On this week’s episode of the Stansberry Investor Hour, Dan starts off by clearing up one important distinction about non-essential versus essential businesses. For a minute, Dan’s rant gets a little heated.
Then, Dan brings James Montier onto the podcast for this week’s interview. James is the author of several well-known books such as Value Investing Tools and Techniques for Intelligent Investment, Behavioral Investing: A Practitioners Guide to Applying Behavioral Finance, and The Little Book of Behavioral Investing.
Dan and James immediately hit it off and talk about what drew them to the value investment, Warren Buffett, oil prices, COVID-19, opportunities in the market today… and much more.
NOTES & LINKS
1:40 – Dan discusses an alarming announcement you may have missed from the head of Tyson Foods. “Farmers across the nation simply will not have anywhere to sell their livestock to be processed… because of the closure of our processing facilities.” Is our food supply chain in danger?
6:32 – Will oil pick up business as usual once things get back to normal? Not so fast… Dan shares why offshore producers will be hit harder than anyone else.
10:21 – Dan clears up one thing about non-essential businesses… “There’s no such thing as a non-essential business. Every business puts a roof over someone’s head and food on someone’s table! They’re all essential and they’re all interconnected.”
17:22 – Dan admits it may sound insane but… “buying crude oil might not be the worst thing you could do right now.” Is it better to invest in oil or the tankers?
24:15 – Dan has a conversation with today’s guest, James Montier, author of several best-selling books like Value Investing Tools and Techniques for Intelligent Investment, Behavioral Investing: A Practitioners Guide to Applying Behavioral Finance, and The Little Book of Behavioral Investing. James is also currently a member of GMO’s Asset Allocation Team (Grantham Mayo Van Otterloo & Co. LLC).
29:44 – James shares how studying behavioral investing let him to value investing…”How do I take that knowledge of how people behave and apply that to investing? And is there a way of investing that mitigates a lot of those behavioral biases? And it turns out that value investing, at least in my opinion, is the solution.”
36:10 – James and Dan discuss common psychological investing mistakes like anchoring… and how sticking to value investing principals helps you avoid that problem.
41:28 – “There’s something kind of odd about value investors…” James explains what makes the traditional value investor different than the average investor… and why value investing just isn’t for everyone.
47:26 – “I think the term investor is overused. We talk about value investing… what other sort of investing is there? Almost everything else to me is some form of speculation.”
55:35 – James and Dan discuss what makes the COVID situation a true black swan. “It was something I hadn’t seen, it was out of the blue, it was not something unsustainable in economic nature, which made it harder to cope with…”
57:45 – Dan asks James if he could leave the listeners with just one thought, what might that be? James responds with some sound advice that every investor needs to remember with every investment they make.
1:00:57 – Dan answers questions from listeners in the mailbag… Was Lehman a victim like Enrique claimed last week? Or were they the architect in their own demise? Is Warren Buffett really a growth investor? Are OPEC, Russia, and China trying to break the oil market?
Recorded voice: Broadcasting from the Investor Hour studios and all around the world, you're listening to the Stansberry Investor Hour. [Music playing] Tune in each Thursday on iTunes, Google Play, and everywhere you find podcasts for the latest episodes of the Stansberry Investor 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's program is an interesting one. Our guest, James Montier, tells us about fear and market psychology and value – three things every investor ought to be thinking about right now. You'll want to hear more. Your e-mails always add value, including superfan Joe V. today with a great e-mail in response to last week's show. If you didn't hear Enrique Abeyta from last week, you should go back and listen to it. And as always, my rant... This week, I'll be talking about enormous changes in the food, oil, and restaurant industries and what I think comes next for each. That and more right now on the Stansberry Investor Hour. All right... Let's talk about a few industries that are heavily impacted, including one that I think could create some real societal issues starting – oh, I don't know – right this minute.
So this letter on Sunday appeared in a couple of newspapers, the New York Times and on the website of the company Tyson Foods. Right? The big meat-processing company. And you've probably seen Tyson brands at the grocery store. So John Tyson, chairman and CEO of Tyson Foods, wrote a letter on Sunday. And he basically alerted the country of an impending shortage of meat. And by association, we just took this as an impending shortage of food. Because what can affect the production of meat can affect the production of all food. Right? And I'll just quote you one little passage that kind of sums up the problem here. And Tyson wrote, "Farmers across the nation simply will not have anywhere to sell their livestock to be processed when they could've fed the nation. Millions of animals – chickens, pigs, and cattle – will be depopulated because of the closure of our processing facilities."
So these are essential businesses, these meat-processing facilities. But they're closing them because people are getting the coronavirus. They're getting sick, so they had to close them. And they closed a bunch of them. So you got all these animals that are mature and ready for slaughter, and there's no place to send them. So what do they do? Well depopulated is... there's all these euphemistic terms – euthanization and depopulation. They kill them without eating them is what happens. They're wasted. And, you know – I mean, I have a soft heart for animals. I'm no vegetarian, okay? But we bring these animals into the world and raise them up and care for them so that we can eat them. And it's tragically sad to see them killed without being eaten.
It makes their lives... you know, it's like they lived and died in vain. I watched a Canadian farmer on Bloomberg TV Monday morning openly emotional and talking about this and talking about farmers having to euthanize thousands of animals at a time. It's terrible. He was more concerned – it was more than just the lost revenue and investment, although that's a big impact, too – it was just the thought of all these animals, as I say, having lived and died in vain. It's heartbreaking, you know? And these are essential businesses, and yet they're still having to close down because people are getting the virus. And Tyson said – this is the thing that got me – he said, "The food supply chain is breaking." The food supply chain is breaking... That's scary. You know, you and I – we're big-time investors or whatever. We got plenty of money in our 401k's or wherever. You know? We got resources we can tap.
And if things cost a little more or get expensive, we can probably still afford it. But poor people who don't have anything to their name... they won't be able to afford it, and they won't be able to get it. The supplies will be gone from the stores. Anybody who can get it will pay a fortune. And people are going to start getting hungry. I'm afraid. You know, at first, people will say, "Okay. Well here I am. I'm poor. I don’t have a penny to my name." Put yourself in their shoes. What are they going to do? They're going to be like, "I'm going to steal this. I'm going to get food any way that I can." That's bad enough. But my fear is that this goes on and on and on, and the government doesn’t let us go back to work soon enough and then we start seeing like mass violence. You know? I don't want to see that, and you don't want to see that. Nobody but the craziest people in our society want to see that.
And this is like – this is the leading edge of that. And I pray... if you think I’m being overly dramatic, I pray that you're right. But man, this one thing, this one industry, it scares the bejeebers out of me. I feel like our way of life... it's one thing to have a severe recession or even a depression, but for our way of life to break down – to be shut down like this – I think it's probably harder to restart than people understand. You know, beyond a certain point, if it goes on long enough... And you can see this in the next market I'll talk about, which is fossil fuels.
And fossil fuels, that's at the heart of every developed country. It's like the blood. You know? The circulatory system of a developed economy. And the shutdown globally has destroyed demand. I saw a map this morning on Twitter of tankers filled to the brim with oil because there's no place to put it on land, hugging every coastline of every continent – in the Gulf of Mexico, all up and down and around the coast of Africa, all up and down and around the Coast of North and South America – it looked crazy. It looked like a bunch of little bugs about to invade the continents. It looks crazy. It's all these tankers just filled to the brim with crude oil. But hey, no problem, right? We start the economy back up, we get going again, we just crank up oil production, and away we go. Everything's fine.
Well, not so fast. There was an article in the Wall Street Journal earlier this week, and it focused on offshore producers. The offshore producers have begun shutting down, and they're saying they might not return to the market for many years. And the suggestion was that it's unrealistic to view crude oil production like some kind of a kitchen faucet where you turn it on and off in an instant. So the offshore producers, you know, they shut in for a few days at a time sometimes when they get a hurricane or something. But the way they're talking now, they're shutting in like 80%, 90%, 100% of their production, some of these companies, because low oil prices hit them a little harder. The offshore producers need a premium price to justify the extra transportation to get the crude oil into onshore refineries. You see?
So, you know, when the price goes negative $12 or whatever it is now, it really hits them harder. And they're saying... They quoted this one guy from Talos Energy – the CEO of Talos Energy, an offshore producer – Tim Duncan. And he said, "In offshore, we don't shut in fields. We shutter them. You begin the process of leaving them forever." Right? So the implication there is we can't just start this stuff up like turning the kitchen faucet back on. And this is meaningful now because offshore producers account for a record 15% of U.S. oil production before the virus hit. Right? Last year, 15%. So if enough of that production capacity disappears – if most of it disappears – here's what I think could happen next in the crude oil market that nobody is really anticipating right now with all these tankers in the water and prices at rock-bottom low's, and we saw negative prices... what nobody is thinking right now is that we could rapidly go from a glut to a shortage. Right?
The cure for low prices is low prices. That's what they always say about any commodity, and it's true. When people are shutting in production because there's no way they can continue to operate, that eventually creates the shortage that is necessary to get the price back up so that they can turn the production back on and produce at some kind of profitable level. So nobody's thinking that right now. I promise you, though... Look, if oil can go from – if it can start the year at $61 a barrel and drop to negative $40, it can soar back from negative $40 to $61 really fast. Nobody's thinking about that... And that's not great. I mean, it's great if you're an oil speculator, I guess. But that's not necessarily a great thing. Extremely volatile prices aren't what oil companies need to see. They need to see steady higher prices. You know? If the price just soars back to $60 really fast, they won't necessarily open up all this shut-in production. You see?
So this situation – this shutting down of everything – it has created these huge imbalances. And once things go badly out of whack in one direction, well then they go badly out of whack in the other direction. You can't operate in either environment in a lot of businesses. And you can see this in the essential business – so-called essential businesses. But let me tell you something about essential businesses. I'm saying you can see it in the essential businesses because they're still operating. Right? But there's no such thing as a non-essential business. That's a huge – that's one of the biggest myths of this whole episode. There's no such thing as a non-essential business. Every business puts a roof over someone's head and food on someone's table. They're all essential.
And more to the point, they're all interconnected. There was a fantastic letter in the Wall Street Journal recently... It was titled – it was in the Opinion section of the Wall Street Journal if you get a subscription – "Bad Government Is Killing Small Businesses." And it was this guy – this restaurant owner from Michigan, Alan Van Dyke, and he wrote in... and he and his three kids are partners in two brew pubs in Grand Rapids, Michigan. And they gave some numbers... They got 59 – you know, before the virus, of course – 59 full- and part-time employees. They spent $120,000 a month on payroll. They spend $130,000 a month at their vendors. And they're shut down. They were ordered to shut down the restaurant on March 16. They kept the takeout and delivery open, but now that's shut down, too.
And guess what? They're still on the hook for $50,000 a month in rent and utilities and a few other things. And this guy Van Dyke, he said, you know, the chain-reaction impact on their employees, vendors, landlord, the lenders at the bank – he finished up his letter with an old nursery rhyme. And he said – this is a quote from the letter – he says, "The old nursery rhyme says that for want of a nail, a shoe was lost. For want of a shoe, a horse was lost and so on until a kingdom lost. Let's not lose the nail." Right? That's what an economy is. By that analogy, it's an interconnected web of nails and shoes and horses. Right? You can't separate any of them. You can't say, "It's okay if we don't operate these million businesses over here. They're non-essential." The essentialness of those businesses, due to the interconnected nature of an advanced economy... the essentialness is a law of nature. You cannot break laws of nature. You can only break yourself and everyone around you against them if you try to violate them.
And that's what we're doing. We're violating the interconnectedness of an economy by saying, "These are non-essential, these are essential." They're all essential. And we're witnessing that now. If you want to get the classic statement of this, you read a piece by a guy named Leonard Read. It's a classic essay. It's called, "I, Pencil." Yes. "I, Pencil," is what it's called. And he writes the thing from the viewpoint of the pencil. And he says, "No single human being knows how to make a pencil." And it sounds like a ridiculous statement until you read through, and he describes what he calls the pencil's "enumerable antecedents" – which is just all the stuff that happens before you actually get a pencil in your hand. And he starts with the tree, a cedar tree that grows – he wrote this thing in 1958 – so at that time, he said, "The Cedar tree grows in Northern California and Oregon."
And then he says, "Now contemplate all the saws and trucks and rope and the other countless gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication – the mining of ore, the making of steel, refinement into saws, axes, motors, the growing of hemp and bringing it through all the stages to heavy and strong rope. Logging camps with their beds and mess halls and cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink." And then the thing continues through every step of the way. And then, you know, you just become aware... Wow. The interconnectedness just to put a freaking pencil in my hand... it's pretty amazing. And of course – his point is it's an economic essay.
So his point is none of this happened by central planning. It just happened by people voluntarily interacting. And when people aren't allowed to voluntarily interact like that, we get what we're looking at... which is a crude oil market that is so insane, even if the price shoots back up, we may have a big problem having enough supply and a food market that could send people rioting in the streets if we let this go on for another couple of months, etc. You see? And you can see the ripples in the restaurant industry as Alan Van Dyke described in his letter, right? The chain reaction – employees, vendors, landlords, lenders – right? Of course, the landlord... all of these people, all of the employees and the vendors and landlords, they have lenders, too, right? It's not just the restaurant lenders.
And frankly, they all have vendors. And many of them have landlords. It's an interconnected web. There's no such thing as a non-essential business. And when you think about it... Ray Dalio made a statement recently on a video. I tried to find it again, I'm sorry I couldn't find it for you... just try to Google around. He said it seems like things are more than – at the time, I think he said 15% broke... and meaning the market was actually only 15% below its high at that point. I think it's about 12% or 13% as I'm talking to you.
So things seem a little more than 12% or 13% broke. And indeed, they are. And I think the only reason the market is rallying is because people think this is going to be a really short episode. And I pray that they are right. I hope and pray that they're right. But man, the interconnectedness is something I don't think most people understand. And we got to get – we got to get things rolling. At the end of his essay, Read says, "Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Have faith that free men and women will respond. I, pencil – seemingly simple though I am – offer the miracle of my creation as testimony that this is a practical faith." Right?
So I think it's a mistake – and he also talks about how people get used to the government having a monopoly over some activity. And he used the mail system as an example in 1958 when he wrote the thing. He said, "They start to believe that only the government can do it. And now I'm afraid they believe that only the government shutting everything down could fix the virus." And that was never true. And a lot of us got it wrong initially. But having gotten it wrong, we owe it to ourselves and everybody else to get it right and sort of unscrew ourselves and put things back where they were. So crude oil probably screams back to life, I'm thinking – the price of it, anyway. Whether or not the producers, the offshore producers, scream back to life is another question.
So buying crude oil is not the worst thing you could do, I think, right now. That sounds insane, doesn't it? It sounds absolutely insane. And I talked about the tankers, tanker stocks. Like, I think we mentioned Scorpio and Euronav and perhaps one other one. Maybe Frontline is the one that most of the retail investors like. Yes, it makes sense. They're getting really great day rates on all of their tankers because of the shortage caused by the demand for floating storage. Got it. Yes. Sure. And they're going to have a great year regardless from this point. But that situation can reverse. I'm not one to want to go in and buy the daylights out of tanker stocks. I think maybe the best thing you'll get is a further – maybe a 20% or 30%, or, you know, I don't know, 50%, whatever it is – 20%, 30%, 50% surge in the prices of those.
But I think at that point, you better sell. These are highly cyclical businesses, as highly cyclical as anything related to any commodity. And they're a second-order effect. So when crude oil falls a little bit, the tanker day rates can fall a whole lot. So if they're getting 150,000 to 200,000 a day for a 90-day voyage on an oil tanker, you know, that can go back to 10,000 in a heartbeat. People just don't realize this. They don't think – they don’t try to see around the corner. And you have to do that now because the situation is so utterly volatile because we've shut everything down. You see?
So I think it's probably better at this point to speculate on oil – going long oil – than it is to speculate going long oil tankers unless you think you're going to be nimble enough to get out. As far as the restaurants go, man, they're tough in the best of times. I'm not one who's going to go take a flyer on restaurants. If you did, though, what I'd want to do is I'd want to look around at a levered restaurant company – I mean, we're talking about a speculation here under the best of circumstances. So you look for a levered restaurant company like Dave & Busters – just an example, I'm not saying you should buy it – and think about whether or not that business is going to survive and return to anything like normal because it's so highly levered. I think they've got close to – by the time this is over, I think they'll have more than $2 billion in debt. $1.9 billion was the balance last time I saw their debt balance.
So maybe you find something like that, and you get a huge pop. I know it got a really big pop off the bottom in March. You know? It went like 3x or 4x in a couple of weeks really quick. So maybe if you think the restaurant business is going to come back, that's a way to do that. Otherwise, you know, you just buy McDonald's or something and Starbucks and things like that. Things that are going to be great businesses for a very long time. So what do we talk about? Food? That's a difficult one. I don't want to venture in with a speculation there. I tell you what, the only food-related recommendation that I've made – that I really still like – is Dollar General. That thing is up sharply, and it has made new high's along with stocks like Walmart. I know Costco has done pretty well.
But I know Walmart has made new highs, and I know Dollar General's made new highs because, you know, people have to buy food. And those are like the cheapest places to buy food, period. And even if there are shortages, they will probably, you know... they know the food supply chain better than anybody, right? Another idea that has been floated to me is something like Beyond Meat, the meat substitute company. So if we have a meat shortage, well there's no shortage of peas – that's the vegetable that Beyond Meat is based on... pea protein. I think that, again, this seems highly speculative to me because these meat substitutes are really for people... in my view, long term, they're for people who want to get off meat for some reason. They want to be vegetarians. I don't think there's a long-term play on people eating a lot less meat.
So, you know, if you want to speculate on that due to the meat shortages that Tyson talked about in his letter, that's between you and God. You know? And you and the market. I have nothing to say about it. I don’t think it's a great idea. And it's nothing I would ever do because I think that the economics around... I heard an executive from a farmer company say, "The economics around pandemics are not great." And that goes for a lot of things. You know? You don't buy things necessarily because the pandemic is going to change everything and we're all going to eat Beyond Meat from now on. So those are my thoughts about those industries.
And we'll probably have more thoughts about more industries as things begin to develop, right? The stories are developing all the time, and we've seen the impact. You've already seen the impact in stocks like Zoom. Right? Everybody's home. They're conference-calling over the Internet. And we've seen impacts on things like, you know, of course, Amazon. And you go to Amazon, and they say, "Hey, you know, your stuff might not get to you as quickly because of this COVID-19." I know we're buying more stuff online than ever, right? I'm sure everybody is. It makes sense. And eventually, Amazon – that is a good long-term play – because eventually Amazon, I believe, if Prime users are spending I think around $1,400 a year now – Amazon Prime users – I think eventually it goes closer to like $10,000 or $14,000 as they take over basically all of the boring parts of your shopping. You know? It goes to some number much higher than that.
And that's pretty cool for that business. Okay. That's it. That's my rant for today. Right now, I want to talk with one of my very favorite people in the financial industry, Mr. James Montier. Let's do that right now.
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James Montier is a member of GMO's asset allocation team. GMO stands for Grantham, Mayo, and Van Otterloo. Very famous Wall Street firm. Prior to joining GMO in 2009, he was co-head of Global Strategy at Société Général. Mr. Montier is the author of several books including, Behavioral Investing: A Practitioner's Guide to Applying Behavioral Finance, Value Investing: Tools and Techniques For Intelligent Investing, and The Little Book of Behavioral Investing. Mister Montier is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. He holds a BA in economics from Portsmouth University and a Master of Science and Economics from Warwick University. James Montier, welcome to the program sir.
James Montier: Thank you very much. Thank you for having me.
Dan Ferris: James, before we talk about your thoughts on the current state of things in the world, I always wonder with my guest at what point in your life did finance become the sort of obvious career path for you?
James Montier: That was when I was very young. I follow in my father's footsteps. So my dear dad was an investment manager long, long ago. And during the school holidays and college holidays, I used to go and work at his firm and try and help out. And so it was really probably when I was doing my GCSE's. So that would've been about the age of 16 that I kind of really decided that this was what I wanted to do for a living. And yeah, the rest is history.
Dan Ferris: What was your first finance gig? Who'd you work for first?
James Montier: So the very first job I had was when I left university... I was hired by Claymore Benson as a junior economist. And that was in 1992? Yeah, 1992.
Dan Ferris: The Pleistocene era. Yes, I remember it well. What did you do there? Just sort of a budding analyst?
James Montier: Yeah. I had a variety of various bits and pieces of jobs. But my least favorite was putting together the calendar of economic events, which back then was regarded as useful. And I had to look at various countries and work out when their release date was, which didn't seem like the highest and best calling of my education... but was a small price to pay for working alongside some extraordinary people who taught me an amazing amount about investing, in particular a gentlemen called Albert Edwards, who I spent nearly 18 years working alongside, and that was a huge pleasure.
Dan Ferris: Yeah. That was sort of where I was headed. Was there anybody, you know – he was obviously, I guess, one of the early people – but was there a breakthrough moment for you? Was there a moment when you said, "Hey, I’m going to be a value investor or a behavioral guy or..." Was there a moment like that in your career?
James Montier: I think there was. It came oddly from trying to not be those things in many regards. So when I started out, I was kind of trying to apply economics to the world of investing because that was kind of the natural thing for me to do, given I'd been an economist. And what I discovered was it was pretty lousy. Not only was I not very good at it, but it didn't really help at all. And what I found was that effectively the kind of recommendations and framework that standard economics offered really wasn’t terribly helpful. And my very first recommended trade for the Foreign Exchange Department, I remember suggesting that we run short the Swedish krona, which eventually came good.
But I do also remember the head of the FX division in my first week telling me we had managed to lose more on that trade than it cost to employ me in a year, which was not saying a lot, since I was all of 21 or 22 years old. But it was a fairly sobering reality check about my abilities to time these things. So in the wake of all of that, I kind of began to wonder why it was that what I'd been taught really wasn’t working. And that's where people like Albert Edwards and Frank Veneroso, Andrew Hunt, Rob Perento... we were all within the same essential Kleinwortz Dresdner organization. And I was able to learn from them a lot more about the way the world actually worked as opposed to what I'd been told.
And it began to dawn on me that, really, economics was largely a failed subject because it proclaimed to be a study of the way that people behaved, but actually all of the behavior and economics is assumed. Everyone is assumed to be rational. And that began the cogs turning into what would become my interest in behavioral science, which was really kind of the... well that doesn't sound like a good description of the way that people actually behave. And so, I began to look at the way that people did behave. And that kind of made a lot more sense to me. And I was then able to kind of apply that to markets.
And then from there, thinking about why it was that people behaved in a certain fashion, it came to me to think about, well how do I take that knowledge of how people behave and apply it to investing? And is there a way of investing that kind of mitigates a lot of those behavioral biases? And it turns out that value investing – at least in my opinion – is the solution to those kinds of behavioral biases. And so, I transitioned from kind of a hard-core believer in math and finance and economics to behavioral psychology to value investing.
Dan Ferris: You know, James, this interview for me – it's a little personal because you're just one of the people I've always wanted to speak with. And I'm glad you've broached the twin topics of behavioral and value. I myself am a value investor. I would call myself a die-hard value investor, which if there are any left in the year 2020, they would have to be die-hard.
James Montier: Right? Absolutely hard-core.
Dan Ferris: Yeah. So here's my struggle that I want to talk about a little bit. And I'm pretty sure our listener has the same struggle because we're human beings after all. I've read books, and I've read your stuff. I've read quite a good chunk of behavioral investing. And then, I've read all of The Little Book of Behavioral Investing a couple of times. And I've read other behavioral books and things. And what strikes me is that... my hope was that the more I learned about this stuff, the more I can sort of get rid of it. But it seems the more I focus on it, the worse it gets. I mean, or at least it's not going anywhere. You know what I'm saying? But luckily, I believe you're correct. You can't eliminate this stuff. But I guess you'd agree with me learning to buy cheap is kind of a start. I think you said that in a recent piece, something like that in one of your latest pieces at gmo.com.
James Montier: Right. Exactly.
Dan Ferris: Is there something – I just want some inspiration, I guess. I really am begging you for inspiration here. Like, what good is studying these biases if I can't get rid of the damn things?
James Montier: Exactly right. So let me recap on something you said earlier about the die-hard nature of what we do. I gave a presentation – I guess it was a year or two ago – wrapped-in Star Wars. I'm an old Star Wars addict and still loving Star Wars to this day. I was six years old when it first came out, and it had a formative impact on my life. and I gave an entire presentation on the relationship between Star Wars: The Force and value investing. And there was a line in Star Wars where Grand Moff Tarkin is talking to Darth Vader. And he says to Darth of the Jedi, "You are all that is left of this sad religion, my friend." And that's kind of how I feel about value investors. There's only a handful of us left in existence. We're a definite dying species. But it strikes me that, you're absolutely right. And Danny Kahneman and Amos Tversky – two of the huge founding fathers in the field of behavioral science and the study of decision-making under uncertainty – also observed that they too suffered these problems.
And I think it was Amos who said his only advantage was that he knew what to call the mistakes he made. And I think that's true Because ultimately, we're all human beings. And we can't stop being human beings. But there is something we can do which is a prescription from the field of psychology, which is, "If you cannot de-bias, then re-bias." So you're absolutely right. It is impossible to stop us from being human. And being human is what creates these behavioral biases in the first place. But can we turn them to our advantage? And that to me is where investment process comes in and having a sensible investing process, which is what value investing is all about... it really comes to the fore. So if we can't force ourselves to stop making mistakes, how do we turn the mistakes we will make to our advantage? Let's take... anchoring is a really good example. Anchoring is clinging to random inputs.
So there have been experiments done on getting judges to roll dice before they sentence people. And the term of the sentence of the issue has been influenced by the roll of the dice – despite the fact that the roll of the dice was clearly completely arbitrary and should've had no impact on them, it did. So we know that people will cling to random inputs. So the question is, you know, how do you learn to look at inputs that make sense? And so, to me value investing is kind of behavioral self-defense 101. It's things like the way that we do it at NASA, the allocation at GMO... we have a valuation framework. And that is absolutely key because it's our anchor.
So on days when the world is falling apart – you know, 2008, 2009, early part of 2009, a few weeks ago – the world seemed to be falling apart. And everybody's panicking. And you pick up the Wall Street Journal or the Financial Times, and no scenario is too pessimistic enough. And it's incredibly hard to resist that sense of fear. It's almost palpable. But at the same time, you then say, "Well hang on. I've got my valuation discipline." And so, "Hey. Look. I'm looking at assets that are returning potentially an expectation, at least, double digits in terms of rates of real return. How could I not own these things?"
And having that is a really good self-defense mechanism. It forces you to say, "Okay, look, I know I'm human. I know I'm feeling the fear. But geez, I've got to be really confident that that fear is going to be absolutely realized because look at the returns I'm potentially getting." And so, to me, designing an investment process that is as robust as it can be and designed to really take the behavioral errors we're going to make and turn them to our advantages is really what the kind of application of behavioral finance to investing is really all about. And to me, it just fits so perfectly with that value-based framework.
Dan Ferris: I want to go back and talk about anchoring because I just want to make explicit for our listener there's a classic example of this, I think. Someone finds a stock at $10, they see it was at $5 earlier, and they say, "Oh, it's already doubled. It's too late." And then there's the other thing where they find the stock at $10, they see it was at $15, and they say, "Oh, it's worth $15. It's destined to go back to $15." I think anchoring on a previous price like that... I know that many listeners are nodding their heads. I should be nodding my head, I've done it. It's very difficult not to do it. But you're saying if we stick with valuation, that will help alleviate this problem.
But of course, the comeback... I'll just be the devil's advocate. I'll be the typical, you know, "homomistakus" you called him in, The Little Book of Behavioral Investing, which is a great book. Everyone listening should read it. And the typical guy would say, "Oh, well, but that doesn’t mean it can't get cheaper." Right? If you value something, you think it's a good deal, that doesn’t mean it can't get cheaper. So then, this is where the fortitude comes in. And this is a topic I return to because it seems to me like value investing at some point, it's going to boil down to this. You know? It's going to boil down to having the courage of your convictions, which was practically a phrase straight out of Ben Graham. Right? "The courage of your convictions." Where does that conviction come from in your opinion? And do you agree that it comes down to that?
James Montier: I do agree with that. Yes. I absolutely agree with that. And I think Sir John Templeton actually had some insights here. Sir John pointed out that we were very bad emotional time travelers. So we weren't good at predicting how we were going to feel at various points in time. So what he used to do was do his analysis and his work on quiet days where nothing was happening, when he turned his computers off. He was just focused on valuing and stock. He'd do his valuation. He'd look at what he'd come up with and then he would place a limit order in the market at that price because he knew that what would happen on the day when, let's say, his favorite stock had fallen half, let's say. He would never have the courage of his convictions.
And so, by having that limit order already out there – that limit buy order – if the stock had got to that price, he'd buy it... it took that ability to override that, that emotional impact of that day, completely out of the equation. And so, one of the ways you can have the courage of convictions is to do exactly something like that. It's to have a battle plan to say, "Okay, look, here's what I think the stock is worth. Here is my analysis. Geez. It's, you know, half that or double that." And then act accordingly. But do your analysis not in the heat of the moment because when you're in the heat of the moment, you find all of those emotional influences are at their very worst. And that's the nature of the beast. Emotion is wired into the way that we function to force us to act in a certain way and to act in what is often not a rational approach but is a lifesaving one.
And this is something that I think is key for investors to understand... that our brains are shaped by a process of evolution that takes hundreds of thousands of years. We're basically designed for life on the African savanna 150,000 years ago – not the Industrial Age of 300 years ago, let alone the information age of today. And so, our brains are, you know... imagine you're walking across the savanna and you spot a twig and you think, "Oh, that could be a snake, I'll give it a wide berth." That's fine, and in an evolutionary sense makes a great deal of sense.
Because if you get that wrong, the consequences are pretty damn fatal. And if you tread on the snake and it bites you, you're pretty much evolutionarily toast. Whereas if you give it a wide berth and it was a stick... OK, fine... It wasn't optimal, but it was good enough. You did well. You survived. And so, the brain is often designed to let emotions do their job. They have like a fast circuit – an override, if you like. And bypassing that is hard in the fleeting instance. And so, I think having a process, having a methodology, doing your work on the quiet basis where nothing is happening is absolutely one of the ways you can get comfortable with having the courage of your convictions and then being able to act on them. And it's those two things that I think have to come together to allow us to behave in a certain fashion.
Dan Ferris: It sounds like you only come to work on the weekends these days, James.
James Montier: I try and avoid work at all times if I'm honest, man. My least favorite four-letter word.
Dan Ferris: Yes. So I guess where I'm left, then... this is not for everyone. This value investing, managing your own money, having your own process, needing to figure out how you're going to have the fortitude to ride out the inevitable drawdowns and mistakes, frankly... It isn't for everybody, is it? It just isn't for everybody.
James Montier: No. Absolutely. It takes a certain type of person. And I've actually hypothesized that there's something kind of odd about value investors. And I say that as one... But it's kind of interesting. There are some studies about social behavior and brain function and also that they relate to pain. And it turns out that the parts of the brain that react to real, physical pain – having your arm broken – are exactly the same parts of the brain that react to social exclusion, doing something different. And as a value investor, you are inherently going to be doing something different. You are going to be buying what others are selling and selling what others are buying. So you're going to be going against the crowd. That is the nature of the beast. But it turns out that that's a little like having your arm broken on a regular basis. So I think in some ways, value investors are kind of financial masochists. We just like the pain. And that clearly is really not for everybody.
Dan Ferris: Clearly not. I'm glad you mentioned this – this bit about liking the pain and the pain... and we were having a conversation about fear and pain. And of course, you wrote this really neat piece dated March 25, 2020 on the GMO website called, "Fear in the Psychology of Bear Markets." And it makes a very similar point to what you just said. Basically the point is, when people just got hurt in the market, they kind of don't want to be in the market anymore. And that tends to be a mistake. And yet, brain damaged people like you and me would keep coming back for more.
James Montier: Yeah. Right. Exactly.
Dan Ferris: It makes all the difference. You know, I talked to a fellow who's part of one of our affiliate companies – guy named Enrique Abeyta. He was making the point – he said, you know, one of the reasons Warren Buffett is so successful is because he's almost 90, I guess now, and all you got to do is stay in the market for decades and decades and decades and not be scared out of it, and you should do pretty well."
James Montier: Yeah. Absolutely. It's one of the colors of being a value investor. We've already touched on it, and you mentioned earlier that there is nothing that stops a cheap stock or market getting cheaper and an expensive stock or market getting more expensive. And valuation is an incredibly useful long-term signal and a pretty terrible short-term one. There is nothing that stops a cheap stock getting cheaper or a more expensive stock getting more expensive. And so, if you're going to be a value-based investor, you are going to need to have a long time horizon. And of course, everybody says that they have a long time horizon right up until you hit that first period of poor performance. And then suddenly, it's like, "well, what did you do yesterday?"
"But you said you were long term?" "Well, yes. But, you know, times are challenging. We need to focus on the short term." And so, there's this insane habit of trying to always shrink time horizons. And I think we talked about how the brain was potentially not well-suited to the Information Age, that one of the side-effects of the Information Age is definitely a kind of increase in short-termism. And Maynard Keynes talked about it in The General Theory. He talked about how he had come to believe that investing should be like a marriage. You know, permanent and indissoluble except under extreme circumstances. But he didn't think that very many people behaved like that. They were all focused on the short term. And that was written in the 1930s. Fast-forward to today and it's just that situation written even larger. And that's a real challenge for any investor, I think, it's how to maintain that focus on the long term.
Dan Ferris: You know, one thing I realized is the difference. I mentioned Buffett just being older, but another key difference seems to me like most people want money. They don't want equity. But Buffett, he wants to own those equities. And he wants to own them forever. He doesn’t want money. He wants to be an equity owner. And I think it's so difficult for the average person to look at it that way and say, you know, the average human being – I'm just acknowledging humanity, I'm not talking down to everyone – It's so difficult for someone to say, "Yeah. I really want to own these equities." What they really want to do is make money.
James Montier: Absolutely.
Dan Ferris: The idea of making money running counter to success in the stock market just sounds crazy to me. It's another sort of crazy counter-intuitive ting that you have to figure out about yourself. You have to know yourself very well, don't you, to do all this?
James Montier: Absolutely. Yeah. And I think that's exactly right. And Ben Graham, obviously – Warren Buffett's mentor – always talked about how a share was a share of ownership. It was a share in a business. It wasn't just a bit of paper. And yet, today I think everybody sees it exactly as you say – as little bits of paper. Not even bits of paper. Now they're just ticks on a screen, right? We don't even have paper-based trading anymore. So it's a world in which it is very hard, I think, for people to remember that you are buying a share of a series of cash flows from a business. And, you know, if you ask a businessman how they would value another business, they would take a long-term view. You're not looking at the next quarter's earnings. That would be insane for them to try to do that. They look at the expected cash flows over a very long time period in exactly the same way as a value investor does.
And so, value investors and business owners have a lot more in common than most of those people who purport to be investors. And I think that term is overused. An investor to me, you know... we talk about value investing. What other sort of investing is there? Almost everything else to me is some form of speculation. But you don't see many people lining up to have the words "Chief Speculative Officer" embroidered on their business card. But it does seem to me that that would be a better description of most of them than "Chief Investment Officer."
Dan Ferris: Right. And we've talked about all of these biases and things and all of these problems. And we come down to – well, what is essentially Chapter 16 of your book The Behavioral Investing – process, process, process. The one thing you can control. And I feel like one ought to be... if you want to be obsessed with something, don't be obsessed with the stock prices ticking up and down. Become obsessed with the process by which you go about choosing and managing investments. Is there anything by way of general outline or insight that you can offer us about that nature of having a good process? Or maybe a description. What does a good process look like? And for an individual investor... if it's different from an institutional one, I don’t really know.
James Montier: Yeah. I think it probably is. But I think the individual has one potential significant advantage, which is they are unlikely to fire themselves. And the institutional world is constantly hounded because it acts as a reinforcing mechanism on all behavioral biases. So it's not only that we're kind of primed to want to be part of the herd and the same as everybody else from a psychological point of view, but the institutional world then layers that on because, you know, Keynes talked it perfectly in that Chapter 12, "The General Theory," where he talks about what Jeremy has called "career risk;" which is, it's better for reputation to fail conventional than to succeed unconventionally. And so, the easiest way to get fired in investment is to be wrong alone or to be out on your own with a different set of results and have the markets move against you.
So I think the individual has one inert advantage, which I think is important and should be utilized. But it's kind of hard to do. So how does an individual go about having a good process? Well, I think it comes back to that point you made, which is you have to know yourself. And I think in The Little Book I use the quote, you know, "You are your own worst enemy." And that is certainly true. And so, I think an individual has to sit down and say, "What are my most lightly mistakes?" And so, this is where that knowledge of behavioral psychology really does come in because it says, "OK, so what are the things I am guilty of? Is it overconfidence? Is it overoptimism? Is it loss aversion? Is it extrapolation?" There are a whole gamut of potential biases that we will suffer.
And so identifying the one you are most familiar with – the one you probably think you make the most – is really important because then and only then can you begin to think about, "How can I build a process that is robust to that mistake? How do I say... OK. Let's take an example. Let's say I'm doing some sort of DCF. I'm doing a divided discount model for a stock. And most people tend to be overoptimistic and overconfident. And so, what they do is they write down their growth expectations, they crank the numbers through the dividend discount model, and they come up with a number that is, let's say, above the stock price.
So rather than following that particular problem – if you know yourself to be overoptimistic in nature – then I think there's a way you can turn that on its head and say, "OK, so rather than starting with my forecast, what I should do is take the market price and back out what's implied. So reverse-engineer my dividend discount model and say, "OK. What growth is implied by the stock price today?" Then let me think about how likely it is that that stock is going to generate that kind of growth. And that reframing of the problem I think can often help mitigate some of the behavioral biases that we otherwise kind of blunder into somewhat blindly.
Dan Ferris: I'm really glad you said that. I write a newsletter called Extreme Value, and that is exactly how we proceed. It prevents you having to predict so much, right? And forecast so much... It's great.
James Montier: Exactly. Exactly. And prediction is one of those sorts of areas where we all are really poor. Forecasting is... yeah, not a good idea. We tend to get very overconfident, very overenthusiastic. Or we simply extrapolate. So if the world is falling apart, you know, it works both ends of the spectrum. At the peak, you want to extrapolate and, you know, we end up with in 2000 Cisco needing to have sales growth that was going to make it larger than the entire planet Earth to make it worth its while. And similarly in the other end of the spectrum, you know, in 2008, no scenario is too pessimistic.
Now the world could end tomorrow, and people are sitting there nodding and saying, "Yes. You're right. It could." And so, this is terribly a habit of extrapolating at both peak and trough. And so, taking that away and saying, "Look, you know, at the peak, yes. Cisco has to grow to be – we have to develop interstellar kind of trade if Cisco is going to live up to its expectations." And similarly, the kind of lows of 2008... you're looking there and saying, "Geez, is Microsoft really going to contract at the rate that it's being priced in here? It's insane." So turning that on its head and using that reverse-engineered approach, I think, is incredibly sound.
Dan Ferris: Yes. And it fights against that recency bias that you wrote about in that recent piece I mentioned on gmo.com. Extrapolating what happened yesterday into the future infinitely out in time forever.
James Montier: Exactly. Right?
Dan Ferris: Yeah. It's hard, though. I mean, on – what was it – March 23 of this year, that was the bottom so far of the current episode. And I can't imagine even 10% of everyone within the sound of my voice wasn't saying, "Oh, my God. What is happening next?" I know I was saying something like that. I thought I was pretty good at this. But it happened so fast, so utterly fast, it was a little scary. It's hard to do that. It's hard to do it when everyone is, you know, shopping for new underwear to put it mildly. You're going to sit there and say, "Oh, well, isn't this all very nice? You know, I’m going to fix myself a drink and take a look at the valuations."
James Montier: Right.
Dan Ferris: Yeah. It's inhuman. It's superhuman.
James Montier: It does make us sound a bit like Spock, right? Now that we've drifted from Star Wars to Star Trek. But, you know, you've spotted a common theme in things I like here. Right? I happen to be an old sci-fi nerd. But it is that kind of discipline. It's saying, "OK. Look. It is..." – And rest assured that here in the recent lows I, too, was panicking because I'm like, "This is different." And it was different for me because in previous times, like 2000 and 2008, to me had been... they haven't ben black swans. They've been gray swans. Actually, enormously they were white swans. Bloody great white swans that anybody should've been able to see coming if only they though carefully of that one.
Because there was an unsustainable economic process at work, whereas the most recent crisis, the COVID situation, is genuinely – I think – much more of a black swan. Certainly to me, it was something I hadn't seen. It was out of the blue. It was not something that... It was unsustainable in economic nature. And that made it hard to cope with. But ultimately, I sat there, and I wrote that piece on fear and psychology on bear markets because I was sitting there thinking about – ultimately let's say this wipes out a years' worth of earnings. Does that really matter in the long-term scale of things? And it wasn't obvious that it did. It would've been incredibly unpleasant and could still be incredibly unpleasant. I have no idea whether the market has bottomed or not.
But I think, you know, it goes back to kind of Howard Mark's wonderful dichotomy of investors – the "I know" investors versus the "I don't know" investors. And value investors, by and large, are firmly in the "I don't know." And so, we spend a lot of time saying, "I don't know," which is not very satisfying as an answer to a question but is ultimately much more honest. But it does mean you have to behave in a certain way, and you insist Ben Graham's margin of safety. So in the heart of that downturn as COVID was – COVID fear, at least – was gripping the world, I was sitting there saying, "Well, look, these assets are cheap."
And one of my jobs when I joined GMO over a decade ago now... one of the things Jeremy asked me to do was to bang the table when things got cheap. And so, I just sat there banging the table because to my mind, things were looking cheap. I've been surprised by how quickly they have recovered in some cases. And I have no idea how sustainable that is or not. But it was certainly a very different experience from my perspective.
Dan Ferris: Well said. We're actually coming to the end of our time here. It went by so quickly. But if I could ask you... if you could leave our listener with just one thought about all this or about anything at all – about sci-fi. If you could leave our listener with just one thought, what might that be today, James?
James Montier: Oh, man. That's a really challenging question, isn't it? I think it would be, have the courage to maintain your faith in your framework. Whatever that framework is, stick to it. Don't be led astray to borrow – Ben Graham's phrase – by Wall Street's fads and fashions. I think that is the tremendous tendency to want to go along with what everybody else is saying... but have the willingness to be different. Dare to be different. And that to me is ultimately the heart of what value investing is really all about.
Dan Ferris: Excellent. That is an excellent final thought. I know you said it's a difficult question, but you kind of nailed it. I sure would like to speak with you again sometime. I have to say, I'm kind of a fanboy. I've read your stuff, and I've enjoyed reading your stuff for years. And I hope you will come back and talk with us sometime.
James Montier: I would be absolutely delighted to, Dan. It would be my pleasure. And thank you very much for having me.
Dan Ferris: Yes. Thank you for making time for us. But I guess it's adios for now. Stay safe and, you know, wash your hands, and take care of yourself.
James Montier: Absolutely. Yes. Maybe that should be my final piece of advice, shouldn't it? Really, wash your hands. That would've been – that would've been the ultimate sign-off. That's what I should've said. If only I had thought of that.
Dan Ferris: Yeah. That's everybody's final sign-off today. All right. Thanks a lot, James.
James Montier: Keep well. Look after yourself.
Dan Ferris: All right. Bye-bye. All right. Well, that was a lot of fun. James is, like I said, he's one of my favorite people in finance. I definitely recommend that you read every word of The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy," by James Montier. It is an excellent, excellent book. And you'll keep coming back to it. I keep coming back to it. Wow. Okay. Let's go see what's in the mail bag today.
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Dan Ferris: This is the favorite part of my week sometimes, man. It's so much fun. This is where we get to have an honest conversation about investing and whatever else is on your mind. You write into [email protected] with comments, questions, and politely worded criticisms, thank you. And I will read every single e-mail that you send me, every word of every single one, and I'll respond to as many as I possibly can. We got lots of good ones, lots of long ones again this week. We've gotten lots of long ones. I think people are stuck at home with the coronavirus, they're just typing away on the feedback e-mails.
But we got a good one here to start out with. This is Joe V. Joe V. says, "Hi, Dan, just finished listening. I have never missed one of your podcasts. I wanted to keep my feedback as concise as possible. But I've never disagreed more with one of your guests on so many points." He's talking about Enrique Abeyta from last week. "Point No. 1," he says, "Lehman had zero to do with the 2008 crisis." And then his response to that is, "Portraying Lehman as a victim of financialization instead of an architect is laughable at best and disingenuous at worst. Hard to reconcile Enrique's view with the advice he received at age 22 about being honest, black-and-white, etc. No. 2. Enrique said stocks are not necessarily ownerships in businesses."
And Joe says, "Only if you trade in and out of them. Big difference in trading versus investing. No. 3. Enrique called Buffett a growth investor." And Joe says, "Not really. His biggest advantage – like Enrique correctly pointed out – is every investor's biggest potential advantage: time. When Buffett purchased Coke, it was not a high-growth company. It was a slow, steady grower with a wide moat and brand loyalty and a consistent growing dividend. Never forget the rule of 72. If it pays a 3% yield, Buffett is doubling his investment every 24 years in respective of share price. Compounding for Buffett is achieved by time in the investment more than intrinsic growth rates. Simply one way to get rich versus buying a high-growth stock, which is a huge addressable market/long runway that does not pay a dividend because profits are reinvested in the business... example, Shopify."
"No. 4," this is his last point, "I like his parting thought about having a positive attitude about life. But when applied to investing, which is after all the focus of your podcast, it is diametrically opposed to your via negativa." He says, "It's more important to take the plunge with investment than it is to find reasons not to invest, emphasizing upside versus risk. I'm sure you held your tongue there based on what you said in Episode 150 about surviving. Stay well. Best regards. Joe V." Lot of great points here. We couldn’t not put this letter on. Thank you, Joe. This is a great e-mail. Point No. 1, Enrique said Lehman had zero to do with the 2008 crisis. Yeah, I think that his point was that Lehman did not cause the crisis. Participated. Right?
And I frankly – I don't know. I'd have to get with Enrique again and talk to him about the difference between "participated in" and "caused." But the bigger point here is something that was raised by another reader. There were a couple of e-mails about this, who said, "To say that Lehman made 250 great decisions and the 251st was the one that tanked the company – and otherwise, it was a great company" – it didn't make any sense to him. And he was a doctor writing in. And he said, "You know, I make 150 decisions and the 151st kills the patient, and I go, "Oh, well, you know, I make great decisions mostly" – I don't agree with that viewpoint either. Stocks are not ownerships in businesses. You're right. I agree with you, Joe. If you trade in and out of them, they're not. Over the long term, they absolutely are.
And even in the short term. The fact that people trade in and out of them doesn't mean they're not part ownership of a business. And Enrique – I remember his answer. He said, "It isn't ownership of a business if you think of it this way, this way, this way, and this way." I didn't completely get that either. He's a smart guy. He's way smarter than me, and I didn't understand everything he said. But then he called Buffett a growth investor. And Joe, I think you're suggesting that a growth investor means he buys high-growth companies. I don’t think that's what he meant at all. I think that growth investor plus this time advantage you're talking about, that's the same thing in Enrique's view. I think you guys actually agree here on Buffett and that you're just kind of maybe having a little quibble with terms on each other. I really do think you're talking about the same thing.
N0. 4, you said you liked his positive attitude about life, is different from my view, which is the via negative. The negative way, the avoiding. The learning of life is about what to avoid. Nassim Taleb calls that the negative way, in Latin, via negativa. No, I think you avoid bad business and you avoid businesses that can't grow for a long time. I don't think that having a positive attitude means that you can't exploit the negative way. I don't think they're diametrically opposite at all. Exploiting the negative way, acknowledging that the learning of life is about what to avoid, does not preclude one from having a very positive attitude about life. I like to believe that I have a very positive attitude about life.
But then you said specifically that he says, "It's more important to take the plunge with an investment than his defined reasons not to invest, emphasizing upside versus risk." I think if you actually look at his portfolio, his risk control is much more prominent than what you're representing there. And maybe even what he said. Yeah, I heard a little bit of that, too. But I think where... we can't extrapolate too much from what Enrique said. He's a really good investor. And if you're a long-term investor in equities, I think what he said is absolutely correct. It's more important to stay in the market over the long term than it is to find reasons to get out because you're afraid. Joe V., thank you. Excellent e-mail. Loved every bit of it. Lots to talk about.
Next, we have Raphael T. Rapheal T. says, "Dear Dan. I enjoy your weekly podcast and all the various topics you cover. In light of the oil markets getting so much attention with negative future prices last week, I recently read that OPEC, Russia and China are trying to break the U.S. oil markets by flooding the world with oil. Eventually their goal is to swap the petro dollar for the petroyuan. Presently with oil trading in dollars, is it not true that most countries hold dollars to buy oil and, if this swap occurred, those U.S. dollars would flood back to the U.S., devastating the value of our currency? I'm reading figures like the entire U.S. economy holds about 1.5 trillion dollars and this would add $6 trillion or $7 trillion as those countries swap their dollars for yuans. Is this something we should be worried about? Another reason to own physical gold? Raphael T."
I am absolutely not worried about this one bit. There is a dollar funding hole in the world that is... I don't know... Ray Dalio says maybe $15 trillion worldwide outside the U.S. That's a demand for $15 trillion. That's a lot of emerging market debt that is getting murdered right now that needs to be serviced, rolled over... something. It's just creating a huge demand for dollars. I'm not worried about this problem – not even the tiniest bit. You know how much global trade settles in yuan? It's like diddly squat. Nothing. They won't let their dollars out of the country. U.S. companies can't get their dollars out of the country. It's weird. So yeah, I’m not worried about this at all.
But very good question. We have one from Gary D. Gary and I follow each other on Twitter. He's kind of a longtime podcast listener. Nice to hear from you again, Gary. He says – he said a lot of other stuff. But this is the part I can print. Not because the other stuff was bad, just because it was long. I should tell you. This is a friend of his asking him this question and he's passing it along to us. All right? "With the inundation of news every day on the government's action to help people, I can't help but wonder where all the money is coming from. Is the federal government borrowing from state governments or are they printing money? If yes, how will inflation be kept in check? When there is already a very high deficit, how are these programs funded?"
And then Gary says – that's his friend's question – Gary says – I actually thought this was a very good question – "The inflation part, you have discussed frequently. Since 2008, all this new money hasn't seemed to create massive inflation as expected. But the actual process by which the U.S. government creates money out of thin air is still a bit of a mystery to me. Perhaps you could provide a brief blow-by-blow of the money creation process and how this process accumulates as part of the national debt. Thanks. Take care and please stay safe. As my friend Clive Cussler once told me, 'Us old guys, we got to stick together.' Gary D." He's friends with Clive Cussler, the author. Pretty impressive. Okay.
So I don't know about a blow-by-blow, Gary. But you can go to YouTube and you can Google, "Ben Bernanke mark up the account. Ben Bernanke mark up the account." That will take you to a 60 Minutes episode with Bernanke. And he says right there in the interview, "We mark up the account." In other words, that's how they print money. "We use the computer to mark up the account," he says. So that's the big mystery about money creation right there. The other mechanism is the Federal Reserve uses the computer to mark up the account, and then they buy Treasuries. That's the mechanism. And that's deficit funding right there. And yes, the U.S. government just borrows it. They borrow the difference. And they borrow more and more and more and more. And the Fed buys more and more and more.
And that's the big mystery. I don't know about the blow-by-blow. I'm sure there's, you know, different steps along in the process. But that’s it. Use the computer, mark up the account, buy Treasuries, rinse and repeat. And, you know, they spend however much they want. And you can hear comments every now and then by Fed Governor, you know, "We're not going to run out of money. We have infinite resources. We're not going to run out of money." And that's what they mean. And the fact that this has not caused really bad inflation doesn't mean that it won't cause bad inflation at some point. You know? Look. Whether it causes inflation or not, you know, you just do things like own gold and silver just as a hedge and an insurance policy because you don't trust these people. That's what's rational and reasonable.
But great question, though. The questions around money-printing and inflation are much better than we ever thought they were because of this mechanism that we explained previously where the Fed prints a dollar and then they buy a dollar worth of bonds. And they basically unprinted the dollar worth of bonds – which is a deflationary effect. It takes income out of the system, and it doesn’t finance anything. You know? It doesn’t inflate the price of anything except for the bond. And most of them are Treasuries. So at this point, they are starting to buy junk bond ETF's, CLO's – collateralized loan obligations. So, you know, maybe we're getting there. But again. The deflationary effect will probably go on longer than you think.
Great questions. Great topic. We'll probably revisit it often until we see real inflation, right? Well keep having to revisit this. Okay, folks. 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 the show with a rate and a review. And if you have any ideas about a guest that you'd like to hear me interview, just drop us a note at [email protected] You can also follow us on Facebook and Instagram. Our handle is @investorhour. Till next week. I'm Dan Ferris. Thanks for listening.
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