Even if you’re in complete denial about the markets, it’s tough to ignore the signs of extreme excess in the markets today…
This year, more brokerage accounts were registered than ever before…
Capital inflows are seeing outrageous all-time highs…
NFTs are selling for millions… and meme stocks are more popular than ever…
So, where can investors find value in the market at a time like this?
On this week’s episode, Dan invites special guest Stan Majcher onto the show to help answer this question…
Stan comes with over 27 years of industry experience, and today he serves as portfolio manager of the Mid-Cap Value fund (HWMAX) at Hotchkis & Wiley…
During their conversation, Dan and Stan discuss one corner of the market that has been almost completely forgotten by most investors.
Stan says that right now, big changes are happening in this industry, and there’s some very strong bullish tailwinds for stocks in this space that the public hasn’t picked up on yet. He says many investments in this space are criminally undervalued and could see much higher prices very soon.
If you’re looking at the markets and are searching around for investments with actual value, you might want to consider some of the ideas Stan shares.
Listen to Dan’s conversation with Stan, and much more, on this week’s episode.
Portfolio Manager/Principal at Hotchkis and Wiley Capital Management
Stan Majcher runs Hotchkis & Wiley Mid Cap Value Fund (HWMAX). He covers energy companies and is a member of the energy and financials sector teams. Prior to joining the firm, Mr. Majcher was an analyst in corporate finance at Merrill Lynch & Co., Inc. He worked on a variety of common equity, equity-linked and debt financings as well as strategic advisory assignments for Merrill Lynch's domestic and international airline clients. Mr. Majcher, a CFA charterholder, received his BS in Finance and Marketing from Georgetown University.
2:05 – Dan can’t escape from the many signs of extreme speculative excess in the market… “If equity fund flows continue at the current pace, this year, we’ll see greater net inflows than the preceding 20 years combined…”
6:52 – During the Dotcom boom, much like we’re seeing today, investor expectations have risen to out of control levels… “We don’t want to make 20% per year, we want to make 100% per year…”
8:01 – This week’s quote comes from Thomas Jefferson… “Books constitute capital. A library book lasts as long as a house, for hundreds of years. It is not, then, an article of mere consumption but fairly of capital, and often in the case of professional men, setting out in life, it is their only capital.”
10:43 – Our guest this week is Stan Majcher. Stan runs the Hotchkis & Wiley Mid-Cap Value fund (ticker:HWMAX). He has over 27 years of industry experience covering energy companies. Prior to joining Hotchkis, he was an analyst in corporate finance at Merrill Lynch and Company.
13:17 – What is it like covering an out-of-favor sector like energy? “There’s a lot of opportunities out there, but not a lot of people willing to take advantage of them…”
17:11 – Dan asks Stan’s take on the latest large shift to E.S.G. investing. “Everyone thinks fossil fuels are a dying commodity… how do you see that?”
23:50 – Stan details why oil production could increase in the coming years, “There’s some signs that the world isn’t producing enough oil…”
29:55 – Stan says oil prices could soon get much higher… “When we saw high oil prices last time, over $100 a barrel, we were actually still growing demand… so those prices could get very high if we end up with an undersupplied market.”
35:55 – Stan elegantly explains why investors should consider adding energy stocks to their portfolio… “The way I like to think of it is, you know, most insurance policies have a cost. This insurance policy probably has a return…”
38:25 – Dan asks Stan a question about his fund which kicks off a serious rant about passive investing. “We see these meme stocks come in, and those tend to be categorized as value…”
43:14 – Dan explains what some meme stocks, like AMC and GameStop, have actually done right lately… “Management did the right thing. That’s what you should do when your stock is egregiously overvalued, you should sell as much of it as you can and raise as much capital as possible…”
46:27 – Stan leaves the listeners with one final thought as the interview closes… “The one thought I would use is: have a framework for how you view the world… for how you view investments. It could be as simple as a balance sheet…”
51:21 – On the mailbag this week, one listener calls in with a funny story about some phony investment system supposedly returning 8% compounding daily… Another listener writes in with a follow-up question about the growth-value trade Dan mentioned last week… And another asks about what quantum computing could mean for the security of our investments in the future… Dan answers these questions and more, in this week’s episode…
Announcer: Broadcasting from the Investor Hour Studios and all around the world, you're listening to the Stanberry Investor Hour. [Music plays] 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, we'll talk with Stan Majcher from Hotchkis & Wiley. Among other things, Stan is really knowledgeable about energy investing, and we will talk a lot about that and a few other things. This week in the mailbag, listener Vicente found another sign of the top, Dr. Dominic wants to talk about the value-growth trade, and listener Steven is afraid that quantum computing might be a disaster in the making.
And remember, the mailbag is a conversation, so talk to me. Leave us a message at our listener feedback line, 800-381-2357, and hear your voice on the show. In my opening rant, man, it's all over but the crashing. I just can't get away from all of these signs of extreme speculative excess. That and more right now on the Stansberry Investor Hour. So what did I do last week? I talked about my value-growth trade, and I wrote about it even in my weekly Stansberry Digest. And in the Digest, I said, "This week I'm not talking about any bearish stuff." Right? Well, this week I'm back to the bearish stuff again because I can't get away from it. And it seems to have ratcheted up. It has just ratcheted up. I don't even know where to begin.
Let's start with a tweet by Robin Wigglesworth from the Financial Times. He says, "If equity fund flows continue at the current pace, this year we'll greater net inflows than the preceding 20 years combined." Yikes. The preceding 20 years combined. So, people are crazier about stocks and shoving more money into them than they shoved in in the preceding 20 years combined, at this pace, you understand. The number isn't there yet, but we're on pace to do that this year. Look at the put/call ratio. This is the ratio of put options to call options.
So when it's really low, that means everybody wants to buy calls and nobody wants to buy puts. And it hasn’t been as low as it is now since the third quarter of... what year again – 2000. Right? And the dot-com bubble had already started cracking then. But, as we got into that year people were like, "No, it's fine. Everything will be fine." Another thing I'm seeing here is the Ameritrade Investor Movement Index. And they just take the data... I mean, they've got all these investors. So they just sort of put all this data together and kind of assess how bullish or bearish or how crazy they are about putting money into stocks. And it's hitting a new all-time high as well.
So people want to speculate more than ever. They want equities more than ever. As I've covered before, equities are more overvalued, they're more expensive than ever, whether you think they're overvalued – OK. I'll leave that out of the equation. But you can't argue that they're more expensive than ever by the measures that have most closely correlated with the subsequent performance, especially in the case of the S&P 500. And the one there that I always use, of course, is price-to-sales. Over time, when price-to-sales goes way up, subsequent 10 or 12-year returns are low.
When the price-to-sales goes way down, subsequent 10 or 12-year returns are high. And the price-to-sales is higher than it's ever been. So we're at like 3 times. We've never been at 3 times, ever. So you can say, "Well, that doesn't mean anything, Dan." But you can't say it's not higher than it's ever been in history. OK? So at the moment, when things are more expensive than they've ever been, investors are clamoring to dump money into them more than ever. That's my point here. That's the kind of moment we're at. I just find it too difficult to turn away from this. Maybe I've been bearish for too long. Right?
Bearish since 2017. Gosh. If I keep this up and we don't get another correction... Of course, I was really hyper-bullish end of March into April and for some months after that. So, I can't really say I'm a perma-bull because when the market is down 30%, I'm pounding the table. But I'm afraid that with the market making new highs and people pouring more money than ever and investors having higher sentiment than ever... and not only that, but they're more optimistic about future returns than ever. Natixis global investors – Natixis is a big financial company, big European financial company. And they do this global survey of individual investors.
And one of their conclusions in the latest survey is, investors expect higher returns than financial professionals say are realistic. So the financial professional survey would say, "Realistic long-term returns for clients, 5.3% a year." Individual investor expectations? 14.5% a year. And those numbers are above inflation. Wow. Right? This reminds me of a story I heard that I'll never forget during the dot-com bubble where a couple went into – it was in a magazine or a newspaper article somewhere. I'm sorry that I don't have the source. But I remember it well.
And a couple goes into a financial adviser, and he says, "You know, I" – he's an optimistic and crazy bull too. He says, "I think you can make 20% a year if you do this and this and this and this." Of course, it's probably in 1999, right near the top when nobody was going to be making 20% a year for a while. And they said, "Well, no. We don't want to make 20% a year. We want to make 100%." Right? So the expectation is just, "Get out of all proportion to reality. When the prices are priced for expectations to be in the opposite direction. The higher the price, the lower the return. And prices are higher than they've ever been, and investors expect high returns, nonetheless.
So they're pouring more money into stocks than ever. It's a classic bubble moment. I just wanted to point that out once again. OK? And for my quote of the week, I'm worried about focusing too much on the bubble. I really am. But when I find evidence of it, I feel like I just have to report it. So I'm taking this out of that for the quote of the week. So I've said what I've said about the bubble. And the quote of the week is actually about books. And I thought it was a really good view with a slight financial spin on it, on books. And the quote is by Thomas Jefferson, and he wrote it in a letter to James Madison, September 16, 1821.
And Jefferson wrote, "Books constitute capital. A library book lasts as long as a house, for hundreds of years. It is not, then, an article of mere consumption but fairly of capital, and often in the case of professional men, setting out in life it is their only capital." I'm going to read that one more time. "Books constitute capital. A library book lasts as long as a house, for hundreds of years. It is not, then, an article of mere consumption but fairly of capital, and often in the case of professional men, setting out in life it is their only capital." I think that's brilliant, that books last as long as a house.
And really, when you think about the content of a book – if it's timeless – it lasts longer than most tangible things. Right? Houses and buildings crumble. But a great book – we're still reading books that were written thousands of years ago. Homer and Aristotle and Plato and all those things. Really, really, really great quote. "Books constitute capital." All right. That's cool. That's the quote of the week. And now, let's talk with Stan Majcher. Let's do it right now. [Music plays and stops]
A while back, I promoted my Extreme Value newsletter here on the podcast, and a lot of you listeners visited the website and bought a subscription. Thank you very much for that. I'm now going to recommend to those who didn't have a chance, to see my filmed presentation back then. Check it out now while it's still available. And in this presentation, I share what I believe is my No. 1 stock pick in more than 20 years of doing this. If you put a gun to my head, said, "Give me one stock pick, all your money, right now. You got to hold it for several years," this is the one I'd pick.
The business model's great. The management is great. I know them personally. The assets they own are fantastic. Balance sheet is great. It's well-managed. It's great. So I'm sharing this on this presentation, and my Extreme Value newsletter readers already have access to this recommendation. And I just want to share it with those of you who haven't seen it yet. This company is currently trading at a price from which I believe you could make 10 times your money, roughly speaking, over the long term. And they got me on camera getting really excited about it. So if nothing else, I think the presentation might entertain you a little bit.
So visit extremevaluevideo.com and get in on the opportunity before they take it down. Once again, that's extremevaluevideo.com. Check it out. [Music plays and stops] All right. It's time for our interview. Today's guest is Stan Majcher. Stan Majcher runs the Hotchkis & Wiley Mid-Cap Value Fund, ticker HWMAX. He covers energy companies and is a member of the energy and financial sector teams. Prior to joining the firm, Mr. Majcher was an analyst in corporate finance at Merrill Lynch & Company. He worked on a variety of common equity, equity-linked, and debt financings as well as strategic advisory assignments for Merrill Lynch's domestic and international airline clients. That sounds interesting. Mr. Majcher, a CFA charterholder, received his BS in finance and marketing from Georgetown University. Stan, welcome to the show, sir.
Stan Majcher: Thank you. I appreciate it.
Dan Ferris: So, Stan, right away I have to dive in. I normally want to talk about some biological origin story-type... but right away, I have to ask you what it's been like to manage an active value fund for the last 10 years, just because that's such a huge topic in the past few years. Everybody's saying, "Wow. Value has just done poorly." And over the long term since inception, your fund has beat its benchmark. But the last 10 years, certainly in the narrative these days and the track record supported it, is that value has been really tough. What's it been like for you?
Stan Majcher: Sure. As you mentioned, it's been tough. So, I started at the firm – Hotchkis Wiley – which has been around for 40 years... I started there 25 years ago. So a quarter of a century. As you mentioned, I'm a portfolio manager on the mid-cap product. We have a small, long, and short product. And I've been covering energy. And I would say over the last decade it's been difficult to be a contrarian, to be a value investor. But probably the worst part would also be being an energy investor. For the last five years, it's been very dismal in terms of returns, in terms of the narrative around the sector.
But as a value investor, when I started in 1996, there were a lot of contrarians around. Value investing was very successful. Today, there are very few contrarians. There's a lot of momentum investors. I believe that creates a lot of opportunities. So, when there is a lot of supply and very little demand things can be very good. And I think there's a lot of opportunities out there but not a lot of people that are willing to take advantage of them. So being an active manager in a passive momentum world covering a very out-of-favor sector has had its challenges historically. But I think that's where the opportunities are, going forward.
Dan Ferris: OK. So, I don't think anybody would deny energy has been a contrarian bet, especially the past year or so. Right around the time when energy prices went negative, when the oil price went negative, that became a. huge contrarian bet. So is that – I notice in the performance of your fund the one-year performance has just crushed it. Just doubled the benchmark. Is energy a big contributor to that?
Stan Majcher: It is. I think the rebound's coming out of the pandemic, our investments in energy started to pay off. We still think the returns in energy, both on the equity side... and we don't do much in the way of commodity. But the returns there are also very good. And while the performance has been strong recently, if you look at longer time periods, the returns have been very low or negative. So when I walk through the investments, I think it's important to kind of put some numbers behind what I'm saying. If you start at the commodity market and you look at the oil market, today the stock price of crude is around $73.
If you were to go out a year and look at the futures market, you can buy that in the mid-60s. So if the commodity market doesn't change, that the stock price is – in a year from now – where it is today, investors can generate an 11% unlevered return just by buying crude futures and rolling them forward. Crude futures are not a good predictor of future oil price. It's really an insurance market. So producers are hedging their future production.
So their cost is the investor's return. If you take that a step further and look at the equity side – so you can invest in exploration and production companies – the returns there, also known as the discount rates or the equity costs of capital... We think those are around 10 to 20% returns. So probably some of the best in the market. Another way of saying it would be, "We think the prices of these stocks are implying something in the mid to low $50-per-barrel for crude oil," which is well below the stock price.
So, we think the returns appear to us to be pretty high no matter what part of the market you're looking at. What's interesting to me is, there are very good returns here, but investors are disinterested. It's a small part of benchmarks. There's a whole host of ESG reasons why people aren't interested. When I look at the rest of the market, to me, the equity cost of capital with companies trading at 30, 40, 50, 100 times earnings is very low. And there's a lot of risk. And yet, investors can't get enough of them. So it is a very strange world where I think there are low-risk, high-return opportunities and there's a lot of low-return, high-risk opportunities and investors are focused on hooking in the low-return, high-risk and avoiding the high-return, low-risk.
Dan Ferris: Well, we are certainly of similar mind on that. It seems – to me, it seems like a crazy, toppy moment just in U.S. equities in general. But let's stick with something that you mentioned. Because as soon as we started talking about energy, it was the first thing that came to mind. The reason why investors don't like... well, we could even say fossil fuels in general, not just crude oil – is this ESG or it's mostly renewable energy, right? Everybody thinks that fossil fuels are a dying commodity which is insane.
If you know the reality of [laughs] how we poured ourselves around this world. But that's the narrative. And how do you see that? How do you see the increasing desire of utility companies – and supported by governments all around the world? How do you see this thing playing out? Because to me, it looks like a lot of resources and a lot of capital is being put into something that probably can't justify it. It doesn't seem like the greatest business move to me. And yet, here we are.
Stan Majcher: Yeah. I think it is analogous to what I was mentioning. On one side of the spectrum, you have these low-return businesses that are seeing a lot of capital. And on the other end of the spectrum, you see high returns and nobody wants to invest there. And what's interesting... and the phrases you're hearing in the market today are, "Fundamentals don't matter. Value investing is dead." I'd like to kind of start with, "The fundamentals don't matter." They do matter.
And what do I mean by that? The framework I use – and maybe the easiest way to describe energy, which is a very complicated subject – is "just take it to its simplest framework," which is thinking about things as a balance sheet. And I imagine on your podcast you've got a full spectrum of investors. A balance sheet – the nice way of thinking about a balance sheet is, it has to balance. So you have to look at the asset side. And it is balanced by how those assets are funded.
And in the commodity business, you can look at: "What types of returns do you earn on those assets? Should you put more capital from the profitability that you're generating into that business?" And then, "How do you finance it?" The debt markets... "What's the cost of that debt?" And then as I mentioned earlier, the cost of equity, the 10 to 20% returns. That's actually the cost of equity to the company financing those assets. So, what does that mean for investing in energy? What does that mean for the supply of the commodity? When you think about that business historically, what got the oil business into trouble – the exploration and production companies into trouble – is trying to grow their asset side of the balance sheet too quickly.
And the ability to do that was the access to capital. So if you went back to 2010 to 2016, you saw prices that were considered very high. Over $100 a barrel. Profitability was very high. Companies had the ability to generate a lot of profitability, reinvest in their business, and also bring in outside capital. So, borrow money very inexpensively. You could issue equity at very high multiples. And so, a lot of capital was going in. What happens is once you expand the asset side of the balance sheet so much you end up with an oversupplied situation.
So the narrative back then was, "Emerging markets are going to grow so quickly. You'll never be able to satisfy demand. Put as much as you can on the asset side because it's such low-risk. The profitability's great." Amazingly, or counterintuitively. But what always happens is, when things are very good, banks are really willing to lend because collateral values are high. They'll lend you money at very low rates. Equity investors will pay very high multiples. They're not really demanding much in the way of returns.
So, low equity cost of capital. Unfortunately, it seems that it's all in demise. Put too much on the way of the assets and the market becomes oversupplied. You outgrow demand and you end up with too much. And that's what happened with the exploration of production business. And it went to an extreme for a variety of factors. One, you saw even though profitability wasn't great, U.S. unconventionals – also known as shales – were still able to raise a lot of money. Banks lent to them. Equity investors gave them more capital. So even though you didn't have the profitability to grow your assets, you could fund it on the right side of the balance sheet. That changed.
So banks in the last few years have pulled away from the market. No longer lend. Some people have just exited energy lending. Once you start taking the banks and the debt financing out, high-yield walked away from the business. So you saw very high interest rates. And then, equity investors became disinterested. So there's an ESG narrative where, for a variety of reasons, investors don't want to invest. It became a very small part of benchmarks.
So people would say, "Why do you care?" What does this all mean? It means that while the profitability is pretty good on the asset side, funding those assets is very difficult. And that's the issue that the industry faces and why you can get a very asymmetric return in the oil and gas business. I mentioned that equity cost of capital is 10 to 20%, which is the return investors receive. But you could get this asymmetry where commodity prices go very high.
And the reason for that is, there is this disconnect or lack of functioning in the financing markets where you really can't borrow a lot of money from banks. You can't aggressively lever up to grow production. Investors don’t want you to grow production. And so, instead of expanding the asset side of the balance sheet, companies are doing the opposite of what they've done for history... which is, they're actually trying to shrink the liability and equity side of the balance sheet. So they're paying down debt. They are returning capital to shareholders through dividends and share repurchase programs – which are creating value.
And so, when you shrink one side of the balance sheet, the other side has to shrink also. And so, we would argue that the signs are that the world – the globe – might not be spending enough money on oil production. So what are the signs of that? If you look at the offshore market where 30% of the world oil is produced, the rig count is less than half of what it was at the peak. If you look at capital expenditures globally, they're half of what they were at the peak.
And this is at a time when on a normalized basis, once we come out of COVID, demand should go back to where it was. The economies have grown. Our estimate is that it will go back, and it will start growing, albeit at a very slow pace. But you're going to see very high, relative to what we saw last year, oil demand. So going back to the 100 million barrels a day of demand that we think is reasonable, the question is, "If people aren't spending in a depleting business, will we have the supply?" And that's the big "question mark."
Dan Ferris: So going back to my original question, then, you're implying that the push toward renewables is not making any kind of a meaningful dent in demand. It may be discouraging investors, and that may be setting up an actually pretty good situation for contrarians. But overall, it sounds to me – what I just heard was no mention at all of any worry about the worldwide, really political movement toward renewables. Like, you're not worried about that at all. You're really confident about demand.
Stan Majcher: I would say let's put some math behind some of that stuff. Look. Renewables do have an effect – alternative energy, efficiency, they do have an effect on demand. That is undeniable. The question is the pace and the amount. So what I'd like to point through is, let's think about electric vehicles. Because then the narrative is one thing. You can tell – anybody can say any story they want. But, you know, is it feasible? Is it likely?
You know, if you think about the cars, trucks, roughly they turn over about 7% a year. So maybe the asset life is about 15 years. You know, half of oil demand is road transport – generously, including trucks, etc. Today, EVs are single-digit share of the total vehicles sold. Let's assume that they were 10%. So if you multiplied the 7% turnover by 50%, by 10%, you end up with on a yearly basis that... maybe it's 30 or 40 basis points, in a very optimistic scenario that the demand would decline. It's really not the very, very large numbers that people assume.
It takes a long time. I think it's arguable that a lot of these technologies, etc., are very capital-intensive, very long lead time, very energy-intensive, and we'll consume actually a lot of [laughs] oil in the path to getting there. So I would say it's not that we dismiss demand, the effects of alternative technologies, of electric vehicles. It's that when you model these things out, it tells a story that, Yes, it does have an impact. But it is not the impact that people would assume.
Dan Ferris: Right. I mean, you're actually preaching to the choir, but I had to ask the question because I know it's on the listener's mind. But yeah. Yeah. All-day long, I hear you.
Stan Majcher: And maybe just say – we can also do the math. That's the demand side. The supply side, it does tell a pretty dramatic story. So if you think about those numbers on the supply side, people will say, "Oh. Well, oil production depletes at 5% a year worldwide." I’m skeptical of that. If you think of the U.S.'s – call it 15 to 20% of oil production with somewhat north of a 20% decline rate, you've got the rest of the world if you assume the 5%... You come up with the world is depleting at probably not 5%, it's probably between 5 and 10%.
And so, if we don't spend money, if we don't replace the production, you could see a pretty significant drop in supply. And I think that that asymmetry is where demand is very hard to affect in the short run, particularly with growing economies, and the expectations are that the world economy is booming – but supply might not be there to meet it. It's a vital commodity that you need. The world can't operate without it. So you could end up with this asymmetry where there is not enough supply to meet demand.
And if you think about commodities, there's kind of three pricing regimes. One is, you have too much supply, so prices go down to cash cost. That forces producers not to produce. Balanced market where... it's where supply and demand meet. It's where producers get their cost of capital returns. And in an undersupplied market, whereas instead of – it's the opposite of the overspend. You're actually trying to force consumers not to consume. And that's a very, very high price.
And if we end up with a disconnect between supply and demand, you need to try to force consumers not to consume. It's an inelastic commodity. When we saw high oil prices, the last time, over $100 a barrel, we were actually still growing demand. So those prices can be very, very high if we do end up with an undersupplied market. And so, I think that's what gets interesting. So I mentioned at the start, "Look. You don't need an undersupplied market. If things stay where you are, you get very good returns." But the asymmetry is also very, very nice.
Dan Ferris: Right. So the counternarrative, then, is, "Go ahead. Push renewables down our throats and discourage fossil fuel production and investment if you must." But you're just setting up a fantastic contrarian play and a fantastic opportunity to get in that third pricing regime, that third investment regime of higher returns... for some period of time.
Stan Majcher: Exactly. I mean, if you think about that balance sheet framework but also the people managing those balance sheets, what they're thinking about, they're looking at it and saying, "OK. My assets – OK. They might be good. Profitability's good today. But how am I going to finance it? It's very expensive. Banks don't want to lend to me. Equity investors don't want me to grow." And if you think about the majority of oil produced around the world, it's not what happens in the U.S... what people think about. It's very long lead-time projects.
You know, as we mentioned, deep water oil is 30% of world oil production. To get something on stream takes a decade. You have to shoot seismic. You have to agree to licenses. You have to drill exploratory wells, and you have to appraise it. Then you have to develop it. There just aren't a lot of companies or investors – as bullish as I am on oil, the thought of doing projects that won't come on until 2031 if you started today... it's just very unlikely. So, you are really putting it to the U.S. shales if we get an undersupplied market. That's really kind of your own short-cycle supply. And, as I mentioned, that's at best 15 to 20% of world production.
Dan Ferris: OK. Now, this fund that you manage – Hotchkis & Wiley Mid-Cap Value – energy's a big component. But the biggest component is financials. Correct?
Stan Majcher: It is. So again. [Laughs] As I mentioned, being a contrarian and being a value investor – being an energy has been difficult. Also being an investor in financials is difficult, being the co-manager on the product... Hunter Doble covers financials. And, again, people are very skeptical of financials. If you look at the businesses, they trade at 10, 11 times earnings. When you – the thing I like to do is take 1 over the P/E, which is the earnings yield. So you're getting a 10-or-so-percent earnings yield. Companies can buy back stock, which creates value.
So you might even be getting a better earnings yield than that. And similar to energy, it provides an offset to what potentially could be a very significant change in the world. So, what am I talking about? So if you look at interest rates, I think in 3,000 years, we haven't had negative interest rates. I would argue interest rates seem very low. I would also argue that quantitative easing pushes the level of interest to rates they wouldn't be if they weren't doing that.
I also think that while quantitative easing in and of itself might not cause inflation because it ends up on bank balance sheets and doesn't get lent, some of the programs that we're now seeing globally – which we haven't seen historically or in limited degrees... if you provide stimulus, if you provide loans that you don't have to pay back, that could potentially lead to inflation. And with inflation, you could see higher interest rates. What benefits, in addition to oil, would be higher interest rates benefit financials.
So again. You might have that asymmetry where you're paying 10 or 11 times earnings today, but those earnings, as interest rates rise and financials' net interest margins expand... they might be even less than that. And so, it's been difficult historically focusing on those areas because the wind has been in our face. Interest rates have dropped. There hasn’t been a lot of inflation. Growth stocks have been going up in price regardless of what they earn.
And so, we look at the portfolios. As an actively managed fund, we say, "Look. We're buying things at very low prices. If the current environment stays where it is" – so if oil prices stay where they are, if interest rates stay where they are – "investors in these areas should earn higher-than-market rates. And if things turn out better than we expect, they should be well above market rates." So I think that when I look around at portfolios, it seems like investors have maybe too much in debt instruments.
At very low interest rates, historically. They have a lot of exposure to long-duration assets. They have a lot of exposure to growth. On the other end of the spectrum, they have very little exposure to things that might hurt their purchasing power, like inflation, etc. And we would benefit. So the way I think of it is, most insurance policies have a cost. This insurance policy probably has a return.
Dan Ferris: Oh. I like the way you put it. Yeah. I'm going to go back to the general topic of energy for a second, though, Stan. Because there's a specific thing that's on my mind. You did talk about the balance sheet discipline that energy companies are exercising these days. And a simpler trend is running through the mining sector, the materials sector, you guys might call it. But I notice, if your website is up-to-date here, your sector allocation is less than the benchmark, than Russell Mid-Cap Value. Is there a reason for that?
Stan Majcher: I wouldn't read too much into that other than, look, materials are correlated with energy, you know, in terms of global GDP growth. We would argue that probably the valuations are probably a bit better in energy than they are in materials. But it's very similar dynamics. You know, these industries have been told, "Don't grow production," and yet demand is growing. So you can end up with a lot of the same conclusions in that area. It's just we would argue that probably energy, we think, the risk-reward is better. And if we looked at adding that, it gives us maybe more exposure than we would want to global GDP growth. So that would be the reason for a lower weight in materials.
Dan Ferris: OK. Not reading too much in is what I need to do. [Laughs] There's also a specific question I have. I noticed, just looking at your website, just looking at the characteristics of your fund, it defined the typical market-cap range for your fund between $500 million and $20 billion. And at first, I was like, "Mid-Cap is $20 billion. Wow." And then, I thought about it. And I thought, "Well, when there are $1 trillion market and $2 trillion market cap companies, $20 billion's Mid-Cap." And the more surprising number is how low the $500 million is on the bottom. You'd think that would kind of inflate as well. Do you really have companies in your portfolio between $500 million and $20 billion?
Stan Majcher: Sure. And your question is going to get me into a rant about passive investing.
Dan Ferris: All right.
Stan Majcher: So here we go. Yeah. So when I started in 1996 when we launched the fund, shortly after that it was – call it $500 to $2 or $3 billion probably. Today, there are mid-cap companies defined as well in excess of $30 billion. One of the issues that you run into, and this is where my rant on passive investing and indexes go, if you look at the makeup of our benchmark, I believe it was the largest stock in the Russell mid-value last year was Twitter. So again. It's a very large company. Not a value [laughs] investment in my opinion.
But it was the largest part of our benchmark. So what are in these benchmarks and passive investing – I think it's interesting because investors or consultants, etc., compare us to the benchmark. And when I look at our benchmark, it is overloaded in stocks. If there's some growth stocks in there, there's some high-growth stocks in there, high-multiple stocks in there... but there's also a lot of bond proxies. There's also a lot of staples, a lot of REITs, a lot of utilities. Historically, those things don't do well when interest rates rise or there's inflation. And what's interesting is, they're thought of as being low-risk. But they might be very high-risk.
And so, it's interesting. When I look at the benchmark, I would say, "Gosh. I wouldn't invest in that." Plus, one of the other issues in passive investing is we're seeing some of these meme stocks come in. You know, those tend to be categorized as value because they're not growing. They don't have a lot of profitability. And the valuation is very high. So passive investing to me I think is creating a lot of distortions in the market. It is investing without figuring out what the business is worth. So an active manager, as I mentioned, we go through and try to figure out, "OK. What are the returns? What's the earnings power? What's this worth?" A passive investor is saying, "Oh. I like this theme," or "I like this group of companies," or "Because I think it's going to go up." And what that does is, it creates distortion of the market.
Dan Ferris: Actually, Stan, the algorithm on passive is even worse. "Receive a dollar of capital, throw it at the benchmark." I mean, it's worse than that, isn't it?
Stan Majcher: It is. I think eventually – and investors will wake up and realize – there's this capital mechanism that we described in energy... which is, investors look at it and say, "Well, OK. This is your cost of capital, and the profitability is high, capital will flow toward it." Today, I would argue that the capital markets are broken. You know, we are investing in things with low levels of profitability or not profitability. They're seeing a lot of capital. The more capital you get, the lower returns go.
And so, it's creating all of these distortions in the market. I mean, a good example would be meme stocks. You know, you see the valuations. Does it mean that we should be adding movie theaters like crazy? Probably not. But that's what the market is telling you. Does it mean that we should be adding a lot of SPACs? The great thing about SPACs is, they actually provide forecasts. When you go through with somebody who looks at fundamentals and you can calculate and say, "OK. This business – OK. You've shown me five years. What does the return on capital look like from this proposition?"
In a lot of cases, it looks terrible. And you can look at businesses and say, "Well, gosh. You owned this asset and it cost you $100 million. The market is valuing it at $1.6 million. Why? If the returns don't look very good, you should pay less than $100 million." But that is what's going on. And so, we are funding a lot of very low-return businesses in my opinion. And that's not a good thing. And we're starving capital in places we might need it. Like you said, like commodities, energy, etc. So it usually doesn’t end well, but it's going to be very interesting.
Dan Ferris: Yeah. You know, I've begun to think of myself – I'm starting to look like the last bear who's about to be gored or something. Because I start scratching my head about a stock like AMC or GameStop or something, and I think, "Well, what if all this money they raised, they really do something good with it? What if it really works out?" It would be crazy, wouldn't it? But the odds of that are – I believe the odds of that are really poor. But I feel like the fact that I'm even drawn into thinking about this – because management did the right thing. I mean, that's what you should do when your stock is egregiously overvalued, you should sell as much of it as you can and raise as much capital as possible.
Stan Majcher: Yes. I mean, and I can't comment specifically on those companies. But if you think about it, those – why do management teams raise equity?
Dan Ferris: Because they can.
Stan Majcher: Yeah, because they can. And because the cost of equity is very low. Now, the cost to the company is the return to the investor. So if they believe like, "Hey. This is even a lower or negative return," the investor is going to get a lower negative return. And so, when you look at these companies in this framework of a balance sheet, they believe that the cost is very low. And so, therefore, the returns are low... it'll issue. And it's not just the meme stocks this is going on. If you look at a lot of places in alternative energy or just growth stocks in general, a lot of these businesses are businesses that we have a lot of familiarity looking at.
And we look at it and say, "Hey. There's no barriers to entry. There's a lot of capital. People are trying to grow for growth's sake. The valuations don't make sense." This is a bad idea. And it's large. I mean, there is a lot of instances. And I think the best – again, going back to the SPACs, as a value investor, we're used to looking at commodity businesses. I can look at what investor – what these forecasts say. and it's like, "OK. This is a 2% return-on-capital business and yet people are paying multiples of the capital."
And you look through how somebody could possibly recommend this on the sell-side. And usually, it's multiples of revenues. Revenues are not profitability. And if you get swarmed with a lot of capital, I would argue that the returns will actually be lower than that 2%. So it's an interesting dynamic. You're not the lone bear. You don't want a lot of these things. I think what will happen is, eventually – as I said, fundamentals do matter, and they can matter significantly and quickly.
Dan Ferris: Yeah. They can matter significantly and quickly. God. I feel like we could stop there, and that would be like the most effective way to do this. But we have been talking for a while. I want to get to my final question for you. And it is, simply, if you could leave our listeners with one thought today, what would it be?
Stan Majcher: Sure. So the one that I would use is, have a framework for how you view the world... how you view investments. And it can be as simple as what I mentioned, the balance sheet. And I think it's applicable to everything we've talked about, which is, "OK. What are businesses doing? Are they growing their assets? What is the cost of capital?" The cost of the company is my return. So if you take that and look at the equity markets, "Where is capital flooding," it's into a lot of speculative areas. "Will you get a return there?"
And the answer might not be what investors – how investors are positioned. On the other end of the spectrum is probably where the opportunities lie. Businesses that aren't trying to grow their assets that have high equity costs of capital, they can create a lot of value. And when I look at the energy business, I don't see the assets swelling. I see them actually, probably getting smaller. You could end up with a tight market. And these investors – these management teams, excuse me – can create a lot of value in this framework, if they can buy back stock, if they consolidate, there's a lot of efficiencies gained.
So the thing I would leave investors with is, Have a framework. Think about things in terms of assets and how they're funded, what can happen in the world. And use that as a lens to viewing investments, and you should get a return on your capital as well as a return of your capital. And try to avoid things that are very speculative. And then, I would – maybe the other corollary to that is, if you're looking in the rearview mirror, you probably see very low interest rates, very low inflation. Those things can change. If you see a lot of money supply growth, that can lead to higher interest rates and inflation. The investment dynamics of the world can change, like I said, very rapidly and very significantly. So those would be my two things that have a framework but also recognize that the rearview mirror is probably not a very good predictor of the future.
Dan Ferris: Oh, I love that. I love that because – especially the first one. That assets and how they're funded, looking at the balance sheet. Because it keeps investors out of the typical mistakes of trying to predict the stock market based on the headlines and following fads. It's very bottom-up. And yet, if you look at enough balance sheets, you get a real feel for industries and for the financial – what do I want to say, the climate in general. Don't you? I like that, Stan. I like that a lot. Thank you for that.
Stan Majcher: Thank you.
Dan Ferris: You bet. So thanks for being here, and we'd love to give you a call back in six or 12 months and see what's on your mind then.
Stan Majcher: Well, that'd be fantastic.
Dan Ferris: Yeah. I really enjoyed this a lot. Thanks for doing it.
Stan Majcher: Thank you.
Dan Ferris: I really enjoyed that. I think that we do a good job of finding people whose job is putting their own and others' capital at risk. And that constitutes a kind of skin-in-the-game of investment that – there's no substitute for it. You can't do anything else that's going to give you that same perspective. Putting capital at risk is what it is. If you're not doing it, you just don't have that perspective. And people like Stan who have been doing it for decades, more than two decades in his case, they tend to know a lot, a lot of really valuable stuff from real investors. That was great. All right. Let's take a look at the mailbag. Let's do it right now. [Music plays and stops]
On June 24, I invited Dr. David Eifrig on the show to discuss the greatest upset in the history of American retirement. If you missed the event, you still have another chance at Doc's thesis but in a different way. Dr. David Eifrig says what's coming next is a phase he calls financial lockdown. So consider this your final wake-up call. He believes millions of Americans will be pushed down out of the middle class, out of private retirement and private health care and out of a decent life based on independents and privacy. Visit www.messagefromdoc.com to find out what's happening, what's coming next and – most importantly – four steps Doc says you should take right now to protect your investments in the years to come. Again, that website is messagefromdoc.com. [Music plays and stops]
In the mailbag each week, you and I have an honest conversation about investing or whatever is on your mind. Just send your questions, comments, and politely worded criticisms to [email protected] I read as many e-mails as time allows and I respond to as many as possible. You can also call our listener feedback line at 800-381-2357 and tell us what's on your mind and hear your voice on the show. Kind of a light mailbag this week. And nobody on the call-in line. But we had a few good ones here. The first one is from Vicente.
And Vicente just wanted to write in to say, "I'm in a work trip in Augusta, Georgia after a long day of work. I'm sitting enjoying local bourbon in a rooftop bar, and I hear this gentleman pitching someone over the phone for strategies and systems. His argument is that the system will tell you when to sell or buy. Guaranteed a win, eight out of 10 trades." And he's pitching the compound effect of 8% a day. Yes," Vicente says, "a day." And then he says, "Like, what? 8% a day compounded? It seems impossible, but it's an amazing pitch. The dialogue is like, quote, "Imagine now instead of $100 U.S. dollars you have $200,000 and you do 8% a day compounded." Anyway. It made me think about the podcast. Have a great day. Keep us all sharp. Vicente."
Vicente, thanks for that. It speaks for itself, and I'm glad you sent it in. Next is Dr. Dominic F. And Dominic F. says, "Thank you for your great show. You mentioned in your last show the growth-value trade. I tried to follow your trade. That value and growth will shift totally makes sense. You mentioned a signal in the chart in June which I cannot see. I have attached the growth chart versus value, and in the chart, growth was always above value in the past 20 years. Looking forward to hear from you on how to set the chart to see the signal. Or was it the wrong ETF? Kind regards, Dominic."
No, Dominic. You used the Russell 2000 Growth and Value, and I said you could do that and you'd see the same effect. And what you have to do is – sure. If you just said a 20-year chart, you're going to see, really dramatically, you'll see it on like a 10- or 11-year chart from 2009. It just looks like growth takes off and the two lines never touch again. However, what you really need to do is set it exactly from the moment when I'm talking about. You can't just look at the chart of the long-term chart and then look at where it is in June of this year and say, "But the lines don't touch."
That's not how it works. You have to start it at the beginning of June. And indeed, if you look at the Russell 2000 Growth ETF and the Russell 2000 Value ETF and you start them at the beginning of June, you will see that the Value ETF is down about 5%, and the Russell 2000 Growth ETF is up about 2.5%. So that's a pretty good differential. And I'm saying that that dip, that's a dip in the value versus growth trade in that you can buy value there, and I think it's going to continue to outperform overall as it's done for several months now. OK?
So what you do is, you have to start the chart from there. And you also – I'm using FactSet, and I used to use Bloomberg. You can do the same thing there. And what you do is, you start them at the same moment and then you index. You don't look at the absolute values. You index them from 100. So if you do that, you start them both at 100... well, the Russell 2000 Growth is at 102. About 102.5. And at the end of that roughly month-long period, the value is at about 95, just call it. Approximately. So that's how you have to do it to compare them easily, to see the relative movement in them. I hope that helps. I'm glad you asked it.
Finally, we hear from Steven. And Steven says, "Hi. Do you think the dawn of quantum computing will be a Y2K-like event? From what I’m reading, quantum computers are developing at a rate where they will soon be able to crack standard public encryption systems. Potential consequences include person loss, business losses, even military and state losses. I have to believe that our military leaders have their pulse on this threat and are planning according. Should investors not be pressing management at the companies they invest in on how they are preparing for this threat? What about our brokerage companies? Please let me know if this is a "Chicken Little" Y2K scenario or if I should actually be concerned. Thanks again for all your great work on the podcast. Steven."
Now, Steven, I'm not a tech guru. And I'm certainly not going to predict the impending dominance of quantum computing. And a previous guest asked the same question months and months ago. We asked Eric Wade, and he said, 'No. it's not nearly as far along as anyone thinks." So it's not nearly the imminent threat that anyone thinks. And from my viewpoint, sure, maybe quantum computing could crack standard public encryption systems – as you put it – but what type of encryption would it enable? There's always another side to it, is my only point there. It's not a problem until it is. I'll just leave it at that. And I shot Eric an e-mail. He hasn’t gotten back to me yet.
And I'm going to keep your question and maybe we'll hear from him again next week. But I don't think we really need to because I doubt anything's changed in the few months since he answered it the last time. Anyway. That's another mailbag, and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as I did. We provide a transcript for every episode. Just go to investorhour.com, Click on the episode you want and scroll all the way down and click on the word transcript and enjoy.
If you liked this episode, send someone else a link to the podcast so we can continue to grow. Anyone you know who might also enjoy the show, just tell them to check it out on their podcast app or at investorhour.com. You can subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts. And while you're there, help us grow with a rate and a review. You can also follow us on Facebook and Instagram. Our handle is @InvestorHour. Follow us on Twitter. Our handle there is @Investor_Hour. If you have a guest you want me to interview, drop me a note, [email protected], or call the listener feedback line, 800-381-2357 and tell us what's on your mind and hear your voice on the show. Until next week. I'm Dan Ferris. Thanks for listening.
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