It’s the 10-year anniversary of this extraordinary bull market, officially – except not really, as Porter explains to Buck in this week’s podcast episode.
Even so – there’s no question a lot of people are making money. But with the S&P 500 having more than tripled since March 2009 lows… who’s been smartest (not LUCKIEST as would be the case with cryptos)? Porter points to believers of the FAANG stocks – and one of them in particular.
Later on, they’re joined by Wesley Gray, a former Marine and professor of finance at Drexel who now runs a fund with $1 billion under management. He has a strategy of buying ultra-hated investments that would make even the most steeled valued investors uneasy. So how do you tell the difference between a stock that’s simply nearing a low… and one that’s doomed?
Wesley will be joining the Stansberry team at our Vegas Conference October 1-2, along with Stansberry editors and guest speakers like Dr. Lacy Hunt, Steve Forbes, Robert Kiyosaki, Penn Jillette, Dennis Gartman, Jim Grant, and many others.
CEO, Alpha Architect
NOTES & LINKS
• Podcast listeners interested in Wesley Gray’s podcast can check it out here.
• Register for the 2018 Stansberry Conference in Las Vegas, Oct 1-2. Meet your favorite Stansberry editors and hear guest speakers like Dr. Lacy Hunt, Steve Forbes, Robert Kiyosaki, Penn Jillette, Dennis Gartman, Jim Grant, and many others.
Announcer: Broadcasting from Baltimore, Maryland and New York City, you're listening to the Stansberry Investor Hour. Tune in each Thursday on iTunes for the latest episode of the Stansberry Investor Hour. Sign up for the free show archive at investorhour.com. Here are the hosts of your show, Buck Sexton and Porter Stansberry.
Buck Sexton: What's up, everybody? Welcome back to the Stansberry Investor Hour. I'm nationally syndicated radio host and host of Hill.TV, Buck Sexton, and I have with me the man himself. He is back, he is bad, he is ready to drop finance knowledge, Mr. Porter Stansberry.
Porter Stansberry: Hi, everybody. Hi, Buck. I'm glad to be back on the podcast with you. It's been a long summer of wasting time, vacations, family time they call that. I love it of course, but I'm really glad to be back. I spent about three weeks on vacation recently with my wife and my children and I love them dearly, but it's so nice to be back in the office where people listen to me.
Buck Sexton: We got Country Club Guy in the house, too, so we've got the original squad right now. We got the whole posse.
Country Club Guy: The A Squad is back.
Buck Sexton: That's right, A Team is back. Very exciting. We do have to get right to this, Porter. Do you owe me a steak dinner? Did you win the White Marlin Open?
Porter Stansberry: No, I owe you a steak dinner. We had a really bad campaign this year. We had a lot of heartache. We had a huge blue marlin. We had the first big bite on the first day of the tournament on Monday about – Jammer, you were there. It was about maybe a 9:30/10:00 bite. It was early in the day. It was a fantastic bite. We were playing cards inside the boat and I could tell just by the reel was running that it was a huge fish. It has a different kind of tone when it's a really big fish. It's hard to explain. It's a lower note.
The fish isn't actually moving as fast because it's so big it doesn't move fast, and it's monotone. There's no variation in the way the fish is running because it doesn't even know it's caught, that's how big it is. Just "waaah" and it just goes and goes and goes and goes. Anyways, we got all the way down to the end of the backing. We almost got spooled. We had all the other stuff in. We started back down on the fish and all of a sudden there was slack in the line.
I'd never seen this happen before, but the fish was so big it bit through a 300-lb. shock mono liter. I've never seen that happen before. I mean obviously it was a shark, but this is a toothy. This is a bill fish. Yeah, it was a heartbreak. I could see him from 600, 700 yards away on the surface, and he looked like a submarine. He was 800, 900 lbs. at least and it would've been a tournament winner for us probably and it got off. So the rest of the week was kind of a kick on the balls because all we're thinking about the whole time is we just had the fish of a lifetime and it got off in a way I've never seen a fish get off before ever.
Country Club Guy: And Buck, guess who was on the reel? Yours truly.
Buck Sexton: For real?
Country Club Guy: I was. I did my best to keep the lines tight and like Porter said, it wasn't my fault, but he likes to take blame on these kinds of things because you were on the rod.
Porter Stansberry: No, it wasn't anybody's fault. It was a freak, freak thing. He must've gotten hooked so far down in his mouth that instead of the wire leading being in the corner of his mouth it was the mono liter and he bit through it. Like I said, I've never seen that happen with a bill fish before, so it was a heartache. We did fine. We caught some white marlin, we caught some other fish.
We had a good time, but the closest we got to going back to the weigh station after the lost blue was we had a nice white that was probably 72 or 74 lbs. It was a nice big fish, but it was a half-inch short so it wouldn't have qualified so we didn't bother killing it. But it was a good time. It was the first year that I fished in the tournament where we didn't come to the weigh station. It was the first year where we really didn't come close to winning something, and that was kind of a heartache.
Just so you know that shit can go from bad to even worse, my boat is fishing in the other big marlin tournament which is going on this week, and I don't usually fish in this tournament because one is enough. It's called the Mid-Atlantic and it's also a very big, very expensive tournament, lots of big prize money. We have one good charter client and they are fishing in the tournament with the boat and the crew, and yesterday they caught four white marlin and one blue and they're leading the tournament.
So just goes to show you there's heartache in every way in sports. Sometimes you're the pigeon, sometimes you're the statue. I feel like the statue lately.
Buck Sexton: Well let's get on to a happy topic for a second, Porter, if I can, and I have a very basic question to ask about it. You saw that the headlines this week were that we are on the cusp of the longest bull market in history right now.
Porter Stansberry: Yeah. It's not quite accurate, unfortunately. The mainstream media gets some of these things wrong, but OK, go ahead.
Buck Sexton: Well, I mean that's what the Associated Press is saying.
Porter Stansberry: Yeah I know.
Buck Sexton: Take it up with them. But what is one to make of this right now? One question that came to me, who's been really smart so far this year? I don't mean individuals or even companies, I mean people who have done what with their money have been really smart this year?
Porter Stansberry: That's a great question. Let me address the issue. First of all, this has been a very, very long bull market, but it hasn't really been the longest. I saw this detail last week, this good group called Bespoke put something out about it. We're about a year and a half or so away from it actually being the longest bull market, and the other thing that is wrong about that data is that bull markets are interrupted by bear markets, and bear markets are technically declines of 20% or more, but there's been twice during this bull market where the market has fallen more than 19%.
So if you look back at the fall of 2012 or 2011, I can't remember. Jammer, maybe you can dig that up. It was either the fall of 2011 or 2012, and then of course it was the winter of 2015-2016. Those were both 19% declines in the S&P. And so I think it's kind of facetious to say that we've had this much longer bull market because in my mind those are both bear markets, and they were certainly bear markets by the way if you were in any kind of corporate fixed income. The fall of 2015 was brutal for corporate bonds and of course a lot of stocks, too.
So who's been really smart? I have to tell you it's the folks who stuck with the FANG stocks, I mean the folks who have been long Google, Apple, Netflix, Facebook, and have stuck with it have done very, very well. They've made enormous amounts of money during this bull market, and not just this year, Buck. If you go back and look at the price of Apple, when it announced the Kindle, I'm pretty sure it was around $40 or $50 a share, right? If you were just smart enough to go, "Oh yeah, people aren't going to buy books anymore. They're going to just download them from Amazon. I'm going to buy Amazon stock."
Pretty simple calculation to make. No, I didn't buy it myself. I screwed that up among many other things in my life I've screwed up. I mean those are the smart folks, the folks who have figured out how technology is going to change consumer behavior permanently and have stuck with those companies, those are the folks who have been the smartest in this bull market, and what I think is interesting about that is that's the same thing that was true about the folks who were smart in the giant bull market in the '90s, the same thing mostly that was true about the bull market of 2002-2008.
I think that the way technology is changing whole industries and consumer behavior is one of the most important trends to follow as an investor and it's certainly something we focus on. We've got a lot of people who study nothing but that, and I'm happy to say that we've recommended Apple in Extreme Value back in 2013. I know we've been long Amazon in Retirement Millionaire. I know we're long Google somewhere, I forget exactly which letter it is. So we've certainly followed all that. The work I've done personally was on Facebook.
I recommended Facebook back in 2016. We've done very well with it and we've stuck with it. I think that Facebook is the greatest marketing engine that's ever been built, and I know it's generated more free cash flow in the first ten years of its life as a business than any other company in the history of capitalism. I bet you, I don't know this for sure, but I'd be willing to bet that Facebook has made more money in its life as a public company than probably 90% of all the other public companies combined.
I mean, it is massively unbelievably profitable, and enormously capital-efficient. So you're talking about capital efficiency of like $0.40 on the $1 for these guys, and they have very little capital costs. Yeah they've got to buy new servers and they've got to buy new programmers, but it's nothing like trying to build factories all over the world. I mean delivering Facebook to everyone in the world is as easy as them turning on a computer and booting up your website or your app.
It's a really fantastic application of technology, and think about how it's changed our world so much just in the last decade and I'm sure that'll continue to expand. I think there will probably come a time where you'll – I don't know whether it will be Facebook or another social network. I'm not trying to say Facebook can't be competed against or can't be replaced, but I'm saying that the way that you shop, the way that you consumer content, the way that you communicate is all changing and it's all evolving into these walled gardens, these enclosed communities.
So just as an example, Buck, I don't know about you, but I have all my content with Apple. I have all my family's pictures. I have all of my movies and stuff. My TV is all on Apple TV. I mean that service revenue for that company is just going to continue to grow and grow and grow, and I think Apple has been really smart in that they haven't bothered to produce their own content so they can host everybody's. They're not competing with Disney, they're hosting Disney.
I think it's going to end up being a smarter choice than Netflix's model. But sorry I'm going on and on. Just the point is that the best investors have made the biggest investments in these new forms of consumer content and entertainment, and I'll give you one little if you don't mind a quick stock tip.
There's a company called Spotify and they have a subscription music service that allows you to basically have access to any music that's ever been published anywhere, ever. So if you're a DJ you don't have to go buy a gazillion CDs anymore. You can just link into Spotify and you have every piece of music that's ever been published, and they charge a monthly fee for it and there's different prices. There's a free version and then there's a paid version of course. I think it's like $15 a month.
They have 100 million or more subscribers growing, and they've been very competitive with Apple Music – which I think is surprising because Apple Music does the same thing for you and I'm already an Apple customer so I just use Apple Music, but they've done OK.
Interestingly there's a guy named Chase Coleman, and Chase Coleman is probably the best investor under the age of 50 in the world. He runs something called Tiger Global which has $19 billion under management. He is the chief protégé of the founder of Tiger Management, Julian Robertson, which is where my friend Erez Kalir used to work.
Anyways, Coleman is a very, very talented investor, a bright young guy, and he has put I want to say 7.5% of his fund into Spotify. So that's a pretty big investment. Now listen, I want to be clear, I don't know when he made that investment, so he could've made that investment while Spotify was still a private company, and as a public company now he could be selling shares. I don't know what he's doing with the stock today, but I think it's just an indication that at the very highest levels of finance there are larger allocations and there is more work being done to understand new consumer related technology than anything I have seen in my lifetime, and there's a big focus on it and that's because there's so much money to be made from it.
Buck Sexton: You know the Journal has a piece today up, Porter, right under that stocks are set to enter their longest bull market, and we've already discussed whether that's really accurate or not, but also that the S&P has hit an intra-day record high, and then right below that the Wall Street Journal has got, "No, stocks aren't cheap, but don't act rationally." So what's the Porter version of, "OK, everything is really high, don't act rationally?"
Porter Stansberry: Well you know, Buck, people get frustrated with me because I'm always warning about what might go wrong because I'm certain that something is going to go wrong, and as someone who serves mostly individual investors I feel like it's my job to keep people cautious and defensive. Opportunity is infinite, but your capital is finite, and if you get destroyed, if you take a 30% or 40% portfolio loss, you're going to be out of the game and you're going to miss out on all of the value that can be created next.
Do you know how many investors that I worked with in the late '90s, Buck, who took round trips on stocks like JDS Uniphase? JDS Uniphase went from $3 to $1,000 and then back to $3. Stocks like Qualcomm did the same thing. Lots of the stocks I covered in the late '90s went all the way up and came all the way back by 2002, and those guys were all out of the game, and so they missed the entire next bull market from '02 to '08. And of course we probably lost something like 75% of our subscribers in '08 and '09.
They got wiped out, and what's interesting is our portfolios did great. My portfolio was into the year 2008 flat and was way up in 2009, but they didn't listen to our warnings about real estate, about banking, and they didn't follow trailing stop losses, and of course they never took any short positions. We made a killing. We shorted Fannie, we shorted Freddie, we shorted Bear, we shorted Lehman, we shorted GM. This was all remarkably great advice and it was – the problems were obvious enough and clear enough that most rational sentient people could go, "Oh yeah, that's going to go to zero" but they didn't take action and instead they just got hammered.
I'll give you an example. NVR is the world's greatest homebuilding publicly traded company. It has a much better model than any other homebuilder because it doesn't own land. That makes it much more capital-efficient, and instead of paying dividends it buys back stock, tons and tons of stock. I think over the last ten years it's bought back more than 30% of the stock outstanding. This is a compounding machine.
Since 2007 when I first recommended it, and my advice by the way was to buy it below $400 and I wrote this in October of 2007, I said, "Hey, housing is going to collapse, most homebuilders are going to go out of business, but NVR won't, and it'll continue to be cash flow positive for the whole time because it doesn't own land and it doesn't have big debts. And on the flipside, someday people are going to need a house to live in again and someday it'll start selling more houses, so use this downturn to buy the stock."
So NVR was over $400. Of course it went below $400. Bottomed around $350. Today it's trading at close to $4,000 a share. My point is that unfortunately I guarantee you no one followed that advice because everything else in the stock market went down and they didn't have cash and they were on edge and they were afraid. So my point is, the reason why we stress so much about what the risks are in the market is that we don't want you to get clobbered. We want you to stay in the game for the long term.
So I am very concerned and I have been since 2015, so three years ago I saw excesses in student debts, excesses in auto lending, and excesses in corporate borrowing. The excesses in corporate borrowing are unbelievably extreme, Buck, and no one's paying any attention to it right now because stocks keep going up.
So U.S. corporations have never, ever borrowed more money as a percentage of GDP as they have outstanding right now, and many of these companies cannot possibly earn enough money to even finance the interest on these debts. There's probably about 15% of the S&P 500 that isn't solvent but isn't bankrupt yet.
Buck Sexton: Who's like a really bad offender in this regard, by the way? Who comes to mind?
Porter Stansberry: Sprint. Sprint owes $31 billion in debt and it can't even make money selling cell-phone service because it's competing with companies that have better products, better networks, better marketing, more subscribers. So I mean that's one example, and by the way, a $30 billion bankruptcy is a big deal. Lots of things that people don't understand about Sprint. I mean when that bankruptcy happens it's going to be really ugly because among the assets that Sprint has pledged to the bondholders is the spectrum that it owns, but guess what?
You're not allowed to transfer spectrum in the United States without the permission of the FCC, and the FCC wants to know that the bondholders are going to provide a service to consumers or they're not going to transfer the spectra. But think about that. If Sprint couldn't make money serving the consumers without spectra, then how the hell are the bondholders going to organize that? So it's just not clear at all how any of that stuff is going to be resolved.
Now I'm not saying that that's a reason not to own stocks, and that's where people get tripped up. I am saying that over the next two years there is going to be an enormous problem in the corporate bond market. In the next two years there's going to be an enormous problem with student lending. Guys, think about this. If you ask anyone under the age of 30 how much money do you owe in student loans, you will be shocked at the answer. You'll also be shocked at the fact that their plan is not to pay it. There's no other plan.
So there's $1.5 trillion in student loans. By my count and by the count of experts that I've consulted with, there's probably something on the order of $1.5 to $2 trillion worth of bad corporate debt. These things aren't going away, but in the short term that is the juice that's powering the stock market. Where is all that money coming from that people are spending on Apple phones and Netflix movies? It's all student loans.
I guarantee you, you go to any dorm room in the country you're going to find in one dorm room with four people in it let's say, you'll find a dozen different Apple devices, all of which cost more than $500. You'll also find that they're probably password sharing, but among them they've got a dozen different content providers, music, movies, TV, all that kind of stuff, right? And they're spending $100 or more a month on content. That's not even talking about the cable TV or anything else.
So there is an enormous amount of consumer spending that's related to all of this consumer debt, and there's enormous amount of corporate M&A activity that's related to all of the corporate debt. Sooner or later, and it's have to be sooner because a lot of these bonds are coming due in 2019, it's have to blow up. So if you look at our model portfolios in our newsletters you're aware of these problems already. I've spoken about them for many, many months, years in some cases, and what we advise you to do is simple.
It's not that complicated. It's, sure, buy lots of great businesses. I recommend that you own Facebook for example, no problem. I recommended that you buy American Express. Sure, American Express is a beneficiary of all of this consumer spending. Of course it is, but it also has the highest quality, the highest caliber borrowers, the highest quality users. It's the most conservative way of playing a consumer credit boom. So we're in these things and we're long them and we're going to stay long them until we either get stopped out or we become convinced that collapse is imminent.
And just in case we're wrong, great, we've got three or four short positions. We've got 40% of the portfolio is either in safe bonds or in safe piles of bonds, and what safe piles of bonds are, by the way, is insurance companies. So just because there's a problem in the corporate bond market does not mean there's not a corporate bond to buy. Of course you can. There's lots of safe corporate bonds. There's also lots of unsafe corporate bonds.
My point is, we are very conservatively positioned. We have a lot of money in fixed income and in things that are like fixed income. We have cash and we have short positions, and our portfolio is going to be less volatile than the market, but we're still long. So last year the market was up 26% I believe at the end of the year. Total Portfolio finished the year up around 19%.
So we gave up a little bit of the upside in exchange for having a lot of insurance. I don't just mean literally insurance stocks, I mean we had a really safe, conservative portfolio that was hedged perfectly. So if I have to give up a little bit of upside to make sure that I can sleep at night and to make sure that we stay in the game, that's fine with me, and that's what we do.
Buck Sexton: Have to take catastrophic defeat off the battlefield. You got no troops, you got no maneuvers.
Porter Stansberry: I was talking to my friend Doug Casey in October of 2008. In October of 2008 more than a half a dozen leading junior mining speculator/investors/financiers had committed suicide. Those stocks were down more than 90% from their high. Gold was in free fall. You guys remember any of that? Why was gold in free fall? Because banks were going broke and when you're a hedge fund manager or an investor and you've got to sell something, you've got to sell something that there's a bid for. People would at least buy gold from you. They're not going to buy shares of Lehman.
So gold was in free fall. Junior miners had been destroyed, and I was calling my friend Doug not because I really thought he would kill himself but just because I was concerned he might be very depressed or upset, and I knew he had lost tens of millions at least and potentially hundreds of millions of dollars in the last six months. So I called him up and I said, "Doug, how are things? You all right? It's a little tough out there." He goes, "Oh, Porter, oh god, I'll tell you. You know, my portfolio, it looks like a medieval battlefield at dusk. People are just going around stabbing them to put them out of their misery."
So if you can take that off the table, that catastrophic failure idea, I think you're going to be better off, and of course Doug would tell you the exact opposite. He's like, "Sure I lost 90% in 2008, but I made 1,200% the year before, and I made 2,400% the year before that." So I mean it all depends on what your game is. If you're a speculator that's the volatility you're going to suffer.
I'm OK with doing that with a small portion of our portfolio, but I think it's foolish to have your life savings in stocks that are that volatile. But you know, what do I know? The people who put all their life savings in bitcoin in 2014 or 2015 or 2016 will tell you that I'm a moron.
Buck Sexton: Why isn't gold, by the way, never mind going up, it's going down recently. The front page of the Wall Street Journal right now, at least at the WallStreetJournal.com, is all about the market is so high – everyone thinks the market is so high, it can't continue forever. Porter, why isn't the reaction in gold? I say this as a guy who actually owns some gold.
Porter Stansberry: Well you know, gold has done fine. People get freaked out about gold. Gold has been at $1,200 for the last, I don't know, five years or so. It hasn't gone anywhere and it should.
Buck Sexton: Right, but why isn't it going up?
Porter Stansberry: Gold is a reflection of the real purchasing power in the economy, so the price of gold never changes, only its ratio to dollars changes. I know that's a hard concept to get, but look, 2,000 years ago if you were walking around the streets of Rome and you needed to buy a nice set of clothes, it'd cost you about an ounce of gold, and today you go into a really nice place and you buy a good suit, it's around $1,500 or $2,000. I mean it's roughly the same price. So the value that you get with your gold doesn't change; the price does change. When the U.S. dollar is strong then gold always does poorly, and the U.S. dollar is strong any time there are real interest rates in the U.S. that are attractive.
Buck, what are the real interest rates right now in the euro? Zero. Probably considerably negative. What are the real interest rates in Japan? Zero, or considerably negative. So if you're a bank and you have to hold assets overnight, where are you going to put your cash? You're going to put it in a place where it'll get you something. And so the dollar has been very strong versus all the other major currencies and especially the emerging market currencies for the last couple years because the Fed has been raising interest rates here and the other central banks have not followed.
Until that changes it's unlikely that anything is going to happen with gold. It's unlikely. Gold is purely a play on real interest rates, and that's hard for a lot of people to understand. It's not really a defense against inflation, although during periods of inflation usually real interest rates are very, very bad so people buy gold.
You recall that when there was a lot of inflation, when was it? Sorry, when there was no inflation in the mid-2000s, the last real big rally in gold, gold from 2001 to 2008 went from something like $250 to over, I don't know, over $800-$900, something like that. It was a big, big rally, like 4 times. There wasn't any inflation in our economy, but there weren't any real interest rates. Why? Well, because remember the Fed had to cut interest rates so far in the recession in '02, and they didn't start raising them again until like '06-'07.
So that created a period where you had strong economic growth and you had really low interest rates, and that combination gives you negative real interest rates and was great for gold. It was also great for oil. If you guys don't remember, oil went to $150 a barrel. So that's what we're looking for. Are we going to see that setup happen? You know, you could. When this eventual debt crisis hits, when they decide they're just going to write off all the student loans, what's that going to do to people that own the student loan bonds? It's going to crush them.
When the corporate debts come due and they can't be paid, what's going to happen to all those bondholders? They're going to get hurt. And in response to that getting hurt, the Fed is going to cut interest rates severely. It's what they always do in a financial crisis, and gold will probably take off again. But in the meantime I've been buying gold consistently since – when did we have our first Long Beach gold coin conference, 2003? I think it was 2003.
Country Club Guy: Little bit before my time here.
Porter Stansberry: Anyways, I've been buying gold consistently since then and I've never sold a single coin. I mean yeah, I'm still –
Country Club Guy: You bought around $400.
Porter Stansberry: I bought around $400 and then I bought a whole bunch more in 2008, too, in October.
Country Club Guy: Still a discount to where it is today.
Porter Stansberry: Yeah, yeah. But people don't understand this, I don't expect gold to go up. I expect gold to maintain its purchasing power. Gold isn't an investment, it is a form of savings and that's it. I don't think I'm going to get rich owning gold. I'm not going to get rich owning gold unless the world goes to hell, but I still want a little gold because it's the ultimate form of liquidity. If I wake up tomorrow and there has been some disaster somewhere, like imagine if you were Venezuela, right?
They lost 95% of their purchasing power in a weekend. If you're Venezuela, having a chest full of gold would be pretty helpful about right now. I think you're foolish if you believe that can't happen in America. I mean it's not foreseeable today, but that doesn't mean it can't happen, and by the time it is foreseeable, guess what the price of gold will be? You have to buy hurricane insurance before the storm shows up, folks.
Buck Sexton: Our guest this week, everybody is Wesley Gray of Alpha Architect. Wesley after serving as a captain in the marines earned his PhD and worked as a finance professor at Drexel University. Wes' interest in bridging the gap between academia and industry led him to found Alpha Architect, an asset management firm that delivers affordable active exposures for tax sensitive investors.
Wes is an accomplished author and contributor to many industry outlets including the Wall Street Journal and Forbes. Wes also cohosts a podcast called Behind the Markets that can be found on Wharton Business Radio, channel 132 on Sirius, or just go to iTunes. Please welcome Wes Gray. Hey, Wes, what's up?
Wes Gray: Hey, guys, what's going on? Excited to be here.
Porter Stansberry: Wesley, thanks for being on the show. Nice to talk with you again.
Buck Sexton: Where'd you serve overseas, Wes, with the Marines?
Wes Gray: Pretty much all over the place, but I was an OIF guy, so Iraq was where I primarily did deployments. I never was an Afghanistan guy. Got out before I could go out there.
Porter Stansberry: Buck, you were in Iraq, weren't you?
Buck Sexton: Iraq and Afghanistan, yeah, both.
Porter Stansberry: What years were you in Iraq?
Wes Gray: Oh, nice.
Buck Sexton: Iraq 2007-2008, Afghanistan 2009.
Wes Gray: Oh, OK. Yeah. I was out there in Haditha which is out in Al Anbar by the dam. That was around 2006 through 2007. Where were you deployed out there?
Buck Sexton: Well, I was in the CIA, so I wasn't actually ever military, so a different kind of deployed.
Wes Gray: Yeah.
Porter Stansberry: "I can't tell you that, Wesley, I was in the CIA."
Wes Gray: Yeah. We'd have to kill you if you told us, right?
Buck Sexton: Wes was doing real work. I was making lattes and giving interviews or rather giving briefings, not interviews. Anyway, the job has changed now, but Wes has some important finance stuff to tell us, Porter.
Porter Stansberry: Right. We can move along. So, Wes, maybe it was about a year ago maybe that your firm was featured in a really good Wall Street Journal article. How have things been going for your firm since then?
Wes Gray: Shoot, I mean we met each other I think face-to-face three or four years ago when we were a twinkle in my own eye. I mean we've got over $1 billion today under management and we still work out of my garage, essentially, and culturally we haven't changed, but we actually are making money now so that's kind of cool.
Porter Stansberry: Yeah. That's very important in business and most folks don't understand how difficult it is to make money in the asset management business. It's very difficult, so congratulations.
Wes Gray: Yeah.
Porter Stansberry: Could you give folks -
Wes Gray: No, for sure.
Porter Stansberry: Could you give our listeners who may not be familiar with Alpha Architect or with your worldview in finance, could you give us just a quick 30-second synopsis about what you believe as an investor and how you try to actualize that in the markets?
Wes Gray: Sure. So if your listeners are familiar with AQR, they're basically a monster quant shop with $200 billion. They do a ton of research. We're kind of a mini-AQR with two key differences. They have $200 billion-plus. We just hit $1 billion. So huge difference there, and then the second one is we're the same idea. We're doing highly researched quants, but we try to focus on what we call "focus factors."
Essentially investing using our computers to buy securities because they're cheap or got high momentum or what have you, whereas an AQR, a Vanguard, or an iShares will buy 1,000 securities and take a small bet on any of them. We do much more concentrated factor investing which is a unique thing in the marketplace and it introduces a lot of career risk and other issues, but that's the path we've decided to take and we're sticking to it.
Porter Stansberry: So we do quite a bit of quant work of course in our research company and I know you've met Dr. Steve Sjuggerud who does a lot of our modeling for us.
Wes Gray: Sure. Yep.
Porter Stansberry: You guys have compared papers and notes. It's a really cool way of being an investor. Can you give us an example, what's your favorite model today? Is that something you're willing to talk about?
Wes Gray: Yeah. Sure. So one of our core tenets of our business is transparency and education, so I'll tell you everything you ever wanted to know about anything we do. We kind of have a high-level ethos. It's pretty simple on how we do investing. It's buy them cheap, buy them strong, and hold them long, and watch the trend if you need to. So what does that mean? Buy cheap, that's value. I know you're a big value investor and you're always promoting the benefits of buying cheap or buying right. Same thing here.
There's 100 ways to cut it. Never overpay, kind of stick to what Ben Graham says. Then the other component, which I'm less sure you're a huge fan of, is just relative strength or academics call it momentum, and that's just simply buying stocks that are winners. The relative winners, we want to keep buying winners or buying strength, and those are two simple concepts. I know Steve has beat them to death as well. I think one of his core models is cheap stocks that are kind of moving, kind of a value momentum.
Porter Stansberry: Yeah, cheap, hated, and in an upturn.
Wes Gray: Yeah. There you go. Exactly. Buy stuff that's cheap that everyone hates, and if you can get it with some trend even better. On the momentum side of the equation we kind of go the other extreme and say hey, we're punting on fundamentals explicitly and just focusing purely on trend, so that's a little nuance difference we have, but I'm also a huge fan of buy cheap, hated, with a trend. That's totally reasonable as well.
Porter Stansberry: I know you do a ton of research and I don't do as much quant research as you do, but I dabble in it, and one of the things that I've found using some of our databases and working with a guy named Richard Smith who built our TradeStops.com product that helps people use trailing stop losses and other things is the benefits of looking for three things: looking for really high quality companies, which always makes me feel good as an investor. I like knowing that my money is safe in something, so let me give you an example. McCormick spice for example, right? People have been trading in salt and spices for all of recorded history. Wealthy people have always liked spices. That's not going to change.
McCormick has the best sourcing in the world, they have the best distribution in the world, they've got the best brands in the world, and they just bought French's mustard and Frank's Red Hot. They have a great business, no question about it. You can see it in their numbers. And then of course it's a fairly valued stock, but the third component is it is not volatile at all. Its beta is a little bit higher than half the market's.
Wes Gray: Yep. That makes sense.
Porter Stansberry: If you put these things together you can end up with a portfolio that is very conservative, very high quality, and has very little volatility, and then here's the fun part. You can leverage it up to where it has the same volatility as the market in general and you're not taking any extra risk, but you get a heck of a lot of alpha doing it. I know this is not new. I know they do it a lot of places in hedge funds and on Wall Street, but this leveraged risk parity kind of investing, do you guys have anything like that?
Wes Gray: So we do, and actually listening to the discussion you had with Dr. Smith, right?
Porter Stansberry: Yep.
Wes Gray: Yeah, and so it's called "vol weighting" or "risk parity weighting," and there's probably fancier ways to talk about it, and as you described the concept is if you put $50 in the stock market and $50 in T-bills you're not really 50/50 allocated because 99% of your risk is going to come from your stock, so maybe a shift a lot more maybe with leverage into your low risk stuff. So aside from a lot of things we do publicly, we run managed futures programs and a bunch of other things where kind of vol targeting or vol allocating is the norm.
So for example, if you have a strategy that has cocoa futures and 10-year Treasury futures you obviously don't want an equal weight across those because presumably the cocoa futures you want to jump off a bridge every so often. So they're a lot more volatile, right? So you may want to allocate a lot more to the 10-year future versus the cocoa futures to kind of balance out that risk. So we definitely do use that concept.
Now in equities it's less important, and I'll tell you why in our context. So a lot of times what we're doing is we're going for dirtball cheap hated stocks, like shit that I know you hate because Amazon is going to eat it, so Best Buy, Kohl's, things that have the most hatred possible because we're focusing on the cheapest of the cheap out there.
Porter Stansberry: But hopefully not JC Penney.
Wes Gray: Not JC Penney. We do have a quality filter not to the extent that you got with McCormick there, which is a different style of investing, but when you're dealing with something where you're buying really, really cheap things and they all have a lot of vol, vol weighting or equal weight across those is not a big deal, but to your point someone like McCormick which has a lot lower beta and a lot less vol, if you're going to pull that with whatever, I don't even know, some crazy stock, Netflix or something, you can probably put a lot more allocation in McCormick and balance that off with a little bit less allocation in Netflix and overall that portfolio would probably do better than presumably just equal weighting them.
So I appreciate and understand the concept, but in our use case in our we allocate to our securities a lot of times in our indexes and our ETFs we just for the most part just equal weight across the final basket just because you never want to get too cutesy with quant in my opinion. Sometimes you quant yourself out of common sense and we try to avoid that when possible.
Porter Stansberry: By the way, all these strategies are like recipes.
Wes Gray: Yeah.
Porter Stansberry: You might put a little cayenne into a barbecue rub, but you're not going to put it on your French toast. It doesn't work there.
Wes Gray: Exactly right. You got it 100%.
Porter Stansberry: So let me switch gears on you. I know we have a lot of young listeners of the podcast and I know we also have a lot of members of the military in the podcast world. Can you tell me how that transition worked for you? How did you go from being a captain in the Marines to a PhD and to Drexel and to becoming a guy with a billion dollars under management? Wesley, that's a pretty enormous career change and it of course speaks to your determination and your intelligence, but how'd it actually happen?
Wes Gray: So I'm actually a little bit unique in the sense that I always knew I wanted to do investing ever since I was a kid, and so I had went into the PC program in finance prior to basically taking a sabbatical from that program, joining the service, and then reentering PhD level finance. So for me it was less of a difficulty because I always knew what I wanted to do. I just also wanted to do my service. So when I came back it wasn't like I was like trying to figure out what to do next.
I had to just sit down and grind and make this shit happen, which sounds difficult, but that's not too bad because at least you got a plan, whereas a lot of people struggle to your point, they come out of the service, you've been war fighting for four, five, six years, and you're really good at being disciplined, being organized, getting shit done, but none of your skills kind of directly translate into, "OK, go run this regression and do this factor analysis on these stocks." I mean the bottom line is you have to get educated and step your game up so you can compete on equal footing with those that chose not to do the service, and that sucks because you're going to have to put in extra effort, but in the end you have a competitive edge because you also have all the training and the background of being in the service.
So you have a longer path to get to victory, but I think you have a higher chance of success once you get there, and it's going to suck and it's going to be painful and you're going to have to train your brain, but that's the bottom line. In the end you have to add value and have a value proposition whether it's a company or an individual, and everyone is going to give you a step up because you are a vet and they respect that, but in the end it's still going to be what have you done for me lately?
That's just something that all vets should be cognizant of. Good veterans, they're not looking for a handout anyways. They're just looking for an opportunity and so I don't think it's an issue for most of us. You know how to grind. Just do that more and you'll be OK.
Buck Sexton: Wes, it's Buck. I thought about going to business school and instead I got a job in media. We often talk about debt in the context of student loans, and I'm just wondering, why did you go the PhD route? Look, obviously you've been very, very successful in what you've done so I guess anything you've done is the right move, but would you recommend that for other people? Usually I'm always told you get a PhD if you want to teach other people how to get Master's degrees, but clearly that's not always the case.
Wes Gray: No, no, 100%. So PhD is definitely a passion project. If you want to get to the highest levels of the game you just have to work harder, be smarter, and just outdo everyone, right? That's not for everyone. If you want to eventually be like a thought leader in finance, specifically quantitative finance, it's clearly probably useful if you're willing to endure it to get the PhD. That's different than saying do I want to get rich and loaded. There's a lot of ways to get rich and loaded. You don't even need brains half the time, it's hustle.
Porter Stansberry: That's how I did it, Wesley. I know all about the second path.
Wes Gray: Well you're smart, too, so if you mix the hustle with the muscle and the -
Porter Stansberry: Wesley, I might be smart, but you can't prove it on paper.
Wes Gray: Yeah. Hey, you can prove it in dollar bills, Porter. You can't fool me. So there's different types of smarts and the PhD is a highly segmented case where if you really love the subject material, like I actually just genuinely would do finance shit even if I didn't make money at it.
Porter Stansberry: Yep, me, too.
Wes Gray: So I mean then it's awesome, right? You're going to endure this crazy pain train of being subjected to all these academics and listening to them and basically fighting with them to convince them to let you graduate. You really have to like it beyond just you want to get paid, but if you want to get paid and you love it I highly recommend it. If you just want to get paid and be good enough to be dangerous, doing an MBA or not doing anything and just doing DIY learning and hustle is going to probably be also an effective strategy for certain people.
Porter Stansberry: Let me jump back into some of your work. I want to tell everyone to go to your website, AlphaArchitect.com. I want to talk about one of your most recent pieces. I don't know if it's your most recent or not, but it is August '07, so -
Wes Gray: So we usually put out three or four a week. I know all the pieces because I edit it. I read them all.
Porter Stansberry: Well, I want to talk about your warning about stock and bond correlation assumptions. Can you tell us what the danger is right now for folks who are assuming that those relationships are normal and are going to continue?
Wes Gray: Sure. I know you've touched on this just on the times I've listened to your materials and everything, but the bottom line is if you look back, and this is kind of obvious but maybe not to a lot of people, if you look over the last 30 years obviously if we could've cherry-picked the best strategy ever, own S&P with 10-year bonds, 60/40, it's been amazing, and a lot of that amazement is because every time the world is blown up, the U.S. Treasury has basically been a fight to quality and did the opposite of what your stocks were doing.
So on that it's been a pretty magical secret sauce. And is there a possibility that could continue in the future where the U.S. equity premium is basically the highest payer and U.S. Treasury is having to be kicking ass for the last 30 years? Sure. But out of sample, and if maybe the world changes, i.e. there's a different regime where the U.S. isn't the winner or maybe we go into hyperinflation or what have you, relying almost exclusively on treasury bills as your sole kind of crisis alpha instrument doesn't make sense.
You guys were talking about gold or bitcoin or whatever the hell it is. It makes sense to just diversify in your diversifier bucket whereas if you talk to a lot of people out there, not actually Stansberry listeners but a lot of financial advisors and "professionals", they're still sitting on literally for their diversifier bucket 40%-50% in Treasury bonds and they're all in on it.
The argument is that regimes can change so you shouldn't just rely essentially on this historical relationship between U.S. stocks and U.S. bonds. Again, common sense, but sometimes you need to do a lot of quant and math and work to just highlight that common sense.
Porter Stansberry: Wesley, that risk I think is especially important to guys like you that area real quant in their structures because all of the relationships that you guys are studying and modeling, they've all been formed during a period of time where interest rates have always gone down.
Wes Gray: Yeah, 100%. That's why I have a sample too.
Porter Stansberry: Sorry, I just know for example Bridgewater, everything they do is modeled after big huge position in government securities because that's what's worked for the last 40 years.
Wes Gray: Yeah, for sure. There's a guy, I saw him at Grant's Interest Rate Observer. I think his name is Hal. He manages bajillions of dollars, and he's basically just been holding a 30-year zero for the last 30 years and I'll never forget it, he stood up there on that PowerPoint after a bunch of these hedge fund guys who are all getting their asses handed to them right now, but they're really smart, at least they sounded smart, and he says, "Listen guys, I don't do anything and I don't know anything, but I own this Treasury bond and I have for the last 25 years."
I mean he's probably that smart to know that was the right trade, but there are people that just rely on that historical relationship as if the last 30-40 years are like the world's gospel. Again, back to your point about the beginning there, just questioning your assumptions. The U.S. does not have to be the winner all the time. In fact, if you look at data prior to 1900 and you look at the equity premiums back then, they're one-third what the U.S. equity premium is so you could arguably say that we're a huge anomaly and to expect that to actually happen in the future would be borderline dangerous.
That's hard because it's questioning people's priors and what they believe about their worldviews. But we're in the game of protecting capital and making money, not accommodating our emotions, and that's sometimes difficult.
Porter Stansberry: It's very difficult. Probably the hardest thing in finance and something no one will ever teach you. You have to learn on your own. Wesley, so great to -
Wes Gray: Yeah, 100 %.
Porter Stansberry: So great to have you on the show. Could you tell folks if they're interested in investing with you what your account minimums are and how they can get a hold of you?
Wes Gray: Sure. AlphaArchitect.com is the best place to find and learn about our firm. We have publicly traded ETFs. You can just go to our website. You can find them all there and then if you want to manage accounts we do offer services there. The min on those goes basically from $500,000 up a lot higher for managed futures and what have you, but we always tell people, "hey, make sure you go to our website, read, learn, know what you're about to get into because our stuff is complicated and definitely not for everybody." But if it's interesting to you we'd definitely love to hear from folks and try to find a win/win and add some value for you.
Porter Stansberry: And I would encourage everybody to go to AlphaArchitect.com and to be on Wesley's distribution list. He puts out incredibly detailed and revealing content, will really help you learn a lot about investing and learn why the market works the way it does. Wesley, again, thank you. I also wanted to let you know I'm going to reach out to you. We're going to be coming up to Philadelphia and there may be a chance that we could get together for a meal or a drink, so I'll follow up with you on that. We'll be up in a couple weeks.
Wes Gray: Yeah, 100%. We'll get you on our podcast.
Porter Stansberry: Thanks so much for being on the podcast. We appreciate you and best of continued success to your firm.
Wes Gray: Yeah, likewise. We'll talk to you guys.
Buck Sexton: Thanks, Wes.
Porter Stansberry: Bye-bye.
Buck Sexton: And for everybody listening, Wes is going to be joining in Las Vegas for the annual Alliance Conference at StansberryVegas.com. For more information on Wes and Alpha Architect, visit www.AlphaArchitect.com. That'll be fun. He'll be in Vegas. I like that guy, by the way.
Porter Stansberry: He's great. It's very rare in finance you find anyone who's that straight of a shooter. The other thing that's amazing is, I'm not joking when I tell you, he puts all their models on his website. I mean really valuable research is on his website for free. Just horse meet water. I can only tell you, I can't make you.
Buck Sexton: So let's get to some mailbag, speaking of horses and water. It's time for your feedback, my friends, very important. Please go to [email protected] if you want to or send us an e-mail at [email protected] We read them all. We try to respond even to the sad ones that tell me that I'm part of the Illuminati conspiracy and probably should be kicked off of Twitter and Facebook as a result. Let's get to the bag. James K. writes, "Hey, it's my birthday and for my birthday I'd love for Porter to explain a few things, his choice. One, EBITDA. I've heard this acronym from him and from other finance guys. Why is it important?"
Porter Stansberry: Earnings before interest, taxes, depreciation, and amortization, and the reason why it's important is because it forms the valuation of a publicly traded stock that may be taken private in a deal that would not be dependent on taxes, depreciation, amortization, or interest. So if you're looking to sell to a private-equity firm they may have net losses that can defer your taxes. They may not have to pay interest because they may have enough capital on their own, and they may not care about depreciation or amortization because sometimes those numbers are inflated to reduce people's taxes. So EBITDA is a simple way to analyze earnings across different industries.
Buck Sexton: Number two here, "Lacy Hunt's long U.S. Treasury position." James wants to know what that's all about. He listened to that interview three times, still doesn't get what the heck is going on with that trade.
Porter Stansberry: That's buying long-dated U.S. sovereign bonds.
Buck Sexton: Number three, "The first, fourth, and fifth amendments to the U.S. Constitution, this is for Buck's benefit. I think I have a pretty good grasp." Well, then it's not really for my benefit.
Porter Stansberry: I don't quite get that.
Buck Sexton: I don't really get it either. I don't know. James, it's his birthday so let's just say that was funny and clever.
Porter Stansberry: I know the First is the freedom of the press, freedom of speech.
Buck Sexton: Freedom of religion, freedom of speech.
Porter Stansberry: And I know the Fourth is freedom from unreasonable searches and seizures. I don't remember what the Fifth one is.
Buck Sexton: Fifth Amendment is that no person shall be held to answer for a capital or otherwise infamous crime.
Porter Stansberry: Oh, take the Fifth. That's right. I don't have to testify against myself. OK, sorry. I haven't been arrested enough so I'm not familiar with the Fifth. I want to be clear about two things. I kind of sped through it. Just to be clear, EBITDA is a measure of earnings that strips out a lot of the accounting changes, so it's a closer to how much a company earns in cash most of the time. Now if you have a lot of interest, expenses, it doesn't really work that way, but it's just a way of allowing you to compare earnings across different industries that might have different accounting conventions.
And then the second thing, long-dated U.S. Treasurys. A lot of people don't know what "long dated" means. So what that means is I'm buying U.S. sovereign bonds that don't expire or don't mature rather for, say, 20 years or 25 years. So a long, long-held position in a U.S. sovereign bond.
Buck Sexton: So next up in the mailbag here we have from Bill in California. "Hi, Porter and Buck. Love your podcast and get tremendous value through listening." Well thank you, sir. "Porter, I went back and reread the transcript of the July 2017 interview with Larry Lindsey this Sunday morning. That interview along with other big picture writings that you and the other analysts have put together really help broaden my understanding of economic investing. Much appreciated.
Since that interview with Larry which focused mainly on the tax cut, I'm curious to understand why from your viewpoint or what has gone according to plan, where there may have been a miss, and your thoughts as it relates to the credit default cycle you felt would hit in 2018 and 2019 timeframe. Thanks in advance from Bill."
Porter Stansberry: OK, so I'd say where there was a miss, Larry was very pro-Trump agenda, and I would say that Trump's agenda has taken a lot longer and been harder to implement than he realized at that time. There were especially, there was a lot of stuff related to trade that hasn't happened yet, although Trump clearly is still working on new trade deals across the board, and the tax cut of course I think has gone according to plan, sort of.
I don't know if it was as deep or as far as Larry thought it would be, but definitely the corporate tax cut has helped a lot of businesses and has definitely led to a good bull market in stocks. I don't really think that either of those things are going to impact the credit cycle, at least not as I see it today, and I still think you're going to see a very big growth, significant growth in corporate bond defaults starting in the second half of 2018 and then really speeding up and magnifying in 2019.
Buck Sexton: Marcus writes, "Greetings, Porter and Buck. I know you've been recommending buying capital-efficient and trophy-asset companies such as Disney and Hershey recently especially when they go on sale.
My question is, for a 30-year-old investor with time on my side, would you recommend buying these companies now and holding them through the imminent market correction, which should occur sometime between now and the next few years, or would you recommend waiting for them to go on sale during the correction and buying them at a cheaper price? A third strategy would be to sell puts on them. Anyway, I know you can't give explicit investing advice, but I look forward to hearing your response. Keep up the good work, Marcus." I'm actually very curious about this question, too, Porter.
Porter Stansberry: Well, I think I answered it at the beginning of the show. I don't think that you want to try to time the markets and make all-or-nothing bets on that timing. You want to have a conservative portfolio and you want to have a little bit in cash and a little bit hedged in case the market does stumble into a bear market. If stocks drop 30% from now until the end of the year, I don't expect them to but if they do, is your portfolio going to be OK? That's a question that you have to ask every year.
As far as capital-efficient companies like Disney and Hershey, I think there's just never a bad time to buy those stocks if they are fairly priced. So to give you an example, he says we recently recommended these companies. I recommended Hershey in December of 2007. That's about the worst time you could buy a U.S. listed equity in the history of the stock market, and Hershey didn't even go down 25% during the great recession. So we didn't get stopped out of it. We're still long with stock.
So there's never a bad time, ever a bad time to buy a world-class, great business as long as the stock price is trading at an appropriate level, and you figure that out by looking at its multiple of earnings, including multiple of EBITDA we just talked about, and looking at the history of that valuation. You don't want to buy when a stock is trading at a peak valuation.
You want to try to buy when a stock is trading at a below average valuation, and we have that opportunity right now in both Disney and Hershey, so a good time to buy those stocks, and I just don't think you can try to time the market when it comes to buying great businesses. Those stocks are going to go on sale when there's either some kind of a problem in the industry or there's some kind of a problem in the market or both, so you have to be willing to act when you have the opportunity.
Buck Sexton: All right, that's going to be it for this episode of the Investor Hour. Porter, it was illuminating as always. Thank you, sir. Excited for Vegas already, by the way. That's coming up soon.
Porter Stansberry: It's a show. It's a good time, and the quality of the speakers that Jammer has put together, Country Club Guy, is great and gets better every year. I really do hope that you guys will all join us if we're not already sold out.
Country Club Guy: We are sold out, but you can still check us out live streaming.
Porter Stansberry: Oh, live stream us. Maybe you should watch us online for one year and then see if it's what I say it is and then if it is join us next year.
Country Club Guy: Then you could join the party and not be on the outside looking in.
Buck Sexton: There we go. I'll be at the party. That's going to be it. Porter, what's our favorite saying?
Porter Stansberry: Love us or hate us, just don't ignore us.
Buck Sexton: [email protected], folks. Please spread the word about the podcast, download it, and we will see you all next week.
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