On a week where the S&P 500 hit an all-time closing high, Dan breaks down what it means for investors – continuing blue skies, or peak of a mania?
Most of the time, he doesn’t care about the market’s valuations – except for two times.
These special circumstances are rare. They come together less that 1% of the time.
And as it happens, Dan has come across a major warning sign in today’s market valuations – something that comes on the heels of billionaire investor Ray Dalio’s recent report that corporate margins, which have propped up increasingly high market valuations, could come falling from right under them.
Then, after reading some tea leaves concerning Amazon’s latest ventures, and a besieged billionaire investor, Dan brings on this week’s podcast guest.
Ben Hunt is the Chief Investment Officer at Second Foundation Partners, a consultant for large institutional investors, and the author of Epsilon Theory, a newsletter and website that examines markets through the lenses of game theory, history and nature. Over 100,000 professional investors and allocators across more than 200 countries read Epsilon Theory for its fresh perspective and novel insights into market dynamics.
In prior positions, Ben has managed a billion dollar hedge fund and served as Chief Strategist for a $13 billion dollar asset manager. He has a Ph.D. from Harvard University, was a tenured Political Science professor, and has co-founded three technology companies.
From the increasing financialization of our economy, to his company’s technology that produces a Zeitgeist – meaning “mood for the age” of our economy and markets, Ben offers all kinds of insights on a market that may be entering a new, treacherous stage.
Chief Investment Officer at Second Foundation Partners, author of Epsilon Theory
NOTES & LINKS
02:53: Dan spells out the two rare instances where valuations matter a whole lot in the stock market. Hint: They both have to do with extremes.
06:10: Dan explains why margin-adjustment indicators haven’t meant anything to investors for a while, and what rising corporate margins have to do with the death of a metric.
10:10: Ray Dalio’s recent report posits that corporate margins could become compressed – or enter a dramatically different (lower) era. Dan explains why that could fatally undercut this bull market.
17:34: The knives are out for billionaire investor Eddie Lampert, as Sears Holding Corp., the company he once controlled, is suing him for stripping them of assets before and during their slide to irrelevance.
22:30: As the department store Kohl’s says they’re going to accept Amazon returns in all of their stores, and Dan has to wonder if this alliance is actually a sign of weakness in Amazon’s once white-hot ascendance.
24:26: Dan introduces this week’s podcast guest, Ben Hunt. Ben is the Chief Investment Officer at Second Foundation Partners, a consultant for large institutional investors, and the author of Epsilon Theory, a newsletter and website that examines markets through the lenses of game theory, history and nature. Over 100,000 professional investors and allocators across more than 200 countries read Epsilon Theory for its fresh perspective and novel insights into market dynamics.
26:26: Dan asks Ben about the most interesting feature on his website, the Epsilon Theory Discovery Map. “There’s nothing like it I’ve seen on any other financial theory website.”
32:16: Ben explains how he applies the technology he licenses not just to Wall Street, but also to the public financial media published every day. It’s called the Zeitgeist – meaning “spirit of the age” and he uses it to get a birds-eye view of sentiment everywhere.
34:45: Ben explains how the market’s upwards trajectory may not make sense from a fundamentals perspective – but when you look at it as a function of narratives, it makes perfect sense.
40:44: Rising corporate earnings sound bullish on the surface, but Ben reveals why these gains actually aren’t coming from improved efficiency, and are all too often just an illusion of prosperity.
57:50: Dan reaches into the mailbag with a question from Paul E., who asks what financial websites users should frequent since Yahoo!Finance’s statistics tend to be so spotty. Dan explains where to go at SEC.gov that will give you a treasure trove of information at your fingertips, including things “a lot of people listening to me don’t know exists.”
Recorded Voice: Broadcasting from Baltimore, Maryland and 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 and welcome, everyone, to another episode of the Stansberry Investor Hour. I am your host, Dan Ferris. I'm the editor of Extreme Value. That's a value investing service published by Stansberry Research. We have a really cool show lined up today, and I just want to get right to it with the weekly rant. And the we're going to have a fantastic interview later on. All right? So here we go. All right, guys. Listen. I don't want this rant thing to turn into Dan being bearish every week, and I think I've done a good job of avoiding that for a while. But as I'm talking to you... we don't normally do this, but I need to timestamp this. OK?
We're about an hour away from the market close on Tuesday as I'm talking to you. And it looks like the S&P 500 is going to make a new all-time high close. Why do I care about that? Well I really don't care about the price, the specific price. Whether it's 29, or 29.34 or whatever the specific price is. Or even whether it's making a new high in price. None of that really means anything to me. The reason why I'm talking to you about this today, and the reason why I kind of timestamped to let you know this is happening is because of valuation. Right? That's the thing that concerns me. That's why I talk about this from time to time. And I haven't talked about it for a few weeks. So, you know, we're having a new all-time-high. So it's time to talk about this again.
So here's the thing. I've said this before, I'll say it again. Most of the time, I don't care what the valuation, you know, like the PE ratio is one way to measure the valuation. Although the regular headline, the PE ratio that you get from the S&P 500 tells you not much at all that's meaningful. But that's one way to measure the valuation. Price to sales is another way. Right? So you measure the price in relation to some metric, and that tells you whether it's expensive or cheap or somewhere in between. I'm telling you, 98% of the time, 99% of the time – more even – I don't care about this. It doesn't matter.
It only matters two times. It matters how expensive the whole, overall stock market is two times. One time is when the stock market is overall very, very cheap like it was in March 2009. The other time it matters to you as an investor is when the overall market is expensive and near an extreme high of expensiveness. That's where it is right now. And so, we're not just near a high in price here. We're at an extreme high of valuation. What does that mean? Well we've talked before about the work of John Hussman from Hussmanfunds.com. And one of his – he's got five of these metrics that correlate... these are the five that correlate the best historically with subsequent 10-year returns.
Meaning, when these five measures are high it's highly, highly likely historically speaking that returns over the next 10 years are going to be low. And when these five measures are low, it's highly, highly likely over the next 10 years that returns are going to be high. Well they're all high now. They're higher than they've ever been. One of them that I think is particularly important today is what he calls MAPE. Right? You may have heard of Shiller CAPE. That's the cyclically adjusted PE ratio. Well that's not quite good enough, because Shiller doesn't cyclically adjust for profit margins. Hussman cyclically adjusts the profit margin. So it's called margin-adjusted PE. And that correlates better with subsequent 10-year returns than the Shiller CAPE. OK?
And the Shiller CAPE is, like, 31. But the Hussman MAPE is, like, 44 – higher than it's ever been before. Higher than the 1929 peak, higher than the dot-com peak. The stock market has literally... by the measures that truly matter to investors, the stock market has never been this expensive. I said the same thing when all these measures hit a huge high back at their other peak back in late August and September of last year. So this is just common-sense investing. Right? Think of it this way. You know, if you buy a piece of real estate and it yields $100 a year, and you pay $1,000 for it you're paying... you know, you're getting a 10% yield. Well, you know, if you pay double that you're getting a 5% yield. And if you pay double that, you're getting – what, 2.5%. And you can keep doubling.
And actually, that's where we are about right now on the earnings yield in terms of the Hussman margin-adjusted PE. It's around 2.3%. Which is really low. It's just, if somebody said, "Hey, I got a great idea for you. It's going to make you 2.3% and you might lose half your money," you'd say, "Up yours, buddy," and you'd be out of there. And that's what the U.S. stock market looks like right now according to these measures that matter. OK? Now another guy... this margin-adjustment thing, it hasn't meant anything for a while. And I'll tell you why. Starting around the late-'90s, corporate profit margins started rising in the U.S. Like, for a long time, the average was around 5.5%. 5, 5.5%. You know, topping out at like 6% maybe. But just around 5% really.
And in the late-'90s, they kind of bumped up. And then, in the early-2000s they bumped up higher, and higher and higher. I mean, in fits and starts, you know, in 2009 when the bottom fell out of everything... you know, the margins plummeted. But as an average, things have just risen and risen. This is the – I'm talking about the net corporate profit margin of U.S. companies. Non-financial companies. And now, it's up around 8%. So it's just gone up and up and up and up and up. And there has been a lot of talk about this – or there used to be. There was a lot of talk about it. But now, I think people have gotten really complacent about it. And they're unaware that, if margins sort of readjust to normal levels... one report that just came out by Bridgewater Associates, the biggest hedge fund in the world, Ray Dalio's the founder – pretty famous investor at this point – they're saying that U.S. equities would be 40% lower without this consistent expansion of margins that we've seen for the last, oh, 20, 30 years.
Without that, if corporate profit margins had just stayed around their average levels like they've done, you know, for decades and decades before, U.S. equities would just be 40% lower at the current valuation. Right? Because there'd be less profit. And, you know, the market would be lower. Well I talked about Hussman. Hussman is, you know... he's studied this stuff really well. And in his estimation – just like a run-of-the-mill correction, a run-of-the-mill, you know, kind of typical end to the long-bare markets since 2009, readjusting for all this margin stuff... just run-of-the-mill would be like buying his 65% from the all-time-high that we're at, you know, as I speak to you.
So Hussman has been – you could say, "Well he was bearish when he shouldn't have been years ago." OK. Sure. I get that. I still think he's done a really great job of learning how to value the overall stock market. But Ray Dalio and the folks of Bridgewater, they've been pretty good at avoiding that type of, you know, bearishness. They've been pretty good at spotting times when things change and then sticking with the trend as it goes higher and higher and not giving into early bearishness. But they're now saying that, you know – he put out a report recently that's called, "Peak Profit Margins: A US Perspective."
And they're saying that, if margins stagnate maybe valuations are a bit expensive, but not terrible. If they revert towards historical averages, though, equities are highly overvalued. And they're suggesting reasons in this report that, you know – I won't go into the whole shebang here. But they're just suggesting that there's reasons why the things that have kept margins that they feel have kept margins pumped up for 10 – or I'm sorry, for 25 or 30 years – are in danger of falling away.
You know, globalization is one of those things, because part of globalization was, corporations wanted to spend less on labor. But that'll contribute to a profit margin. Won't it? So they globalized. They took their manufacturing offshore. Well now, the profit... or I'm sorry, the wages... are kind of approaching a more equilibrium kind of a state, according to folks at Bridgewater. So that advantage, it's just not there as much as it was, and they think that'll continue. And there are other things, you know. They spotted some other things. You can just look in the report. But that's just one of them.
And there are other reasons why they think, you know, that it's starting to be a good time to worry about this. And with them, when I look at the... you know, if you keep that margin adjustment in mind when you look at what the margin-adjusted PE is, it's higher than it's ever been in the history of everything. There's cause for concern. OK? There's a little cause for concern. OK? So in other places – I've just looked at... you know, to see what other kind of smart people are saying about this.
One of them is our friend Jason Goepfert at sentimentrader.com. And he noticed something that kind of – it really feels kind of bad to me when I look at it. He says, "In recent weeks, Wall Street analysists have been raising price targets on stocks in the S&P 500." But at the same time, they've been lowering their earnings estimates. Right? So he says, "Well they're technically bullish. They think the stock market's going to keep going up." And this report was from April 15. So, you know, so far so good. Right? The stock market has kept going up. But they say that, you know, they're lowering their earnings estimates at the same time.
And he says, "Usually there's a positive correlation between the two, if they're raising their estimates, raising the price... you know, expectation – OK. All the price targets go up, all the earnings estimates go up together, or if they're lowering the price targets, they're lowering the earnings estimates altogether... that all makes sense. Right? The other scenario where they've been bullish on the earnings, the opposite of what we have now, and they're bullish on the earnings and bearish on the stock prices... stocks rose every time. And when they're like they are now, where they're bullish on the prices and bearish on the fundamentals, the performance has not been great. It's been a negative in the past.
So Jason Goepfert at SentimenTrader also notes that something else that I've been saying – OK. I've said this before, and it bears repeating until it's, like, no longer true is that the difference between gross stocks and value stocks like everybody knows growth has been beating value for a decade here. And lots of people expect that to continue. We're just totally irrational. But right now, the ratio reported by Jason Goepfert of global growth to global value, it's back at its prior peak. Like, from back in the dot-com era around March of 2000. So, you know – and Goepfert just notes, "Over the past 40 years, the other times it has neared this level and rolled over, it was bad for the S&P 500, horrible for growth stocks and not too bad," he says, "For value."
You know, maybe all these things happening at the same time is not a big deal. Maybe I shouldn't be worried. Maybe I should stop wringing my hands like this. But like I said, I think this is the one time when you need to look at these things and think about them and be careful. The only advice I have for you is to be careful. Don't buy something just because you think it's going to go up. You know, build a really fundamental case and don't overpay for things. And, you know, avoid all of these IPOs of companies that are trading at, you know, 10, 20, 30, 50 times sales that the new company called Zoom is trading, like 50 times sales.
You want to avoid that stuff, because that's the stuff that gets people killed and loses them 80, 90%, sometimes 100% of their money at times like this. This is the phase when speculation is taking over. Right? Early phase of the bull market, it's just the return of a confidence that business is going to be OK. Then the middle phase is earnings go up and they, you know, confirm that sense of confidence. And it goes on for several years. But then, we get into the final phase and it's when people just get way too optimistic about everything. And baked into this valuation of the market is like every kind of optimism there is. Margins are going to stay sick. You know, sicker than they've ever been. Valuations are going to stay higher than they've ever been. Everything's going to stay more wonderful than it's ever been.
And that's generally been a really bad expectation. You don't run out and sell all your stocks. You just, you know, use trailing stops. You know, kind of risk controls you think, and extreme value. The newsletter I write, I have consistently recommended that people be very careful about overpaying. Don't buy super-expensive companies. Sort of go for the extreme value... you know, the companies that are at the lower point in their cycle. A lot of companies are at the high point in the cycle, making lots of new all-time highs. But we found companies like related to the mining sector that are really great business models with low downside, great management, et cetera. Just cash-gushing dividend-growing beasts.
And, you know, they're at the lower end of the cycle. So they've already had all the optimism wrung out of them, and they have pessimism in their price. So that's the kind of thing that I would recommend buying. And if you hold plenty of cash and don't overpay – and those two things relate. If you're not overpaying and buying tons of tons of overvalued stocks, then you're holding plenty of cash. It's just a residual effect. Right? And I think that's where we are right now. That's what I have to tell you this week. It's just an overall, cautious positioning that I would recommend right now based on the exorbitant valuation. You know, adjusted for cycles and margins of the S&P 500, you know, as representative. I mean, that's 85% of the market cap of all U.S. stocks.
So, you know, it kind of means something. Right? When money comes out of the stock market, it comes out of the S&P 500. All right. That's the rant. Let me know what you think. Write in at [email protected] Tell me if you're bullish or bearish, or somewhere in between. And I look forward to reading those notes. So let's get on and find out what's new in the world.
[Music playing] OK. What is new in the world? Well, one thing that's new in the world is that Sears is going after Eddie Lampert. Right? So Eddie Lampert was the hedge-fund guy who controlled Sears for a long time and kind of ran it into the ground. And Sears Holding Corp is suing – he was the former chairman of Sears Holding Corp... and is suing Eddie Lampert for – and they're alleging him of stripping them of $2 billion in assets. And asset-stripping is like a standard thing. It's not always, you know, an evil, illegal thing. But it's kind of a standard thing that you do when you find a company that's loaded with maybe redundant assets as such it doesn't need. Or maybe it's a kind of a distress situation. Which Sears wasn't really super distressed when he came into it many years ago.
But it's a typical thing for a hedge fund to find a distress situation, but the company owns some valuable assets and maybe they're able to buy the company for less than the good assets are worth. So they buy it, they get control, they sell off the good assets, maybe they pay out a big dividend or buy back a bunch of stock and the stock goes way up. And yay, everybody's happy. But this is different. They're accusing him of not acting in the best interest of anyone but himself. They filed for bankruptcy in October. You remember we reported on that. And, you know, Lampert came in to allegedly save them, acquiring most of the assets for $5 billion. And the court sanctioned that, you know, purchase through his hedge fund.
But now, I think they're having trouble with the way he's – you know, the shareholders are having trouble with the way he's handling it. So they're going after him in court. We'll see how it all turns out. It's been a disaster, it really has. And yes. I'm going to brag one more time, that back in 2012 when, you know, Lampert had merged Sears with Kmart and they had all this real estate and stuff that they were going to monetize... you know, I said, "Stay away because this is not going to be the next Berkshire Hathaway." People were talking about him as a value investing genius, and he was going to start a new holding company. You know, he called it Sears Holding for a reason. But I said, 'You can't do this. You can't have this holding company built around a retailer."
Berkshire Hathaway built around an insurance company, which is a fantastic vehicle for building a great holding company. But retailers are terrible vehicles for that. And, you know, I just said to avoid it. And, you know, it's been pretty much downhill ever since. All right. End of bragging. OK? Another item in the news that I find interesting is Netflix on a spending spree again. They say they plan to offer $2 billion in debt to fuel more content-spending and other expenses. They expect to reach their peak cash burn in 2019.
So this is going to be the big cash burn. All those other peak cash burns, they were phony. This is going to be the peak and the cash burn. And the company offered another $2 billion in debt as recently as October. Right? And they're offering another $2 billion in debt now. So I guess whatever they're doing better work. Huh? Because they need to start making more money at it. And, you know, I don't know where Netflix winds up. I know that, you know, Disney now has a whole, whole lot of content.
And, you know, investors who know what they're talking about really like that stock for that reason. I know YouTube has a whole lot of content and some pretty smart folks I know think that is a way undervalued resource. And, you know, it's like a call option embedded within Google. It's a really, really competitive thing this content creation for television and video. And I don't think anybody can claim with any credibility that they know how it'll all turn out. I just don't like to get involved in these highly-competitive, enormous stakes undertakings unless you can do it with some type of a cheap option.
But that's hard to do here. I mean, I think Google is arguably the only way to do that. Wow. OK. One more item here before we get onto our guest who – oh man. I can't wait to talk with this guy. One more item. So Kohl's. Kohl's, the department store. They say they're gong to accept Amazon returns in all of their stores starting in July. So, you know, they started out – I think it was last year – with just, you know, a handful of stores. And now, they've moved the partnership with Amazon to include all of their stores. So more than 1,150 stores across the country, if you buy something in Amazon and you want to return it, you can go to a Kohl's store and return it. I mean, I wonder – they rolled it out to 100 stores. I thought it was last year or a year before. I don't remember. Not important [laughs].
But now, they're going to do it at all of them. And I have to wonder. Amazon has been on a bit of – you know, they were on a bit of a tear. They bought Whole Foods, and they're building their own different store concepts, including the one where you just kind of walk in and grab stuff off the shelf and you walk out and you're automatically charged without ever going down a checkout aisle or anything. And I just wonder if this is Amazon trying to get a bigger, you know – just taking baby steps towards getting a bigger footprint.
Although I can't honestly see them wanting to own 1,200 Kohl's stores because that's just... I don't know. It's just a big expense. It's like a huge investment that you would think they wouldn't want. Curious to see what happens there. Lot of stuff... lot of outcomes here that are just really uncertain. But that's all I have to say about what's new. You know, Sears going after Eddie, and Netflix is spending a lot of money on content. And who knows? Maybe Kohl's will be part of Amazon in a year or two.
[Music playing] All right. Our interview guest today is Ben Hunt. Ben Hunt is the chief investment officer at Second Foundation Partners that's a consultant for large institutional investors. He's also the author of Epsilon Theory newsletter and website that examines markets through the lenses of game theory, history and nature. Over 100,000 professional investors and allocators across more than 200 countries read Epsilon Theory for its fresh perspective and novel insights into market dynamics. In prior positions, Ben has managed a billion-dollar hedge fund and served as chief strategist for a $13 billion asset manager. He has a PhD from Harvard University, was a tenured political science professor and has co-founded three technology companies. Ben spends a lot of time on a family farm, which inspires may original ideas in the parallels between human and animal behavior. Ben Hunt, welcome to the program, sir.
Ben Hunt: Thank you, Dan. It's great to be here. I've got to get you to do my intro everywhere. That was sweet.
Dan Ferris: I know. Our intros are legendary. [Laughs] So I'm really thrilled to have you on, because I love your website. I just want all the listeners to know, I'm a huge Epsilon Theory fan.
Ben Hunt: Thank you.
Dan Ferris: Yeah. You just put out so much material. I'm like, "How does this guy have time to hang out on a farm and manage money and do all these other things?"
Ben Hunt: Well the good news is, I'm not managing money right now. You know, we've spun out my partner and I just Rusty Guinn, we spun out the Epsilon Theory publishing and research assets from our asset manager employer for the last five years. So it's just been fantastic for the last seven or eight months, we've been out from the belly of the beast with no compliance department, and not having to manage other people's money. So it's been wonderful. A good chance to do a lot of writing and a lot of research.
Dan Ferris: Yeah. And you have done a lot of that. Ben, one of the things that fascinates me on your website is the Epsilon Theory discovery map.
Ben Hunt: Mm-hmm.
Dan Ferris: There's nothing like it that I've seen on any other financial website. Where did this come from? How did you start doing this? And what is it? Why don't you tell our listeners what it is?
Ben Hunt: Sure. Sure. Sure. Well as you said in your wonderful introduction, we try to look at markets through the lenses of game theory, which is my academic background... Through nature – so I write about bees, and sheep, and all the animals that we've got here on the farm. But also through the lenses of – we call it history, but it's really narratives. What it really is, is the words that we use. Right? That we are immersed in as investors, as citizens. You know, it's what would be called unstructured data.
So this is not something that fits neatly in the spreadsheet. It's not a price time series that you get off of Bloomberg. It's the text that we hear from CNBC, or we read in the Wall Street Journal, the language that we're immersed in. And, you know, we all know that we are impacted by what we hear and we read, and what I will tell you is that we are hardwired to respond to these patterns of what we hear in very specific ways. And what has really changed over the last three to four years is that we now have just the sheer computer processing power to start to measure these words, and images, and, speeches, and television shows that we are swimming in just in a daily basis.
And so, what the discovery map is an application of that just raw computer processing power to accomplish something that's called "natural language processing," NLP. And the whole idea behind NLP is that you can take 1,000 articles, or the transcripts of, you know, all the speeches that people give and then you compare every word to every other word in these articles or speeches or what have you – which is a massive computing process, right, to do that – but then, when you do compare them and you apply these pretty simple Matrix algebra techniques that have been around a long time, it's just we didn't have the processing power to really apply them... when you do apply them, you see the patterns that emerge, the structural elements of narrative of the drum beating of financial media, of the patterns in what people say on CNBC and the like, and we can actually visualize them.
So what you're describing with the discovery map is something we did to the articles that we write on Epsilon Theory. So we created our own map, our own visualization of the narratives that we talk about, so that people can not just only search for an article.
But, you know, the problem with search is you really got to know what you're looking for. But you actually can engage in discovery. And what I mean by that is that, you can visualize which articles that we've written are similar to and the words we use, and the arguments we're using to other articles that we've written.
I'm old enough to remember going to the library and wandering the stacks. And you'd look up in the cart catalogue a specific book you were interested in. But then, the most wonderful thing to me was to go into the stacks, find the book you were interested in or you had search for, but then see all of the other similar books on the shelves above and below, and next to it, and to the right and to the left. That's what I mean by discovery. And I think that's something that's really been lost in our lives. Right? Since we're so dominated by the Internet and search ability. It's an effort to use some new technology to bring discovery back into what we read in here.
Dan Ferris: Does it also – it also ties into your Zeitgeist, your daily message. Does it not?
Ben Hunt: That's right. That's right, Dan. So this technology – and it is a technology. It is. You know, we license it from this company called Quid out in San Francisco. There are a couple of companies that license, again, what I'm calling NLP, natural language processing and technology. You can apply this tool kit to any collection of words and articles and transcripts – any collection of unstructured data. So we apply it to – like I say, the stuff we write ourselves to show our audience the library shelves, if you will, of what we've written. We apply it to the research reports that Wall Street puts out so that we can see, what is the narrative around Tesla, or around the financial sector that's coming out of Wall Street.
But we can also apply it to just the public financial media that's published every day. And so, what we do in this feature, we call the zeitgeist... which, you know, the zeitgeist, is a 10-dollar German word meaning, "The spirit of the age," right? It just means kind of what's in the air. And that's what we're really picking out here, is using these new technologies to read everything. So we use the technology on a daily basis to look at everything that was published publicly in financial media sources. And then, what we do is, we see, "Well what are the most connected articles?" Believe me. They're not necessarily the best articles. Well they're rarely the best articles.
But what they are is the most connected articles, or the most representative of the stories that we are being... again, immersed in on a daily basis. And so, when you identify those it's a wonderful tool to say, "OK. What am I being told today? What are the messages that I'm being exposed to today? What are the stories or the narratives that are really swimming around me?" And an example of a use of this sort of technology I think can make this to be, you know, much more aware investors.
Dan Ferris: And I also have to say, it seems like the perfect tool for this moment – not just because we're so inundated in information, but because it seems like narrative has more influence in the market than ever. But that could-
Ben Hunt: Oh, my God.
Dan Ferris: I'm not saying that's absolutely true. But it sure looks that way.
Ben Hunt: I think it is absolutely true. Or let me put it this way. We haven't seen a role for narrative in the markets this pronounce since the 1930s. And that's no coincidence, because the 1930s was the last time when fundamentals really didn't seem to matter. When the ground doesn't seem steady beneath your feet. I mean, at least for the last 10 years the direction of the market has been up in a way that doesn't really make sense. Right? Unless you think of it in terms of the narratives and the stories you're telling... it doesn't make sense from a fundamentals perspective. You know in the 1930s, nothing made sense from a fundamentalist perspective. It's always going down. But that's the similarity, right? In both cases, it's been a decade of fundamentals not mattering. And yet, we have to ascribe some why to what we do. And in these periods when the ground isn't steady beneath your feet, it really is the role of narratives and what we call in game theory the missionaries who create them.
Dan Ferris: And you have pulled out in interpretation of those last 10 years that I really like. You talked about it recently. The financialization of our economy... Tell me a little bit about that.
Ben Hunt: As you know, that word "financialization" has been around for a while now. And what really bugged me was that, it's a lot like the thing about narratives. I know it's out there. Right? I know that I am being told certain messages. But it's just really hard to put my finger on it. You know, what is a narrative? And so, let's say we – and other people as well – are applying this new technology to try to measure and identify the narratives that are impacting us. And so, I was trying to do this with this kind of amorphous word, financialization. And what I believe is that, the meaning of financialization, what we're trying to get at when we say, "Oh. The world and the economy has been financialized," it's actually a very simple concept.
And that concept is, when profit margins grow without labor productivity growing... right? And it seems like a simple thing. But here's what that really is meaning. The whole engine, I think, really of capitalism and, you know, making advances in your company or your economy as a whole... is that, you get better and smarter at whatever it is that you do over time – that you produce more widgets with fewer inputs. And that input includes labor that you make more with less. Or you're a service provider. Right? That similarly you apply technology. Or you, you know, apply investment in a new group of people. Right? To train, and then hire these people that will give you more bang for your buck. Right?
I think that really is the driving force behind real economic growth and a vibrant capitalism. And you see that measured in what, you know, governments collect what they call "labor productivity." And labor productivity is simply that. It's how much stuff or services are we producing per, you know, hour of labor per unit of labor. And in the 1990s, and really into the early 2000s, this country enjoyed really tremendous labor productivity growth. We were growing our profits, we were squeezing more profits, out of a dollar of sales for the right reasons. Right? I mean, this is what capitalism does. It's all about that invisible hand. It's all about what this, you know, Austrian economist Joseph Schumpeter called the creative destruction of capitalism.
It's a beautiful thing. And it really does allow for an economy to grow. Not from taking on debt, right? Not from, you know – I'll call it a zero-sum game where you're taking from someone else to, you know, get rent to make yourself better off. You're really growing the whole pie. And that labor productivity growth slammed to a halt with the great financial crisis. And it has not ever recovered. And it's the biggest I think failure of central banks and the Fed. They thought that by making all of this money available with the cheap financing available to companies... they thought that the companies would use that to then invest in, you know, plans, equipment, technology, training, hiring. You know, that they would invest in growth, and that we could have an economic recovery similar to what we had really through the 1990s.
But the truth was that, that's not what happened. And you look at our productivity numbers for the last decade, and they're horrible. They're just horrible. And yet, at the same time – at the same time that we have not invested in technology and equipment and new factories and training and hiring – even though we haven't done any of those things, our profit margins continue to increase to the point where they're at an all-time high. So how does that happen? Well it happens because what corporations have done is that, they've expanded profit margins, they've expanded earnings – not from squeezing more out from a dollar of sales, not from being efficient or investing in technology, or in people... but from tax arbitrage. From balance-sheet arbitrage. That's financialization.
And that is truly been the story of what appears to be, right? Expanding, and earnings. And so, we've got a reasonable P/E in multiple on the market. You know, the P/E multiple on the market today is 19. I will tell you that if we had not had this earnings expansion due to tax arbitrage and balance sheet arbitrage... if you hadn't had that available to corporate management, the P/E ratio on the market today would be 28. Right? It would be incredibly expensive. So this is what it creates, I think. And this is what we have today with financialization and why it feels, I think, so off to so many of us. Right? That the market, you know, is close to an all-time high today.
And yet, it doesn't seem like – and it's not producing. It's not giving us the real economic growth and the productivity growth that we've had in the past. That's what I mean by financialization. That's why I tend to rail at the Fed, because we've taken a group of strategies that I would say "zombify" our economy. Right? It creates the ability for companies to do fine, to get by – not from building better products, or offering better services, but by using tax and balance sheet arbitrage to hit their numbers and to do well for earnings. Right? And it also enriches particularly management through stock buybacks and the like – what are called the oligarchs. The oligarchs have really, I think, triumphed in this country over the last 10 years. So that was a long-winded explanation. But I think it's such a core, important concept for us to talk about the financialization of our economy. And the really, I think, way it just subverts the powerful forces, the powerful positive forces of capitalism and productivity growth that we've had in the past.
Dan Ferris: OK. A couple things. First of all, it sounds like a simpler... you know, if we wanted to just sort of simplify this, if I'm hearing you correctly, a corporation is saying basically, "Look, if we can make more profit without having to make more stuff or become more productive per unit of labor, why wouldn't we?"
Ben Hunt: Right.
Dan Ferris: So it's kind of – as you said in your piece you wrote about this, it's the easy move. The smart move.
Ben Hunt: It's the easiest. You're right. It's the smart play. It's the easy play. Why would you want to take the risk? And it is a risk. It's a risk any time you hire somebody. Right?
Dan Ferris: Yeah.
Ben Hunt: Yeah. You know that, Dan, from the business you've built. And all of your listeners know it as well. Right? Any time you make an investment because you want to grow your business, well it's a risk. So why would management do that when they can borrow money at nothing, right? Or in the case of Europe, you can borrow money and be paid to borrow money [laughs]. Right?
Dan Ferris: Yeah.
Ben Hunt: Yeah. Use that money to buy back your stock. Use that money to, you know, buy a company that has no profits but just as, you know, has a good story. That's the world we've created over the last 10 years.
Dan Ferris: Yes. So I get the balance sheet arbitrage as pure financialization.
Ben Hunt: Yep.
Dan Ferris: The tax arbitrage, I mean... you know, this is a way to keep from wasting money on taxes that you could use, you know, purportedly productively.
Ben Hunt: Well what I mean by tax arbitrage – the best example I've got is around stock buybacks. Right? So when a company issues either restricted stock or stock directly, or stock options to employees, because of our tax code the companies can deduct that from the taxes that they have. Right? So you see that in so many companies like Salesforce.com. Right? Which has, you know, billions of dollars in revenues. Amazon – another great example of this. When you can deduct the stock you're giving to your employees, you can deduct that from your tax bill.
And so, what I mean by tax arbitrage is that... for example, right, issuing stock that's tax deductible. Then you borrow money at nothing, or you use your revenues. Whatever you want to do. And then, you use that to buy back stock, which sterilizes the stock that you've issued to your employees. Some of your readers should do this sometime. You know, a company like Facebook for example, or a company like – any company that buys back stock. Right? Really any of them. Go take a look at what the total share count is for that company over time. And what you'll see is that, you would think, "Oh. Well they're buying back stock. They're shrinking their base of shares." Well for so many of these companies, all they're doing is they're just neutralizing the stock that they've issued to themselves.
Which, by the way, if you've held that stock a year versus a long-term capital gain, of course, that gain has been tax-advantaged as well. So when I'm talking about tax arbitrage, I'm not talking about doing everything you can to minimize the taxes you pay on your actual productive efforts and outcome. What I'm talking about is, using the tax code to, again, financialize and enrich a group of people. Which in this case, is predominantly corporate management.
Dan Ferris: I see. So it's actually a part and parcel of the balance sheet arbitrage really.
Ben Hunt: It really is. They work hand-in-hand. They absolutely work hand-in-hand.
Dan Ferris: Right. OK. So the question I have now for you, Ben. Well I have to tell you. This reminds me famously, Jeremy Grantham, the famous investor kind of threw in the towel on expecting margins to mean revert a couple of years ago. And he was right. They haven't.
Ben Hunt: Yep.
Dan Ferris: Does this ever mean revert? Do margins ever get back to where they were?
Ben Hunt: Well yes. That is really I think the question. Right? If you care about a valuation for the market. Recently. And by recently, I mean just a few weeks ago, Bridgewater – you know, the biggest hedge fund in the world – came out with a piece where they're saying, they do think that we are at peak corporate earnings in the U.S. And their argument – and it was similar to the argument that Grantham made in the past, right? Their argument is that we've had this margin expansion because of globalization. Right?
So we've been able to make these in technology and our ability to basically find, you know, cheaper labor somewhere else and then bring the products back over here. You know, the typical story of a technology and globalization. And that, they say – and I think they're right about this – globalization is now retreating – it's in retreat. And also, this ability to use what I'll call labor arbitrage, you know, to take your production facilities down to Mexico at your Auto parts manufacturer... that's in retreat as well. And so, they say, "Well with all these factors and retreat, we think this is peak margins, margins roll over.
If you hadn't had the impact of globalization, they say, well earnings would be 40% less. And so, all of the things equal, the market could have been, you know, 40% lower. Right? That's Bridgewater. Like I say, the biggest... and they're fantastic. You know, I live down the street from those guys and they are the biggest bounce. I think they're probably the best hedge fund in the world. The reason I don't think they are – let me back up a second. I think they are right about what they are saying. I think they're absolutely right about the retreat of globalization towards nationalist, you know, economic policies – well I'll call it even balkanization where it's not global now.
But it can be regional at best... I think they're also right in which the way the political pendulum is swinging away from capital and towards labor. I think that's right as well. But where I agree with Jeremy Grantham is that, so long as central bankers, federal reserve, ECB, Bank of Japan, the Bank of China... so long as they provide zero interest rate financing for corporations, and the case of course in Europe it's negative interest rate financing for the investment-grade corporates. Right?
So long as that's the case, you don't need real productive growth. You don't need technology. You don't need globalization to continue to have expanding profit margins. So I think for as long as this goes – and I really think that was the core of Jeremey Grantham's argument, that, "Look, this doesn’t mean reverting anymore. We've got a new – we've got a new sheriff in town." Right? And it's not the fundamentals. It's what is being provided in terms of the price of money and the availability of capital from central banks. It really does change those dynamics.
That said, I do think Bridgewater is right about the decline of globalization and the retreat to nationalism. I do think they're right about how the pendulum is swinging away from capital and back towards labor after 40 years of it going very much in favor of capital. So I don't see margins expanding much from here. Right? Because I think the real-world forces do work against corporate margins expansion. But I also don't see them collapsing. I also don't see them collapsing, because of these factors that I'm talking about around financialization.
Dan Ferris: Yeah. That's a reasonable view, isn't it? Ben, we're coming to the end of our time, OK? But I want to leave the listeners with something that I've gotten a great deal of enjoyment out of. Maybe you could just tell us, what is the difference between a raccoon and a coyote?
Ben Hunt: [Laughs] Well I'd say – so, you know, my farm here. We've got a lot of dogs. And, you know, we got this enormous – you know, five-acre invisible fence so we don't have to worry about the dogs. And the truth is, our dogs aren't that smart. Even our, you know, German shepherd dog. You know, she's really not that smart. She's not nearly as smart as the coyotes who live around us. And I say that because my dogs have to wear the collars to know where the invisible fence is. The coyotes don't need a collar. Right? The coyotes know exactly where that demarcation line is.
And I know it because they play games with our dogs. They'll just cross over and leave their scat on our side of the, you know, demilitarized zone. Our dogs don't even register with them. It doesn’t even register with them that the coyotes are playing this very smart game of, you know, competition with our dogs. And that to me is what a coyote is.
And I feel like I'm a coyote. And with most of the successful people I know in our business are coyotes. We're very clever people. Right? We're really good at playing that game, "Oh. I'm competing with these dogs over here. I'm going to do something really smart and clever. Because I know where that invisible fence is even if they're too dumb not to." Coyotes make the world go round. Right? But we can get too clever for our own good [laughs]. Right?
Dan Ferris: Right. Yeah.
Ben Hunt: I know that I've been this way my career, and most, you know, clever coyotes I find that they get their comeuppance more than a few times in a career because – this is the Brett phrase, which is wonderful. "They're too clever by half."
Dan Ferris: Yes.
Ben Hunt: That's what coyotes are. We're too clever by half. And where we always get undone is what I call the "metagame," meaning that it's the big picture. Right? We coyotes, we can be oh so clever in figuring out this little, you know, twist on a strategy or something. But we don't see the forest through the trees. And it always comes to bite us in the ass. That's what happens to coyotes. So I was writing an article about this, because that's really what I felt about bitcoin for so long... that it was invented by crypto and journals promoted by individuals who are really liked. Right? Because they're really smart, and they're really trying to figure things out.
But the problem was, they're too clever by half. Right? They come up with these great ideas. But look. You don't see the forest through the trees. And the forest o the trees is the government hates crypto. And it makes it easier for you to avoid taxes, and for them to have a harder time controlling their money. You know, you've got to take into account the bigger gain, the metagame. So that's a coyote. But my bigger problem with crypto, bitcoin, or frankly with financial innovation period is that it brings out another kind of animal. And that's the raccoon. So raccoons, unlike coyotes – I like coyotes. I mean, I don't want them coming onto my property, but I admire them. Right?
I hate raccoons. I despise raccoons. Raccoons are just thieves. Right? They think they're clever, and they are pretty clever. And they got the, you now, paws with apposable thumbs or whatever. Right? But raccoons are just thieves and murderers. They're just criminals. And the problem with financial innovation is that, it's always created by coyotes and then it's taken over by raccoons.
And my God. We saw this in every aspect of financial innovation, you know, that I've ever been experienced with. And we sure have seen it with crypto and bitcoin, where you get the shysters that come out. You get the, you know... at best, they're conmen if they're not outright thieves. So I really do find it useful to kind of divide the world into coyotes... and the flaw of the coyote is when you're being too clever by half. And then, raccoons that you just got to get rid of.
Dan Ferris: Right. Beautiful. I just love that. "Raccoonery" is something I'm constantly on the lookout for now thanks to you, Ben.
Ben Hunt: Thanks.
Dan Ferris: So I can't thank you enough for making time for us. I've really enjoyed it, and I hope you'll come back and talk to us again someday.
Ben Hunt: Any time.
Dan Ferris: Yeah. Great. And I noticed there are five authors listed on your website. I encourage our readers to – or listeners rather – to become Epsilon Theory readers. It's great stuff. And there's a ton of it. You'll never run out of good stuff to read. So thanks a lot, Ben, and we'll talk to you soon I hope.
Ben Hunt: Thanks, Dan. Really appreciate it. [Music playing]
Dan Ferris: All right. Wasn't that great? I love Ben Hunt, love his stuff, love talking to him. Hope we'll talk to him again soon. Let's do the mailbag now. OK. We've got a couple interesting items here. The first one is from Paul E. And Paul E says, "Hi, Dan. This week's episode was outstanding." That is, last week's episode. He said, "Your explanation of the Five Essential Financial Clues was great. I really appreciate you taking the time to provide this type of education that can be helpful to us investors. Question. During the mailbag segment, you mentioned Yahoo Finance as not being a good source of data. Could you provide any suggestions on better sites for basic research?" And then he says, "P.S. Just a thought. Could you play a little classical guitar sometime on the podcast? Some good music could help put things in perspective. It's a crazy world we live in."
Well I don’t know if we're going to do that, Paul. But as for a better source of data – look. For the basic earnings data... you know, earnings and revenues and all kinds of details about the business, you cannot be starting with the basic security filings. Right? You go to SEC.gov, and you click on – gosh. I've done it so many times I don't even know what the thing is. But there's a thing right on the front that says, "Company Filings," right in the top-right of SEC.gov.
And you just click there, and you can even enter the ticker symbol once you do that, and it'll bring up any public company. And you can read their 10-Ks, and their 10-Qs, and their 8-Ks, and all these weird documents that have all kinds of information that I bet a lot of people listening to me don't even know exist. That's the place to start. There are many good services that are really expensive, though, like... one of them of course is Bloomberg is a typical one. You know, it's like hundreds of dollars a month I'm pretty sure or something like that. $900, $1,000 a month, something like that. they're paying a ton of money to give me a Bloomberg at Stansberry. I know that. But you can, you know, you can do really well just by learning to navigate those documents at SEC.gov and I would recommend that you do that. And it's a really good question.
Thank you very much. All right. I'm just going to do one more of these today. This one is from Alan M. And Alan M says, "Love the podcast. Keep up the great work. Last week, during the Tesla podcast you mentioned stock buybacks as a good thing. I can understand that if it's a buyback of dividend-paying stock. It's an improvement to the balance sheet. But a general buyback of non-dividend-paying stocks is a wash. Correct? It seems that the value of the stock would go up on a per-share basis, but the cash used from the balance sheet negates improvement. Am I thinking of this correctly? Please dive in a little deeper if time allows." OK.
So the basic question here is whether or not it matters if they're doing buybacks on a dividend-paying stock or a non-dividend paying stock. And it absolutely does not. The primary factor, the most important thing, is whether or not they are buying back the stock at a reasonable or preferably cheaper than, you know... cheaper than reasonable valuation. That's really the main thing, because then you are passing along more than a dollar of value and you're paying less than a dollar. You're either paying a dollar for it – which is OK – or less than a dollar, which is better.
And so, the example to follow on this has been Warren Buffett. But I notice even over time, Buffett's standards have kind of creeped higher and higher. But he bases it all on valuation. He says, "As long as he thinks he's buying it back below intrinsic value, he knows it's going to turn out just fine." I would add something to this, which is the factor of debt. Which we talked about a little bit with Ben Hunt today on the interview. And I've talked about it before. You know, borrowing lots of money to buy back stock... you know, if the business remains a cash-gushing, wonderful thing forever and never has any trouble paying off this debt or paying the interest payments or whatever... OK. Maybe I can see it. Maybe some businesses can just tolerate more debt and they should have it, you know, just to make things more efficient for the shareholder. Because that would drive returns on equity, it would make the shares more valuable, et cetera.
But you also have to be aware that not every business stays absolutely wonderful forever. And loading up on debt when times are good can backfire on you when times are bad. So that's just – it's something else to think about. You know, there's no hardcore, you know, black-and-white flip to switch analytically speaking. Switch-to-flip, I should say, analytically speaking. You have to analyze each situation. And in general, you want to buy back the stock at less than intrinsic value and you want to be careful about adding too much debt to do that.
Those are the two big points there. And thank you very much. That was a good question. And that's it for this week. That's another episode of the Stansberry Investor Hour. Listen. Be sure you check out the website. You can listen to all the episodes there, and you can get show transcripts. So just go to the website, www.investorhour.com. And you click on whatever episode you want, scroll all the way down and that's where the transcript will be. Put your e-mail in there and get all the latest updates. You know, tell your friends about us, and they can put their e-mails in too and listen. All right? Thanks a lot. That's it for this week, and we will talk to you next week. Bye-bye.
Recorded Voice: 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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