On this week’s episode, Dan turns to Dr. David Eifrig for his thoughts on the Coronavirus. Now that we know 80-90% of people who are infected with Coronavirus have with no problems, Doc says it’s time to re-open America.
Then on this week’s interview, Dan welcomes Rupal Bhansali on to the show. Rupal is Chief Investment Officer and Portfolio Manager at Ariel Investments, where she manages over $6 billion in portfolios for both institutional and retail clients.
During the interview, Rupal shares her fascinating story of growing up in India and working her way up Dulal Street, the Indian version of Wall Street, where she learned the fundamentals of investing for several years before coming to America and trading her first stock.
Rupal also tells Dan about the biggest lesson she learned from George Soros during her time at Soros Fund Management. Later, Rupal also explains to Dan why an extremely popular stock found in many of the listeners portfolios is extremely overvalued. Plus she mentions a long-forgotten stock that she thinks could be a massive winner. You won’t want to miss it.
And finally Dan answers questions from listeners in another mailbag. One listener asks, what’s the best way to invest in Chinese equities and ETFs? Another listener asks, is it even possible to fight the Fed when they just keep pumping money into the market? And finally, what are your top must-read books for newer investors just getting started?
Dan answers these questions and more on this week’s episode.
chief investment officer and portfolio manager of Ariel’s international and global equity strategies.
Rupal Bhansali is chief investment officer and portfolio manager of Ariel's international and global equity strategies. In this capacity, she oversees our global research effort and manages multi-billion dollar portfolios. She also co-manages our global concentrated strategy. Rupal joined Ariel in 2011 after 10 years with MacKay Shields where she was senior managing director, portfolio manager and head of international equities. Previously, she spent 5 years at Oppenheimer Capital, where she was responsible for international and global equity portfolios and was promoted to co-head of international equities. Additionally, Rupal has held various roles at other financial services firms since she began her career in 1989, including Soros Fund Management. In 2009, Forbes International Investment Report named her a "Global Guru," in 2015, Barron's recognized her as a "Global Contrarian," and in 2017 PBS's Consuelo Mack referred to her as an "unconventional thinker." In January 2019, Rupal became the newest member of the prestigious Barron's Investment Roundtable, which showcases "10 of Wall Street's smartest investors." She is a frequent guest on Bloomberg, CNBC and Fox Business News, and authored the book, Non-Consensus Investing: Being Right When Everyone Else Is Wrong. Fluent in several Indian languages including Hindi, Rupal earned a Bachelor of Commerce in accounting and finance, as well as a Master of Commerce in international finance and banking from the University of Mumbai. She later earned an MBA in finance from the University of Rochester, where she was a Rotary Foundation Scholar.
NOTES & LINKS
1:31 – Dan shares his mixed feelings on the Coronavirus response, “I don’t think the government should be too deeply involved, however… when I look at the way people behave, I have to wonder about it…”
4:29 – Dan reads an internal memo from Dr. Eifrig about the Coronavirus that has been going around the inner circles at Stansberry Research.
15:10 – Dan isn’t the only Stansberry editor who is bullish on gold right now. Dan explains how Stansberry’s top traders are also excited about trading gold today.
17:34 – Dan has a conversation with today’s guest, Rupal Bhansali, Chief Investment Officer and Portfolio Manager at Ariel Investments where she manages over $6 billion in portfolios for both institutional and retail clients. She is also author of the book Nonconsensus Investing: Being Right When Everyone Else is Wrong. More recently, Rupal was named the 2019 North America Leadership Honoree by 100 other women in finance.
23:29 – Dan asks Rupal about her time working with George Soros… “The most important lesson I learned from Soros and the hedge fund world; it is that in order to enhance returns you actually must reduce risk. That is a paradox of investing that few people realize.”
32:02 – “How is ‘quality’ the mother of all mistakes?” Dan challenges Rupal on some of her unconventional opinions.
38:20 – Rupal shares a big name stock she thinks is extremely overvalued, plus a well-known but slightly boring company that is actually a hidden gem.
42:03 – Rupal and Dan discuss her book and the pitfalls and traps that befall many individual investors. “Frankly, a lot of people need to learn about how not to lose money.”
44:00 – Dan’s interview with Rupal winds down and she leaves the listeners with one final thought. “Investing is not about picking the hot stock… it is about avoiding the losers and the losses.”
46:30 – On this week’s episode of the mailbag… what’s the best way to invest in China? Or any other emerging market for that matter? Is it even possible to fight the Fed when they just keep pumping money into the market? What are your top must-read books for newer investors just getting started?
Announcer: Broadcasting from the Investor Hour studios and all around the world, you're listening to the Stansberry Investor Hour. Tune in each Thursday on iTunes, Google Play, and everywhere you find podcasts for the latest episodes of the Stansberry Investment Hour. Sign up for the free show archive at InvestorHour.com. Here's your host, Dan Ferris.
Dan Ferris: Hello, and welcome to the Stansberry Investor Hour. I'm your host, Dan Ferris. I'm also the editor of Extreme Value published by Stansberry Research. Today, we'll talk with investor-author Rupal Bhansali. She has written a very good investing book which sits on my desk here because I keep referring to it. It's great. It's called Non-Consensus Investing: Being Right When Everyone Else is Wrong, and I know that's something you want to learn about so stick around. She's very smart and a great communicator, too.
This week in the mailbag, listener Ron K. asks, "How is it even possible to fight the Fed under these conditions?" Great question – we'll talk about it. Listener Romeo B. asks about Chinese equities and listener T.J. asks about my favorite investing books. In my opening rant this week I'll talk about coronavirus, stocks, and gold, including a little quote from Stansberry's own Doc Eifrig, that and more right now on the Stansberry Investor Hour.
Alright, let's just say a few words about the coronavirus situation. You know how I started out on this, right? In the beginning I was like, "Oh, you better shut everything down, better get the government involved," then I had to backpedal. One of our listeners who became one of our interview guests, Kevin Duffy, kind of called me out on it, and he's right. That's exactly what I think. I don't think that the government should be too deeply involved.
However, when I look at the way people behave, I just – I have to wonder about it. We took a road trip down to southern Oregon. I live in southern Washington, in the Portland, Oregon general area. And, you know, it's an urban area – urban, suburban. It's a crowded area, right? When I go out in this area, I see lots of people wearing masks and keeping their distance.
As we sort of drove into the country, as we drove out of the city into the country, you know, we stopped here and there for a couple of different reasons, about a five-hour drive, and you know, fewer and fewer and fewer and fewer people were wearing masks. And then we got down to Medford and actually attended a wedding and there were maybe 40 people there, 40, 50 people. We were outside. We were standing right next to Crater Lake in southern Oregon, gorgeous location in the background as the happy couple said their vows. So we were all quite good at keeping our distance, but some people, you know, they were shaking hands and hugging and stuff, and not one person wore a mask. And I think – you know, it made my wife kind of nervous because she has asthma so she absolutely does not want to get any kind of a serious respiratory illness. So we bought this hand sanitizer that smells very strongly of tequila, so you know, I basically spent three or four days bathing in tequila every so often. It was a lot of fun.
But it surprised me a little bit that more people weren't wearing masks. And you know, somebody pointed out on Twitter that Friedrich Hayek, who is like one of the patron saints of the libertarian movement because he – you know, he just – he doesn't like too much government intervention in the economy, he specifically named disasters like pandemics as one of the things that governments ought to do. So the libertarians, like one of their patron saints is not helping them out here. And we had John Stossel on the program and he said, you know, "There's probably – there's a role for government here in a pandemic." So truly I'm not sure exactly what that role looks like, but like totally shutting down the whole economy just strikes me as really extreme.
And I'll tell you, we exchange a lot of ideas among the folks at Stansberry just internally, and there was a little thread, e-mail thread earlier this week one morning, and Doc Eifrig, who of course is a physician – I mean, he's a physician who used to work at Goldman Sachs, right? So he's a finance guy, a big-time finance guy, big-time physician. And he sent a comment around – he said, "Yes, coronaviruses will be with us forever. Influenza will be with us forever. It will kill lots of elderly, a few children, and others with crappy immune systems." You know, and then he said, "There's HMPV, RSV, PIVPV, and some of those will kill and cause lung damage." And then he said, "Please open up the world and let us get back to having 80 to 95% %of people get infections with no problems," right?
My take from all of these inputs is that, sure, maybe there's a role for government here, but shutting down the entire world and just locking everything down like that – I mean, the word lockdown comes from prison culture, right, when they lock all the cells so that the prisoners can't leave their cells. So maybe a lockdown of our entire economy is a bit much. I'll probably be wearing a mask sometimes when I go out, and I want my wife to wear one, too, because I don't want her to get sick with her asthma. So it's – I don't know. That's where I am on coronavirus.
Anyway, I want to talk about stocks because we talked – remember, we interviewed my friend Jeff Ross in a recent episode, and we both admitted that we have typical human confirmation bias, right? Confirmation bias is simple. You get an idea in your head and you go around looking for confirmation of it instead of trying to disconfirm it and falsify it, right, which is what you should do. That literally is the essence of the scientific method in life, is you test your ideas. You try to break them to make sure that they really, truly work.
So I got a little bit of confirmation bias for you today, but I also have some thoughts about not being too bearish right now. You know my spiel. I was bearish for three years, big drawdown in March related to the COVID-19 lockdown, 34% bear market over the course of like 30 or 32 trading sessions, something like that, like a month, a one-month, 34% bear market straight down, brutal.
So, you know, then I started saying, "Well, okay, this is what I was waiting for; let's buy some stocks." Of course we've had this just soaring recovery, soaring, and I said, "Well, I'm sorry. I've got to get back to where I was." But I'm not completely 100 % back, right? I did qualify a little. I said, "You know, overall the stock market is really expensive." It's expensive enough for me to be concerned about its valuation. That is not a timing mechanism. That's just – it's a comment on the attractiveness of the long-term proposition and the likelihood of like 10- and 12-year type returns in the S&P 500 not being very good. That's all I'm saying. I'm definitely not calling, you know, the top at this moment.
I have seen some other confirmations, like there was an article on LinkedIn by a guy named Peter Atwater who is a professor who studies emotions. He has a book out about, you know, how emotions work in the stock market and stuff. But a quote from his article – he's concerned about all the speculative activity with these small investors buying lots of call options, which they're still doing. And so here's just a quote from this article, why he's concerned. He says, "Much like house-flipping called the top of the housing market, I think today's call-buying craze is calling an extreme peak in not just financial markets but in the perceived omnipotence of the Federal Reserve and other central banks." So he thinks – and a lot of people think this. You've seen this. This has been a theme kind of in financial news, that maybe too many people think the Fed has their back.
And ultimately, you know, if we look at the example of Japan, right – because ultimately that market peaked in like – what was it, '90 or '91 or something? It was like 30 – I think the Nikkei 225 was like 34,000. It ultimately bottomed out years later, like many, many years later at something like 7,000. It was like almost an 80% drop over many, many years, and basically it's gone sideways and it's around 25,000 now, still hasn't gotten back to that 1990 peak. And you know, they have intervened a lot. You know, the Bank of Japan has intervened a lot, and they're buying equity ETFs. They've been doing that for almost 10 years, and of course, you know, corporate bonds and Japanese government bonds and all the rest of it, similar to what the Federal Reserve is doing now.
So, you know, I think thinking the Fed is omnipotent is a bad idea. It's like another reason for Dan to be bearish and all this buying of garbage stocks by folks trading on the Robin Hood app and buying things like – you know, I saw another article. They're buying mortgage REITs, and they're not just buying them. They're getting, like, heavy-duty in. The number of Robin Hood accounts holding mortgage REITs according to a report by BCA Research, this firm called BCA Research – they said the number of accounts holding mortgage REITs on Robin Hood has risen 93-fold on average since the S&P 500 peaked in February. This is like – this stinks of classic yield-chasing behavior – except, BCA notes, the three companies they name in this report, Invesco Mortgage Capital, MFA Financial, and AG Mortgage Investment Trust all failed to meet margin calls from their repo lenders and have either suspended or cut dividends, so you know, not such great dividend plays right now. And they're getting margin calls. Well, you know, they're highly, highly, highly levered. They borrow tons of money and they buy mortgages that yield next to diddly squat and they pay these huge dividends. That's how it works, you know, supposedly. Well, you know, the mortgages are so safe because – whatever – they're either backed by Fannie and Freddie or, you know, they're just mortgages and mortgages are safe. So to me, you know, that just stinks and it's another reason why I'm just shaking my head going, "Oh, God, you know, it's all going to fall apart."
However, I work with a lot of smart people, and one of them is a guy named Scott Garliss, and Scott is – I swear that guy looks at more data in any given market day than anyone I know. The stuff he sends around, it's just like a whole page of comments about all kinds of markets and central banks and different countries, and he's just – he covers the waterfront every single morning. It's incredible – and every afternoon, too.
So he sent around something recently where he said the non-commercial speculators are net short S&P 500 futures, like more so in terms of the numbers of contracts since 2011, okay? The Dow Jones Industrial Average futures, largest short on record by number of contracts, largest short ever. NASDAQ is the same as S&P 500, short position is the largest short interest since 2011. And this is among, like, non-commercial traders, like smaller speculators. And Scott says, you know, he learned on the Street, on Wall Street that the market tends to do whatever's going to hurt the most people the most, you know? It's going to hurt the most people and it's going to hurt them the most, most severely. And he looks at this and he says, "You know, the one thing that'll hurt the most people the most severely right now is for the market to sort of surge higher because all those small speculators who are net short, record net short, would have to turn around and end the pain and start buying." And, you know, so the market goes up – ooh! And then the pain starts, and then they start covering the shorts, and then it goes up even more.
And so this setup, this situation here – and the AAII Sentiment Survey is really, really bearish lately. I think the average bearishness on there is like 30.8%, and it's like 47%, up almost – up more than nine percentage points over the previous week. So there's too much bearishness, and when that pain starts, then traders start reversing, and then it sends – you know, there's the initial move higher that creates the pain, and then boom, they start covering and send the market higher. And it smells to me like Steve Sjuggerud, my colleague at Stansberry, Steve Sjuggerud, his Melt Up scenario seems more likely now than I thought it was in February. I never tried to say, "Hey, this is the moment." We don't call tops, right? Prepare, don't predict. But now we've had this big washout and we've had a big run-up, 40%, and all these people still want to be bearish, and they're even more bearish than they were just a week or two ago.
So, you know, what happens next, right? Is my bearishness so blind that I can't see that this spring is compressing and it's getting set to release and send the market higher? And, you know, there are these other arguments. I saw that, you know, the cash on the sidelines argument – I think it was in the Financial Times. And the said, "Well, there's like $1.2 trillion in money markets and $105 billion of it has come out in the past four weeks." And so there's – you know, that's the cash on the sidelines coming into the market. Cash on the sidelines is stupid, though. Don't ever get fooled by the cash on the sidelines argument, because what happens to the cash? It goes from this sideline to that sideline. It doesn't get – they don't light it on fire once you buy stocks with it. It goes into somebody else's account. So there's always cash on the sidelines. It's silly. The cash is always there. It's silly. So that argument doesn't wash either, but these sentiment things and the structure of the speculators in the futures market, I mean, it just – it looks to me like you'd better get out of the way. And that's all I'll say about that.
Let me just talk about gold a little bit. Of course, Stansberry's sort of trading experts, Ben Morris, Drew McConnell – who we interviewed on the program not too long ago with Greg Diamond – they're bullish. They're saying, you know, the gold bull market looks really, really attractive to them as traders. And as I speak to you in the microphone today, gold has just recently traded above $1,760 an ounce. And our other guy Mark Putrino, who he used to work for Steve Cohen – he's an informed guy – he sent an e-mail around, you know, internally recently. He said, "Watch for a breakout above that level, that $1,760 level." And so, you know, as I speak to you – fingers crossed, maybe by the time you hear my words we'll still be there and we could be headed to – who knows? Maybe we're headed to $1,900, to a new high, maybe even this year. I would not bet against that at all. There's reason to think stocks are going to go up. There's reason to think gold is setting up to make a move higher, and that's where we are at this moment. And there's also a reason to think maybe the government could help us out with the coronavirus, but maybe just don't shut absolutely everything down and treat us like we're in prison.
That's all I've got for you today. Let's talk to Rupal Bhansali. I can't wait for you to sort of meet her on the program here and hear her ideas.
Dan Ferris: This week, our guest is Rupal Bhansali. Rupal is chief investment officer and portfolio manager of Ariel's international and global equity strategies. In this capacity she manages over $6 billion in portfolios for both institutional and retail clients. Rupal's career and investment approach can be described in one word: unconventional. Unlike most long-only managers, Rupal's buy-side career began over 20 years ago on the long-short side at Soros Fund Management. This formative experience taught Rupal how to think about both the long and short side of the trade. She credits her uncommon investment success to her uncommon investment process, one where non-consensus thinking and the courage to go against the grain play a pivotal role. Sounds good to me. It is not surprising that Barron's christened her a global contrarian, Forbes called her a global guru, and PBS's Consuelo Mack referred to her as an unconventional thinker. In January 2019 Rupal became the newest member of the prestigious Barron's Investment Roundtable which showcases ten of Wall Street's smartest investors. Rupal was named a 2019 North America Industry Leadership honoree by 100 women in finance. She is also the author of the book Non-Consensus Investing: Being Right When Everyone Else is Wrong published by Columbia Business School Publishing. Rupal earned a bachelor's as well master's of commerce and finance from University of Mumbai. She later earned an MBA in finance from University of Rochester where she was Rotary Foundation Scholar.
Wow, Rupal, you've done a lot. Welcome to the program.
Rupal Bhansali: Happy to be here, Dan.
Dan Ferris: So I always get started – with people in your profession – I always have to get started with a similar question. How old were you when you first got bitten by the finance and investment bug?
Rupal Bhansali: Jeez, I was about nine years old.
Dan Ferris: Wow, that's really young! What were the circumstances?
Rupal Bhansali: Well, you know how life is full of twists and turns. I actually was born into a very rich family. My dad was a stockbroker in the 1960s, and so I got put in the best school – the best private school, the best country clubs. And then in the '70s, you know, the markets fell and our fortunes fell alongside, and I really discovered that a lot of things that I wanted, you know, when I would go to my mom and say, "I want this or I want that," she would say, "Well, when I have more money." And I just wondered, "What is this mysterious thing called money and why does it matter so much?" And so I learned about money, you know, up close and personal because my early childhood was a rollercoaster in the markets. And I learned about equity markets and how they can go up and more importantly how they can go down, and that bills don't come due at market tops. I know these are all old adages. I lived them firsthand, and so I started learning accounting at a very young age. And I was just fascinated with markets, you know, more so than I guess young girls typically tend to be. And I learned on the job, and over the years I just kept learning from the best, I believe, in the industry and from books, which is why I wrote one. And here I am.
Dan Ferris: Wow. Most people do not have an answer anything like that. They all say just about the same thing. You know, it started in college or after college or something. So that is really interesting to me. Did you wind up doing any trading as a young woman like, you know, in your teen years or younger?
Rupal Bhansali: Not at all. In fact I had nothing to do with actual equity investing till a very much later date. In India, you know, markets are net developed. You didn't have direct online brokerage accounts. It was all very difficult, besides which you need money to trade, and I didn't have it. So the first thing I did is figure out how to earn money and how to learn money, and so I started working at a very young age on Dalal Street, which is India's Wall Street, and I learned how to think about financial analysis, financial statement analysis, balance sheet and accounting, all sorts of things at the back end, before I actually got my break when I came to the U.S. to actually start investing clients' monies. So I started trading at a very, very late stage in my career, more in my 30's than in the 20's, and certainly not in my teens.
Dan Ferris: Do you think that benefited you, that you waited until you were older?
Rupal Bhansali: With the benefit of hindsight, enormously. I think that a lot of people don't realize that they're actually not investing, they're speculating, because they don't know what they don't know. And I learned the hard way that ignorance means loss, not bliss in markets. So learning, you know – investigating before you invest is very important. But a lot of people are very keen on the action, so you know, I guess they just dive in. I had the opposite experience and I think that makes me a much more measured investor, a much more deliberate investor because patience and waiting for the trade to come your way as opposed to chasing it is so important in value investing.
Dan Ferris: Wow – man, you can say that again. So I have to ask you about your time at Soros Fund Management, just because – well, if for no other reason, George Soros is such a big star and has been so successful. What was that environment like for you?
Rupal Bhansali: Well, it was awesome. In fact, you know, Soros was a client of mine, and when I was on the sell side that was my first job. And they liked my stock-picking in particular because I could recommend shorts, not just longs, and that sort of piqued their interest I believe, and they invited me to join over, which is how I got there. This was in the mid-1990s, so in the aftermath of the gigantic sterling bet, you know, the one that made him famous, of course, for all good reason.
Stan Druckenmiller was also active in the business back then with him, so I would say that credit goes to both of them for teaching me and for my learning, you know, just through osmosis. Stan was a very quiet man and remains one, so – and George, you know, is not a very communicative person either. So you really learn, you know, in this industry by just being around very smart people, and they certainly were.
One of the things that was very instrumental in that experience for me is most bottoms-up stock pickers tend to learn company analysis, which of course is what I do as well, but George and Stan helped me understand country analysis. As you may recall, Soros was really a macro hedge fund. While I was part of, you know, one of the satellite capabilities that they had in terms of picking stocks, their genius was really macro investing. And I learned a lot about how to look at countries, not just companies, and today in my job as a global equity CIO and portfolio manager I cover 50 countries around the world. And I can tell you, country analysis is as important as company analysis when it comes to international and global investing. So that was a great experience for me.
The other thing is, you know, risk management is something that I think the hedge fund world and Soros in particular did exceptionally well. And so I really learned, unlike many long-only managers who think about return management – you know, how much a stock can go up and how much money you're going to make – I started learning about what can go wrong. What's the risk of the trade? What's the short side of the thesis and the downside? Which is why I think in my book, you know, I talk so much about investing is about not losing money, not just about making money. And that was really my instrument. I mean, I would say the most important lesson I learned from Soros and the hedge-fund world, it is that in order to enhance returns you actually must reduce risk. That is a paradox of investing that few people realize.
Dan Ferris: Yes, it's a very interesting topic to me because, yeah, I write a newsletter and if I don't have a new stock pick, you know, sometimes for a few months, people write in and say, "Hey, you know, give me another pick! Give me another pick!" So I've had to go on this kind of campaign to try to teach them that what I call negative advice, you know, what you avoid is at least as important as what you actually do. And you have a whole chapter in your book which I love called Do No Harm. It's wonderful. But it's an interesting thing, isn't it? All professionals, they always tell me this. You know, if they're on the sell side or if they're in my position or something, people are constantly asking them for action and ideas. And then when they get on the other side and they've got client money in their hands, if they're smart they're like you, and what they don't do is as important as what they do. But it's not very sexy, is it? It's nothing a client wants to hear, is it?
Rupal Bhansali: No, but you know, I thought someone described investing in a great way. They said it's like watching grass grow. On any given day, you know, nothing seems to happen, but after a couple of months and a couple of years, I mean, you have a garden that looks great. But then you sow the seeds you have to patiently wait for them to mature, and to prematurely trade seeds would be the wrong thing to do, and to not sow any seeds is also the wrong thing to do. So I think research helps overcome this vacuum of ideas that sometimes prevails, but I hear you. You know, when markets are at manipulated levels as opposed to market levels, it's extremely hard to generate buy ideas. And I think that cash has become a four-letter word. It shouldn't be. It's actually the best protection you can have in a market that is extremely inflated, and I would argue on opioids, let alone steroids.
Dan Ferris: Okay, I just want to address the listener directly because I've said what you just said. I must've said it 20 times by now. And I just want you to know, Rupal worked for Soros Fund Management. She's smarter than I'll ever be in my life, so – and she just said the same thing.
So I want to dip into your book, into that chapter Do No Harm, because a particular paragraph having caught my attention, and it's almost provocative. It says, "Measuring the wrong thing is the biggest risk you can take." I've never heard anyone say that. What do you mean by that? That sounds interesting to me.
Rupal Bhansali: Well, you'll find a lot of non-consensus thoughts in the book. That's why I called it Non-Consensus Investing. And one of them is clearly people conflate risk measurement as risk management, and worse, they measure the wrong things. For example, they think that tracking error is a source of risk. In fact, the word error suggests that someone is making a mistake. And tracking error means that you look very different than the benchmark and you behave very differently than the benchmark. And so, people keep thinking that the greater the tracking error the more risk you are taking, but it's a wrong sort of measurement of risk. Another measure of risk is volatility or beta. Again, all these things are viewed as sources of risk.
I would argue that the biggest risk you take is actually not knowing what you own. It doesn't matter if it's a house, if it's a business, if it is a stock, if it is a bond. And to me nobody measures what they don't know and what's going to be their blind spot in investing. And that to me is a risk that goes unmeasured, but that exposure that you have and the loss that you could potentially have from owning something that you don't understand very well, you know, what risk exposures you're exposed to, is the biggest harm you can do to yourself, and if you're managing money, to others. So that's why I mean by risk measurement is not risk management, and in fact risk is measured wrong with all these statistical metrics that are backward-looking, while risk is actually a forward-looking attribute.
And this is, by the way, the gigantic misunderstanding that people had with respect to, you know, risk assessment, is before the great financial crisis when a lot of people thought in the banking sector and investment banking sector that VAR, you know, value at risk, was the metric to use to measure what risk exposures the balance sheets of these entities had and how well they were capitalized. That was again the wrong measure, and because it was the wrong measure people thought they were managing risk when in fact they were mismanaging it.
Dan Ferris: Yes, and you know, I don't – I think a lot of people didn't even worry about whether or not they were managing it. They just had this – they could just point to VAR and say, "See? We're managing the risk." And they were really just trying to sell something and it was adding another – you know, it was just adding something to the sales pitch. It wasn't really – I think – in other words, my point is so few people on Wall Street are truly concerned with risk management in the way that you practice it and the way you describe it, and I think that's a travesty really.
Another thing that really grabbed me in your book – which, by the way, I've dipped into it – as I do with all investment books, I'm just dipping in here and there and reading all different parts of it. And another topic caught my attention, and it's a particular topic for value investors because of course the great journey of Warren Buffett was from Graham and Dodd cigar butts to higher-quality companies. And you called quality the mother of all mistakes and the mother lode of all opportunities. That again – like you said, there's a lot of provocative stuff in the book, but how is quality the mother of all mistakes?
Rupal Bhansali: So I think an analogy with the health care profession might be useful here, because we've all heard about, you know, when you do testing you can have a false positive and a false negative, so hopefully your audience will understand this construct. It's a similar development in equity investing or in any form of investing, where there can be false positives and false negatives. And quality is the biggest source of false positives and false negatives. People misdiagnose quality all the time, and that can either be a problem or an opportunity.
So, for example, if people think that a particular business is a very sound business and therefore a very high-quality one and then they choose to overpay for it, if they've made a false diagnosis, i.e. it's a false positive, they will end up losing a lot of money. And one of the examples I give in the book, because I am a big believer that you should apply what you know or learn and teach because academic learning is not helpful as a practitioner. So I talk about, in my view, Apple is the false positive. I think Apple is misdiagnosed as a very high-quality business and I disagree with that assessment and so I would not own it. But a lot of people think it's a very high-quality franchise, makes a lot of money, you know, the stock has worked out so well and so on and so forth because they love the product. And what people misdiagnose about the quality and therefore the risk profile of Apple is that it's ultimately not a technology company but a consumer electronics company with a hit-or-miss product cycle, and frankly of late the iPhone, which is the biggest contributor to earnings, has had more misses than hits. And, you know, this pivot to services that they argue is going to be their nirvana is actually their Achille's heel because services, the ones that are consumed most by iPhone users or anybody else on the mobile cellphones, tend to be services that are ubiquitous and not proprietary. You know, for example Spotify music or Netflix or video games, they're available on any mobile platform, not just on the iPhone.
Now many people will argue with me and say, "Gee, how can you say that this is the mother lode of all mistakes? Because I will never give up my iPhone and, you know, I know a lot of people who will never do that." Now, my argument here is not that iPhone will disappear or that Apple will disappear. All that it takes for a growth company and a growth stock is for them to disappoint. And if the replacement cycle of an iPhone extends from say the two-year cycle to a three-year cycle, that's a third less in revenues for the company, because remember, it's a consumer electronics company selling hardware. It's a treadmill. Every day it has to sell something that has no annuity stream it can count on. And so this example I've given you people don't realize, but many people I talk to, they would agree with my assessment that they are going to replace their iPhone much later than what they traditionally used to because there is no feature set, there is no application, there is no need to spend another thousand bucks, especially with a kind of recession and kind of unemployment happening around us. So I think this is the kind of analysis that people mistake, and that is why I said, you know, even what appears to be a high-quality business can actually prove to be a very low-quality one on a forward-looking basis.
On the flipside, imagine if I told you that a company like Michelin, you know, which is a tire company which obviously does not appear to be on the surface a very high tech company, in fact would appear as a commodity company – after all, tires have been around forever, they're made of rubber, and it appears like it's just a pair of wheels. I mean, what can be so complicated about that? Well, frankly all over the world we are actually buying bigger and bigger cars, more specifically SUVs, and a bigger diameter tire, i.e. an 18-inch diameter tire which is what you need for an SUV, compared to a sedan which are more the 16-inch tires, the barriers to entry of making them are extremely high. So that makeshift where you can upsell, you know, your own product set to something that is going to be more lucrative rather than less lucrative, and there are very few competitors in the world who can actually make those tires, not to mention tires are specifically very important for both fuel efficiency and safety, two attributes that always differentiate a car or an SUV. I mean, it doesn't matter which vehicle you're buying, you always care about those attributes.
So here is an example of a company like Michelin that trades on, you know, half the multiple of what say an Apple trades at and is not perceived to be quality and perceived to be quite low tech. But it's actually an annuity stream, because unlike a car, you know, a tire has to be replaced every couple of years or every few thousand miles, and that makes it an annuity stream, not a discretionary product. But it's valued as if it were discretionary to replace.
So this is the kind of analysis about quality, you know, that can yield a stock that it not valued as such and therefore becomes a mother lode of an opportunity, because as the earnings for Michelin come through, over the years of course – near term all companies are going to have a challenge. And, you know, in the meantime you can clip a dividend of roughly four %. That's actually a very attractive value proposition where the risk is low because the stock is already priced for failure and success is not in the price. On the opposite end of the spectrum, a lot of the success is already priced into Apple's stock, but the failure is not. So that asymmetry of risk and reward is what value investing is all about. Where do you have the marginal safety? I would argue it is greater in Michelin's stock than it is in Apple's stock. And that's my non-consensus view of investing.
Dan Ferris: Yeah – oh, that was brilliant. That was absolutely a perfect juxtaposition. You know, I read something recently that Apple is getting set to do an update on the operating system that will leave behind a whole slew of users. I think it's up to the 6S, the iPhone 6S. So in other words, those people – they're never going to get another update that they can use ever again, and the big question is will these folks spend, you know, as you say, another thousand bucks or not? I don't know. It seems a very binary sort of a situation that could reveal this vulnerability that you just discussed in a very quick and ugly way.
Rupal Bhansali: Dan, I think this is again another blind spot that people have. A lot of people confuse Apple with the U.S. market. The growth opportunity for Apple is in China, and the evidence is already there. Apple has been losing market share in China for a number of years, and a lot of Chinese are preferring to own the mid-end phones which are actually very competitive to the high-end phone of an iPhone at a far lower price point. So the evidence is already upon us – it just happens to be overseas. And that's exactly the power of research. A lot of people extrapolate the U.S. experience, U.S. anecdotes, and that is not what causes the financial model of Apple to kind of – it's not what makes or breaks the expectations priced into the stock. It's really the international growth prospects and they don't look good and they've not for a number of years, which is in my view partly why they stopped reporting iPhone sales. To me, that's as big a tell as any.
Dan Ferris: Ah, I see. Well, thank you for that. Listen, we are starting to get short on time so I want to cover two things quickly. The first one is, the funds you manage were recently awarded five stars. Was that from Morningstar?
Rupal Bhansali: Yes, the international equity fund that I manage at Ariel Investments.
Dan Ferris: So you sound like a value-oriented investor and you're getting five stars. That's kind of rare these days. How are you doing it and other value investors are getting left behind?
Rupal Bhansali: Well, thanks for that question, Dan. Frankly, because I want other people to be able to do what I have done, I wrote the book and I will literally share my investment process and kind of how I do this for a living because it's not the first time that the funds I've managed have received five stars. It happened in my previous career at MacKay Shields as well. So it's happened in very different market environments, and I think that speaks to a very robust investment process, you know, one that can adapt to whether it's old economy stocks driving the markets or it's an abnormal economy like the one we've had led by _____ in the last couple of years. It truly is a testament to this investment process, which is very counterintuitive, I grant you, which is why I had to write a whole book on it, to explain and lay it out as to how active investing can work, because a lot of people believe that active investing does not work and I've made a career out of making the opposite point.
So I think it's hard to give you a soundbite as to how I've done it, but I think the key variable is really thinking about risk management before you think about return management, because losing money is the albatross of compounding money. And I talk about how not to lose money. A lot of books talk about how to make money, but frankly a lot of people need to learn how not to lose money. And I talk about the pitfalls and the traps that befall a lot of different kind of investors, value investors or growth investors, because ultimately active investing is about picking stocks, not styles. And so this is what I write about in the book and I hope that anybody who wants to learn how to do this, that's why I shared and want to spread this knowledge. So thanks for the opportunity, you know, to do so and the shout-out for the book, because as a practicing professional it's an extremely difficult decision and one that one could argue could be counterproductive if I spawn a lot of people to follow what I believe is the secret to my professional success. But I'm a big believer, if you make the sport better we are all better for it. So I hope that you and other people learn and can make the same kind of investment outcomes as I've managed to in my career.
Dan Ferris: Yeah, I feel like you wrote this thing for me, just looking at the chapters. I mean, To Stand Apart You Must Stand Alone, Do No Harm, Sizzle Fizzles, Patience Prospers, it's just – this thing is right up my alley. Anyway, Non-Consensus Investing: Being Right When Everyone Else is Wrong. I've had it on my desk ever since I got it, and I keep referring to it. It's great. Rupal, we're just about out of time and my last question in just about every single interview I've ever done is the same. I think I know what your answer already is, and if you want to reiterate it that's fine because it's very important. But if you could leave our listener with a single important thought today, what would that single thought be?
Rupal Bhansali: Investing is not about picking the hot stock or the hot dot. It is about avoiding the losers and the losses. So figure out how to do that first before you think about making money.
Dan Ferris: Boom. Perfect. Thank you for that. Excellent. So I've enjoyed talking with you. I hope, you know, maybe we could do it again sometime in six months or a year or something.
Rupal Bhansali: Oh, I would love to, and thanks for all the services that you provide to your listeners and your audience. It's so important to keep the faith and the conviction in value investing. I know it's been tough, but there is a way forward and people like you and me will make that happen.
Dan Ferris: Fingers crossed, from your lips to God's ears, yes, absolutely. So thanks very much and hope we'll talk to you soon.
Rupal Bhansali: Likewise, bye-bye.
Dan Ferris: Wow, that was a lot of fun for me, and I'm serious about this book, by the way, everybody. It's just – like I said, I feel like she wrote it for me, you know? It's got all this stuff that I keep harping on you about. Of course when I find a professional who's worked for George Soros and has this five-star fund that's doing really well, you'd better believe I'm going to have her on and tell you about the book. Yeah, Non-Consensus Investing, I just – I keep – I do. I keep it on the desk, and I keep referring to it. It's excellent.
Alright, let's see what's in the mailbag.
Dan Ferris: In the mailbag each week you and I have an honest conversation about investing or whatever is on your mind. Send in your questions, comments, and politely-worded criticisms to [email protected] I read every word of every e-mail you send me. I did it again this week, and I respond to as many as possible. And you know, I say as many as possible, but it's like as many as are really compelling, so you know, do your best here. Compel me to answer you, right? Engage me.
Alright, first one is by Romeo B. He says, "Hi, Dan. Thank you for answering my question a couple of weeks ago. I'm considering investing in Chinese equities and ETFs. Chinese equities and ETFs seem to be the best way to get started. For one particular business I would aim to pay around 10 times free cashflow, but how much would you be willing to pay for a passive fund that includes hundreds of companies? Maybe my thinking is flawed, but it occurred to me that I might never get that kind of valuation for an entire market. Looking forward to hearing your thoughts, Romeo B."
Actually, Romeo B., you know, I never did this but I know some investors who kind of caught the ride in various emerging markets over the years and they got whole swaths and whole markets cheaper than 10 times. So whether or not you should wait to do that, to buy Chinese equities and ETFs, that's up to you. All I'm saying is, this idea of correlating one particular business to the overall market isn't totally crazy. They're very different. You have all kinds of companies. And it really depends on the country and its level of development, I would probably say. When can you ever get the U.S. market for less than 15 times earnings, or 14 or something like that? Hardly ever, right? And so you'd have to study. I haven't studied this, but you'd have to study those Chinese equities and think about where that economy is now versus where it was five or 10 years ago, and decide accordingly, right? So I can't really say yes or no on this, but I can say that if you think of China as an emerging market, and it seems to be the biggest swath in some of the emerging market _____ – I don't even know if that's right anymore, if that's a good idea and makes sense anymore. So getting it dirt cheap is not a crazy thought. I'm going to leave you with that.
Next one is from Ron K. Ron K. says, "Dan, with the Fed loosening policy and doing whatever it takes every time volatility spikes up in the stock market, isn't the stock market destined to continue rising until they finally tighten policy months or years from now? How is it even possible to fight the Fed – that is a stock market crash – in these conditions? Thanks, Ron K." So I think Ron K. means, "How is it possible to fight the Fed, meaning how can you expect a stock market crash with the Fed pumping money into the system the way they've been, you know, printing and buying bonds, pushing rates down, encouraging people to speculate on stocks and other risky assets, frankly?"
It's a great question. It's a great question. I have to point you back to the example of Japan, and even the example of Europe. You know, it's not like the European Central Bank created some massive wonderful recovery and everything's fine and the market's producing great returns and outperforming, right? No. The evidence – and there's scant evidence of modern developed economies. There just by nature aren't a lot of them around, right? And it just so happens, of course, the U.S., Japan, and Europe, well, that's like most of the reserve currency in the world, isn't it? You know, you have to keep all that in mind, but those examples don't really indicate that it's a done deal that once the Fed starts easing and pumping and buying and printing that, hey, you can never short stocks again. I don't believe that at all.
Earlier in the program, I talked about how there is concern among some investors these days that people think the Fed has their back. They're just too convinced of that, and I don't believe it for a minute. The Fed doesn't have your back. I mean, you think the world really works that way? Look, people can get away with all kinds of crazy garbage for eons, eons. You read some of these books like by David Einhorn or, you know, that book about Bill Ackman's big short and Einhorn's short of Allied. I forget what the Ackman book was about. I didn't really get through much of it. But whatever it is, you know, these guys, they work on these short theses for years and years and years, and they actually document how these guys have been running a really questionable, flaky operation with weird accounting for a long, long time. These things can go on for a long, long time. And when you're printing money, when your game is not even an individual company with funny accounting, it's printing money to buy securities and printing the world's reserve currency, that game I promise you could go on much, much longer than any short-seller could ever remain solvent. I mean, do we really believe the world works that way?
I don't. You know, all you have to do is print money and everybody will be just fine? No. Real wealth is goods and services and things that are valuable to you – you know, things I make that are valuable to you, things you make that are valuable to me. There's a real economy down there somewhere. I'm going to leave it there.
Last question this week is by T.J. and T.J. says, "Hi, Dan, absolutely love the podcast. I was wondering if you could maybe share your top must-read finance economics books. My top ones would include Taleb's books, Nassim Taleb, El-Erian, Mohamed El-Erian from PIMCO, and a Random Walk Down Wall Street – that's by Burton Malkiel – and Economics in One Lesson by Henry Hazlitt. However, I'm quite new to the game," he says, "and I'm eager to read more to improve my knowledge. Any others you would recommend? Thanks, T.J."
T.J., I like your list. I love Economics in One Lesson. I think it is the first economics book anybody ought to read. It's fantastic. I read it many, many years ago. It's on my shelf. It's just been beat to death. I'm surprised it hasn't fallen completely apart. It is quite excellent. It gives you a really firm grounding in the basics of economics. Thomas Sowell has a good book called Basic Economics, too, that I would recommend in that same vein.
Okay, I bet long-time listeners can probably name these as well as I can because I've talked about them frequently. So the first book I think any investor should read, novices and people with some experience who aren't professionals, let's say, it's called The Elements of Investing by Burton Malkiel and Charlie Ellis, and the first chapter's on saving and I maintain that saving is, like, the cardinal skill, the essential skill that – on top of which you build all your other skills as an investor. If you can't save, you won't have the foundation necessary to build the other skills. There's that. Accumulating capital, the ability to accumulate capital, spend less than you make and accumulate, so that book is good for that.
My list is mostly about bottom-up investing, so there's The Little Book that Still Beats the Market by Joel Greenblatt. There's chapters eight and 20 of The Intelligent Investor by Ben Graham. Sort of the most general book is The Most Important Thing by Howard Marks. Another good book for bottom-up sort of value-oriented investors is by a guy named Joe Ponzio. It's called F Wall Street. And while those – like I said, those are my core books, but there's some other stuff that is really, really good, like just about anything by Marty Whitman. Marty Whitman, he's like an old-time value investor and he has a book just called Value Investing: A Balanced Approach, and it's like – it's just different. It's a different orientation from the usual stuff about cash flows and revenues and all that. It's just a slightly different orientation and it's worth looking at.
I'm physically looking at my shelf as I'm standing here, and I think besides Whitman there's books about Warren Buffett. I mean, probably the best one – well, it's by Lawrence Cunningham and it's called The Essays of Warren Buffett where he just basically goes through every single Berkshire Hathaway annual report and he takes out all the good parts and he, like, categorizes them and puts them in the right order so that it's like Buffett wrote a chapter about this or that particular subject. I think that is absolutely essential. If you haven't read that one, T.J., maybe that's your next one, The Essays of Warren Buffett by Lawrence Cunningham. And of course, you can go through and read all the Berkshire Hathaway letters and all that same material is in there, but this stuff – I'm telling you, what Cunningham did is a great service to investors, so that's another good one.
And I think I'll leave you with those. That's enough to get started with, okay? So check those out and see what you think. Maybe write back. You know, if you find a good book – anybody finds a good book, write into [email protected] and tell me about it and maybe I'll read it and we'll talk about it.
All right, that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as I did. Do me a favor. Subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts, and while you're there help us grow with a rate and a review. You can also follow us on Facebook and Instagram. Our handle is @InvestorHour. Also follow us on Twitter where our handle is Investor_Hour. You have a guest you want me to interview? Drop me a note, [email protected] Until next week, I'm Dan Ferris. Thanks for listening.
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