In This Episode
The biggest news over the last week has undoubtedly been the release of Warren Buffett’s annual letter to Berkshire Hathaway investors, which contains some gems Dan is ready to break down for you.
By now, as Buffett points out, his partner Charlie Munger is 95, making 88-year old Buffett the young one. And there’s one prospect Buffett mentions in his letter that “causes my heart and Charlie’s to beat faster.”
You also may have heard Berkshire has been stockpiling cash – but precisely how much cash may surprise you. With $112 billion in Treasury bills and cash equivalents, a lot of critics charge Buffett with missing out on a historic bull market. But Dan, who’s urged readers to hold cash too, explains why Buffett’s caution is utterly sensible.
He’s later joined by this week’s podcast guest, James Grant. James is the editor and founder of Grant’s Interest Rate Observer. Before founding Grant’s Interest Rate Observer in 1983, James started wrote for Barron’s in 1975. He has also originated a weekly column devoted to interest rates called Current Yield, and his journalism has appeared in a variety of periodicals, including the Financial Times, The Wall Street Journal and Foreign Affairs. In 2013 James was inducted into the Fixed Income Analysts Society Hall of Fame.
James has plenty of insights about the Fed’s very real powerlessness over the valuation disaster it’s created, as well as thoughts on the very few worthy opportunities he sees for investors today. He ends with a warning – the day of reckoning for the Fed’s era of easy credit won’t hit all sectors equally. You’ll want to avoid two in particular.
1:11: There’s no single most important key to successful investing – but Dan reveals the quality he would go with if he had to pick just one. Hint: It’s a negative skill – something you don’t do.
5:38: We all have an idea what kind of money you can make in the market to feel like a genius – but Dan reveals what the biggest investing legends say about how much you can expect to gain by simply not being stupid, year after year.
11:45: Dan begins the news of the week with the Academy Awards Ceremony. “I promise I’ll put an investing spin on this.”
15:25: Warren Buffett’s annual Berkshire Hathaway shareholder letter, published last week, has a few gems starting with Buffett’s $112 billion in U.S. Treasury bills and other cash equivalents. Dan’s advocated to hold cash before – but is holding tens of billions of dollars no matter what too extreme?
20:31 Buffett is a card-carrying liberal – so one passage in his annual letter grabbed Dan’s attention. Here’s the logic that makes the U.S. government a de facto shareholder in Berkshire Hathaway.
21:17: Buffett’s explanation for why Berkshire doesn’t do debt on the level of other businesses is one for the ages. Sure, CEOs who gorge on debt make money most of the time – but then again, Russian Roulette isn’t fatal most of the time, either.
23:42: Dan introduces this week’s guest, James Grant, the editor and founder of Grant’s Interest Rate Observer. Grant founded Grant’s Interest Rate Observer in 1983. Prior to that Grant started writing for Barron’s in 1975. Grant originated a weekly column devoted to interest rates called Current Yield. Grant’s journalism has appeared in a variety of periodicals, including the Financial Times, The Wall Street Journal and Foreign Affairs, and he contributed an essay to the Sixth Edition of Graham and Dodd’s “Security Analysis” In 2013 Grant was inducted into the Fixed Income Analysts Society Hall of Fame.
30:54: Dan asks Jim to connect the dots for our listeners, as simply as possible, between the actions of the Federal Reserves and the insane overvaluations we see in the stock market today. “We take this connection for granted, but no one ever draws me a map.”
33:55: Jim explains how the Fed is more impotent than people realize now that the its federal fund’s rate has lost its potency as a lever. So what does the Fed do? It has the capacity to create credit… but it’s much harder to transmit it to the broader economy.
44:42: Jim asks Dan if he’s seeing more or fewer opportunities as a value investor these days. Dan compares the opportunities passing his criteria today to sheaves of corn falling off a truck. “Much of it is in the admittedly “relative value” and not the “absolute value” category.”
46:25: Jim leaves listeners with a final thought: be aware of the ever-present consequences of an abnormal low-rate regime over ten years. Some sectors in particular are riding for a fall after the wave of easy credit.
48:55: Dan answers a question from Matthew B., who asks what happens to companies gorging on buybacks once interest rates go up. Dan explains why it could be a major problem for dividend-paying companies.
NOTES & LINKS
Announcer: Broadcasting from Baltimore, Maryland all around the world, you're listening to the Stansberry Investor Hour.
Tune in each Thursday on iTunes for the latest episodes of the Stansberry Investor Hour. Sign up for the free show archive at InvestorHour.com. Here is your host, Dan Ferris.
Dan Ferris: Hello everybody and welcome to another episode of the Stansberry Investor Hour. I am your host, Dan Ferris. I am also the editor of Extreme Value, a value investing service published by Stansberry Research.
We have a great show lined up for today. So I'm just gonna get right to it with the weekly rant. Okay. Now, if you forced me to pick just one most important skill for investors, I'd actually have to acknowledge that there is not just one but I could answer the question as asked. I could do it. It'd be easy for me to name the most important skill for investors, in fact. That skill is saving: saving money, spending less than you make and setting aside some portion of your earnings on a regular basis for the purpose of accumulating investment capital. Saving is the master investment skill.
Now, right now I'm willing to bet some of you are groaning: "Oh jeez, here we go. This week's rant is investing for children." Well, you'd be wrong if you thought that. In fact, it's the opposite. The really experienced and successful and probably wealthiest investors listening to the sound of my voice are probably nodding their heads right now saying, "Yup, that's right." And they're waiting for me to get the rest of the argument right. So it's not for children. It's fairly sophisticated actually.
And the rest of the argument is simply – most of the rest of the argument really is simply that saving money is a negative skill, okay? It's something you don't do. You don't spend. That's how you save. I first came across this negative skill thing when I was reading one of Nassim Taleb's books. I can't even remember which one it was. I think it was Fooled by Randomness. He talks about "via negativa," and he says: people who really know what they're doing – they always define things negatively.
And it's the same with investing, and the most important skill is a negative skill, the skill of saving. And the way the saving happens in your life – it's like going to the gym: sometimes it happens every moment and it gets into all kinds of decisions. Basically any time you say, "No, I'm not gonna do this or that because it's a poor use of my time," that's your saving muscle that you're flexing. And more directly, every time you say, "No, I'm not going to buy this or that; I'm not going to spend money in this or that way or deploy capital in this or that way because it would be a poor use of my hard-earned money and it would prevent me from accumulating more investment capital" – when you say that to yourself, you're building that saving muscle.
And so you can imagine, throughout a lifetime, the way this works. It's like going to the gym and lifting weights. You don't do it like once a year [laughs], you know? You do it, I don't know, however many times a week: two, three, four, five, whatever it is. And with the saving muscle, you probably flex it in some way every single day. Saving money is like not eating or drinking too much, right? You're avoiding something that's bad for you. It's a negative action.
So, later in – this is the more sophisticated part, okay? Later in your investing career, that same muscle that you used to not spend your money helps you say things like, "Well, I'm not going to invest in this or that company because it's too risky," or maybe, "I don't really understand the business well enough," or some other reason. You're using this ability to say no. And if you've read about various innovators like Steve Jobs – he says: you say no so many more times than you say yes to come up with a good product, and you say no so many more times than you say yes to come up with investment success throughout a lifetime.
Saving money means saying no. And if you don't learn to say no to a million bad deals, you'll have a lotta trouble hanging onto what you've saved. Which, by the way: yes, it's much harder to hang onto what you've earned and saved, and therefore that's the more valuable skill, right? It's more valuable to be able to avoid losing it than making money as an investor. It's crazy. It's a crazy thing to say. But logically I believe it holds up. Being a successful investor isn't about making a lotta money first. It's about saving as much money as possible and learning to spot all the stupid things you shouldn't do with it first. It's about that first. And all the great investors define their core beliefs and philosophy negatively.
So here's some famous advice. See if you can identify these folks. One of 'em says, "Rule number one: don't lose money. Rule number two: see rule number one." That's Warren Buffett. Here's another one: "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid instead of trying to be very intelligent." You know that one? That's Buffett's partner, Charlie Munger. Here's another one. This is a slightly different take on the negative action. He says, "I am always wrong and I try to correct my mistakes. In other words, I'm always doing something I should not be doing and I wanna not do it as quickly as possible." And the he says, "That is the secret of my success." You know who that is? That's George Soros.
One more. This guy's got three quotes. He says, "It's very important for most people to know when not to take a bet." He also says, "At any given time there's so much you're not seeing. My biggest advantage is not what I know. It's that I know I don't know a lot." He's just defining negatively, negatively, negatively. And if you don't recognize that one, it's Ray Dalio, the guy who started Bridgewater, the biggest hedge fund in the world.
So, in his latest letter to Berkshire Hathaway shareholders which came out just this weekend – and we're gonna talk a little bit more about that later in the program – Warren Buffett wrote this. He says, "Remember, earlier in this letter, how I described retained earnings as having been the key to Berkshire's prosperity? So it has been with America. In the nation's accounting, the comparable item is labeled 'savings.' And save we have. If our forefathers had instead consumed all they produced, there would have been no investment, no productivity gains, and no leap in living standards." Right? So Buffett's telling you that saving is the most important thing that those who came before us did, and that capital is what build this country.
Now, when you understand the master skill of saving, you also understand that negative action is the most important action we ever take as an investor, as I said. Negative action is what keeps you from the catastrophic losses that destroy your ability to preserve purchasing power and grow substantial long-term wealth. In fact, I alluded to this earlier when I was talking about Nassim Taleb, and he'll teach you this if you read his books. He says: one of the ways – this isn't a quote. This is just how I interpreted what he said. He said: one of the ways you can tell a charlatan from the real deal is that the charlatan is always stumping for some new bet he wants you to make. He's just giving you nothing but positive advice: "Do this, do that; buy this, buy that," instead of mostly talking about avoiding risk to your hard-earned capital. Avoiding risk is something that all the great investors talk about.
The book Most Important Thing by Howard Marks has 18 most important things in it. And three of those chapters in that book are about risk: avoiding risk, controlling risk, what not to do. And I know all about this stuff firsthand, okay, because I promise you I could've made a lot more money – well, I could've made a lot more money as an investor; I could've made a lot more money in the newsletter business by just throwing stock picks around and giving tons of positive advice all the time and just dealing stock picks like playing cards out of a six-deck shooter on a Vegas blackjack table, you know? Just one after another, right? But I didn't do that. Instead I focused on value investing, which is a terrible thing to do if your goal is selling newsletters. But it's the only thing that makes any sense if your goals are capital preservation and appreciation with lower risk. Over the long term, right?
And you can look at things I've done in the past. In 2015 I only recommended two stocks all year, and nobody – the publisher doesn't like it. The reader doesn't like it. Nobody but me likes it because if you can't find something to recommend you can't find something to recommend. And of course at that time, 2015 turned into the worst year since 2008. Until last year came along. And going into last year, I said, "Hold cash, hold cash, hold cash," and cash outperformed like better than 90 percent of global assets according to Deutsche Bank. You know, I think I'm doing my readers a good service. But it's not one that they [laughing] necessarily feel like paying me a lot of money for, you know?
So if we sum all this stuff up about saving, you'd have to conclude something like: saving money teaches you how not to destroy your capital, and that'll prove to be the single foundational skill allowing you to accumulate substantial capital and make the best decisions about how to deploy it in order to both grow it and preserve it. As it turns out, the skill of preserving your capital winds up being inextricably bound up with the skill of growing it. In short, the best way to improve your odds of making money as an investor is to learn what not to invest, to learn to preserve it. Learning what not to invest in leads you naturally towards what you should invest your money in. You say no to a million bad deals, and what's left? A few really good ones.
So, do you wanna make a lotta money in the stock market – and who doesn't, right? Yes, yes, yes, of course we do. Well, save, save, save. Develop the healthy habit of saving, of not spending, of avoiding frittering away your hard-earned capital. That'll set you up to avoid lousy investments that'll destroy your capital, and it'll lead you naturally to the few really great investments you ought to make to preserve and grow your capital.
Okay. That's the weekly rant. If you agree, disagree, or have something to add, e-mail us at [email protected].
Okay. Let's get on to the news of the week. Very few items I'm gonna deal with this week. And I'm gonna start with one that you never would've guessed. But I promise I'll put an investing spin on this. So, what happened this weekend? Well, the Oscars happened, the Academy Awards ceremony. And I never really thought about this very much until I started learning about businesses and competitive advantages and marketing and what people do to preserve their competitive advantage. And I realized that all of these awards ceremonies are the same thing.
The Emmys and the Grammys and the Tonys and the Oscars and Golden Globes – it's all the same thing. It's a marketing event for the wealthiest, the most heavily promoted, and the most entrenched, well-connected interests in the entertainment business. And I could do this for a lot more examples but I'm just gonna use one example, and maybe take my word for it or not. And if you think I'm wrong, again, e-mail and let me know and we'll have a conversation about it. But performance by an actress in a supporting role, okay? The nominees were Regina King, Amy Adams, Marina de Tavira, Emma Stone, and Rachel Weisz.
The only one I never heard of before was Marina de Tavira. Turns out she's the granddaughter of the person who started the Mexican multinational company called Grupo Bimbo. It's a bakery company in Mexico. I mean, the fact that that word is "bimbo" in English – I don't even know what to say about it. The joke is made. You don't even have to make the joke [laughs]. But Marina de Tavira is not a bimbo. She's an actress. If you see her face, you'll recognize it though you may not recognize her name. Same with Regina King, whose name I did not recognize. And she actually won.
But Amy Adams, Emma Stone, Rachel Weisz – they've all been around forever and they've been in dozens of movies and they're all among the richest and most heavily promoted and most well-connected interests. And I think you'll find that for most of the categories, certainly all the actor and director categories. And that's my take on the Oscars. That's what I think these things are about. And I can't imagine, for example, not being in that room when that ceremony's happening and giving the least crap what's happening in that room. It has nothing to do with anything in anyone's life but the people in that room.
Okay. That's my bit on the Oscars. The other thing that happened this week is that Warren Buffett published the Berkshire Hathaway shareholder letter on the Berkshire Hathaway website. So I went through and I just picked out some excerpts from the letter and I thought we'd go through and talk about them a little bit. Well, I'll talk about them [laughs], and if you wanna talk about them, you can e-mail us, [email protected]. How's that for a deal, okay?
So the first excerpt I wanna talk about is – I'll just read it for you. It says, " Berkshire held $112 billion at year end in US Treasury bills and other cash equivalents, and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities. We have also promised to avoid any activities that could threaten our maintaining that buffer." In other words, he's not gonna do anything that would threaten that $20-billion buffer. So they've got a ton of cash, in other words. And they're gonna hold quite a bit of cash, $20 billion, no matter what, in case some big re-insurance catastrophe happens and they have to pay out a lotta claims. And that's the responsible thing for an insurance company to do.
But my point is: it's a responsible thing for investors to do, for people to do. You should always have some cash, some ready cash, enough to cover six months of your bills or a year of your bills, something like that. It's just kind of basic investing 101, and nobody does it better than Berkshire. I think a lotta companies out there have borrowed a lotta money. We'll talk about that in the feedback today, in the mailbag. And I think that's a mistake. They're net debtors. They're not net cash holders like Berkshire Hathaway is.
Let's see now. Next excerpt. Buffett says this. He says – remember we talked about predicting the future in a previous weekly ran, and that predicting the future is not a skill anyone has [laughing]. Buffett says, "In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: prices are sky-high for businesses possessing decent long-term prospects. That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities." In other words, he's not gonna buy a bunch of big businesses for tens of billions of dollars. He's probably gonna allocate it to the two guys he hired, Todd Weschler and Todd Combs, and expect them to allocate it into marketable equities, publicly traded stocks.
So, to continue here, he says, "We continue, nonetheless, to hope for an elephant-sized acquisition. Even at our ages of 88 and 95 – I'm the young one" – meaning Charlie Munger's 95 – "that prospect is what causes my heart and Charlie's to beat faster. (Just writing about the possibility of a huge purchase has caused my pulse rate to soar.) My expectation of more stock purchases is not a market call. Charlie and I have no idea as to how stocks will behave next week or next year. Predictions of that sort have never been a part of our activities. Our thinking, rather, is focused on calculating whether a portion of an attractive business is worth more than its market price." And that last bit of course is what I'm always hammering on.
Oh [laughs]. One reader in the mailbag, in the nicest possible way, used the phrase "browbeating," that I'm always browbeating you about that. And it's true. This is arguably – he's certainly one of the two or three greatest investors who ever lived. And he's telling you: they don't bother trying to predict the stock market. They wanna know what's a good business, and is it attractively priced? And I think that's the thing to do. I think that's what you should do as well. And I think, more to the point, you have a much greater probability of being able to do that, of being able to learn about what's a good business, and learn about whether or not it's overvalued or undervalued, than you ever will of predicting the direction of the stock market over any period of time. So put the odds in your favor and be a smart investor.
Here's another expert. If you wanna know how to approximate Berkshire Hathaway's intrinsic value, Buffett tells you. He says, "I believe Berkshire's intrinsic value can be approximated by summing the values of our four asset-laden groves," meaning the four categories of businesses they own, of assets they own, "then subtracting an appropriate amount for taxes eventually payable on the sale of marketable securities." Boom. Done. That's what Berkshire Hathaway is worth. Most people don't tell you that. They don't tell you how to think about the value of their business and how to calculate an approximate value. And Buffett says later – elsewhere in the letter he comes out and he says: "You know, a responsible corporate guy tells you all the things you need to know to figure out the intrinsic value of the business. That's why we do this, this letter."
Here's one more. I found this next bit fascinating because Buffett is a long-time card-carrying liberal. He votes Democratic. He stumps for liberal and Democratic causes and liberal, Democratic candidates, and has made no bones about it over the years. But this next little bit – it just leans almost – I know that he thinks it's okay. But it's like fodder for Libertarians. Just listen to this. He says this in the annual letter. He says, "Like it or not, the US government 'owns' an interest in Berkshire's earnings of a size determined by Congress. In effect, our country's Treasury Department holds a special class of our stock – let's call this holding the AA shares – that receives large 'dividends' (that is, tax payments) from Berkshire."
So you see what he's saying? He's saying the US government effectively owns a chunk of Berkshire in relation to the amount of earnings they take in tax payments. He continues, "In 2017, as in many years before, the corporate tax rate was 35 percent, which meant that the Treasury was doing very well with its interest. Indeed, the Treasury's 'stock,' was paying nothing when we took over in 1965, had evolved into a holding that delivered billions annually to the federal government. Last year, however, 40 percent of the government's 'ownership' (14/35ths) was returned to Berkshire – free of charge – when the corporate tax rate was reduced to 21 percent. Consequently, our 'A' and 'B' shareholders received a major boost in the earnings attributable to their shares."
Now, my guess is that Buffett thinks this is not good, that corporations aren't paying enough taxes, although I didn't see him come out and say exactly that. But he's often said, "Rich people don't pay enough taxes and people who make less money pay too much." But really what this says – this guy is not a Libertarian but he's come out and said in the most explicit way, as only Warren Buffett could say, that when you live in a confiscatory tax environment, the government owns a piece of you. Period. Like it or not. And I don't like it [laughs]. And I think a lot of other folks – I wouldn't call myself a Libertarian, but I don't like it.
All right. Let's do one more excerpt. This is really good. He says, "We use debt sparingly. Many managers, it should be noted, will disagree with this policy, arguing that significant debt juices the returns for equity owners. And these more venturesome CEOs will be right most of the time. At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal. A 'Russian Roulette' equation – usually win, occasionally die – may make financial sense for someone who gets a piece of a company's upside but does not share in its downside. But that strategy would be madness for Berkshire. Rational people don't risk what they have and need for what they don't have and don't need."
And that – I can't think of a better place to end this segment, okay? I've been telling people to raise cash. We've been talking in the mailbag and in the rants and places about debt. And of course, of all people, Warren Buffett has stated it most brilliantly and just has gotten right to the point as only he can.
Okay. It's time for our guest. His name is James Grant, and he is the editor and founder of Grant's Interest Rate Observer, a twice-monthly journey in the financial markets. Grant founded Grant's Interest Rate Observer in 1983. Prior to that, he started writing for Barron's in 1975. Grant originated a weekly column devoted to interest rates called "Current Yield." He has appeared on many major financial-news networks. His journalism has appeared in a variety of periodicals, including the Financial Times, The Wall Street Journal, Foreign Affairs, and he contributed an essay to the Sixth Edition of Graham and Dodd's Security Analysis. In 2013 Grant was inducted into the Fixed Income Analysts Society Hall of Fame.
Please welcome, in my humble opinion, the greatest newsletter writer, one of the greatest financial writers of all time. Please welcome Jim Grant. Thank you for being here, Jim.
Jim Grant: Oh, after that introduction I'd be nowhere else.
Dan Ferris: [Laughs]. So, Jim, I've been reading Grant's for some time. I think it's the greatest newsletter ever produced. And I noted recently – this was a few issues back – your mention of a certain 500-year-long bull market, which I had not noticed its 500-year length, I have to say. So I wanna thank you for providing the service of pointing that out.
Jim Grant: There's a young historian at Harvard and his name is Paul Schmelzing. I hope I'm not butchering his last name. Paul has one some very fine work in the history of interest rates that complements the published work of Dick Sylla, who wrote this great thing called The History of Interest Rates. So, anyway, Paul has gone back and has traced the yields on the foremost sovereign debt issuer of each era going back to the late Middle Ages and the early Renaissance. And he concludes that sovereign bond yields of the top issue – that is the United States of the 19th century, of the 17th or the 16th – that the top issuers have issued bonds and the yields have been almost continuously in decline for half a millennium, which I guess constitutes a kind of momentum, doesn't it?
Dan Ferris: [Laughs]. Yes, it does. One would never want to sell such a thing, would one?
Jim Grant: Well, one could make a great name for oneself of course by calling the top of a 500-year – think of the glory. And people would remember that feat for as long as like six months. You'd be in clover for fully a half-year. That's the temptation in our line of work, isn't it, to say something dramatic? And I myself have fallen victim to this impulse or this temptation from time to time. But I was so struck by this finding or this determination that if you connect all these dots, which I guess the Fed is famously doing or not doing – but if you collect all these dots, what you find is that bond yields have gone down. And I guess that my young friend Paul says they will go down until there's no more down to go to I guess.
But I don't know about you, but I am much more in sympathy with the sentiment of a certain French nobleman who around the time of the French Revolution, around 1790-ish or so, said that he would rather have a mortgage on a garden than on a kingdom. This reflects his I think wisely and deeply-held suspicion of the motives of politicians who borrow money. So I can't square my suspicion with the statistical evidence, but there you have the conflict.
Dan Ferris: You know, it's an interesting point that your historian is predicting that things will go lower until there's no more low to go to, and in fact, as you recently pointed out in Grant's Interest Rate Observer, there's $11 trillion worth of bonds that have gone into zero or negative yielding territory.
Jim Grant: Isn't that something? It's the foremost fact of our time. It boggles the – I mean, another way of looking at it is that the holders of $11 trillion worth of IOUs would rather be guaranteed a certain loss – mind you, in currencies that have no definition in the law or in central banking doctrine. They would rather invest for a certain loss than buy stocks, buy gold, buy annuities [laughs]. I don't know. I guess there's not enough room in many markets for $11 trillion worth of buy tickets. But, my goodness. You know, I just cannot conceive of it. And you read about: why do they do it? Why, oh why, do they do it?
Well, one reason they do it is because they are indexed investors. And if the index has in it a slug of securities that, owing to the polices of the Bank of Japan and the European Central Bank, and the Swiss – if the index has these securities, you have to buy them. So they just go out and buy what the index says to buy. So that's where indexation, at least in this one facet, has led us to follow the leader and to certain losses; not just possible losses, mind you, but guaranteed losses. Never mind the fact that – it's not as if there's no inflation in these countries that're selling securities for yields of less than nothing. I don't know. I just can't comprehend. But there are the facts.
Dan Ferris: It is a major head-scratcher. Jim, I have a question for you, and it's something I recently thought, "I'm gonna ask this question of anyone I know who knows anything about bond markets, or really specifically, the Fed." And you comment on the Fed quite frequently, and I've enjoyed your comments. So my question is: for me, the average equity investor guy – can you, Jim Grant, or someone you know, draw me a map from Federal Reserve policy all along the dots, connected as concretely as possible, to arrive at the final dot, which is what I believe to be quite an overvalued equity market? We take this connection for granted but no one ever draws me a map.
Jim Grant: Well, you know, in the day, there was something like a hydraulic system that one could point to. And I think the schematic of the hydraulic system, to use that analogy, was fairly helpful as a way of thinking about things. So that the Fed would buy securities and would credit the bank accounts at the Fed of the sellers. So the sellers were the so-called primary dealers. And they still are. But you think of Morgan Bank and Citibank. So the Fed goes out and infuses the accounts of these banks with fresh dollars. And these are called bank reserves. So the banks then have the wherewithal to lend. And assuming that there is a demand for credit, more credit flows into the economy thanks to the impulse provided by the Fed in the purchase of securities with money that didn't exist until those funds were credited to the accounts of these banks.
So a couple things happen. One is: more credit is more good, more bullish. And there was a tendency on the part of the Fed in conducting these open-market operations – it would tend to push lower the policy interest rate, that is the federal funds rate. So those are the kinds of mechanical or the hydraulic effects. And lower interest rates, if the end result were lower interest rate, lower interest rates of course leads to higher asset values if you think of the proper price of an asset as the discounted cash flow – estimated future cash flow. So that's the way things worked way back when. And, as I say, I think that that model was reasonably helpful.
So fast forward from 2008 to the present day, and much of this model is now dysfunctional. The reserves in question are in excess of needs in the sum of about a trillion and a half dollars; it'd be $1.4 trillion. So that the federal funds rate as a lever has lost its potency. And so what does the Fed do? Well, it still has the capacity to create credit but the transmission mechanism, as they say, is not what it was. So it's much harder to connect the impulse to the outcome in any direct way. But what the Fed has retained is the capacity to work through the imagination of the market. So never mind the primary dealers; never mind the impulse of the Fed buying securities and crediting the accounts of the banks.
Never mind that for a second. Just consider that when the Fed takes action say to cease and desist the normalization of its policies, as it did early in January, it sends this kind of electric brainwave into the market's head, suggesting that the Fed will ever be on guard against market declines, and if it sees a market decline coming, it will stand by to loosen policy, to lower interest rates, and to infuse the banks with new credit. So I think that the current model of the Fed – you asked I think a fair number of minutes ago how, functionally, this works, and I think the way it works now is to condition the market to expect ever more credit in support of ever higher asset prices. So I think it's become a psychological connection rather than a mechanical one.
Dan Ferris: Well, that was a fantastic answer. Thank you [laughing]. But it sounds like they sorta had things rigged and then they broke their own machine. They kept using it and it broke.
Jim Grant: The bull market was young. Ben Bernanke got on the 60 Minutes show and looked into the camera and said they can raise rates in 15 minutes if they wanted to, if they had to. But time passed, and wouldn't you know it, we all became acclimated to very low funding costs. In fact, funding costs, in some cases, closing in on zero. And low rates facilitated easy credit and a great deal of corporate borrowing. And it seems that now it's not so easy to raise rates. In fact, the declaration of intent to raise rates is seen as a major storm signal. And we appear to be stuck.
The Fed is very stock-market-minded. Do you remember James Carville way back when said this endlessly-repeated line that if he had to come back to earth as something or other, he would come back as the bond market because the bond market was omnipotent; it was in charge of everything. This was when Bill Clinton quailed before the threat of the bond vigilantes going on a buyer's strike and refusing to buy his securities if he didn't balance the budget. Well, that was paleolithic times, and now it seems that if James Carville had his druthers, he should tell Saint Peter that he wanted to come back as the stock market because the stock market is the hot button of the Federal Reserve.
Dan Ferris: Fate and irony and karma being what they are, I bet he'd show up as the stock market and it would crash the next day. Isn't it typical that in their pursuit of stability, they create the conditions for the greatest instability?
Jim Grant: You know, _____ _____ _____ going out on a listening tour to hear – and I daresay they could get an earful at the Stansberry operation. They can certain get an earful at Grant's.
Dan Ferris: Yep.
Jim Grant: They could get half an earful at The Wall Street Journal. But I think for the most part people have not seen the danger of these things. And there's fair reason for that. Bull markets are lovely things. And who is going to protest the Fed's nurturing of higher and higher asset prices? It's a gift horse and one should proverbially not look it in the mouth. I guess that duty falls to those of us throwing stones on the side. But it would be hard to run a political campaign based on – let's see. The platform would be: "I have chosen to – I am going to announce – Dan and I are going to run for office on a platform of lower asset prices and honest interest rates. We are going to demand that interest rates be set free."
Dan Ferris: _____ _____.
Jim Grant: Right. How do you think we're gonna do, Dan?
Dan Ferris: Well, I think we're gonna have trouble raising money for that campaign [laughs]. Between the three of us, we'll put $1,000.00 or so together maybe.
Jim Grant: Yeah. I feel a little foolish actually raising the possibility of this run for office on this particular platform. But I think that we are storing up trouble. And I think that interest rates are prices better left discovered than imposed. And I think that fake prices beget fake valuations, and a great delusion. Which delusion, however, happens to be very pleasant as you are living it. And that's the trouble.
Dan Ferris: And isn't it – maybe you agree or not. Isn't it so that at this point in history, it's unlike 2007 where a lot of the distortion was focused in the housing market and in mortgages. And there's some in the stock market as well and other markets. But it was more focused then. But now it seems more broad-based. Global equity markets and global bond markets. It seems like we're setting ourselves up for a bigger calamity.
Jim Grant: Well, it gets back to the $11 trillion of negative-yielding securities. Certainly that is as outlandish, I say, an excess as anything that was on the table in 2007. It's a bit more nuanced. It's kind of a subtler one. It is calculated to force the scratching of heads mostly of professional investors. I think amateurs – their eyesight blurs on the sight of it on a page. But the Fed is kind of undaunted. I see that the San Francisco Fed has produced a research piece kind of singing the praises of the negative interest rate proposition and pointing to that policy next time around. Certainly we're very close to negative even now. And what is supposedly, and what certainly is in relative terms, a fairly good economy. Things are not so bad. And can't raise rates.
Dan Ferris: Yeah, they're not so bad, and yet here we sit, near all-time lows of interest rates. So, what does one do? Is there a bargain to be had nowhere in the world, Jim?
Jim Grant: No, there are. I think, to borrow a phrase from value tribe, there's always something to do.
Dan Ferris: Peter Cundill.
Jim Grant: Yeah. Peter Cundill, and before him, Paul Isaac, who was a fabulous investor at Arbiter Partners. He's wont to say that. So, we every once in a while have been fortunate enough to talk with value-minded people who have come up with ideas that are way out of the beaten path, and certainly that they all fall in the category of business managed risk, that old expression meaning that they are cheap, these ideas, for a reason. And they are likely to go low before they go higher because that's the way things in the value world – things are down and they have no public following, and they're waiting to be discovered by people who see the future as others don't see it. And in the current issue of Grant's, in fact – I'm glad you asked – we talked with one of these tenders of the flame of value whose name is Darren Maupin, M-A-U-P-I-N.
Dan Ferris: Yeah, I know Darren.
Jim Grant: Do you? Yeah. He's a very good investor and a thoughtful one and one who's not afraid to do something different. And he told us all about Genkosh I think and Trading Limited. GNK is the ticker there, and Eagle Bulk Shipping Inc. EGLE is that ticker. Both listed in the US, one on the big board, the other on the Nasdaq. And these are stocks that have been buffeted by – I guess I'm supposed to say now high winds and heavy seas. 'Cause they're shipping stocks. So I will say that. In fact, I just said it. But the economics are – we think; we agree with Darren – are very promising. And it's very contrary and these things are very cheap. So, with all that said, to answer – long answer to your very concise question is: we do find some things to look at and like, fully mindful of the fact that most everything is extended, but certainly not everything.
Dan Ferris: Yeah. In fact, in my newsletter, Extreme Value, we covered this same too about 40 percent ago. Early as ever [laughs]. Well, it's our job to be early, isn't it, Jim? We're value investors.
Jim Grant: It is. You got to give people time to convene a committee – meeting of the advancement committee. You know, people to fly to a certain destination – that might take some months, right? So you can't just wait for the bottom tick. And also they don't call it Extreme Value for nothing.
Dan Ferris: They don't [laughing].
Jim Grant: It's extreme.
Dan Ferris: Getting extremer and extremer all the time.
Jim Grant: [Laughs]. Well, let me turn this over back to you. Are you finding the crop of opportunities to be richer or less rich than say a couple years ago?
Dan Ferris: I don't know if I'd call it a crop. But every now and then a stray ear of corn falls off a truck and we run out into the road and pick it up and fix it for dinner. So we don't eat much these days [laughs]. It's all roadkill [laughs].
Jim Grant: And mindful of the onrushing traffic as you reach down to pick up that cob.
Dan Ferris: Oh yes [laughs]. And the oncoming traffic comes in many forms. Some of them are readers who say, "Are you ever gonna pick a new stock?" [laughing]. But we found a few things.
Jim Grant: I know you do.
Dan Ferris: Much of it is, lately, admittedly in the sort of relative value category and not in what Darren would call the absolute value category. Jim, I have to ask you: we were at the annual Stansberry conference last year. Are you planning to join us this year?
Jim Grant: Well, I would be honored, as always. I think that you guys do terrific work and I think that Porter is the best businessman in the financial publishing business. So it's always an honor and a pleasure to be a part of things at Stansberry. So I'd be delighted.
Dan Ferris: And I wonder: is there anything you'd like to leave our listeners with?
Jim Grant: I would leave this thought: that I think we ought to be aware of the ever-present consequences of about ten years of abnormally low and artificially low interest rates. These consequences are evident everywhere you turn. We have been long-time bears on Kraft Heinz, and that recently – that did what it was supposed to do recently. And we are equally long-term bears on Restaurant Brands International, RBI. That's another Warren Buffett 3G business.
And the entire restaurant and fast food business is afflicted by the consequences of very easy credit. Because the number of restaurants keeps going on whereas the number of diners doesn't. And margins are under pressure. And these stocks, many of them, are very aggressively valued. So you can see the mark of these interest rates almost everywhere you look. And I think we will all be happier if we look back five years from now and say, "Yeah, I was aware of it and tried to minimize the likely damage in my portfolio." So that's my parting shot.
Dan Ferris: Excellent. Well said, as always. Jim, thank you so much for being on the program.
Jim Grant: Great. Thank you again. It's been a delight.
Dan Ferris: All right, everybody. It's time for the mailbag. Remember: your feedback is important to the success of our show. You can simply e-mail us with a question or a comment at [email protected]. We read them all and try to respond to every single one but we've been getting a lot of it lately. So, can't respond to every single one.
Okay. I have a lotta mailbag here and I'm gonna get through it as quick as I can. Now, in order to get through this, I just want you to know: if I'm reading your e-mail, you won't hear the entire e-mail. I figure if I just read the best bits, I can get through more of this and interact with more listeners. So, getting right to it, mailbag number one has some nice stuff in the beginning. Likes the show. Thank you very much. And then Matthew B. says, "I also really enjoyed what you talked about last week regarding stock buybacks. I know you said that you don't like trying to predict the future but where we are in the market cycle certainly feels like the top. What happens to these companies who are buying back stock at record pace, and likely borrowing money to do so at very low interest rates, if the stock craters and interest rates go up? Thank you for reading, Matthew B."
Thank you. Matthew B. You asked two questions. One is about stock buybacks if the stock craters, and then what happens if interest rates go up? So, if the stock craters and it's a big bear market, it doesn't necessarily mean the buybacks were a mistake. Over the long term, one would expect the stock price to go higher in part due to buying back the equity. But in the short term, you can actually buy your stock back at a cheap price and it can fall.
But you mentioned: what if interest rates go up? And that of course could be a major problem, right? Because if you're doing this basic arbitrage we talked about where say you pay a three-percent dividend and you can borrow at two percent, well, you're gonna save one percent – and actually more than that since you can write the interest off on your taxes. You're gonna save one percent and then some all day long, borrowing money and buying back stock. But at some point debt is debt and you pile it up and pile it up and pile it up, and you're creating more risk.
Not every business goes swimmingly 100 percent of the time. And if rates go up, the other – what I think you're really maybe getting to here: if rates go up of course, this source of cheap money for buybacks and other purposes – it dries up. So the buybacks go down and maybe corporations have to do something different and they can't buy back so much stock. Good question.
Mailbag number two. Actually, I wanna refer you, Matthew, to episode 76 when we interviewed Chris Cole from Artemis Capital. If you look through the transcript for that, you'll find him discussing a $2-trillion short volatility position, part of which is all the stock that companies have bought back. And of course I said not necessarily is it a bad thing if the stock craters but, let's face it, most companies overpay dramatically for their stock so they're gonna destroy value over time by buying way too much of it at near market peaks. Good question.
Okay. Mailbag number two. This is from Terry B. and he says, "Dan, you recently said if an investor could not do basic stock analysis then they did not have any business investing in stocks. I somewhat disagree. If it were not for those day-trading speculator investors, who would be left to sell stocks to when they finally realize the value of your recommendations?" So I won't read the rest of this e-mail but I just want to address this idea of what I said previously. So, what I said was: you're right, if people don't do good fundamental analysis and don't understand the businesses they're buying, they have no business buying them. And it sounds like you think I'm saying that there can be no other strategy for buying stocks. And I'm not saying that.
What I'm trying to say is that most of those speculator/investors that you name who aren't necessarily doing lots of fundamental analysis – I think they're making a mistake. I don't think they're very experienced or informed or good at what they're doing. However, there are plenty of those people who are. There are plenty of people who are not doing deep fundamental value analysis who make money and trade on all kinds of different strategies. And, yes, they provide liquidity to people who wanna sell, to value investors who might wanna sell. So don't get too caught up. I'm not a value dogmatist. I think there's more than one way to skin a cat. Okay? So I'm gonna leave it there, and thank you Terry B. for that question.
Mailbag number three. "Hey, Dan, I'm a big fan of your work and have read your newsletter for years. I like the Investor Hour so much better with you at the helm now that it's focused more on investing and less on politics. However, I did noticed what I perceived to be two conflicting ideas on the show this week" – that is, last week – "and was hoping you could clarify your thinking on this issue."
And he says, "You opened the show with the rant instructing investors to invest based on value rather than price and disparaged technical analysis. However, later, along with your guest, whom I respect immensely by the way" – that was Richard Smith – "you begin to praise the merits of stop-loss-based selling, which at its heart is a simple momentum-based technical system affected only by price with no consideration whatsoever to the value of the underlying security. My question is: why should value matter when purchasing an investment but price when selling?"
Okay. This is a very good question. Personally I see no conflict between a value-based purchase strategy and using stop losses on the exit to both keep you in the position, as long as it doesn't get too volatile, and take you out of it if you make a mistake. Because I'll tell you something: I have one of the better long-term batting averages in the newsletter business in general, and my batting average is basically 53 percent. I have 53-percent winners. Doesn't sound that great, does it? Slightly more than half the time I pick a winner and the rest are losers? And that's why you need some kind of a stop-loss discipline. You need discipline 'cause you can be wrong. So, you see, they're not necessarily conflicting. But it is an excellent question. The point is to be disciplined and have a strategy at both ends of the transaction, right? So that was Kit C., and I thank you very much, Kit. C.
Next question. "Hi, Dan, I always appreciate your reminders about how useless my trying to divine something from the lines on stock charts is. I waste a lot of time looking with an untrained eye at the exact same lines all the other amateurs are looking at." I'm gonna stop right there and say: thank you for saying that. That was the point. When I was criticizing technical analysis, I wasn't criticizing professional sophisticated technical analysis. I was criticizing what I believe you are referring to, which is the kind of what I call naïve technical analysis that I think way too many people do. So thank you for acknowledging that and writing in.
And then this fellow continues, "I also gained a little confidence from Richard Smith," our guest last week, "saying it takes people about ten years to start to get the hang of investing. For me, I've spent since 2010 slowly realizing how little I know. But I've enjoyed the journey and Stansberry's been a huge part of that process." And there's some more stuff that I won't take time to read that's very complimentary. And that's by Trevor P. Thank you, Trevor. Thank you for acknowledging exactly the point I was making about technical analysis. And, you know, for kind of defining negatively – we talked about negative skill in the weekly rant this week, and you said you've spent since 2010 realizing how little you know, just like what Ray Dalio said: he knows that he doesn't know a lot. You're a wise fellow, Trevor. Thank you for writing in.
I got another one. Lots of mailbag. Carl B. says, "What is your perspective on high-frequency algorithmic trading? Do these strategies make much money and to what extent does this distort the market? Any lessons for the ordinary investor?" Yeah, there's a big lesson: you and I don't have the brains or the math or the computers or anything to compete with these people. But it doesn't really matter because we can – they're trading in milliseconds and seconds and fractions of a second and I don't think they're really disrupting anything I'm doing. I think it's a bit of a red herring to worry too much about these people. In fact, they're part of what creates deep liquid trading markets. And so if you think deep liquid markets are good then I think the high-frequency traders are out there just trading constantly, creating that liquidity. Good question.
Next. Here we go. John H. says, "I've been a subscriber of yours for several years and listened carefully to your second rant this week. I agree wholeheartedly. It is a shame that civility is becoming lost in our society. But you are now a target for no other reason than that you've put yourself out there as available and some individuals simply can't resist the opportunity to attempt taking others down." This is the good part here. "My father once told me some things that're true when, as a youngster, I expressed my concern over childhood disagreement. His observations were that most insecure people express all the courage in the world when they can hide behind a phone and a written word, and the best one was, quote, 'Never worry about someone who tells you that they are better than you. Only worry about the ones that come and prove it.'"
That's John H. Thank you, John H. I'm reading your e-mail just to pass along your father's wisdom. I love that quote.
All right. Got a couple more. This one says, "Good afternoon. Just wanted to jump on the Dan-is-doing-a-great-job bandwagon." Well, of course I'm gonna read that one, right? He continues, "I too initially was hesitant when Porter stepped away but after a few weeks I've started looking forward to the weekly time with Dan." Well, thank you for saying that.
And he continues: "Within the last year, I purchased the TradeStops package with the True Wealth subscription. What a difference when you are properly allocated on position size and have the ability to adjust the portfolio for volatility," which you can do with the TradeStops software. "Within the first four months, the cost of the service paid for itself." And here's the money shot, folks. This is Tim B., and he says, "Not many financial products out there deliver what they sell but TradeStops does."
You know, I agree with you, Tim, so much. It's so hard to make any guarantee when your service is active advice providing stock picks and bond picks and things. You can only guarantee that you'll do your best really in the end, and you can say, "Well, I've done pretty well up to now and I'm gonna do my best, and hopefully I'll do better in the future." But TradeStops isn't like that. TradeStops, in my opinion – I'm not gonna use the word "guarantee" because it's probably illegal. But TradeStops, I believe, is highly highly highly likely to improve the result of everyone in the stock market, everyone within the sound of my voice, every professional who's not using it and every amateur individual who's not using it. And I just can't agree with that point more, and thank you, Tim B., for writing in to point that out.
Okay. Gosh. I have so many of these. Why did I pick all of these? I'm just gonna do one more, okay? This one is from Brandon R. And he says, "Hi, Dan. I hope this e-mail finds you well. I'd like to start by saying that I thoroughly enjoy you on the podcast and look forward to it every week. As a value investor, it's been a big of a slow go finding world-class companies on sale the last few years. Now that they seem to be hitting my screens, I wonder about the metric that I have never really addressed but that you have been warning us about. That metric is debt. When I look at companies like" – and then he gives me the ticker symbols for General Mills, AT&T, IBM, Occidental Petroleum, and Franklin Templeton.
He says, "When I look at companies like this, they look to be great value buys. However, with the recent implosion of KHC" – Kraft Heinz, who Jim Grant mentioned in his interview on the program earlier." He says, "However, with the recent implosion of KHC, debt seems to be something that just can't be ignored, with a 28-percent drawdown on KHC in 1 day. Is there a quick rule of thumb that novice investors can use to avoid land mines such as this? Such as debt to free cash flow or total debt to equity or something else? As a follow-up, what methodology would be useful after such a massive correction in a stock such as KHC to determine if it's a buy or a potential falling knife? Thanks for your time and great work. Such a great blend of knowledge and entertainment. Regards, Brandon R."
Brandon, thank you so much. First of all, you have to take individual businesses on a case-by-case basis. But there are some benchmarks. The folks at Royce and also Whitney George, who's now at Sprott, who used to be at Royce – they like to see assets at two times equity or less. That should definitely keep you out of debt-ridden companies. Other than that, I frequently look for companies that have more cash than debt or companies who might not have more cash than debt but their earnings cover the debt payments so many times over. You know, like 5 is a minimum I would think, but 10 or 20, or some of 'em are even more than that. So that the debt is really a small burden. Even though it might seem like a high number, the payments are such a small burden.
But the real point is: yes, you should think about that with every stock you buy, especially nowadays when so many of them are so expensive. And your follow-up on KHC, Kraft Heinz – let me tell you something about these – this is a consumer packaged-goods company, right? And we've been concerned – in the Extreme Value newsletter, we've been concerned about these for going on two years. Because things have changed.
The old formula for consumer packaged goods was: you make some kind of decent, maybe even mediocre product, and you slap a nice label and you pay for a lot of advertising and you pay for shelf placement at the supermarket or end-cap placement at the end of the aisle of the supermarket, and then you advertise, advertise, advertise so that when shoppers go into the store it's top-of-mind, they see the label, and they associate it with the advertising and you make a sale. Well, what are things like nowadays? Well, advertising isn't scarce. You can go online and you can type whatever features or benefit of any product, you know? I mean, if you have a headache, you don't necessarily want Bayer aspirin. You just say, "I have a headache" into a search engine and all kinds of ideas come up, many of which might have you buying absolutely nothing. Maybe you're dehydrated; you just need to drink some water. Okay?
So the competition in consumer packaged goods is more intense because we have more alternatives. Because now we're searching for the features and benefits. We're not just deferring to brand. So all that expense that went into advertising – the return is not what it used to be. And we find this with all kinds of brands and things.
And in Extreme Value, we're short an advertising company because, let's face it, Google and Facebook own advertising now. So tradition – you know, Mad Men style – you remember the TV series, Mad Men about the advertising industry? Well, the Mad Men-style advertisers are having a problem, and it's gonna get worse. And the problem is that there's just too much competition among brands so you can't defer to brand the way you used to as a consumer. You don't want to. You don't need to. And you can't defer to brand the way you used to as an investor. I hope that answers your question. And it is an excellent question. Thank you so much.
And that, folks, is another episode of the Stansberry Investor Hour. And thanks for tuning in. Be sure to check out our recently revamped website. You can listen to all of our episodes there and you can also see show transcripts there. And I get some e-mails about this from time to time. Just go to the website, click on the episode that you wanna see the transcript for, and scroll all the way down, and the transcript will be down at the bottom. And when you go there to InvestorHour.com, you can enter your e-mail to make sure you get all the latest updates. Just go to www.InvestorHour.com and you can do all that stuff.
All right. Thanks a lot, folks. I will talk to you next week. Bye-bye.
Announcer: Thank you for listening to the Stansberry Investor Hour. To access today's notes and receive notice of upcoming episodes, go to InvestorHour.com and enter your e-mail. Have a question for Dan? Send him an e-mail at [email protected].
This broadcast is provided for entertainment purposes only and should not be considered personalized investment advice. Trading stocks and all other financial instruments involves risk. You should not make any investment decision based solely on what you hear. Stansberry Investor Hour is produced by Stansberry Research and is copyrighted by the Stansberry Radio Network.
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