book, who tells us, “Many shall be restored that now are fallen, and many shall fall that now are in honor.”
6:16: Dan calls out the man who, in his opinion, has done the best work he’s seen in determining the valuation of the stock market. “He’s figured out these five different metrics… and he figured out they’ve correlated the best, in history, with the 10-year return period following.”
13:25: Dan has been no fan of Facebook as an investment in recent years – but now he says stocks like Facebook, Google and Apple don’t look that expensive right now. Even so, “you have to consider other cycles when you’re evaluating the FAANG stocks.”
21:00: Dan makes sense of Bank of America’s new report titled “The Sum of All Biggest Fears.” It’s at its lowest level since July 2014 – even as JPMorgan is warning of an imminent reckoning as investors plow into another credit bubble.
25:07: Dan introduces this week’s podcast guest, Dr. Jeffrey W. Ross. Jeff retired in 2017 from a successful first career as a fellowship-trained Interventional Radiologist and a board-certified Diagnostic Radiologist. The previous Secretary/Treasurer of Colorado Springs Radiologists, P.C., Dr. Ross also sat on the Board of Directors as co-owner of Penrad Imaging in Colorado Springs, CO. He is now the CEO and managing director of Vailshire Capital Management, which he founded in 2013 with the motto of heling clients “Live well and invest wisely.”
27:28: Jeff explains why he left his career as a physician, with all it’s prestige, to jump into finance. “It just seems kind of crazy… but when I told my fellow physicians I was going to retire from medicine, almost uniformly they understood what I was talking about.”
31:50: Jeff lays out his investing philosophy, which is a focus on value investing with an eye towards harnessing momentum.
39:29: Jeff reveals what’s keeping him up at night. “We should be heading into a recession by almost all measures… we’re still doing well but we’re definitely near the top.”
45:04: Dan picks Jeff’s mind about some prominent health care companies. Jeff explains why, even though he normally likes to be primarily in healthcare, it’s the most concerning sector to him at the moment. “It’s absolutely ripe for disruption… the system is broken.”
46:25: Dan answers a question from listener David J., who asks if valuations are so offensive, why isn’t Dan shorting more stocks in Extreme Value. The answer is simple: valuation alone isn’t a good reason to bet against a stock in the short term.
NOTES & LINKS
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Dan Ferris: Hello and welcome, everyone to another episode of the Stansberry Investor Hour. I am your host, Dan Ferris. I’m the editor of Extreme Value, a value investing research service published by Stansberry Research. We have a great show lined up for you today, so let’s get at it. Time for the Weekly Rant.
Now if most investors already understood what I’m about to say and acted appropriately, this whole rant would be totally unnecessary. Investors would be at zero risk of getting caught up in moments like the dot-com peak in March 2000, housing-bubble peak in 2007, and frankly probably somewhere around the current moment I think, maybe a little higher than this. But these moments do happen, so we clearly need to talk about them, OK?
Now, I can sum up today’s entire rant in just two words: "cycles matter." It’s a good time to talk about cycles because we recently had the 10th anniversary of the big March 2009 stock bottom that took place March 9, 2009 when the S&P 500 bottomed at 666, the ominous 666. So, you know, market cycles, economic cycles, credit cycles, industry cycles, they matter to you. If you buy stocks for your own account, these things matter to you. If you own not just stocks, bonds, real estate, just about any asset you might consider putting serious money into, you must understand how cycles affect it or you are flying blind.
The fact is, most things in financial markets are cyclical, right? Markets are good for a while and then they’re not so good for a while. Oh, and then they get better again. That’s cycles, right? Sometimes the ups and downs are huge. Sometimes they’re more subdued. As with a lot of things in these rants, this isn’t just about investing... It’s about life. It’s about using a time-honored principle of prudent, wise living to inform your investment activity, and this stuff goes way back.
In the front of Ben Graham’s classic value investing work Security Analysis, he quotes the ancient Roman poet Horace, and Horace said, “Many shall be restored that now are fallen, and many shall fall that now are in honor.” Cycles. Cyclical. There’s a more famous one that you probably have right on the tip of your tongue, Ecclesiastes 3 – later made into a pop song – and Ecclesiastes 3 starts out, “To everything there is a season and a time to every purpose under heaven.”
And if all of these fancy references mean nothing to you, just remember what goes up must come down. So, I’m primarily an equity investor and I’m willing to bet most of you are, too. I’m willing to bet you’re more interested in stocks than most other types of investments, so we’ll focus on our discussion on cycles in the stock market today, all right?
So, in the stock market, it only make sense to think about the longest-term cycles. Longtime readers of my newsletter and folks who have attended the Stansberry annual conference in Las Vegas have heard me say I struggled with this for a long time. I struggled to find a way to value the overall stock market and think about the valuation of it, and I finally figured it out. 95% of the time it doesn’t matter. It just doesn’t matter. You don’t need to think about it.
But you do need to think about it at two specific times, when the valuation of the overall stock market is at an extreme high historically speaking, or when it’s at an extreme low. You’ve got to be able to spot those kind of big bottom-y looking moments like September 2002, March 2009, and those big toppy looking moments like March 2000, October 2007. And the best way to – I think valuation really is the best way to evaluate these things in the stock market, because valuation is ultimately what determines your future returns.
Now, it occurs to me unfortunately that some folks don’t get the difference between price and valuation. Price is the headline. You go to the store and it costs $3 for eggs or something. That’s price, a stock price, right? Berkshire Hathaway is around $300,000 a share. That’s the price. The S&P 500 is around 2,800 these days. That’s the price.
Valuation is the price relative to the value of the business, expressed as a multiple of sales or earnings or cash flows or some other way of thinking about what the business is worth. Price in relation to the economic value generated by the business. So, I struggled with this for a long time. I think I finally got it. And there are other methods to the ones that I lean on that are pretty good.
Warren Buffett learned a really great way to value the overall market from his mentor, Ben Graham. They used a ratio of total market cap of U.S. stocks to U.S. GDP. It’s analogous, sort of like a big old price-to-sales ratio kind of, and I think it’s around 1.6 these days, like 160%.
For me, for my money, I’ve looked around a lot and I’ve thought about this a lot over the years, and I think the best work on figuring out the valuation of the overall U.S. stock market – you’ve heard me say this before on the podcast – it’s done by a guy named John Hussman at HussmanFunds.com. He’s figured out these five different metrics.
One of them is price-to-sales. Another one is price-to-margin adjusted, cyclical PE ratio – what he calls "MAPE" – or what you might call "margin-adjusted cape" if you know these things, and all of them are different types of price to earnings or price to sales, and he uses them because he figured out that they have correlated the best in history with the subsequent ten-year returns on the S&P 500.
So, when Hussman says these things are expensive, that means historically from this point the returns have been terrible. And when he says these five things are cheap, historically from that point, returns have been really great. And John Hussman, if you’re listening, I want to have you on the podcast as a guest, OK? We want to talk to you about this.
So, the basic principle, as long as valuations aren’t at these historical extremes, the odds of a big stock market correction at a historical high, the odds of a big stock market correction impairing your ability to compound over the long term is kind of low, and likewise as long as valuations aren’t well below these historical extremes, at a historical low extreme, the odds of hitting huge homeruns over the next few years are also kind of low, but your returns are probably going to be just kind of OK, maybe even very good.
Well, guess where we are today? We’re nowhere near the all-time lows, and in fact, Hussman put out a thing last August and he said it was the most expensive moment in history at the end of August, and then we peaked at September 20, 2018. That was the most expensive the S&P 500 has ever been. It was just about 2,900, and here we are 2,800, right? That was the single most expensive moment and we’re like 100 points below it, which is not much at all.
And just so we’re clear, it’s not because that was the highest price. It’s that was the highest valuation as measured by these five metrics that I really like, which I don’t want to dig into them until we get Hussman on the program. So, one of the principles of cycles that’ll do you the most good is the far – and you probably guessed this already – the farther we get from valuation norms, the farther we get from kind of a midpoint valuation, however you want to define that, the more violently things will snap back the other way.
So, when you get up to moments like September 20, there’s going to be a violent snapback. The unpleasantness of last fall, which ended on December 24 with the S&P 500 bottoming out on Christmas Eve, that could be the beginning. It could just be a little correction on the way to new highs. I don’t predict these things. We don’t predict, we prepare. And the same thing, the cheaper a market gets, the more violently it’ll snap back up. The more expensive it gets, the more damage it can do. The cheaper it gets, the more opportunity.
So, that’s the stock market right now. You also should understand cycles in various industries that you’re invested in. For example, today with U.S. stocks near all-time high valuations, gold stocks are still not far above cyclical low valuations. They had a brutal bear market from about 2012 through early 2016 and they’re not – we got a nice pop on the gold stocks immediately after that, but then we settle back down here and they’re still pretty cheap historically speaking.
Shipping stocks, the dry bulk shippers, I’ve written about this in Extreme Value, they just got brutalized, absolutely brutalized. On the same very approximate schedule as the gold stocks, and they’re still insanely cheap nowadays. Most mining-related stocks are historically if not absolutely cheap today, and the shipping stocks are kind of related to them. So, it pays to know which industries are prone to this kind of stuff, the cyclical highs and lows, right?
We just mentioned mining. Mining is probably the most cyclical industry group on the planet. There’s crazy bottoms where everybody says, “Oh, it’s all falling apart. It’ll never be the same again.” And then there are these crazy tops when people think it’s going to just go to the moon.
Then there are other industries like consumer staples, companies that have actually had a bit of a rough time lately like Kraft Heinz and AB InBev and stuff, but these changes are not – see, this is a good point here. The changes in the mining industry, they’ve been very typical cyclical changes, but the changes in like when Kraft Heinz lost 28% of its market cap like that in an instant recently, well, those are more secular things. You need to understand the secular, the long, long, long term beyond cyclical changes, things that change and don’t come back in the consumer staples.
For example, in the consumer staples I seriously doubt if the old model of scarce TV and radio advertising plus kind of a mediocre product with a catchy name, plus shoving money into the distribution channel to get the right shelf space and end caps and all that business, I doubt if that model is ever going to return. It’s gone and that’s affecting those businesses. The Internet has just made advertising too cheap and abundant, and it’s harder to keep an economic moat around a consumer packaged-goods brand.
So, in general, highly cyclical industries like mining, they have less pricing powers than companies that aren’t as cyclical. Miners have no pricing power. A gold miner doesn’t have any power to change the price of gold, right? It is what it is and he has to deal with it. Microsoft has some pricing power over its products, right? It’s not anything like those miners.
So, one of the reasons why the so-called "FANG" stocks, Facebook, Apple, Amazon, Netflix, Google, one of the reasons why they’ve done well is they’re perceived as being strong new brands that aren’t cyclical, right? That’s one of the things you ought to know about them. You have to evaluate them. You have to just keep that in mind as you evaluate them. Frankly I don’t think Google for example and certainly Facebook, they’re not that expensive these days, and Apple is not that expensive, but you have to consider other cycles when you’re evaluating the FANG stocks because what happens?
Well, sometimes people get way too interested in stocks in general. Sometimes they get way too interested in tech stocks, and you have to decide whether or not we’re at that kind of a moment. At this moment in March 2019 I think we’re OK, but we’re bumping up against all-time valuations in the overall stock market. So, that’s stocks.
The credit cycle is very important, and I believe the credit cycle is setting us up for a horrible time over the next few years. Again, you look at valuation, and in bonds, valuation is easy, right? A low yield means a high valuation, period, and a high yield means a low valuation. That’s all there is to it. You can also evaluate, like with junk bonds you evaluate the spread over some safer instrument like treasuries, and those spreads are historically very low right now.
So, whether a high or low valuation is deserved or whether it’s an anomaly, that’s a separate more complex thing that you need to think about, but again, we’re just talking about the big trends. Our guest a couple weeks ago, Jim Grant, told us that there were $11 trillion of sovereign bonds priced for negative yields. So, if you buy them you are guaranteed to lose money if you hold them to maturity. The reason why anyone would buy such a thing, again that’s a separate topic. You can go to Episode 90 if you haven’t already and listen to Jim talk about that.
So, corporate bonds, junk bonds, they’re trading near all-time low valuations, like multi-decade lows starting back in the 80s. One of the horrible things about bonds being dramatically overvalued is that most people think bonds are safer than stocks, and generally speaking that is true, but you have to understand those negative yielding bonds that you might have tucked away in some ETF somewhere, like if you have an international bond ETF, they were safe, but now they’re toxic waste because they’re negative yielding.
So, you need to think about that kind of stuff, and you need to think about just things like right now for example, there are a lot of bonds rated BBB. Why is that important right now? Well, that’s important right now because BBB is the last investment grade, the last so-called "safe" rating just above junk, OK? So, it’s just kind of a coincidence isn’t it that with bond yields really super low at the end of this long bull market where interest rates fell and fell and fell, we have this cohort, this huge cohort of bonds rated BBB just one notch above "junk."
It’s a little suspicious to me, and if you recall, the ratings agencies really screwed us over in the housing bubble because they priced a lot of subprime mortgage bonds as AAA when they should not have been anything like AAA. So, you have to say are these BBBs really BBBs? You can go back and listen to our guest Adam Schwartz a few episodes ago, several episodes ago now, talked about how some of these bond ETFs like an investment grade bond ETF, it’s kind of a hybrid thing where it’s got genuinely investment grade rated stuff and then it’s got all this BBB, so it may be kind of part junky. You got to know about this.
And according to PIMCO, the big bond fund manager, the credit fundamentals have deteriorated lately, so you want to know about that, and this is a toppy looking moment. Overall in the big scheme of things in bonds, this may not be a toppy looking month. You may have six months or even a year or two to run, but you need to understand what you’re getting into and when you’re getting into it. Understanding cycles is about when in general.
So, stocks look like they’re near a huge cyclical top. Bonds look like they’re near an enormous cyclical top. Gold looks like it’s near a big cyclical low, and the action on gold has been kind of nice lately, right? It was below $1,200, punched up through $1,200, then it went up through $1,300, hit $1,340, and now your average technical analysis guy would say it’s tested the $1,280 region, and I think as long as it holds above $1,280 there’s a chance it’ll move higher. So, that’s where we are in those cycles, and cycles are something you need to think about if you own any of this stuff, stocks, bonds, golds, any of it.
If you don’t know where we stand in this cycle, you can get run over and lose a ton of money or you can fail to seize a huge once-a-decade or even once-in-a-lifetime opportunity to make a lot of money. So, cycles matter. That’s our Weekly Rant. Let us know, write into [email protected] if you want to talk about that, and let’s move on, find out what’s new in the world.
All right, folks, it’s time to find out what’s new in the world, and this week, of course, I talked about cycles in the opening Weekly Rant. I was kind of trying to think about cycles as I was looking around for what’s new, and one thing I looked at is if you go over to CNN Business, money.cnn.com, they have this fear and greed index, and they give you the index and then they give you the components of the index. Right now, it’s just sort of – it goes from zero at extreme fear to 100 at extreme greed.
Greed is like the moment when you want to be careful when everybody is way too bullish, and fear is the moment when everybody is way too bearish and you want to look for bargains. So, 50 is right in the middle and right now it’s around 60-ish, and the indicators, there are seven indicators that go into this, and I thought it would be fun to just sort of get through them real quick.
One is stock price strength, and another one is stock price breadth. This is the number of stocks hitting new 52-week highs, and the number of stocks going up versus the number of stocks going down. They’re both at extreme greed levels. There’s another thing called "safe-haven demand." That’s just not extreme greed, but it’s in greed levels. That’s have stocks outperformed bonds? Have bonds outperformed stocks? If bond are outperforming, people want safe havens. If stocks are outperforming, they don’t want them, and stocks have outperformed over the last 20 days.
Market volatility – they just use the VIX and they say in the 13 range here it’s neutral. It’s neither fear nor greed. Then they looked at the put/call ratio – the ratio of put options to call options. They say that’s neutral. And then they look at market momentum and junk bond demand, and they’re both kind of in the fear range, so people are – the market doesn’t have a whole lot of momentum compared to an extreme greed reading, and junk bond demand is kind of lower I would guess they mean by that. So, that’s one way of looking at cycles.
Another one is Bank of America put out this report where they have this thing that they all the sum of all biggest fears. It’s a credit report, and they have this thing that they track quarterly called the sum of all biggest fears, and its at its lowest level since looks like July 2014. So, people are less afraid, according to Bank of America, people are less afraid to put money into bonds now than they’ve been any time in the past just about five years.
So, moving on, JP Morgan came out, and this was in Business Insider I guess, they said – the JPMorgan guy said, “This will end poorly.” That’s a quote. JPMorgan execs warn of imminent reckoning as its biggest investors plow into another credit bubble. So, they’re not saying it’s over now, but they say eventually it will end poorly, right? They’re thinking about where we stand in the cycle.
Another report from Financial Times says, “Investors log off from tech stocks after years of outsize gains” and there’s commentary from the folks at Bank of America about big funds, big equity funds of various types, kind of lightening up on stocks like Apple and Facebook among others. So, these are all – most of this stuff sounds pretty toppish to me, right? It sounds like news items you’d hear near the top of a long cycle.
Another one I think you hear is crazy stories about companies like Tesla. Tesla ought to be out of business probably by now, but we just hear these crazy stories like a couple weeks ago they said they’re going to close most of their retail stores. Their retail stores were kind of a controversial thing because they didn’t have the dealership model, they just had a retail store and you went in and they had salespeople in there. You could actually test drive a car and they’d step you up to the computer if you wanted to buy one. You could build exactly which model you want and all this stuff.
So, it was different. When they said they were going to close them a couple weeks ago, then Elon Musk came out and he reversed course. And before he closed them, a few weeks before that, he said, “Oh, our retail stores are very important.” Then he comes out and says, “Well, we’re going to close most of them.”
Then he comes out and says, “Well, we’re not going to close as many as we thought.” It’s a little crazy, and as an investor in a public company you look at this and you think, what the hell is going on here? These idiots are running a public company. I’ve got my money in this thing. What are these idiots doing? It’s toppy-looking to me.
Whereas in a bad market, people don’t tolerate that stuff and the stock goes to zero or something. They can’t raise money and they can’t survive. So, other end of the cycle there are stories about Barrick. The latest story says, “Barrick drops Newmont bid.” This is in the Wall Street Journal a couple days ago. “Both agree to joint venture.”
So, Barrack is running around. They merged with Randgold, and they are run by – there’s a guy named John Thornton. He’s read all the right books and he’s got all the right thoughts about generating free cash flow and making returns on capital and all kinds of stuff mining companies only think about near the bottom. They were trying to buy Newmont and it fell through and they agreed to a big joint venture. Again, that sort of speaks to the bottom-y-ness in the gold market. I’ll just kind of leave it there because I want you to go ahead and kind of look through the news and see what you see, and we’ll get on and we’ll talk to our guest.
All right, it’s time for our guest today, and his name is Jeff Ross. Jeffrey W. Ross, MD. Retired in 2017 from a successful first career as a fellowship trained interventional radiologist and board-certified diagnostic radiologist. Wow. The previous secretary treasurer of Colorado Springs Radiologists, PC, Dr. Ross also sat on the board of directors as co-owner of PENRAD Imaging in Colorado Springs, Colorado. In addition, he was an active member of the investment committee executive committee radiology peer review, and Penrose-St. Francis Hospital’s cancer committee.
We’re not done, folks. This guy has done even more. Jeff is now the CEO and managing director of Vailshire Capital Management LLC which he founded in 2013, passionate about investing, investing wisely and teaching others to do the same. Jeff is a former Motley Fool and current Seeking Alpha contributor. Under the state of Colorado’s division of securities, Vailshire Capital Management is a registered investment advisory created to help willing clients live well and invest wisely.
Jeff is also the general partner managing director of Vailshire Partners LP, an innovative long/short health care and technology-centered hedge fund based in Colorado Springs. In addition to his Vailshire duties, Jeff joined AngelMD in August 2018 and is currently serving as senior vice president of clinical investment operations there. Ladies and gentlemen, please welcome my friend Jeff Ross. Jeff, welcome to the program.
Jeff Ross: Hey thanks, Dan. I’m happy to be here.
Dan Ferris: I dare say after that introduction, anyone would be extremely happy to be anywhere.
Jeff Ross: I think so too.
Dan Ferris: So, Jeff, of course anyone who listens to that introduction is going to go, “This guy had a fantastic job. He was a radiologist. That’s like one of the cush gigs” perceived by us outsiders, “in the medical profession. Why on earth would you leave such a cush gig and go off and start fooling with other peoples’ money?”
Jeff Ross: You know, that’s a great question. I get asked that all the time. People come to me and they say that exact same thing. They’d say, “Why would you leave medicine? You had such a great job going. You had all those years of training under your belt. You have the prestige that comes with being a physician.” It just seems kind of crazy.
You know what’s funny, Dan, when I told my fellow physicians that I was going to retire from medicine back in the day, almost uniformly they understood what I was talking about. Several of them pulled me aside and said if they could be done working as a doctor they would, but they just didn’t have any kind of side business to drop into.
Dan Ferris: Wow.
Jeff Ross: That’s that side of the story. The other side of the story and the main reason why I retired from medicine is honestly I have always loved investing. I love serving people, and I love helping people invest wisely, and if they don’t want to invest on their own wisely like you teach people to invest wisely too through your newsletters and through this podcast, I’m happy to help them and do it for them through Vailshire Capital Management.
Dan Ferris: OK, Jeff, now I don’t know how many interviews you’ve done, but you can’t drop a bomb like all your colleagues pulled you aside and said, “I wish I could get out” and not explain it.
Jeff Ross: I don’t like talking about this too much, but it’s sort of an unheralded secret in the world of medicine that lots of physicians are actually pretty unhappy with their careers, and that’s unfortunate because most med students and residents who are going into medicine are very bright-eyed, intelligent, great people who just really want to help people. They want to change the world. They want to use their minds to improve the health of their patients.
Unfortunately, once you get into health care you realize it’s kind of this system that is much bigger than you as an individual. It’s not the romantic view of the doctor/patient relationship that we think of. It’s not what patients want and it’s not what physicians want, I think. What physicians and patients both want is to have as much time with each other as possible. Patients want their doctors to have the time to sit and listen to them, to listen to their troubles, to figure out what’s going on, to diagnose their condition if they have something, and then to provide treatment and provide hope for them.
But what it’s turning more and more into is a system that is liability-based. Physicians feel concern that if they don’t order a certain amount of tests or do something right or do something wrong they’re going to be on the hook for it somewhere down the road, and so I mean that’s just a small piece of it, but it’s hard to be content in a system where you feel like you’re being directed to how you can treat people, to what you can say to people, to the tests you can order, things like that. It just becomes kind of frustrating and it wears you down over time, so that’s sort of the tip of the iceberg, but it’s part of the explanation for why physicians aren’t happy.
Dan Ferris: That’s right, Jeff. That’s why I didn’t go to medical school. It’s not because I wasn’t smart enough to get in, it was all that stuff.
Jeff Ross: Absolutely. You would’ve been a great doctor, Dan.
Dan Ferris: Yeah, I’m not sure about that. So, you turned into a professional investor then. You left medicine and you turned into a professional investor. Folks who want to follow up on this can go to your website, by the way, but talk if you will a little bit about your philosophy of investing. What’s at the core for you?
Jeff Ross: Sure. At my core, first of all I would say that I am a generalist investor, and so I started out actually mostly as a value investor, and so I really love the work that you do. In fact, for the last ten plus years I’ve been a Stansberry Alliance member. Love reading your work and the work of your colleagues, and we can get into this in a little bit about my thoughts on value investing and what the Federal Reserve and their counterparts around the world are doing to our monetary system.
But basically, the way I look at it for my clients is I want to grow and protect my clients’ assets. And so, whatever is working in the market, that’s the approach that I take, and that’s kind of a nebulous statement. I have an approach where I’ll blend both growth and value investing and then also use a momentum component to it, and we’ve talked about this before and I know you’ve had Richard Smith from TradeStops on your program. But I really believe that momentum investing over the long-term has a lot to offer.
And so, what I do in my hedge fund and for my individual clients is I’ll invest across multiple asset classes that are showing positive momentum, whether they’re undervalued or growth stocks which are two totally different ways of looking at investments, and I’ll stay in them while they’re trending higher, and then I use stop losses on everything, so when they hit their trailing stops, we’ll get out of those positions and be sitting in cash and waiting for the next up trend to resume. So, that’s kind of a nutshell of what I do.
Dan Ferris: Well, from that description I sure wish I had been you for the last ten years instead of me.
Jeff Ross: No kidding. We’ve talked about that for a while and the fact that we are due for the next golden age of value investing. I’ll tell you what, I’ve been thinking a lot about this and I’ve been trying to figure out why some of the world’s greatest investors, and I would actually include you on that list along with Warren Buffett and Charlie Munger and great hedge fund managers like David Einhorn, Bill Ackman, all these guys who just knocked it out of the park prior to the Great Recession.
Why are their investment techniques not working anymore or not working as well as they should work is how I look at it? And I really think it’s because of the quantitative easing. It’s just distorting our monetary system, and I think that if you don’t have a solid currency, a stable currency that you can value, I think that makes it hard or even almost impossible to value a company. If you think about it, the most fundamental measuring unit that we use for our valuation methods is the dollar.
And so, if the dollar is in unlimited supply with the modern monetary theory and kind of what we have going on right now, if you can print it to infinity, then the ability to value any company or any asset basically becomes impossible. It’s such an interesting thing, and so I think that’s a huge reason why things like value investing are so difficult for people these days.
I think that system is just going to keep going on and on, because basically like a bunch of crack addicts or heroin addicts, our markets are just completely dependent on what the Federal Reserve does now, and I think that’s tragic, and I think it’s just going to continue to lead to funny money and market distortions all the way up until this next bubble pops, and it’s going to be absolutely ginormous. You’ve been talking about this yourself about how we are definitely very close to the peak of the latest market cycle, and this one is going to be a doozy.
Dan Ferris: Yeah, I think it will be a doozy, and you’re right, Jeff, it’s all the Fed’s fault. I haven’t made any mistakes.
Jeff Ross: Yeah, I can’t think of a single mistake you’ve made, Dan.
Dan Ferris: That’s right. So, we know your philosophy then. You’ve got this really I would say undogmatic wise view of things. What are you doing right now? You must have a portfolio filled with technology stuff right now. I know you run health care and technology.
Jeff Ross: Pretty close. My hedge fund itself is this long/short health care and technology-centered fund, and that’s because I obviously have a competitive advantage. That’s not bragging or anything, but being a physician you have a competitive advantage in the health care sector because you know how it works from the inside out, and also technology is a sector that I just happen to love. About half of my hedge fund is filled with technology and health care companies.
Now of that, two-thirds of that is actually technology companies and you’re right, and it’s because these companies in general are the ones that are showing rapid revenue growth. They have high margins. Their models are scalable. This is an overused word, but it’s true that they’re disrupting the old analogue ways of doing things and making it better and more efficient, and so those generally are my favorite stocks to own.
Now with the caveat, those things are extremely volatile, and again I think they’re fueled kind of like rocket fuel with the Fed’s quantitative easing and this kind of funny money. They can just grow and grow and grow and they can borrow money cheaply to keep growing faster and faster. They don’t have to have profits. In fact, when I look at a lot of these smaller tech companies, I honestly don’t pay much attention to the bottom line. I don’t really care if they’re earning actual profits right now. I want to see revenue growth.
Are they creating or disrupting a market, and are they growing market share? Those are the kind of things I look for a lot, and do I see that they have huge potential in the next five or 10 years to continue to just get bigger and bigger and more dominant in whatever field they’re in. So, about a third of my hedge fund portfolio is in tech.
Dan Ferris: So, Jeff, I started out the program talking about cycles, and I’m sitting here realizing that my assumption as I was speaking earlier was that you want to be careful of participating in something that might be about to turn around, but your view seems kind of wiser. You’re like, “Well, this is how things are going, and this is what I want to participate in. I want to see growth. I don’t care about the bottom line, and that’s where we are right now in the cycle and I want to maximize it.” It’s kind of more in touch with reality, I think.
Jeff Ross: Right. You keep using the word “wiser.” I’m not sure that it’s wiser, but like you, even though we have kind of different investment styles currently, I’m all about preparing for the worst, and so even though I have a lot of these tech stocks, I rebalance. It used to be quarterly and now I’m down to rebalancing almost monthly kind of in anticipation of the next fall.
Dan Ferris: How about that?
Jeff Ross: I keep my position sizes small and I’m rebalancing into just other asset classes all along the way. And so, I’m losing a little bit of upside. I’m not kind of doubling down on tech hoping for this melt-up and hoping to profit wildly, but I am taking advantage of it for as long as possible. And I’ll tell you, Dan, this is the kind of thing that keeps me up at night. We are due for a secular just basically business cycle to end, and we should be heading into a recession by almost all measures. We’re still doing well, but we’re definitely at the top. We’re looking at the next recession coming. That’s one thing.
The second thing is interest rates are trying to rise. We may have bottomed as far as our treasuries are concerned back in the summer of 2016 as you know and Jim Grant talks about all the time. That is – the yields are trying to rise, and we’ll see if that’s successful or not and if we actually are at the beginning of a very long bear market in bonds. But the third piece is the piece that we’ve never had to consider before, and what about the central banks? And what if they just keep printing more and more and more money that continues to be inflationary for the stock and bond markets like we’ve seen?
And I think it’s deflationary for things like commodities and other things, and I think the reason why we’re not seeing rampant inflation at least like in the CPI index is that their funny money and all this business, it causes distortions in the market. So, we’re living in an age of distorted markets. How do you invest in that age is what I’m always thinking about. I’m wrong sometimes and that’s why I have trailing stops for when I’m wrong, but when we’re right we hope to be really right.
Dan Ferris: Yeah. I think this is a good time to have stops on. So, you said you have a bunch of small positions. Do you have one largest position that you have high conviction about, or do you not do that? Let’s just go there for a second.
Jeff Ross: Well, first of all, I don’t do that. In a contradistinction to lots of our colleagues at VALUEx Vale that we go to in the summer, they are generally high conviction, deep value guys that have whatever, 8 to 20 positions in their portfolio, and I am much more like – I don’t believe in reincarnation, but if I did I’d say I’m kind of the Peter Lynch of this age. I like lots of companies. I like any stock that has a story that I like I’ll generally buy a small position in it and sit and watch it and see what it does and then add to it if necessary or get rid of it
So, for me, a large position is about 4% or 5% of my portfolio, and that would be gigantic for me. The last time I had a fairly large position was in Shopify up until about a year ago, and that was almost 10% of my portfolio, and I literally couldn’t sleep at night. Even though I was doing great things, the volatility just kills me, and all I can think about is downside protection when I think about stocks like that. So, I steer away from doing that. I like to take tons of small bets in little companies and just kind of see what happens with them.
Dan Ferris: OK, so a moment ago I was trying to formulate a question. Let me just give you the simplest version of it. You’ve talked a lot about kind of macro issues and things. How much are you bottom-up and how much are you top-down? How would you describe your mix of top-down and bottom-up?
Jeff Ross: I would say based on that question first of all that I’m mostly top-down and then at the end I look for bottom-up kind of companies. So, what I mean is my strength in investing, or one of my strengths I would say, are in kind of looking out three to five years and trying to figure out where we’re going in the world, like where is technology going, where is health care going? What will the environment look like in five years from now?
And then I kind of take a step back and say, OK, if I think we’re going to be here, then this is the sector that should benefit from that, and here’s a sector that I think will get hurt from that, and from there then I go and start the bottom-up approach and start looking for companies within these sectors that if I think a value play is a great way to go then I’ll start looking for deep value companies, and to be honest, I’ll look for companies that basically you bring up in Extreme Value in your newsletter. I’ll look at what Vitaliy Katsenelson is talking about. I’ll read Jim Grant intently and think about things like that.
And if I’m looking for more growth-oriented technology companies I’ll kind of set my sights on that and do kind of some bottom-up analysis in that sector. So, it really just depends on where I think we’re going, and I know it’s all guesswork. I completely understand that. But at the same time you can see the writing on the wall for some companies and some trends, as well as see the potential in other trends. For whatever reason I seem to be pretty good at doing that, and so I’ve positioned my portfolio accordingly and it’s been working pretty well.
Dan Ferris: OK, I understand that. You’re working your circle of confidence.
Jeff Ross: Yeah, exactly.
Dan Ferris: You mentioned Vitaliy Katsenelson who we had on the podcast. Now interestingly, he and some of the other value guys, including myself, are long stocks like Allergan. He’s long McKesson, the big drug distributor, and I mean, you’re the health care guy. I should be asking you about these things, not him.
Jeff Ross: Right. So, health care is an interesting thing, and I’ll tell you what, I normally like to be more invested in health care, but I don’t like health care in general as a sector to invest in right now. I think any sector that’s out there to invest in especially in the United States, health care is the most concerning to me. It is absolutely ripe for disruption. It needs to be disrupted, and I’m sorry to keep using that word because I know it’s overused, but the system is broken.
So, what does that mean for investment implications? The companies that I’m currently avoiding are big pharmaceutical companies and large biotech companies, and those are some of my traditionally favorite companies to invest in because they just gush cash. They’re safe. They have dividends that they grow year after year.
I like those kind of companies, but they have had huge headwinds and I think they will continue to have large headwinds politically, and that’s because Trump and basically everybody in Congress and across both parties, the only thing they seem to be able to agree on these days is that drug prices are too high. It’s the mantra you keep hearing from them whenever they speak about health care.
And so, I think that any pharmaceutical or biotech company no matter how great they are or how well they’re run, their drug prices are high and everyone knows that. They know that, the patients know that, the doctors know that, and that’s how they make their profits, or at least that’s one of the ways they make their profits. I would be very wary and skeptical of investing in any pharmaceutical company or biotech company currently for those reasons.
In my portfolio I’m actually almost completely out of anything pharma and anything biotech. I think the only biotech name that I have that’s a large cap is Regeneron currently, and even that I’m nervous about it. I’ve been trimming the position lately.
Dan Ferris: Let me get this straight. The physician with years of experience and training hates these companies and the value investors who aren’t doctors like them. I don’t know who I want to bet – I don’t think I want to bet against you here.
Jeff Ross: Well you know, there’s something to that, right? We all know that the health care system is broken and we know that it needs to be fixed, and I think the easiest way for politicians to fix it is to focus on – they always do this. They focus on one oversimplified issue that will basically have almost no effect on the system as a whole, but they feel like they’re doing something and the public feels like they’re doing something, but it really will have no positive benefits as far as I’m concerned.
Now granted, if you have a family member that has some condition and you need one of these really expensive drugs, I completely applaud their efforts. I think that these prices need to come down. There’s no reason a medical condition or whatever you have should bankrupt your family. It’s just tragic the stories you hear in this area.
So, I think that’s great, but yes, I’m very concerned about those kind of companies going forward, and I think if you want to focus on health care there are other sectors that are kind of outside of the spotlight right now and that should continue to do well, but I’m out of those kind of companies right now.
Dan Ferris: Wow. OK. I’m kind of glad we’re talking to you. So, if the doctor doesn’t like health care, what does he buy? What does he like?
Jeff Ross: First of all, there are a few companies in health care that I liked. What I talked about at VALUEx this year is the medical device companies. I still like those. They are still kind of in the cool gadget technology category of health care and they’re out of the limelight. People don’t really focus on those and you don’t ever hear people talking about we need to get those prices down. So, I think in that environment they will continue to do well, and some names I like there are Abbott and Boston Scientific. I’m trying to think of what else.
Those are probably a couple of the main ones. Intuitive Surgical is another good one. I’ve been focusing more in other areas and mainly in tech like we’ve talked about. I also actually like China at least for the short term. Now China is literally fraught with problems. They are just an absolute train wreck waiting to happen, but their stocks are currently cheap and they’ve been beaten way down, and so I anticipate a "Melt Up" in Chinese stocks in the near future at least before another monumental meltdown happens. So, I plan kind of like a Steve Sjuggerud philosophy, I plan on being long until they all hit my trailing spots and then sitting in cash at that point.
Dan Ferris: I see. Just for the listener, Steve is long China partially because of some changes in regulatory and the listing of securities. It’s kind of a – it’s a simple argument, but it’s got some pieces to it, but it’s interesting. As you say, it’s the cheap moment that you can take advantage of. It’s a catalyst so that things will be less cheap in the future in China.
Jeff Ross: Exactly. That’s a good example of bad to less bad to participate in part of that rally.
Dan Ferris: Right. The way you describe it, you’re a real value investor in China. You’re bad to less bad. Things are cheap. It’s interesting to me how you can – through your knowledge of medicine, you can buy something that might be on fire and trading at high multiple on the one hand, and yet you understand value and you can buy cheap Chinese stocks on the other. That’s really cool. You could have a gigantic business one day.
Jeff Ross: It definitely keeps things interesting and keeps me on my toes.
Dan Ferris: You know, Jeff, you could have a gigantic money-management business one day because if you understand all these things and you get more assets under management, you find people to work them for you and you’re like the puppet master, Vale sure could become an enormous business whereas most people I talk to they say, “Well, I focus on this little thing and we do this little thing and that’s pretty much all we do” and I think to myself, well, you’re managing $200 million and you’re never going to have much more than that, but your business sounds really like it’s got a lot of promise, a lot of potential.
Jeff Ross: Well, that’s kind of you to say, Dan, and it means a lot coming from you. I appreciate it.
Dan: I mean, just from talking to people. What do I know, right?
Jeff Ross: I think you know quite a bit.
Dan Ferris: I need to say thank-you to you because I saw your presentation of course at VALUEx Vale, and folks at Stansberry – we have these brainstorming meetings every now and then, and they needed us to come up with some names, and they choose different themes from time to time, and I think one of them must’ve been small cap or something. The idea that I put out there was Simulations Plus, and I never would’ve heard of it if you hadn’t mentioned it. Do you still have Simulations Plus in your portfolio?
Jeff Ross: I do. I still held it. In fact, that was the stock that I, out of all the ones I brought up during my presentation, that was the one I went with as far as to measure me by. We all have to make a stock pick and then we keep track of them over the years to see how they do. So yeah, I think that’s a fantastic company, actually.
Dan Ferris: I like it because it seems kind of – it’s royalty-like, almost.
Jeff Ross: Yes, and it has a really neat model. I like the business model of where it’s trying to help companies, like pharmaceutical companies and other major companies that spend tons and tons of money doing studies to make sure their drugs are safe and that they’re efficacious for people, but the way Simulations Plus works, one of the things they do is they have basically a computer model that looks at the molecular structure of the compounds that they’re trying to analyze, and they have a predictive model that says this is how the molecule will get absorbed into the body if it does or if it doesn’t.
These are the effects that you should expect that it will have. The predictive model is actually pretty good, and as all things AI are going, the models are getting better and better. So, that’s very valuable to pharmaceutical companies and biotech companies that want to have some validation of their compounds before they spend hundreds of millions of dollars on these Phase I through Phase III trials. I like it.
I think that’s a great company for the long term. I think it’s a good buyout candidate, although I never buy companies for that reason, and it’s small, too, which I like. The market cap is about $350 million today and I think it’s going to go a lot higher over the next several years.
Dan Ferris: Do you know the average market cap of your portfolio? Is it mostly small?
Jeff Ross: It’s mostly small. I don’t know what the average is, but if I had to guess I would say it’s kind of in the $10 billion to $15 billion range. I’m kind of a mid-cap guy at heart, but I’ll buy a large-cap company if I think it’s still got a ton of potential. The criteria I use is do I think this company will grow, the stock price will appreciate at a 15 to 25% annual rate? So, I basically want a company that will double in three to five years. If it’s a large cap, that’s fine. If it’s a small cap, that’s fine, too. I don’t really care. But I have to believe it based on its either fundamentals or its growth strategy.
Dan Ferris: You know, you remind me of something I’ve wanted to bring up with other folks and I didn’t remember to do it, but a lot of people talk about growth, but I don’t hear a lot of investors, professional or otherwise, talk about returns on capital. You get the big returns on capital, you don’t need a lot of growth, and you’d almost rather have less growth and bigger returns on capital.
Jeff Ross: Exactly.
Dan Ferris: I think from your top-down viewpoint though you seem more focused on the growth, which lately has been just a dynamite call ,I guess, over the past few years.
Jeff Ross: Right. Exactly. You know, I will tell you, I fully plan on switching and getting – we’re definitely in a growth market. It’s a distorted QE world. We’re in a growth market. You can have companies like Tesla, I know you’ve talked about that ad nauseum with other guests. Tesla should go bankrupt. Everybody knows that. Its financial statements are just a complete disaster, but it doesn’t matter because we live in this world of funny money. They can get funding from people and they have a lot of believers, and that’s fine. I don’t wish them any ill, but they shouldn’t exist in a real world where valuations matter.
And so, I think while we’re in this funny money age of growth stocks and growth investing, at some point it will come to an end and that will be a time to get extremely defensive, to hold a ton of cash, and I think it will usher in this new era of value investing that will be unprecedented. You will be like the king of that world, Dan, because you’re so good at value investing, and that is when valuations will finally matter again. I think what will happen is people will no longer believe in the central banks’ policies that you can just keep printing and printing and printing and drive down bond yields, increasing bond prices, and credit is cheap. All of that stuff that currently exists.
At some point, the system will no longer believe that, and the market participants will no longer believe it, and that is the day that it will just be just a complete disaster in the markets, and the value investors at that point will be the people leading the new charge for fantastic long-term investment returns. I fully plan on switching teams back, and I know that’s almost blasphemous for a true value investor to hear, but like I said, I do what works, and I think right now while value investing doesn’t work that well, I think its day is coming and it’s coming sooner than probably most people expect.
Dan Ferris: Well on that note, Jeff, we have used up our time, and I think that’s a great place to leave it for me.
Jeff Ross: Sounds good.
Dan Ferris: I want to thank you for coming on the program, and I’m sure our listeners are really happy about everything they’ve just heard.
Jeff Ross: Great. I really appreciate you taking the time and letting me come on today. It was fun talking to you. Hopefully you can do it again.
Dan Ferris: Yeah, we will definitely do it again. Matter of fact, we’ll do it again when value comes back. How about that? That’ll be soon.
Jeff Ross: That sounds great. I’ll look forward to that.
Dan Ferris: OK, Jeff, thanks a lot.
Jeff Ross: Thanks, Dan. Have a great day.
Dan Ferris: You too. Bye-bye.
Jeff Ross: Bye-bye.
Dan Ferris: It’s time for the mailbag. Remember your feedback is very important to us here. You can simply e-mail us with a question or a comment at [email protected] I read all of them and I try to respond to as many as possible, and this week I think I’ve got three of them for you.
The first one is from David J. David J. says, “If valuations are so offensive, why don’t you short more stocks in your newsletter? I enjoy all the work you do, just curious, thanks. Regards, David J.” This is a good question, David, and the answer is very simple. Valuation alone is not a sufficient reason to short an individual stock. Also, shorting individual stocks is different than noticing stocks in general are very expensive and it’s hard to find bargains. I’ll just leave it at that. Shorting stocks is about a lot more than just valuation, and it must be timed well.
When you’re buying based on value, you don’t necessarily have to time it perfect as long as you’ve got the stomach to hold through a good drawdown, but with shorting, you better time it well or you could get killed. Mailbag No. 2, this is from Alan M. He’s a frequent correspondent.
Alan M. says, “Dan, gold is usually considered to do well when there is inflation, probably one of the strongest gold relationships, but it seems to me with all the credit extended in the world and the extremes that central banks have induced to promote/produce that credit, the most likely result would be for the credit to decline because bubbles pop. That decline should produce deflation. What are your thoughts on this? Thank you for reading my prior feedback online, Alan M.”
You’re welcome, Alan M. Excellent question, and I would say you’re almost there. You almost have the answer yourself because you’re asking, well, OK, here’s what’s happening. What next? Just ask “What next?” one more time and you say, well, when asset prices start to fall, what’s the response going to be from the central banks? Well, they’re going to ease and they’re going to inflate and they’re going to do all the things that they do to try to support asset prices.
We’re at a point now where there’s not a whole lot left to do because interest rates are already extremely low, so they’re running out of ammo, and if they try to push on that string I think we’ll see $2,000 gold faster than anyone would believe. Very good question.
OK, last one, No. 3. This is from Peter G. Peter G. and I have gone back quite a bit. We did a show where we interviewed a guy named Fraser Buchan from Tradewind Markets, and he told us about this technology they have that is behind platforms like OneGold.com where people can go and buy and sell physical gold, and I was pretty excited about it. I was reacting in a very excited manner to the things that Fraser was telling us. So, Peter G. did exactly what you ought to do. He didn’t take my word for it, he went and did his homework.
Part of his homework, he came back and said, “Dan, you really ought to try this stuff out before you recommend it.” Now I was excited about it when I was talking to Fraser, but I didn’t want to leave you with the impression that I had used One Gold, I have not, or that I knew chapter and verse about One Gold, I do not. I was excited about the vault chain technology behind it mostly.
So, Peter G. had a few words for me, but then I asked him, I said, “Can you expound a bit?” And he said, “First”, when he went to One Gold, he said, “I was told that what I was buying and what was being stored were gold bars. However, if you go to redeem the bars there’s an additional premium on the bars. Second, there’s no storage fee until April 1, but it is unclear what the storage fee is.
When I called the customer service guy, didn’t quite know if it was 0.12 of the value or 0.012. I’m assuming it’s 1.2% and not 12%, but even so, that amounts to at least double to what a safe deposit box would be. Third, it is unclear what the additional charge is to ship and handle your gold or silver if you redeem it. So far, Dan, those are my initial observations, but I have not traded, withdrawn, or redeemed any investment yet. Peter G.”
And I thought Peter was really kind of giving me a hard time. He wrote one last e-mail and said, “You’re a good dude and you’re trying to help people make a living. I totally understand that.” I appreciate that, Peter. As I did – I think I responded to him in e-mail, and I’ll tell you all, Fraser did mention that there’s a premium when you redeem gold bars, but the other stuff of course we didn’t get into those details because obviously Fraser doesn’t work for One Gold, he works for Tradewind Markets behind One Gold. As far as I’m concerned, I’ve called Peter G. a "model correspondent." He’s kind of a model listener/reader.
I wish everybody behaved this way and went and did their own due diligence and said, OK, this is my money, not yours. I’m going to figure out the situation here. So, thank you, Peter G. That’s the mailbag and that’s the show. That concludes another episode of Stansberry Investor Hour. Be sure you check out our recently revamped website, OK?
You can listen to all of our episodes there and see transcripts of each episode, and you can enter your e-mail to make sure you get all the latest updates. Just go to that same address: www.investorhour.com. OK, folks. That’s it for this week. I’m your host Dan Ferris. I’m really happy to talk to you and I’ll be happy to talk to you next week. Talk to you then. Bye-bye.
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