Trey Lockerbie (00:02:38):
100%.

Kyle Bass (00:02:41):
Yeah, five and a half. So here’s what chain-weighting means. They say, “Trey, we realized that your bank account just went down by $41,000 because you wrote a check for a new car, but we the government, well, we must compare apples to apples.” So in your new car, you have a digital speedometer in your old car, it was an analog speedometer that was just driven by more mechanical means.

Kyle Bass (00:03:04):
So if you were to replace your digital speedometer with that analog speedometer from 1990, then your speedometer wouldn’t cost $900, it would only cost $70. And so they chain-weight every part of the car. You have electric windows, well maybe in 1990 you had the roll-up windows. So you have to subtract the cost of electric windows. You have to subtract the cost of your GPS navigator. You have to subtract the cost of everything to try to compare an apple to an apple.

Kyle Bass (00:03:35):
When in reality, your bank account still went down $40,000 and you wrote the check, but you have to realize that so many things are tied to the CPI, especially like government pension payments and there is the cost of living adjustments tied to that number. It’s so fascinating when you peel back the layers of the onion, to try to understand what the incentives are behind the people putting these numbers together.

Kyle Bass (00:04:00):
And then what real life is, real life is your bank account. Real-life is what things actually cost you, not what they used to cost 30 years ago because you had analog this and roll up that. It’s what can you buy today? How much does your bank account decline? So they’re playing fantasy football with the numbers. They’re not giving you real numbers. It’s really important to think about.

Kyle Bass (00:04:21):
They always talk about also CPI, X food, and energy. So they’re like, “Wait a minute. If you don’t drive or eat, your bank account would’ve been okay.” It’s just crazy. So I try to look at things in real terms and how they affect the population and what your wallet’s really feeling, when you go fill your car up and what your wallet’s feeling when you take your wife out to dinner and you get the bill and think it’s in pesos, but it’s in dollars, it’s insane what’s been happening.

Trey Lockerbie (00:04:47):
All right. So keeping on the topic of inflation, I also wanted to highlight this soundbite from episode 351 with Morgan Housel. At the beginning of the year, a lot of people were speculating around hyper-inflation just simply because of the money being printed.

Trey Lockerbie (00:05:01):
But Morgan’s point was highlighting that hyper-inflation really doesn’t happen until there’s also the supply side component. Now funny enough later in this year, we’re starting to see some real inflation numbers due to supply-side issues. But what Morgan’s really getting at here is how at risk, the dollar is from hyper-inflating away.

Morgan Housel (00:05:18):
Most historical periods of hyper-inflation if we’re really talking about real hyper-inflation, virtually all of them, I would struggle to find one example that did not take place in a society where they had massive output shrinkages. Because either it’s during the war and their factories are bombed to rebel, like happened in, Weimar Germany, or happened at the end of world war II in a lot of countries, or if it’s because the government has confiscated the major industries and run them into the ground as happened in Venezuela and Zimbabwe.

Morgan Housel (00:05:45):
It’s never just too much money, it’s always too much money during a time where your production, your GDP are collapsing. And I think that’s really important because of what happened after 2008 when the Feds started printing a lot of money. So many people, including myself, by the way, were saying, “Hyper-inflation right around the corner,” Feds printing so much money, you know what’s going to happen.

Morgan Housel (00:06:04):
And it didn’t. And I think the reason it didn’t is that the economy was well able to soak up a lot of that excess liquidity because our factories still had all the capacity that they can make stuff and produce stuff in a way that did not exist during Weimar Germany, or in Zimbabwe when the government had confiscated so many of the firms and run them into the ground. Or in Venezuela where the oil industry has been confiscated and run into the ground because they didn’t keep anything up.

Morgan Housel (00:06:30):
So it’s not to say that you can’t have a rise in inflation unless you have a decline in supply. It’s not that, but most of the time, big bouts of inflation come from a massive shrinkage in any economy’s ability to produce. Now, could that happen in the United States, too? Sure. Could it happen that we just don’t keep up with factory investment or we’re not investing in the right fields and we get to a spot where supply is shrinking, yes, of course, that could happen.

Morgan Housel (00:06:53):
And it’s happening right now in some specific fields. What’s happening in housing right now and particularly lumber is really fascinating, where the price of lumber is just going berserk. It’s going off the charts. I think it’s up about fivefold in the last year, the price of lumber to build a house. And from my understanding why that is, is not because we ran out of trees or even ran out of cutdown timber, there’s plenty of timber that’s been cut down and stripped of as bark, there’s plenty of that.

Morgan Housel (00:07:18):
From my understanding, a lot of the mills last spring said, “Oh, because of COVID, we’re going into the next great depression, shut down the mill, don’t invest in the mill, lay off the mill workers.” And now even though there’s plenty of logs, there’s not enough supply to manufacture finished wood. So we do have a decline in output in something like that. And sure, in enough we have nearly hyper-inflation in lumber.

Morgan Housel (00:07:41):
So it can happen in specific industries. I wont to be surprised if it happens in airlines this summer too, where you have airlines, some of whom have laid off tens of thousands of their workers or just through attrition have lost thousands of workers, flight attendants, pilots, and whatnot. Because last year, there was no work for any of them, and now this summer everyone who’s vaccinated is going to want to get on a plane and go somewhere.

Morgan Housel (00:08:02):
And so at the same time, you’re going to have maybe record demand, you have a huge decline in supply and could that lead to huge inflation in airlines? I think almost certainly. I think it’s some senses it will. The other area where I know it’s happening right now is rental cars. Where last year, a lot of the rental car companies just in a bid to survive started liquidating their fleets, just so that they had enough money to survive.

Morgan Housel (00:08:25):
And now that everyone wants to book a vacation right now, there are so many fewer rental cars available right now than there were last summer. So is there going to be huge inflation in rental cars this summer? Probably, but again, I’m making this point that it’s not just the money coming in, it’s the supply that went out that really causes the problem.

Trey Lockerbie (00:08:44):
So again, a theme for me this year was looking at high growth companies in a different way. I found Brian Feroldi, to be a great resource on this topic specifically. And in episode 375, Brian and I talk about high growth companies and how much valuation really matters depending on the life cycle of a company. I think it’s particularly interesting to think about using things like price earnings ratios for later stage companies and not earlier companies, but there’s a few other points of wisdom. So let’s take a listen.

Brian Feroldi (00:09:12):
Valuation is an extremely tricky subject to really master because if you learn anything about valuation, it just makes sense. What’s the thing, we’re all tared by watching Warren Buffet, you want to buy a dollar for 80 cents or 60 cents or 50 cents, that is all smart investing. And if you are the type of investor that puts valuation first, you are just never going to buy the best growth stocks on the market, period.

Brian Feroldi (00:09:39):
Because the bests of growth stocks on the market are almost always quote unquote, insanely overvalued the entire way up. If you look back on the history of some of the greatest performing stocks of the last 20 years, your Amazons, your Netflixes, your Market accesses. They have historically traded at very high valuation multiples even 20 years ago. And yet if you bought them 20 years ago and held, even if you paid a very high valuation multiple, you have significantly outperformed the market.

Brian Feroldi (00:10:11):
How can that be? While the greatest growth stocks, can grow for a far longer time period than anyone would possibly give them credit for. Amazon came public 24 years ago and it’s consistently put up double digit growth that entire time. And yet in 2020, Amazon grew another 40%. If you were to run the clock to 2000 or 1999 and put that into Excel spreadsheet, it would laugh at you.

Brian Feroldi (00:10:39):
It would be like, “What kind of crazy assumptions are you putting in here? That this company’s going to grow for 20 years and then grow another 40%.” But that’s what’s happened. Why? Because Amazon is one of the highest quality growth companies in the history of the stock market. When I’ve learned things like that, I have learned to de-emphasize valuation. That doesn’t mean I don’t look at it, but I’ve learned to seriously de-emphasize it.

Brian Feroldi (00:11:05):
And it also depends on just the stage and nature of a company. If I find a company that is worth $1 billion today, and I do the work and I say, “I believe that this could be a 20 billion company someday.” I’m just going to buy it. I don’t really care about the valuation because if the market cap is one billion and I think it could literally be a 20 bagger in a decade or so, the valuation I paid doesn’t matter. What matters is, am I right, or am I wrong? If that company goes up to 20 X in value, the initial valuation I pay will be irrelevant.

Brian Feroldi (00:11:37):
On the flip side, if you find a company that is big, but mature and much slower growing, then valuation really matters. So if you were going to buy a Microsoft today, a Procter & Gamble today, a Coca-Cola today, I would seriously emphasize valuation, because their future is so predictable and so known. But if you found a dynamic high growth company that was trading at a $1 billion valuation, I would de-emphasize valuation. So it’s always about keeping it in mind, but knowing when to emphasize it and when to ignore it.

Trey Lockerbie (00:12:10):
All right. So now having heard that from Brian, you might start to think to yourself that valuation doesn’t matter, especially for really high growth companies, but as he tends to do, Howard Marks comes in with some evergreen wisdom in episode 378, as Howard would put it. It’s not what you buy, it’s what you pay for. And there are problems with thinking that there is no price too high. He provides a great example from his personal experience. Take a listen.

Howard Marks (00:12:34):
Malcolm Gladwell, wrote that great book, Outliers, who talked about the importance of what he calls demographic law, what you and I might call right time, right place. And I was lucky in a perverse way because I started my career in the investment management business in 1969, at Citibank as a security analyst. And in those days, the banks did most of the investing. There were no boutiques. There were very few firms like, Oaktree or the firms that are on everybody’s lips today.

Howard Marks (00:13:08):
It was the banks, and most of the banks, what we called the money center banks, that’s the banks in New York, in Chicago and Boston and places like that. Most of the money center banks invested in what we called the Nifty50. And these were the 50 best and fastest growing companies in America, companies that were considered so good that nothing could ever go wrong. And because they were so good and nothing could ever go wrong, that meant there was no price too high.

Howard Marks (00:13:33):
And if you look the index of my recent book, Mastering the Market Cycle, under no price too high, you’ll find, see there lots of citations because that’s… We talked before about a bubble. That’s one of the greatest indications of a bubble. If investors can think of an asset class and say, “Oh, you know what, for that, there’s no price too high.” That’s a bubble because by definition, it’s irrational for everything. There’s a low price, a fair price and a price too high.

Howard Marks (00:13:59):
Anyway, so the banks invested in the Nifty50, that certainly included Citibank, when we were one of the great leaders. That meant IBM, Xerox, Kodak, Polaroid, Merck, Eli Lilly, Hewlett Packard, Texas instruments, PerkinElmer, Avon, Coca-Cola. And unlike that, great, great, great companies. And if you would’ve invested in those companies the day I started work, in September of ’69, and held them for five years diligently you would’ve lost almost all your money investing in the best companies in there.

Howard Marks (00:14:29):
Why? Because people ignored price. And so they didn’t get enough [inaudible 00:14:33] words, terminology. And the answer is that price matters a great deal. And the shorter your time horizon is the more it matters. The shorter your time horizon is the more important it is that you’re not overpay. So anyway, the Nifty50 we’re selling at P/E ratios today, the average P/E ratios in the low 20s, P/E ratios between 60 and 90 in those days.

Howard Marks (00:14:59):
And for the most part, those P/E ratios have never been seen. And then five years later, the P/E ratios were between eight and nine. And that’s a good way to lose 90% of your money, which most people did. So that taught me an important lesson, and I concluded at the time, it’s not what you buy, it’s what you pay for, that really matters. Then I was very fortunate. The break of my life came in 1978, when I was assigned to the Bond Department, I wanted to get into money management.

Howard Marks (00:15:24):
My reign as director of research at Citibank, involved as it was with the Nifty50 was not so successful. I said, “I wanted management.” They said, “Okay, we’ll put you in the Bond Department,” started a convertible bond fund, which I found very interesting was a backwater that nobody else was looking at. And then in August of ’78, I got the call that changed my life from the head of the Bond Department. He said, “There’s some guy out in California named, Milken or something. And he deals in something called high-yield bonds.” Can you figure out what that means?

Howard Marks (00:15:53):
Because a client had come in and they said, “We want a higher [inaudible 00:15:56].” So now, I’m investing in the worst public companies in America and I’m making money safely and steadily. Whereas, investing in the best companies in America had been really dangerous. So then I concluded that good investing is not a matter of buying good things, but buying things well. And if you don’t know the difference, then you shouldn’t be doing much investing.

Howard Marks (00:16:22):
So, that brush with the Nifty50 taught me the importance of paying a fair price. The real lesson is that there are no assets which are so good that they can’t become overpriced and dangerous. And there are few assets which are so bad, which that at the right price they can’t be bargained. One of the things that Oaktree has done for the last 33 years with great success, is investing in the debt of bankrupt or likely to be bankrupt companies.

Howard Marks (00:16:56):
We call it distressed debt investing, and you might say, “But Howard, how can you invest in the debt of bankrupt companies you know you’re not going to get repaid?” And the answer is that if you buy the debt of a bankrupt company or soon to be bankrupt company, it embodies, it gives you a claim on the value of the company as a creditor. If you buy it cheap enough, that maybe you’re paying a price for that claim which is so low, that it’s going to have a great return. And that’s what we try to do. So I think that price is extremely important, and as I said in bubbles, basically what it means is they ignore price and that’s a terrible thing to do.

Trey Lockerbie (00:17:39):
And lastly, on the topic of value and valuations, I wanted to highlight this soundbite from, Chamath Palihapitiya around his definition of value, because I think it just adds one more angle to this discussion. So here’s, Chamath.

Chamath Palihapitiya (00:17:53):
It’s this very funny thing, because every time I ask people, “What is the definition of value?” And everybody’s like, “It’s a word that they can’t define. We all know what it means. Except when you go to investing, you have the honest version of what value is, the language has been perverted.” So I think what value means is its worthwhile, it’s useful, it’s excellent, it’s important, that’s what value is.

Chamath Palihapitiya (00:18:21):
Is the Mona Lisa valuable? Yeah. It’s worthwhile, it’s excellent, it’s important. Are airplanes valuable? Yeah. How incredible is this? These things have completely transformed GDP and transportation, they’re useful, they’re important. And then you go into the financial markets and you say, “Is Slack valuable?” They’ll say, “My God, no, it’s so expensive. Oh, this oh, that.” Is Snowflake valuable? “No, oh my gosh, these things trade at huge multiples of they come up with every excuse.”

Chamath Palihapitiya (00:18:54):
And then I say, “Well, what is valuable?” And they say, “Philip Morris is valuable.” And then they’ll point to some number, here’s their ROI, or here’s their NOPAT, or here’s their dividend yield, here’s their free cashflow yield, here’s their multiple of sale. And basically, as long as the number is small people turn their brains off. Think about it. Literally, you could ask a blind monkey on that dimension, how to rank growth stocks.

Chamath Palihapitiya (00:19:22):
And all they would do is just basically, rank by ascending order and cut it off before the numbers change into double digits. Pick your metric, that to me seems insane. Philip Morris causes cancer, let’s just be honest about it. Google organizes the world’s information. What would you rather owe? So my perspective on value is that I think I’m a value investor. I want to find things that are worthwhile, useful, important, and excellent. And I just want to buy them at a fair price.

Trey Lockerbie (00:19:51):
All right. So you guys know that I’ve studied Warren Buffet extensively. And one of his major pillars of investing, is focusing on what he would call vigilant leadership. So it’s always been important to understand who is running these companies, what their values are, how reliable they are, et cetera. But this year, this theme became much more profound. And it started with my discussion with Tom Gayner, in episode 332. Tom, takes both a qualitative and a quantitative approach in assessing a management team. And he explains how he does so here.

Tom Gayner (00:20:21):
Quantitatively, if you look at a company and a management team that has produced pretty good results, and they’ve done it over a period of years, that is a very good tale and marker that it’s being run well because when customers are doing more business with you every year, there’re more revenues and proportionate profitability. That is a marketplace stamp of approval that, “Hey, this company is doing something for me.”

Tom Gayner (00:20:47):
As I wrote, a great company is a company that does things for their customers rather than to their customers. And if you’re serving your customers and doing things for them, that increases the odds that they’ll come back and want to do business with you again, and refer other people to you and your reputation will help you in the marketplace. And a lot of that really does tie to that aspect of integrity. There’re other aspects of it that are really a matter of quantitative feel.

Tom Gayner (00:21:13):
And I don’t think you should not trust your own judgements about whether you think people running these businesses are good people or not so good people. And what are their motivations and styles and trust your gut a little bit. Trust your visceral reactions to how you feel about people when you encounter them. And again, a business that has not been successful that has not put reasonable, not perfect numbers, but not reasonable numbers on the books for a long period of time, is one that one of the reasons for that is maybe they don’t have that fundamental value that you’re looking for. So, okay. Move on, look at something else.

Trey Lockerbie (00:21:49):
Right. And I’ve heard you talk about leverage and how that might be a key indicator for determining how much integrity the management has. Can you elaborate on that?

Tom Gayner (00:21:58):
I will. And indeed, and I want to give credit to Shelby Davis as I do this. So in the very earliest years, when we were starting to buy the Markel Ventures businesses and move outside the realms of insurance and buy these businesses that we had not had firsthand experience operating before. I remember being with Shelby, and it was in Omaha, during one of the Berkshire meetings and the convening and running into people and just having a meal with people or having a drink with people or running into somebody in a hallway or a bar that we did.

Tom Gayner (00:22:28):
And he and I were talking about this new strategic initiative of Markel to indeed look at what Berkshire had done and go from passive minority states and businesses to controlling states and owning businesses. I was asking him about his experience. He’s older and wiser guy than I was, and trying to hone in on exactly that point about integrity and his response as Shelby, often could just put his finger right on it.

Tom Gayner (00:22:55):
He said, “Well, if you want to buy a business that’s not run by crooks, I have one where they don’t have any debt.” And so I leaned in and asked him about that. He says, “Think about it. When you’re financing a business with debt, you are borrowing money. So somebody else’s money to run your business. If you’re financing business with equity, well, that’s your money now, crooks don’t want to steal their own money, they want to steal somebody else’s money.”

Tom Gayner (00:23:21):
So it’s actually a tale not perfect, but it is a tale that generally speaking, businesses which are financed largely with equity, tend to have a different character and nature of people running them than businesses that are financed with a lot of debt. Because the risk reward for the managers is different when you have a heavily debt financed business than when you have the heavily equity finance business. If it’s equity and it’s yours and it’s your family’s assets.

Tom Gayner (00:23:51):
And if you lose that money, you’ve lost everything. You’ve lost your livelihood, you’ve lost your business, you’ve lost your reputation. And it is awful. If you run a business and it’s externally financed and it’s not really your equity capital in the game, it’s not great, but you can move on. And there’re countless examples of that. And given the fact that I feel that I’ve attached myself and my reputation to this business, I want partners and colleagues who feel the same way about it.

Tom Gayner (00:24:20):
I don’t want to attach myself to people who might run things into a wall and not care as deeply and as much as I do. I’m not saying we won’t make mistakes, we do make mistakes. We make them regularly. And I pray that we never get into a period where we don’t make any mistakes. Because that means we’re not doing enough. We need to be willing to take risks and try things, but let’s be thoughtful and prudent, and as our former Chair and Alan Kirschner used to say, “Let’s make some new mistakes, not make the same ones.”

Trey Lockerbie (00:24:47):
And on the topic of management, one of the more surprising takeaways came from Jim Collins, in episode 372. Where he outlines his first, Who principle, you have to remember that this principle was a result of years and years of research. So how important is the management team? Let’s find out from Jim Collins.

Jim Collins (00:25:05):
The principal’s called, First Who, Then What? And it’s a very deep principle that came from our work that we found that those who make the shift from being first, what. What are we going to do? What’s our vision? What’s our direction? What’s our strategy? What’s our method? What, what, what, what? We make that shift to saying, “Actually that’s a secondary question.”

Jim Collins (00:25:24):
The primary question is who? Who do we want on the bus? Who do I want to work with? Who can we rely on? The question is not, how should we solve this problem? Or what should we do? It should be who should I have work on it? If I get a cancer diagnosis, the question is not, what’s my diagnosis, my treatment, my schedule, the real question is who’s my oncologist. Who’s the radiologist? Who’s the surgeon? Who’s the expert in this field. I got to find the who’s to get the best what’s.

Jim Collins (00:25:53):
And it’s a shift in the world to basically, as you think about it, to basically say, “It’s part of making the shift from being a time teller to a clock builder.” You make the shift from I’ll figure out the what’s and tell people what to do to, I’m going to figure out the who’s, and if I get the who’s right, we’ll figure out a lot of great what’s to do. It’s a first who strategy. So how do we come up with that?

Jim Collins (00:26:14):
Where did that come from? Back up here for a moment, everything we’re going to talk about today of key ideas that come from our research, come from research. It’s a research-driven approach, and it’s done with a very specific methodology that was given to me, or we really co-developed Jerry Porras, my research mentor at Stanford. And what Jerry really had the insight to push us to work really hard to embrace is the idea that you have to have a comparison set so that you can always say, “What is different about those that build something truly great?”

Jim Collins (00:26:54):
What is in those companies, from those that don’t make it. And the really key question is not what do successful entrepreneurs or successful companies or enduring companies share in common? It’s what do those who built something truly great share in common that is different from those that could have, but did not. And so the idea being that if you go to any given industry to any given time in history, you can very likely find matched pairs.

Jim Collins (00:27:22):
So you can find companies that were in the same spot, same time, same resources, same potential at the same moment in history. And they have the same customers, they have similar scale, they have similar access to capital. They know the markets equally well, they’re like twin, there’s this almost like a controlled historical experiment. And then what happens is one separates and becomes a much better, or maybe even great company.

Jim Collins (00:27:46):
And the other one that was starting from the exact same place with the same opportunities and everything else, as much as possible, you’re zeroing down to very controlled variables at that point. Then from that point, didn’t do as well and maybe even die. But in most cases just didn’t do as well over time. And then you contrast them, and you say systematically, what did one do different than the other? And then you replicate that across a range of types of companies and industries and eras and technologies.

Jim Collins (00:28:17):
And we’ve done that for about 6,000 years of combined corporate history and our research database across four major research studies that have used that method through different lenses. Now, one of those studies was the good to great research study. And we were looking at companies that made this point of inflection, where you had two companies, think of multiple match pairs companies that were equally average performers for a significant period of time. And they were in the same industry, same time, same resources.

Jim Collins (00:28:44):
Classic example from our research historical case, Kroger and A&P. And if you rewind the tape of history, there was a point in history when these two grocery chains and it’s retail, it’s grocery, but it’s very interesting pair because they both were relatively average performers in the same era heading into a major seismic change, which was going to be the shift from old style grocery stores into what became superstores.

Jim Collins (00:29:11):
Either one of them could have made that shift brilliantly and then gone on to have the great results over time. They were virtually equal in their strength capability to make this transition and that good to greatly at that at moment. But today with the passage of time, Kroger, is still here and actually doing very well in its world, A&P is gone. Then you ask step by step, year by year, what did they do different? How did they think different? What were the ways that they went about doing things at Kroger that were different than the way they did things at A&P?

Jim Collins (00:29:49):
And from that kind of analysis, rigorous data-driven analysis, going back in time and watching the tape of history unfold and to figure it out, you begin to get insight. The comparison leaders, comparison cases had leaders who would often come in, they would be like a genius with a thousand helpers. They would come in and say, “I know the vision. I know the direction. I know the strategy. I figured out what to do and where to go and I’m going to motivate people to go there.” And I would’ve thought that that’s what our great cases would do, but that’s not what happened.

Jim Collins (00:30:21):
They took a different approach. The people like, Everingham, at Kroger, they asked different questions. They said, “I don’t necessarily know where to drive the bus. What I know is this, is if I get the right people on the bus and I get the wrong people off the bus and they get the right people on the key seats. If I get that done first, then with a great group of people, we’ll figure out where to drive the bus.”

Jim Collins (00:30:43):
And then you’ve got one other giant advantage. He’s a history professor by the name of Edward T. O’Donnell. And he has a fantastic quote that I’ve always loved from. It came from one of the great courses I mentioned earlier, as a course on the history of the United States from 1865 to 1920, America in the Gilded age and the progressive era as it’s called. And professor O’Donnells says, “History is the study of surprises.”

Jim Collins (00:31:09):
And think about that, isn’t that wonderful? And it is. And we’re living history, I don’t know about you, Trey, but I sure as heck was surprised by COVID when it came 18, 24 months ago. It’s not like I knew that was coming so I better get prepared. We have no idea what’s coming next. And all we know is we’re going to have surprise, after surprise, after surprise. All we know is there will be no new normal.

Jim Collins (00:31:29):
There were just going to be a continuous series of not normal events. And this is just the nature of history that we will live through. If we can’t predict the what and one thing I’m sure all of your great investors have told view is no one can predict much of anything. If you can’t predict the what, what is your ultimate hedge against uncertainty if you’re building a company? It’s the Who. It’s having people who can adapt to whatever the world throws at you.

Jim Collins (00:31:59):
And if I got a bunch of people on the bus for a specific strategy, a specific direction, a specific expectation of what the world will be, and our idea fails, or that particular strategy doesn’t work, or the world throws us a surprise as it will that wipes all that out. If I only got people on the bus because of the what, and now the what’s changed, I’m in trouble.

Jim Collins (00:32:23):
But if, instead, I got people on the bus because they’re the right who’s, who can adapt to multiple kinds of what’s and they share the values that we’re trying to build to. And they’re incredible people that I can rely upon and we can navigate this together. Well, then you’re in a very strong position to adapt to that uncertainty. So in the more uncertain the world, the more you want to bet on the who, not the what, because the what’s are going to change.

Trey Lockerbie (00:32:50):
All right. So one of the other major themes of 2021 was around the Fed and their policy. Now, from what I’m seeing, a lot of people are subscribing to this new narrative that the stock market really can’t go down because the Fed is there to print more money, and create liquidity that will flow back into assets and keep it propped up. But I love this reminder from Jeremy Grantham in episode 371 about how the Fed’s actions do have limits. The best analogy I can come up with is that the stock market is a complex system, similar to say the human body. You could drink coffee all day long, but at some point you are going to crash. Your body will just give out. I think that’s what Jeremy is touching on in this example. So enjoy this takeaway from Jeremy and his thoughts regarding the Fed.

Jeremy Grantham (00:33:34):
No, I think Powell, belongs to the Greenspan, Bernanke-Yellen, little cult, they all fit together. They all realized that lower rates and moral hazard pushed out the price of assets. They all realized that assets going up generates a positive income effect. It simply does. You spend a couple of percent of what you unexpectedly gained. You count on gaining a bit, but if you gain five bits, then you spend a little bit of the extra, the following year.

Jeremy Grantham (00:34:05):
So it has a very positive income effect. The same happens with housing. If housing goes roaring up, you remortgage, you make a trip to Spain, you kid through school, you do all those good things. And on the downside, you do completely the reverse. Anyway, so Greenspan and the boys, and the girl took a considerable satisfaction in the positive effect they had on pushing up asset prices, lower rates of moral hazard will raise the price of assets, which they did all over the world.

Jeremy Grantham (00:34:37):
And no one was a bigger friend of the stock market than Greenspan. And he did rise to the rescue when it finally lost air, it only the S&P went down 50% from a very high level, but they only hit long term trend. This was the first bust in history that didn’t go crashing below trend and stay there for 10 or 15 years. So he did have an effect. What he wasn’t able to do, is he didn’t start the Nasdaq from dropping 82%.

Jeremy Grantham (00:35:03):
If you’re interested in Amazon, it dropped 92%. It had been the star of 2000, still dropped 92% before making everybody rich. But who I wonder held under the psychological damage of 92% decline. And the S&P went down 50%, and then you fast forward to Bernanke. Bernanke completely didn’t see the housing bubble and the risk it posed. He said the U.S. Housing market, that merely reflects the strong U.S. economy, the U.S. Housing market has never declined. It never had declined, because it never had a bubble before, every time there’s been a bubble there it has always declined.

Jeremy Grantham (00:35:38):
And Hyman Minsky lives. You create a situation like that. It will eventually blow up of its own weight burst of its own weight. Anyway, he was convinced it wouldn’t collapse. And of course it did. And the housing market went all the way back to trend and below, which was dreadful hit and it created so much chaos. It carried the stock market down with it again, 50% on the S&P almost exactly at the first decimal point. These are not small declines and yet they occurred in the face of passionate defenders and promoters of moral hazard.

Jeremy Grantham (00:36:15):
And I’ll come to your rescue, and we’ll make money cheap as it takes. And that took us through Yellen, and then into Powell, same story. They all talk a wonderful game about, they’ll be the friend of the asset class. Asset class pricing, the friend of the Star Market. And yet it didn’t stop two of the greatest wipe outs in American history. The most impressive thing here. It’s not that they do the same thing over and over again as if they have somehow no memory.

Jeremy Grantham (00:36:43):
It’s the faith the financial community has in them, despite the fact that they have been let down badly twice. These were not insignificant setbacks. The tech crash was brutal. Amazon down in ’92, every growth tech start was down 70 or so it seemed, the housing bust was merciless. The stock market declined of those, seven was really painful. And yet it’s as if it never happened. Oh, Powell says this, Powell says that, the Fed has money. The Fed is going to be our friend. Hey, Greenspan was our friend.

Jeremy Grantham (00:37:19):
The Bernanke was our friend and we got croaked guys. What is the matter with you? Why do you think the federal reserve simply does not understand the risks of asset price bubbles and asset price collapses? It is clear from the data, they don’t get it. Greenspan could never make up it mind whether the market was overpriced, irrational expectations or whether in fact it was fine, Yellen couldn’t, Bernanke, couldn’t see a housing bubble that was a three Sigma 100-year event.

Jeremy Grantham (00:37:52):
Where were his statisticians? The answer is the federal reserve statisticians do not do asset bubbles. They are in that respect, utterly clueless. And we apparently never see that we are willing to look through the crash of 2000. The housing crash really dangerous affair. They didn’t do their duty, they didn’t head it off, they didn’t raise the limits for mortgages, they didn’t want anybody, they allowed it to happen.

Jeremy Grantham (00:38:22):
And yes, they were pretty good in the decline. They were pretty good at applying bandages and stimulus and support for the wounded, but they sure as hell should not have allowed that housing bubble to occur. They don’t get it. They don’t see the risks and they don’t see them now. And so this time, we don’t just have a housing bubble. We have a housing bubble, a stock market bubble, a commodity bubble, and above all, an interest rate bubble. This is going to be the biggest write-down. The next time we are pessimistic, we have more potential to mag down asset prices than we have ever had in history, anyway.

Trey Lockerbie (00:39:00):
I just love that. And I couldn’t resist sticking with Jeremy just for a little bit longer because this episode has so much great wisdom in it. Jeremy provides an amazing history lesson in this episode and described how he’s seeing the signs of a bubble and also the sign that lead to a potential pop. Specifically. I love this term around confidence termites. Let’s take a listen.

Jeremy Grantham (00:39:22):
And here we are. I thought we entered bubble territory last June about a year ago, and I’ve made it quite clear what I consider a definition of success. And that is only that sooner or later you will have made money to have sidestepped the bubble phase. So I am suggesting that the last 20 or 30% of the market will be retraced with interest. And I would expect that the fair value of this market would require the market to approximately half.

Jeremy Grantham (00:39:54):
And I would be surprised if it did much less than that. And if it goes up another 20%, it will have to get rid of that as well as a bonus, you can very seldom identify the pin that pops it. 1929, no one’s agreed yet what the pin was and they say about 1929, that selling came in from the country, which means that the initial selling pressure was from the Midwest, not from Boston and Philadelphia and New York.

Jeremy Grantham (00:40:25):
What was going on was probably that the economy, which had been unbelievably strong was turning down. But because of the lags in the data, the City Slickers didn’t know it. But the guys out in Chicago, who he had businesses and farms and cattle and so on. They knew that things had turned out and they decided sitting around the club at lunch that they better take a few profits.

Jeremy Grantham (00:40:48):
And so selling came in from the country and the bubbles tend to peak at absolute optimism when the economy looks perfect and you’re extrapolating it forever. And that’s the definition of a bubble, and they have to be facilitated by friendly monetary conditions. When you’ve had a wonderful economy and friendly monetary conditions, you’ve pretty well always had a bubble. They’re not that common, and here we are again but we feel the economy looks wonderful if we extrapolate it forever, it means it’s worth a huge price.

Jeremy Grantham (00:41:21):
Of course, it never does last forever. But if it did, it would be worth a huge price. And that’s the mechanics that is going on. And then you can say, “What might rattle the cage?” Well, I think unexpected COVID problems on a global basis and in the U.S., I rattle the cage unexpected inflation that doesn’t go away in a hurry and then starts to run into longer term inflationary pressures, which we could discuss that might rattle the cage.

Jeremy Grantham (00:41:49):
And the biggest cage rattler of all, is everything else you haven’t thought about that could go wrong. And my guess is that’s probably the cause in the end of most of bubbles deflating, the mechanics of a bubble is you have maximum borrowing, maximum enthusiasm, and then the following day, you’re still enthusiastic but not quite as enthusiastic as yesterday. A week later, you’re not quite as enthusiastic as last week and last month.

Jeremy Grantham (00:42:19):
And gradually, the enthusiasm level drops off a bit. You have no more money to borrow. You’re fully borrowed and buying pressure gradually slows down and that’s it. And there is a very interesting warning signal that has only happened a few times. And that is in a bull market, the risky stocks go up a lot more than the Blue Chips. In 1928, the junkie low priced index went up over 80% and the S&P went up, let’s say about 40. That’s what you expect. But in 1929, as we approached the cliff edge, the low priced index began to go down.

Jeremy Grantham (00:43:00):
Even though it had a better of two, that is to say, you would typically expect it to go up or down twice the market. And here you had the market, the S&P going up another 40% prior to the crash. But the low priced index was down to the year, the day before the crash, it was not just down, it was quite badly down, over 30% for the year, which is remarkable and nothing like that happens again until 1972, going into the Nifty50 market, which was a huge break by the way, 62% in real terms, it’s still the biggest break since The Great Depression.

Jeremy Grantham (00:43:34):
And during that 1972, the S&P is up about 17% and the average big board stock is down 80. That’s a 35-point spread, which isn’t bad. And the average stock is a higher risk, higher volatile should have been going up more, but it did. And as I said, nothing on the upside happened like that between 1929, 1972, of course, the risky stuff goes down more in a bear market, but in a bull market always goes up more. And then there was a six-month window related to the Iraq war, which we’ll call a draw. And that brings us to 2000.

Jeremy Grantham (00:44:09):
In 2000 March, they start to take out the internet stocks, the pet.com and they shoot them, and they drop light stones. A month or two later they’re shooting the junior growth and then a month or two later the middle growth. And finally, by mid to late summer, they’re really shooting even the Ciscos, which were giant companies. And they took the whole 30% of the market which was TMT, they called it Tech Media Telecom.

Jeremy Grantham (00:44:37):
And it was down 50% by September. It had been murdered, but the S&P was unchanged. Which meant that the other 70%, the Coca-Colas and the rest of the boys, the IBMs were up about 17% on that to balance the books. So what had happened is that the confidence termite side, I think of them. They had started at the most crazy pet.coms and worked their way down through the Ciscos, which were pretty out outrageously, 80 times earnings.

Jeremy Grantham (00:45:06):
And then finally they arrived at the broad market and the entire market rolled over and fell 50% in two years. So nothing like that happens again until now, but what’s happening now. And it may be a false alarm, it may be a head shake, but Russell 2000, which as I said, put in this 50% rally in three months ending on or around February the 9th, it’s down since February the 9th. And this month, it’s nine percentage points behind the S&P 500.

Jeremy Grantham (00:45:38):
So the S&P 500, the Blue Chip index has been picking up splendid, bull market, everything intact, but the Russell 2000 has just lost 9% on a relative basis and is down from February the 9th. Now last year, the Russell 2000, which is the 2000 stocks after the biggest 1000 taken out, it was huge. It was far and away the best index followed by the Nasdaq, which has some Blue Chips in, followed by the Standard and Poor’s.

Jeremy Grantham (00:46:08):
This year, the Standard and Poor’s suddenly year to-date comfortably in first place, let’s say up 10%, the Russell is now up about 10% for the year. Having been the strongest index. It’s now the weakest and the Nasdaq is five points higher than the Russell. And the S&P is three or four points higher than the Nasdaq. A lot of it has happened in the last year. And then when you look at the super crazies, you find that the Spark index is down 25%.

Jeremy Grantham (00:46:39):
The number of Spark selling below 10 is way down, they’re quite remarkable and all the Sparks, as I said, have gotten weaker. The meme stocks are down maybe 40, 50% from their spikey tops, AMC GameStop, and others and Tesla is down from 900 to 640, it’s a big decline. So I would say the termites are doing a pretty good job. That they are starting at the crazies and nibbling away, not that Tesla isn’t the brilliant company, it is, but they’re nibbling away at the ones that have the most confidence.

Jeremy Grantham (00:47:15):
And on some grounds could be argued as the most extreme over pricing. Tesla having just gone up eight times in a year on a sales great gain of 35% is a pretty good demonstration of super confidence. And so I would say there’s a decent chance that this process that we saw before the other great bubbles in American history is on its way. They all lasted a few months, nine months in 1929, almost a year in ’72, 7 months in 2000. And here we are maybe five months into the game, six months. So it wouldn’t be amazing to me as a historian if this thing lasted till the end of the year.

Jeremy Grantham (00:47:58):
And it wouldn’t be amazing if it started to kill over in a month or two, it’s lasted longer than I thought last June or last fall, for two reasons, I don’t think anyone expected quite the success of the vaccination. That’d never been one as successful as the RNA ones and the Moderna and the Pfizer. So that was one reason. And the other reason was, I don’t think anyone expected this year scale of the bailouts. These are the biggest bailouts as a fraction of GDP, not only in the history of our country, but in the history of any country.

Jeremy Grantham (00:48:35):
This is a far greater stimulus program, both from the Fed and the government that we have ever seen with money supply spiking at 25% increase with the government buying 40 billion a month of mortgages, even when the real estate market is up over 20% in a year to the highest level ever recorded, these are fairly crazy or reckless or unusual features. And we didn’t anticipate either, and they’re going to tend to send the market higher and longer. But as I said before, it doesn’t change the fair value. It doesn’t change the eventual outcome.

Trey Lockerbie (00:49:10):
So, as asset prices are getting higher and higher, and you want to start moving more to caution as Howard marks would put it, you start thinking a lot about your asset allocation. When I talked to Joel Greenblatt about this in episode 339, it bloomed into this amazing sound bite, where he talks about his circle of competence, position sizing, and the importance of luck. All three points are fascinating. So I’ve included them here.

Joel Greenblatt (00:49:34):
Knowing an industry deep and well would be a big advantage. I think that’s an excellent way to go about investing. Although one of the analogies I gave and one of the books was knowing a little area, let’s say you live in Cleveland, knowing the nicest house in Cleveland, may not be so nice relative to Beverly Hills. And if you only know Cleveland, you may think you’re getting a decent bargain, but relative to what’s out there, maybe you’re not seeing the whole picture.

Joel Greenblatt (00:49:59):
So that would be a risk in only knowing one little industry, but there’s a big advantage in having an edge. And so I’m fore having an edge. And I think if I have an edge at all is not on the micro level, I know many better… I’ve met too many people who are better analysts, individual company analysts. I think I’m really looking from 40,000 feet usually and taking a step back and contextualizing things and sticking to things I find simple and I’m trying to simplify things.

Joel Greenblatt (00:50:28):
And if I can’t simplify things, I won’t do it. It doesn’t mean I’m so good at it, means I know my circle of competence. If I can’t understand that in a simple way, and there’s not 9 million moving pieces, but it’s super simple and I can understand it. I feel really good about that. And so knowing where that is, is my edge and being disciplined and to bet to take my investments when I feel that I’m there. And of course, experience is helpful. Having a lot of years of experience knowing, “Hey, this looks like that thing I saw 15 years ago, and now I can contextualize it across all the other opportunities I’ve seen over that.”

Joel Greenblatt (00:51:02):
How does this risk reward set up? What is my certainty level here relative to other things? I think that where I’m good, I’m a good portfolio manager looking out 40,000 feet, where should I size my positions? You could do great. I think some of the best analysts I know, size their positions wrong. If you’re really great at something, and you take a 1% position, you weren’t right, you blew it. You should have a 10 or 20% position if you really have high certainty.

Joel Greenblatt (00:51:26):
And if you are right, but only took a 1% position and you should have taken a 10 or 20, you didn’t get it right. You blew it. And so I think that’s being able to size things. And the other encouraging thing I tell my students is that, and I laugh with my partner, Rob Goldstein all the time is that if we worked for somebody else, we would’ve been fired many, many times. We’ve made so many mistakes over the years and big mistakes.

Joel Greenblatt (00:51:48):
And so what I tell my students is you can still be successful over time, making lots of mistakes, and that should be encouraging to you because you will make mistakes. You don’t want to die from any of them. So portfolio sizing does matter knowing when to hit the gas pedal does matter, and some luck does matter, and there’s no way getting around it. I mean, FIAs, Malcolm Gladwell. I got out to Wall Street in 1981. The market hadn’t gone up in 13 years, got big bull market since pretty much ’82.

Joel Greenblatt (00:52:16):
So that was pretty good timing, I’d have to gotten out of the way in a really bad way, not to have been successful during that time. And so I don’t want to be overstate, success I’ve had, or some of my cohorts that were lucky enough to be born in the right country in the right year and the right time and go to Wall Street at the right time. I will say that market hadn’t gone up in 13 years and not many people I knew were going to Wall Street on the investment side. So I think that was lucky and the fact that I got smitten. And so once again, I have to thank Ben Graham, for writing about it and just hooking me while I was still in college.

Trey Lockerbie (00:52:50):
All right. So shifting gears a little bit, I wanted to share some of the takeaways around risk. I love hearing about how people define risk and how they weigh things like selling a position. Now in episode 385, David Gardener talked about his 25-point system for risk. We didn’t go through all 25 points, of course, but I wanted to, at some of his examples, because they’re pretty illuminating. Let’s have a listen.

David Gardener (00:53:14):
Now I personally don’t think that there’s any really good defined way of rating the riskiness of stocks. We do that a lot with debt these days, and there are whole firms, Moody’s that rate the debt of things, the financial viability, but to actually look at a stock and say, “What is the risk of that stock?” The unsatisfying answers I’ve often seen in the past are medium, low to medium. I’m always like, “What does that even mean?”

David Gardener (00:53:37):
So for me, we first have to define risk and I define risk as the chances that holding this instrument over a long period of time, you would suffer in the end, a dramatic loss. That’s the risk that I try to avoid. If it’s just beta, how much does the stock bump up and down? I don’t think that’s a very satisfying approach to risk. That’s like using batting average, going back to baseball, to evaluate who’s a really good valuable hitter in baseball. It’s intuitive in some ways and understandable, but how much the stock bounces around is not really, to me what risk is about.

David Gardener (00:54:12):
So I first tried to define my term and then I tried to build a simple system. That’s 25 points. They’re actually questions, and each one is simply a yes or a no. So for each of the 25 points, well, it’s a question it’s a simple yes or no answer. It’s a binary question. And every time you say yes, that’s good. Every time you say no to the question, that’s bad and you add a point.

David Gardener (00:54:37):
So if you have 25 nos, that’s 25 points, that’s the riskiest imaginable investment. So again, hire the rating, hire the risk. So I’ll give you a few examples of the yes or no questions we ask. This is really off the top. I haven’t really prepared this, but how about, number one, the first one we asked, was the company profitable during the previous quarter and past 12 months? Yes or no.

David Gardener (00:55:07):
Now does that mean its good stock or that the company is a good company or not? No, not necessarily, it’s connected. I mean, those things matter, but none of this is a litmus test in the end for the company or the investment. We’re just accumulating answers. And again, every time we say, no, we’re like, “That’s looking a little riskier to me and I probably would favor things of less risk.” I’ll give you a couple more examples. And then the key insight that I have from this risk-rating system, which anybody can use by the way.

David Gardener (00:55:35):
Another example is, does the company maintain a high standard of disclosure consistent with SCC guidelines in the U.S? Actually even better, that’s number eight, number nine is, would an intermediate level investor find the company’s financial statements and management ownership disclosures relatively easy to sift through and understand? So how transparent is this company?

David Gardener (00:55:57):
How easy or not is it to read its financial statements? Is that an all or nothing? Litmus test for the company or how good this stock’s going to be? No. Is that a helpful thing to think about and say yes to, or no to, yes. Another example, number 13, moat. I mean, we talked about sustainable advantage. Warren Buffett calls it a moat, would potential new competitors face high economic technological, or regulatory barriers to entry? Yes or no.

David Gardener (00:56:24):
Yes is good. Hard to mess with them, big moat, no is bad. So as you do this, you end up building up a risk rating and rather than say, low to medium or high risk, you can say four or 16, which to me is a much more intelligent answer or a way to talk about it even though it’s obtuse initially, or it’s obfuscatory of, it’s not transparent to somebody if you see, say eight in answer to the question, but then you can explain that the eight is based on eight nos and you can give the exact homework that you did to explain why it’s an eight.

David Gardener (00:57:00):
And the key insight about this to close my answer. Thanks asking me about the system. I haven’t talked about it in many interviews, but it’s something that I’ve done for years for my picks. The key insight is this people think that risk equals reward, I disagree. I think this is another example of conventionalism. They think, “Oh, the greater the risk, the greater the reward, actually secret, some of our great performers have had low numbers.”

David Gardener (00:57:26):
So turns out you can have your cake and eat it too. You can buy a low risk company that becomes one of the great performers in our markets over the following 25 years. The biggest challenge for most people is, they’re not willing to hold it more than a year, let alone 25 years. So the insight is that it’s not always higher risk equals higher rewards. Sometimes it’s the opposite.

Trey Lockerbie (00:57:51):
And as far as my favorite definition of risk, I think it came from Morgan Housel’s book where it says risk is what is left over when you think you’ve thought of everything. And in my episode with Morgan, he shared some amazing color around it. Here it is.

Morgan Housel (00:58:05):
People hear that and they think, “Okay, that’s great,” but let’s talk about the biggest risks that are out there. And you’re like, “No, no, no. The biggest risk is what no one is talking about because it’s impossible to know.” Or it’s so unlikely, it’s so crazy that people just wouldn’t even think about. Here’s a story that I wrote about this week that I think is really fascinating.

Morgan Housel (00:58:20):
During the Apollo space missions in the 1960s, before we started launching ourselves into space in rockets, NASA tested all of its equipment in super high altitude hot air balloon. So they would take a hot air balloon up to 130,000 feet, like just scraping the edge of outer space and they would test their equipment. They’d test their theories before they actually went up in rockets. So one time in 1961, NASA sent up a guy named, Victor Prather to 130,000 feet.

Morgan Housel (00:58:48):
And the goal of this mission in this hot air balloon was to test NASA’s new space suit prior to actually going into space. They wanted to go up to 130,000 feet, make sure everything was airtight. It worked under pressure, et cetera. Victor Prather goes on this mission, goes to 130,000 square feet, test a suit, the suit works beautifully everything’s great. Prather, Is coming back down to earth and when he’s low enough, he opens up the visor on his helmet, the face shield on his helmet.

Morgan Housel (00:59:13):
When he is low enough to breathe on his own, he can breathe the earth’s air, he’s low enough that he can do that all fine. He lands in the ocean as his planned and as the rescue helicopter comes to get him, he’s trying to tie himself onto the rescue helicopter’s rope and he slips, slips off his craft and falls into the ocean. Again, not a big deal because as soon is designed to be watertight and buoyant, but Victor Prather had opened up the mask in his helmet. As he falls into the ocean, he’s now exposed to the elements. His suit fills up with water and he drowns.

Morgan Housel (00:59:44):
And this to me is so fascinating because the NASA space missions during the moon race in the 1960s was probably the most heavily planned mission ever. You had thousands of the smartest people in the world, planning out every single minute detail and checking it over and over again, and being signed off by the most sophisticated expert risk committees that exist in the world, and they were so good at it. I mean, to have men walking on the moon, you need like every single millisecond was planned out every detail. And with Victor Prather, it was the same thing. They planned out every second of that mission.

Morgan Housel (01:00:20):
And then you overlook one tiny little microscopic thing, like opening your visor when it’s okay to breathe the earth air. And it kills them, and that to me is just an example of a risk is what’s left when you think you’ve thought of everything. And I think that’s an example of what happens in a lot of fields. Think if you were an economic analyst in the last five years and your job is to forecast the economy and you spend all your day, you spend 24 hours a day modeling GDP, modeling employment trends, modeling inflation, every detail about what the federal reserve is doing.

Morgan Housel (01:00:50):
You built the most sophisticated model in the world to predict what the economy’s going to do next. And then a little virus sneaks in and 30 million people lose their job. That’s how the world actually works. No economists in their right mind would’ve included that in their forecast. If you go back to 2019 or whatever, no one would’ve said, “Oh, I expect GDP is going to fall 20% next year, because we’re going to have…”

Morgan Housel (01:01:12):
No one said that. Of course, you couldn’t. You would be ridiculous to say that, but that’s how the world works. And I think it’s the same thing if you look at September the 11th or Pearl Harbor or Lehman brothers going bankrupt, because I couldn’t find a buyer, all the big events that actually move the needle, are things that people didn’t see coming.

Trey Lockerbie (01:01:30):
And last but not least, we have Howard Marks sharing his thoughts on risk. Check it out.

Howard Marks (01:01:36):
I think there are three ways to increase your caution. Number one, go to cash in holder in part, very difficult. Because number one, it’s a two-decision action. You have to get out, but then you have to get in at a more propitious time or else it wasn’t worth it. Charlie Munger, says it’s actually a three-decision process because you have to get out, you have to get in and while you’re out, you have to figure out what to do with the money.

Howard Marks (01:02:04):
This is very difficult. And the other thing about, I try not to make decisions, which are going to be a disaster if things don’t break your way. I think one of the important aspects of being a good investor is you try to set things up so that if things go your way, you do great. But if things don’t go your way, you still do okay. So the first way is to raise cash, but that’s a real big problem because if you go to cash today and the market doesn’t crap out for the next two years, let’s say it goes up 12% a year, two years from now, you’re going to be behind the eight-ball you lost out on 24% of appreciation, you’ll never make that back.

Howard Marks (01:02:42):
So going to cash problematic, we never do it. The second, change your asset allocation. So for example, we all know which asset classes are supposed to be more defensive than others. Bonds are supposed to be more defensive than stocks. Big stocks are more defensive than small stocks and merging markets are less defensive than developed markets. The U.S. is more defensive than Europe, et cetera. So you can move from aggressive assets into defensive assets. And the trouble with that is you have to really transform your portfolio.

Howard Marks (01:03:16):
You have to do a lot of selling and a lot of buying and if you’re in funds, it’s hard to get out and so forth. The third way of being defensive is the one I would suggest to most people. First of all, remember, most people don’t know when it’s time to get in and out. So they shouldn’t be doing aggressive things. What they should do in my opinion is at the margin who may changes in your portfolio, that biases in a certain direction, so let’s say you want to be more defensive.

Howard Marks (01:03:42):
So in every asset class, be it high-yield bonds, stocks, high-grade bonds, anything, there are ways to be defensive and ways to be aggressive within the asset class. So for example, you say, “Well, I have a 30% commitment to let’s say high-yield bonds.” There are high-yield bond funds out there, which make the most in the good times, but lose the most in the bad times, there are other high-yield bond funds that lose the least in the bad times, but don’t keep up in the good times.

Howard Marks (01:04:13):
So you can switch managers within your high-yield bond commitment, switching from aggressive managers to defensive managers, and that’s the one that I think most people should look at. It’s just hard to get it right to justify major changes in your portfolio based on hunches, what I think they are hunches about the macro.

Trey Lockerbie (01:04:37):
So those were some of my top takeaways from 2021. I wanted to out this episode with one more sound bite from Howard Marks, where he talks about the most important thing to consider when you’re investing now, whether you agree with this approach or not. I do think it’s an interesting perspective. That is just a little too easy to lose sight of sometimes. So with that, please enjoy the most important thing in the eyes of Howard Marks.

Howard Marks (01:05:05):
This is what I want to say to your listeners, Trey, the most important thing is to start an investment program while you’re young, continue it as you grow and don’t screw it up. That’s my most important recommendation. How do you screw it up? You tamper with it too much. And of course, as I mentioned some time ago, the biggest screw up you can do is to sell out at the bottom. And so most people are not really suited for getting in and out of the market.

Howard Marks (01:05:34):
And I think the that’s how you’re going to practice defense, it’s very problematic. If you look at the stock market, the stock market has returned about 10% a year for the last 90 years. And if you can make 10% a year and if you can avoid paying any taxes, so don’t sell, your money will double every seven years. Money compounds at 10% a year, it doubles in seven years. So let’s say your grandchildren are five. They’re going to live to 75, got a 70 year program ahead of them. That means if you can do 10% a year and not pay taxes, both of which are his heroic assumptions that it’s going to double 10 times.

Howard Marks (01:06:18):
So you put in a dollar today, the kid is five, 2, 4, 8, 16, 32, 64, 128, 256, 512, 1,024. A dollar deposited when the kid is five will be $1,000 70 years from now, just don’t screw that up. Don’t get in the way of the compounding machine. I think it was Mark Twain, maybe Albert Einstein said, “The greatest invention in history is compound interest. Just get out of the way, don’t screw it up.” So I think that, and by the way, my grandchildren should probably be at about 95 or 100 on my risk return dial from 0 to 100.

Howard Marks (01:07:03):
Why? Because they have their whole lives ahead of them, and their parents and their grandpa is probably going to backstop them anyway. So they should invest early, probably all in the stock market. You don’t have to get fancy with other things. And by the way, that means index funds really, an S&P index fund, a Russell 2000 index fund, you want to get maybe an emerging market fund. You might want to have some exposure to the emerging markets, smaller companies, certainly to China, which is probably going to before those grand and children become adults, China will be the biggest economy in the world.

Howard Marks (01:07:43):
So you want to have exposure to China, and perhaps the other emerging markets. So I think my advice is a variety of equity index funds, which compliments and round out each other, and then leave it alone. When automation began to make great inroads into employment, as they did in the Autumn, and especially the teens, they used to talk about the factory of the future in the factory of the future there’s one man and one dog.

Howard Marks (01:08:09):
The dog’s job is to keep the man from touching the machinery. And the man’s job is to feed the dog. It’s the same with the grandchildren. My job is to create a portfolio for them and keep them from putting their hands on it. I think that that is a formula which is sure to work in the long-run and anything you do in the short-run to try to outthink the market is probably going to reduce your likelihood of achieving your long-run goals.

Trey Lockerbie (01:08:39):
All right, everybody that concludes this episode of my top 2021 takeaways. I really hope you enjoyed it, this was something new. We’d love to get your feedback. So please reach out to me on Twitter @TreyLockerbie. And lastly, I just want to, again, thank you all so much for listening this year. Thank you all for very kind to me, because I know I’m a new voice on the show. Your support means everything, and I really appreciate it. So with that, please enjoy your holiday, stay safe, and we’ll see you again in 2022. Cheers.

Outro (01:09:08):
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