So, Stig, you wanted to first start off this conversation by talking about the valuation process that we personally have used for years, how it’s evolved, has it evolved, and just kind of talk heart to heart on our seeing things these days. So, I’m going to throw it over to you to start us off. 

Stig Brodersen  01:18
I’ve gotten a lot of emails and questions here lately a lot about you, Preston. I don’t know why they’re there, but I get a lot of questions about, “Hey, it seems like you and Preston are like you’re no longer value investors.” They’re cursing we’ve been bad guys because we talk about sound or not sound money. We talked about momentum and macro assurance of asset classes. So, I wanted to have a discussion about where we came from.

If I have to go first, I would say that, generally, I haven’t really changed my approach. I am still primarily an equity investor. I do have multiple investments outside of the stock market, but I think I would probably have had that regardless. Really, the approach of looking at the current price and then estimate the future cash flows of the business and discounted back that hasn’t changed at all. 

The thing that’s important for people to know is that when we talked a lot about so many other things that we did in the very beginning, a lot of that was also just us exploring. That’s not necessarily us endorsing this type of investment. We were really trying to get smarter together with the audience.

What I do want to say is that, compared to 2014, when we started TIP and did the very first podcast, I would say that valuations have become more complex. When I started up my investing career before 2014, the way I looked at stock investing at the time was the same as Warren Buffett, when he talked about 10-year Treasury yield as the opportunity cost that you can also use as a discount rate. 

I think a lot of people are puzzled, probably, about that statement because it’s a statement that still pops up these days. They think, “Oh, the 10-year Treasury. Mine’s 7, so we don’t need to discount anymore. All the valuations are just great.”

I would say that where I came from in 2014, very much looking at it as a value investor, I was thinking, “Okay, we need to have modest growth rates. It would be even better if we had no growth at all.” And then, identifying strong companies that then could sustain the next 10 years, at least, if we were able to look out, and say, “Oh, it’s probably going to make at least the same.” That was sort of where I came from. I look at historical data and extrapolate that and say, “Yeah, that’s probably what’s going to happen,” especially if you can find them attractive valuations.

I’m also starting to look at that process a bit differently. I had a few painful lessons. I actually had quite a few painful lessons over the past ten years in terms of investing. I’ve been vocal about all the pain with National *inaudible*, GameStop which we have talked about multiple times. I remember you, Preston, years back, you were saying, “Yeah, I don’t know about this company. It looks cheap, but it also looks pretty bad.” 

However, I was going for all the moves, like, “Oh, I need to invest in that.” It was just so painful. So, I guess what I’ve done is I focused more on quality today, than, I guess, historical data and low valuations.

Also, I guess I’m a bit more realistic with the growth rates on some of the stock picks. I’ve been mentioning Google, Alibaba, and Spotify, on some of the earlier Mastermind groups. Those three are companies that I’ve invested in. It’s interesting. Whenever I thought of going into investing back in 2014, I would never, ever think of investing in companies like them at those valuations. Really trying to summarize before I go too long here, really, to answer how my stock valuation approach changed since we started TIP, fundamentally, hasn’t changed. 

What has changed is that I’m looking at more asset classes than just bonds, than just 10-year treasuries, to determine my discount rate and the opportunity cost of equities. I’m looking at currencies. I’m looking at private deals as long as they’re genuine cash flows. I’m also looking at very different business models than before. The valuation technique is exactly the same, but the assumptions, especially about growth, have changed. And I guess so far, so good.

In terms of macro, I know we do talk a lot about macro here on the podcast. I’m still a hard micro investor, but I think that macro is really important to support any investment thesis that you have. Value in itself is still a driver. I would still take a position based on value itself, but I’m sort of looking at macro as a really powerful catalyst that could drive value stocks to its intrinsic value faster. For instance, through momentum, but it can also be a catalyst in other ways.

Preston, I’m curious to hear. Going into this 6 years ago, after more than 300 episodes, what has changed? What hasn’t changed in your valuation methods?

Preston Pysh  05:57
Well, I’ve changed a little bit definitely on the momentum stuff. But I think the thing that’s changed most is just the environment that we’re operating in. Coming out of 2008-2009, I was of the opinion that we were dealing with free and open markets. I think that was a pretty normal assumption to have coming out in 2008-2009. 

Today, I don’t necessarily think that’s really the case anymore. I’m not saying that to get a rise out of market participants or to sound controversial. I really think it’s a sheer fact that when central banks can step in and drop that much money, trillions upon trillions of dollars into the market, I don’t think you’re dealing with free and open markets. 

The question then becomes how do you adjust your investing style to accommodate a manipulated market? Because if you don’t adjust to the facts, as that’s what you’re dealing with, you’re just going to get torn up.

So, I think one of the biggest things that have come out of this aggressive manipulation, I would say, in the last 10 to 12 years, is that it’s all about the data. These companies are able to harvest data and then intelligently make decisions based on the data. The data is like the crown jewels of business at this point, and companies that haven’t adjusted to that are not going to compete on a relative basis, as far as growth rates. 

If you’re going to compare the brick and mortar company that’s in a small town, whatever, to a company that can compete on a global scale as far as their growth rate, because they’re harvesting data and using that data intelligently, you just can’t even compare the two.

One of my biggest pet peeves in investing is when people say, “Oh, well, that’s a different asset class. You’re comparing apples to oranges.” I’m comparing dollars to dollars, right? Like what gets me the fattest return with reduced risk based on the competitiveness of the assets that sit on their balance sheet. 

So, when I’m looking at that, and I’m saying why has value underperformed, well, so many value picks, in my opinion, are kind of those companies that fit the local business model or the brick and mortar business model, and they haven’t been able to compete globally unlike Apple, Netflix, Amazon, Facebook, Google. 

I’m comparing a chart of the S&P 500 compared to Amazon. Just since 2014, we’re talking about large cap companies in 2014, to now, just in the last six years, Amazon’s performance is 595% versus the S&P 500, which was 68%. Like, that’s insane. That’s nuts! And that’s a large-cap company. So what’s driving that? Why do we see these companies that are able to do that? 

I would tell you that it all comes back to their ability to capture data, and then use that data intelligently for areas that don’t even seem like they’re related to the core original business model that was out there. It’s the same thing with Netflix, same thing with Facebook, same thing with Google. These companies are masters at collecting data, harvesting the data, and then stepping into a completely different business model using that technology to speed things up, to take people out of the process to save their costs.

If you are going to plow into their financials and understand why these companies have been able to do this, it really comes down to one thing. Because they have lower costs, like, let’s look at Google, for example. They have huge margins in the advertising space for what they’re doing. There’s no one sitting there running. It’s been completely outsourced and decentralized to run ads, so they’ve got fat margins. What are they doing with those margins? They’re then plowing all those margins back into capital investments that the company owns through R&D.

When you spend R&D dollars in your company, those are expensed immediately. Those expenses go on to the income statement. Let’s say they spend $50 million on R&D. That’s expensed, and then it’s listed on their balance sheet. That asset that they created then goes and sits on their balance sheet. 

It looks like they’re not making any money because it was expensed on the income statement immediately that year. Well, if you see this, that doesn’t look like the company’s making any money.

If we go to the Amazon model, it doesn’t look like they made any money, or it looks like it’s a net balance of zero at the end of every income statement that they pump out each quarter and every year. Well, what they’re doing is they’re creating assets that then go sit on their balance sheet, as far as listed assets are not based on valuation, but just the listed asset because they expensed it according to GAAP accounting rules. 

It may look like the company’s making no money, but then, that asset starts kicking in more and more cash flows, which then they go and invest in more R&D and create more and more assets. So, that’s how the companies are growing, but as far as if you were looking at it from a value investing stamp, from an income statement standpoint, it’s going to be like a mirage. However, if you’re looking at the price action, and you’re looking at the momentum, it keeps going up.

I think you have some really interesting things happening over the last 10 years, specifically, that’s a direct result of central banker intervention that’s allowing this to take place. The fact that we have technology after decades of inflationary monetary policy, you’ve set up an incentive structure that has allowed technology to do these crazy things. 

And now, it’s kind of this endgame of the biggest companies can now step into markets that weren’t even their originally intended market, yet because they have access to data and they have so much intelligence in their decision-making, they’re able to capitalize in industries that they are just stepping into because they’re looking at things at such a different angle. Furthermore, they’re able to do it so much cheaper than before.

Moving forward, as far as my investing approach goes, you better believe I’m keeping an eye on Apple, Netflix, Amazon, Facebook, Google, the big companies that continue to just suck the blood out of everything. I’m definitely using a momentum-based approach because one of the other effects of a manipulated market and for value investing to work is you have to be able to do a discount rate. 

You have to be able to conduct a calculation on what something’s worth. At the core of value investing is that you’re dealing with sound money. So, if you’re not dealing with sound money, and the money’s getting debased at a breakneck pace as we talked with Lyn, and she was saying 7% or 8% just added debasement rate. That, I guess, becomes your new risk-free rate at a minimum, and that’s assuming that 7% or 8% persist into the future, which I’m very skeptical of. I think it’s going to be higher than that. 

I guess what I’m getting at is it’s really hard to be doing these valuations and math of what a business is worth when the ruler is being changed at a breakneck pace simply because of all the macro things that we talked about on the show. And so that’s hard, and that’s concerning to do really well. I think that’s why I’m leaning more towards a momentum strategy.

Now, if we would go back to sound money, and we’d have some type of ruler, risk-free rate, or a debasement rate that was sound or not flexing all over the place and has all this variance in it, value investing would crush it. I have no doubt about that. I think that it would outperform tremendously. Those are some of my thoughts on why we’re seeing what we’re seeing. 

Stig Brodersen  13:35
Really interesting response, Preston. That sort of ties into the next two points we’re going to talk about here for today’s show. Next up is machine learning secular trends in the 21st century. Then, I would really like to talk about what to do when you’re investing in a world with no sound money.

The first point here is about machine-learning secular trends. We spoke with Arif Karim from Ensemble Capital just a few episodes ago. I really wanted to hear his thoughts on potential undiscovered secular trends. Who would like to be invested in Amazon even before it was like the Amazon we know today? He did agree that if you can find undiscovered secular trends, that would be fantastic. 

But he also said, it’s really, really, really hard. You can still invest in secular trends and make a lot of money if you play your cards right. He mentioned MasterCard and Amazon as just two of those companies who’ve been riding on secular trends that everyone was out there to see for decades. But still, you can make a ton of money from that.

One of the most impactful books that I read this year was Jeff Booth’s book, The Price of Tomorrow. I absolutely loved that book. We interviewed him back on Episode 294. Again, you should definitely listen to the interview, but if not, pick up the book, in any case. It’s a fantastic book. Jeff talked a lot about how competing in the 20th Century is different than competing in the 21st Century. I thought a lot about how to tie those two together about what we’ve said and what Jeff said.

One more point that Jeff made was that it used to be economies of scale. That was how you competed in the 20th century. If you’re a big company, you can limit your size to get discounts for suppliers. Walmart would be an example of that. They have economies of scale like other old generation companies. That worked really, really well in the 20th Century. 

The problem is that those types of businesses have a bias that they have to prioritize what sells best. Since they have limited storage, they will continue with the best-selling products. It sort of becomes a self-reinforcing effect that leaves out innovation.

Jeff then talks about how networking effects is 70% of the gain of these tech companies. Comparing Walmart to something like Amazon, where you have customers doing the choosing. You have suppliers doing the promotion. 

The market automatically innovates for Amazon in a very different way than it can do for Walmart. Again, I’m talking about the traditional Walmart. I do know that they’re doing a ton of new stuff on the internet lately, even though it definitely derails what Amazon has been doing.

Now, of course, you could also have advantages like cognitive scale. It’s not like it’s not important anymore. But the real winners, companies like Google and Amazon, emerge as winners in the 21st century because we’re now in a winner-takes-all or close to a winner-takes-all type of industry. 

They just have a vast amount of data to serve the customers the very best products and services. I know what you’re thinking: “We already knew that. Preston said that 10 minutes ago, we knew that.” It seems like everyone knows that right now in the stock market. And yes, that is my entire premise, but I would also like to put a layer on that in terms of how we can, perhaps, make money off something that is not priced in using the same secular trend.

So, again, let’s say that the networking effect is here to stay, and so is the case for machine learning. Which countries will really benefit from this more than any other? Preston and I have previously talked about Kai-Fu Lee’s book, “AI Superpowers,” which is a great book in itself if you want to learn more about big data. He talked about how Google, in his opinion, had the best engineers. They are the best in machine learning in the world. But he also talked about how mediocre AI engineers with more data, at any time, would outperform a company like Google.

I was trying to do a high-level thinking of, okay, so we have three regions in the world right now with a lot of technology and a lot of data. You have the US, Europe, and Asia. Specifically, China in Asia. I wanted to take an alternative view of not just thinking about the current situation, but include ideology in terms of predicting what’s going to happen in the future. 

Let’s talk about an ideology that has failed. By that, I basically mean a data processing system. So, one that failed is communism. Communism failed because the data processes were just all centralized. The western capitalist societies won because the modern economy of the 20th century was just so much better off with a decentralized data processing system. 

Let me just give you an example of the virtues of a great information system in the 20th century. There was this famous story about Gorbachev sending a key aide to London to learn what the British did well and what they didn’t do well. 

Gorbachev’s aid was taken around in London, and he was shown how the British businesses operated and then after a few hours, he just burst out. “We’ve been going back and forth in London for the entire day, and there’s just one thing that I don’t understand. In Moscow, we have the finest minds in our country working on a planning system and people still have to wait in line for hours, but I see no queues in London. Please take me to the person in charge of planning.”

Now, I’m sure you see where I’m going with this. There was no person in charge of the breadline. That’s the entire point. That is the secret of why Western capitalist countries did so much better than the Soviet Union.

To bring the point home, which data processing system will be most competitive in the 21st century? Assuming that data and machine learning is as important as we think it is, Europe will be in a world of pain in the 21st century. You already see a lot of that now in terms of how we collect data in Europe. 

You might argue that it might be better in terms of personal privacy, but in terms of competing with the US with the current legislation, it’s just much more business-friendly in terms of big tech, so the US definitely has a leg up there.

Now, then if you compare that with 21st century China, I would argue that they have a leg up. With the changing technology, that is, in many ways, just much more efficient than a decentralized system because machine learning works better the more information you can analyze. I want to emphasize that this is by no means a way for me to glorify communism. Actually, the very opposite is my point.

I think that everyone who’s been listening to the podcast for the past six years knows that I’m the very opposite of that. But I’m saying this because the way the Communist Party in China controls the population and collecting all the data without the population’s consent, in a weird way, may turn into a competitive advantage. I clearly think it’s horrible, but not something I should ignore either as an investor as a private citizen of the world. 

I’m saying this because we need to think about which type of world we want to live in and which type of sacrifice we’re willing to make. I just wanted to have this as a new input to investing and the opportunities in a secular trend that we all know; machine learning, privacy, networking effects. Whether we like it or not, as private citizens as investors, how should we position ourselves?

Again, and I said this before, but my point is not that I want the Chinese to outcompete the West. In close to all areas of business, a free market will always be better. But I am very concerned that big data might change the rule of the game, where the more data you collect, and the more ‘big brother’ society is, the more it can be turned into a competitive advantage in the 21st century. I hope I’m wrong, and I do hope that capitalist and free economies will prevail, even in the world of big data. I’m curious to hear what you think, Preston.

Preston Pysh  21:44
I think this is really simple. When you’re looking at democracy, the engine for democracy is capitalism. But in order for capitalism to work, you have to have sound money. Period. Right? Because with sound money, you can now conduct economic calculation. You can price out how much it costs to go buy flour, how much it costs to do the labor, and then you can competitively step into the market and compete. And if you suck, you fail. You go bankrupt, right? That’s how capitalism is supposed to work. If you suck, you go bankrupt. 

Right now, today, I would argue you don’t have that. It’s not just me who’s saying this. You have Ray Dalio, who’s arguably one of the best investors to live, right now, who’s literally come out this past week and said that we don’t have free and open markets anymore. 

So, I would argue, democracy becomes at risk when capitalism is not actually being conducted. We’re not allowing there to be a free and open market for companies to fail and for companies to prosper if they figured out a better way to do things. 

So, stepping in and saving the company that makes jets just because there’s only one of them in a country, and they’ve mismanaged themselves, let them fail. Let them fail. Some people will step in there. Some companies will step in there and buy their assets, and repurpose their assets. It might not be the price that we like. It might not be the price you like at all. It might be for 20% of what you thought it was worth on your balance sheet, but somebody will step in there and buy that. 

They will repurpose it, and then they will prosper. And they will take off because they have a better way to manage the business so that they’re not cashflow negative. We have to allow that to happen. When you do that, all economic calculations will take care of itself and everyone has an equal opportunity to prosper.

We’ve gotten far far away from that not just in the United States, but all around the world because of an academic idea on money printing and controlling economies. It works over a long period of time, but if you keep doing it for 80 years, you get yourself in a situation where now they have to print to prevent social unrest.

A communist country like China, is the epitome of control and manipulation. When I think communism, I think, peak manipulation. If there’s one thing that I’ve learned in nature is that when you don’t allow function free and open, you get yourself in the biggest drastic setbacks. It might not happen in a 10-year timeframe or even a 40-year time frame, but eventually, it’s going to erupt and explode because there’s a human being in the loop controlling, as opposed to allowing free and open markets to naturally work themselves out through the process of capitalization of failure and success.

So, I’m hesitant to agree, Stig. I might be missing your point with the way you were describing it, but I don’t think artificial intelligence or any type of technology is going to allow communism or some type of hybrid communism to succeed. Please correct me if I’m misunderstanding your thesis there.

Stig Brodersen  25:12
I feel that AI and machine learning could turn the tables, which again, is not what I want to happen. We can think of this as capitalism versus communism, and I think we would all, for good reason, have a pre-notion of what we think is right. Clearly, capitalism is better. No discussion. 

My thesis is: Let’s see if we can leave the ideology out of this and only think in terms of data. If China can collect 10 times as much data as Europe and three times as much data as the US, does that or does that not give them an advantage? I would argue that it gives them advantage. 

Like I said before, I hope I’m wrong. Since I clearly don’t side with China and global competition. I think privacy and democracy is at the very core of a good society to live in, but if the rule has changed and it’s a question of the amount of data, which is the main input of machine learning, I unfortunately think that more data is an advantage.

Preston Pysh  26:10
That’s much clearer now that you say it that way, Stig. I’m with you. I think that if a communist nation is able to enforce all the businesses inside of its borders with a massive population, if they’re able to force the companies to push all their data through their prediction models to do this AI, they’re probably going to have better intelligence in order to act on that.

Now, what that means as far as the performance of those businesses relative to a democracy where we have much freer and open markets than then over in a communist nation, I don’t know from a performance measure, from an investing standpoint, whether you’re going to get an outperformance in the communist nation versus an outperformance in a democracy. I know this as far as an investor, it’s getting really hard for me to invest in China. It just is. 

I see some of the things that are going on. And maybe it’s just my home bias that I have, but I just find it very concerning. I find it really concerning if you think about how they could potentially outsource those AI models that they’re using to other nations, and what that might mean in the future. 

So, as much as I don’t want to agree with you, I think I do agree with you. From an investing standpoint, I just am not going to participate in those markets. At the end of the day, I don’t think that that’s going to have any impact. Of course, it’s not going to have an impact. But I guess that’s just me, thumbing my nose at that system and just trying to remove myself from the thought of that happening.

Stig Brodersen  27:57
Let me take what you set there and tie back to the first topic of today about how we’ve evolved in our valuation process over the past six years. I really wanted you to challenge me on something I’ve been thinking a lot about because I’m primarily invested in global equities. 

I completely agree, and we’ve talked multiple times on the show that there is a debasement of the US dollar and you see the debasement of different currencies across the globe. We talked about the CPI before, that that’s not covering the true debasement. Lyn talked about that in the last episode about how that might be a percent of whatnot.

However, my base thesis for being invested in equities is that if you own shares in a company that adds value to the customer, customers will exchange whatever they have of value in exchange for that product or service. It doesn’t really matter if it’s called the US dollar, euro or whichever currency we have. Not long ago, it was toilet paper, hand sanitizers, you know? It seemed like that was the new currency. Whatever they have that they deem is worth, I would save that while the manipulation has become more prevalent, valuations have been harder. 

The principle of owning companies that spin off cash in any kind of nominal currency is still valid, because the fundamental relationship between the real cost in equities and the real return, on one hand. And then, the nominal cost and number return is the same unless we see a massive change, like hyperinflation. Even in the case of hyperinflation, you would still like to own real assets because they have intrinsic value.

Preston Pysh  29:29
I completely agree with you. I think what the thing to really focus on is: Which company’s assets are not going to be impaired through a depression-like scenario? So, when you look at Google, are their assets going to be impaired through that? Probably not. Amazon? Well, I think we just saw how Amazon performs through dire situations, right? It performed flawlessly. 

So, when you’re looking at the assets, not necessarily the dollar figures that they’re listed for the income statement, the numbers that are flowing through it, but you actually look at the qualitative value of the assets that are sitting on their balance sheet and whether they’re going to be impaired through a dire situation. Those companies that are plentiful and have those types of assets on their balance sheet are going to do fine.

Where I think that it’s going to be a challenge is if we move to a new currency, that company even though they’re sitting on great intangible assets or tangible assets that aren’t going to be impaired, their ability to transition to this new currency is going to be vital for them to continue to keep pace with the valuation of the new underlying currency that steps in. That’s what Ray Dalio talks about in his book, Big Debt Crises. It’s that investing in equities is a mixed bag for that reason. But what you’re talking about Stig, I completely agree with.

I don’t necessarily see that we will not have fiat currencies for a very long time. I don’t think enough of the right people have an incentive to do that right now. I’ll outline a lot more about that in the main newsletter that was sent out. I’ll make sure to link to that in the show notes. I think we might have different opinions on that because I know you said that it’s something that will be demanded. I think it could happen, but I don’t think it will happen anytime soon.

I think what’s important right now, in 2020, for investors to understand is that there’s nothing inherently bad, at least in my opinion, with fiat currencies. It’s about how they’re used and that they’re used in that system that’s been designed because it’s two very different things.

If you say that I’m being robbed every single year because I hold cash and that’s supposed to be the case, the government’s robbed me. I’m not saying that you’re not having a good point. But in that case, my counter-argument would be: So, what do you do about it? You can go to the Fed’s homepage. There, it says that the goal is to debase the currency. It’s not like it’s a secret. That’s the official policy. 

If even so, you want to save up US dollars, you’re going to be in the world of pain. So, how do we navigate? How do we protect our principal? And how do we compound our wealth in a fiat-based monetary system? I guess that’s what I’m trying to figure out. 

For me, right now, one of the things that I’m doing is holding global equities. To me, that’s the key more than focusing on a monetary system that we should have because that’s not happening. It’s more like a philosophical question than something for investors to act according to.

Preston Pysh  32:34
One of the things that I think is really important for people to understand about a change in the way that I’m investing is I think that the basement rate you’re seeing now is so different from what we saw 10 years ago. Prior to 2008-2009, your debasement rate was kind of your rate of inflation that you would see on CPI. 

Now, I think it’s being totally masked because the QE is going straight into the asset prices. So, if you’re using that debasement rate that Lyn talked about on the last show, and you’re saying, “Okay, well, what do you own now?” That’s really the big question. 

At the end of the day, you have to own something that has some type of scarcity to it where you have to own equities that have really great assets, like the ones we were talking about earlier on the show. You have to own those that aren’t going to be impaired through really difficult times. We’ve been talking about gold on the show. We’ve been talking about gold miners on the show. We’ve been talking about Bitcoin, even though a lot of people don’t like us talking about Bitcoin.

With that, let’s just take gold and Bitcoin, for example. They totally have outperformed the S&P 500 for this year. That doesn’t mean that it will continue to do that. I suspect it will, but that doesn’t mean that it will. I think that these companies that have really strong assets, like the ones we talked about are going to continue to outperform because there’s going to be a demand. 

Regardless of what happens to the currency, whether it happens quickly or slowly, there are those companies that are going to continue to perform just because of the sheer demand that the public has for the products and services that they produce.

You see a huge debasement so you should do anything but just holding cash. I don’t know if this should be in an entirely different episode, but I fear I’ll be paying the opportunity cost if I’m waiting for another monitor system to happen because I have my living expenses, my taxes, and everything else that’s linked to fiat currencies. I want to protect that. I want to compound that, if possible. 

Now, what that means in terms of purchasing power, I don’t really know. I know that being in equities and other assets is better than just being in cash. I guess it’s easy to understand why, but that’s sort of like what I’m trying to get at here. So, what should we then do? You mentioned Bitcoin as one example. If this new monetary system change will happen decades from now, I don’t know how much my purchasing power will be diluted if I’m not doing something about it.

Yeah, I think it’s happening sooner than that. I think there are a lot of people that disagree with me on this, but I think we’re within a three-year time frame that there’s going to be a breaking point. The reason I think that is I’m just looking at the speed of debasement that’s happening across the globe with central bankers, and the fact that you have no interest rates, and the speed is aggressively accelerating.

When I look at the solutions that are in place today, or the solutions that are being proposed today, there aren’t any, and there’s much more debasement that’s expected just before the end of this year, in the next six months before 2021 even arrives. You have got major banks saying that that’s to the tune of $5 to 10 trillion more, and I just don’t even know what it’s actually going to fix because, at the heart of it, I think you have major fundamental issues with the economy. Everything that they’re doing is just propping it up for another four or six months until the next debasement tranches and drops into the economy, not just in the US, but all over the world.

That said, I suspect this is going to really start to unravel at an accelerated pace. Not only that, but I hear a lot of people say, “What about UBI?” If they start doing UBI and not QE, well, then maybe we can counter some of these forces and make this play out a lot longer. 

I think I have an unpopular opinion there, too. I think that UBI will only further enhance the need for quantitative easing, and here’s the reason why: Lyn, on the last episode, started talking about how the average household income actually went up through COVID because of all the policies that were in place for unemployment, like the UBI check that went out that we all suspect to get turned back on before the end of the summer. 

Think about what that’s going to do to prices of various commodities in the economy. It’s going to make it go up. We saw that with meat prices, and there are many other examples of things that have gone up in price through this.

If we continue to do UBI, maybe what we start to find is that there’s a further sell-off in the bond market because all this UBI is supplying buying power to the masses, who are then going out and buying their basic needs and actually driving the price of those items that fit into that CPI bucket up. 

And if those prices are going up, and CPI is going up, well guess what? It starts getting priced into the bond market. There starts to be a premium above the inflation. The CPI inflation that we haven’t seen being priced into the market, that adds pressure. That increase in CPI means that you now have to have a premium above the inflation rate if you’re owning a bond. That would put even further pressure on the ownership of bonds for all those bondholders. 

They’re going to want to sell that off in order to account for that premium above the inflation rate. To add, that is only going to be subsidized by more quantitative easing in order to fix the yield curve, which we’ve already talked about extensively.

I kind of suspect what’s going to happen is that as they continue to implement more UBI around the world, it’s going to put even further stress on the need for more yield curve control by fixing the yields. Because all that is people that actually own the bonds are stepping onto the market, and the Fed’s stepping in and buying everything that’s being sold in order to fix that yield curve at a certain yield –call it, 50 basis points for the 10-year or whatever. 

I suspect that UBI is only going to further enhance the need for more QE. It’s going to create even more debasement. Add in the fact that you have this competitive devaluation happening around the world. We just saw this. 

The US stepped in, printed $4 trillion, and what did that do to every other economy around the world? Europe, Japan, –you name it. What happened to their currency? It took off. It started gaining and appreciating in value relative to the dollar. 

So then, they had to step into the market and start debasing in order to make their prices for goods and services competitive on a global scale, so you’re seeing this pick up speed, this competitive devaluation across the entire world. 

As the US steps in and does more UBI and they do more QE, it even puts more pressure on these other countries to do the same. And it’s a race to the bottom. So, it’s just crazy stuff we’re seeing right now in the realm of currency, fiat debasement, and what implications that means for people wanting to own equities or people wanting to own whatever security.

Stig Brodersen  40:10
Alright, guys. I can already say now that for the next current market condition episode, we definitely want to talk a lot more about sound money currencies and monetary systems. I think it could be very interesting to explore even more, but we also have a few other things I’d like to do for this episode. I want to talk a bit more about what we’re seeing in TIP Finance in terms of what is interesting for us in our investing universe. And then, we also want to play a question from the audience.

So, looking at TIP Finance, whenever I look at our filter for large-cap stocks, the fourth cheapest stock, Bank of America, right now is trading at a TIP multiple of 2.7. This is in comparison to the TIP median which is 10. So historically, it is trading at a low valuation. 

Not surprisingly, the momentum of bank America is red. While the near future looks bleak for Bank of America, as with so many other banks, a bet on Bank of America is really a bet on the US riding up the storm, which I’m confident will happen. So, those are some of the reasons why I really wanted to talk about Bank of America, specifically.

Now, if you look at the top three super investors, and I’m referring to DATAROMA where they collect information from asset management companies or individuals that manage more than $100 million dollars because that needs to be disclosed. If you look at the top three super investors who are the most exposed to Bank of America in their portfolio, it’s Charlie Munger, Warren Buffett, and Guy Spier. 

Number four on that list is Bill Nygren from Oakmark. He was actually here in Episode 293, where he pitched Bank of America. I thought that would be interesting if you want to know more specifically about Bank of America.

Anyway, I just wanted to give you guys a few pointers. Clearly, the exposure you have also from these super investors depends on which price you bought at. Buffett bought Bank of America last time in Q2 2019 at $28, and he was trimming his position in Q3 of $32. 

At the time of recording here, the first of July in 2020, Bank of America is trading at $23 in change. It’s just a stock that I had on my radar that’s been validated by investors that I really respect and that looks relatively cheap compared to all the US large-cap stocks.

Now, going from a value play, we also have a momentum play. S&P 500 turned green on May 5th, after turning red on February 26. We’ll make sure to include a screenshot of that in the show notes, but if you follow the momentum tool, you would have made a decent profit back when our momentum tool told you to sell S&P 500. 

It was trading at 3116,  and then, it recommended that you would buy back at 2868 points. That was back in May 5, and now the S&P 500 is trading at 3100 again, and the momentum is still green, indicating that you should continue to be invested in the S&P 500.

If you do the quick calculation, you would have made an 8% return if you follow the momentum tool compared to a 1%, if you just held on. So, a way to play this could be to just stay in the S&P 500 if you’re already invested, and then whenever momentum turns red, you might want to consider some of the international markets that we talked about on the last current market conditions back on episode 300. I’m curious to hear, Preston. What you find interesting on TIP Finance right now?

Preston Pysh  43:47
Well, Stig, like you I start off kind of filtering for value to see what kind of companies are hitting the top of the filter. It’s interesting that one of the companies that has popped into the filter is Intel (INTC). There, they’ve got a green momentum status. They’ve got good valuation metrics. Whenever I step in and do an intrinsic value on Intel, I’m getting a valuation that is an IRR of around 8-9%. 

So, when we’re looking at how this will perform in the coming years, going back to what we were talking about earlier, as far as a debasement rate maybe being the best way to think about risk-free returns relative to just how much we should expect equities to appreciate in nominal terms, I think this company would do well relative to the rest of the S&P 500 or whatever major index you would like to use as a comparison.

I went in and looked at the free cash flows of the business. It has really good free cash flows, a positive trend to free cash flows as I interpolate those out into the future. I’m coming up with an IRR around 8-9%. I think that this is a company that, as far as the assets on their balance sheet and their competitiveness moving forward, it’s going to do fantastic. Or, at least it should do fantastic. 

We’re looking at the top line. It looks fantastic, so I’m really happy with this. This was a pleasant surprise to see it come up as far as large cap companies. In valuation terms, to come up so high on the filter and to also have a green momentum status. So, it may be worth some of the listeners’ times to dig a little bit deeper into this one. 

Stig Brodersen  45:43
Alright, guys. At this point  in time in the show, we will play a question from the audience. This question comes from Cole.

Cole  45:50
Hey, Preston and Stig! I absolutely love the show. I know this isn’t TIP’s focal point, but you guys seem to discuss Bitcoin quite often. 

I’ve been in the Bitcoin committee for about a year and a half, and I can sense that my information sources, Twitter primarily, are beginning to become a bit of an echo chamber. How do you guys subject yourselves to opposing viewpoints relating to Bitcoin? Or any topic that matters that you have strong opinions towards? Thanks, and keep up the awesome work! 

Stig Brodersen  46:16
Cole, I absolutely love that question. Just but doubting your own sources of information, you’re way ahead of the pack. When you ask me specifically, yes, there is a lot of information that I don’t pay attention to. That’s also one of the reasons why I’ve been much less active on social media. 

For instance, every Sunday, I’ve dedicated seven minutes on Twitter, typically to share the newest episode to respond to the audience. Of course, once in a while, find great content, but I really try to limit my time on social media for the same reasons as you mentioned because I tend to live in the echo chamber, too. 

I typically only seek new information if it’s by a trusted source or referred by a trusted source. That is partly to save time, but also to enhance the quality of the time I do spend consuming new information and making myself smarter. I try to do that a few hours a day.

Now, this is not the same as saying that I’m not critical about the information I get. But I do spend a lot of time thinking about whether a trusted source is right or wrong, and of course, whether I’m mistaken myself. At least in my experience, when it comes to investing, it might be even worse with Bitcoin, as you mentioned. It can get pretty ugly. 

You have one extreme who, “found the truth,” and everyone who is not invested in Bitcoin must be almost cognitively challenged by not understanding the virtues of Bitcoin. For the other extreme, you have people who look at Bitcoiners as degenerate gamblers who found a digital tulip mania. Those people typically never researched Bitcoin with an open mind and sort of sticks to the Charlie Munger notion of Bitcoin being rat poison.

Keeping that in mind, I would like to elaborate more on how I go about combating my own biases because I don’t want to be in those two extremes. What I do to combat my own biases, and I sure have a lot, is that first I always think about the incentives whenever I listen to what people are saying. I’ve experienced a lot of people, who missed the boat on Bitcoin, were wrong in their analysis and become really angry when it comes to Bitcoin. 

Even though you might say that they don’t have a financial incentive, if they, in their mind, are losing thousands of dollars every time the price of bitcoin moves $50, all financial biases kick in and they continue to look for explanations why Bitcoin will eventually fail, instead of being objective that they could just have been wrong, but then I would say the Bitcoiners are just as biased. 

If you argue for Bitcoin, you typically have a long position and there’s nothing wrong with that. You might rightly say that it wouldn’t make any sense to queue passionately about Bitcoin if you don’t have skin in the game. So, people are in no way insincere whenever they have a Bitcoin position and argue that it’s valuable. They truly believe that, and you can count me in on that.

But they have all the incentive in the world to spread the gospel of Bitcoin, since it’s by definition is based on trust mass adoption. So, if I can choose who I’ll listen to, I don’t want to speak to the firm believer or the firm non-believer, but the thoughtful person who used to hold Bitcoin and now sold, or it could be the thoughtful person who, after careful analysis, took a position. 

Lyn Alden, whom we had on the last episode and whom we referred to a few times, is a good example of the latter. She’s an example of someone who was very critical, and then decided to take a position because of careful analysis after being very skeptical. Or it could be the other way around.

That really takes me back to my argument of understanding both sides of the argument to get rid of my own biases, challenge myself, speak to Preston who would do everything he can to challenge me, which is great. If you want to truly understand both arguments, what should you then do? It is very difficult. We are wired a different way in terms of how we collect our information, but I found that to be very useful.

To give an example of what I’m doing right now, I’m very interested in understanding economic systems and the role of governments through history. I try not to speak too much of that here on the show because I don’t want to make the podcast into a financial history lesson. I think everyone would just be super bored if I did that, so that’s not the intention. But I do get a lot of inspiration from understanding those systems better by looking back in history.

Just last week, I was reading Adam Smith’s The Wealth of Nations, and now I’m reading Capital and Ideology by Thomas Piketty. He, of all people, a French economist, comes from the very opposite spectrum of the pure capitalists like Adam Smith. He definitely has a very different agenda and incentive, but to me, it’s too easy and wrong just to read one genre and say, “Well, then, that’s the truth. This economist refers to this economist who says that this economist is right.” No. If they’re all in the same study group together, you’re not going to be any smarter. You might think that you don’t form your own opinion then.

So, to answer your question, not through short posts, but through multiple and well-research resources, primarily books, with opposing opinions, and speaking with thoughtful people who argue both sides of the arguments. If you are well-aware of the incentives of those authors and those people you speak to, that is how I would say that you should form an opinion. It’s quite a time-consuming approach. 

Most people don’t want to do it for that reason because most people prefer to listen to pundits who are very one-sided, because it confirms what they already believe in and they don’t have to reflect on it and make their own conclusions. That is what you want to avoid. I would suggest the other way around. Even though it is a time-consuming process, I think you’ll find that you’ll be rewarded in the end. 

So, Cole, I absolutely love this question. I think this is such an important question, especially right now with everything that’s happening in the world. There was a book that Stig and I covered. We did a whole episode on Superforecasting. 

This book really helped me gain an appreciation of how important it is to see the arguments for both sides, like Stig was mentioning. I would highly encourage you to go read that book. It is a fantastic example of why it’s important and how lethal you can become by looking at both sides of an argument. 

Preston Pysh  52:56
I remember Charlie Munger talking about when he went through law school and how they would be given a case and they’d have to argue one side of the case, and then they would go back and they’d retry the exact same case over again, but then they’d have to take the counterparty to the side that they just got done doing. 

What it taught him is an analytical way to remove emotion and everything, but the facts surrounding both sides of an argument. I think that whenever you’re doing any type of investment, whether it’s Bitcoin, stock, or a commodity bond, whatever it is, you have to try to exercise this process.

Now, when you’re online, it can get very difficult to do this effectively. I think it’s really important for people to focus on. Especially on Twitter, in particular, when people step away from focusing on the ideas and they start focusing on the person or the personality of the person. 

For me, that’s somebody I don’t want to follow. That’s somebody I don’t really want to interact with because they’re letting emotion and feeling enter into something that needs to be much more objective and focused on the actual ideas. So, try to find people that are like that, they’re not slandering you or other people. When I see that, I try to remove those people from my feed, and I try to only focus on people that are hyper-focused on the ideas.

The other thing that I tell you is ask yourself, Why? five times. When somebody says, whatever the argument is, “I think Bitcoin is going to be successful because of X, Y, and Z.” Say, well, why do you think this particular thing? You’ll see different responses from people, and you can go another layer deeper. I would challenge you to go five layers deep on whatever the issue is. You might even have to go deeper than that, to really start to fully understand something.

On Stig’s point about somebody’s own interest, like Stig, I own some Bitcoin, and so that in itself will bias or warp the way that we see things because we have a vested interest in it going up or it succeeding. So, you always have to tell yourself or challenge yourself in saying, “Am I leaning in this direction simply because I have a position?” 

A lot of the time, you’re going to find that you are, and so you have to try to seek out the people that have counter opinions. But just don’t seek them out because they have a counter opinion. Seek them out because they have a deep appreciation or understanding for a counter opinion. I think the way that you can understand whether they have a deep appreciation or understanding of the counter opinion is by going five layers deep, asking yourself five times why they have this position, and really challenge it. It’s a lot of hard work. 

At the end of the day, what you’re talking about, to have an unbiased or a balanced position or understanding of a topic, it’s a lot of hard work, and in Bitcoin, in particular. That’s one of the reasons why I’m constantly on Twitter, arguing with one side of the issue or the other side of the issue simply because I’m trying to uncover the truth. I’ve been doing that for five years at this point.

To sum it up, the only way you’re going to really understand something is by hearing every side of an argument and exposing yourself to that vulnerability, and to really dig in. It’s not easy stuff. It’s a lot of hard work.

Cole, for asking such a fantastic question, we’re going to give you a 1-year subscription to our TIP Finance Tool. We’re thrilled to have you part of the community. If anybody else out there wants to get your question played on the show, just go to asktheinvestors.com. If your question gets played, you’ll get a 1-year subscription to our TIP Finance Tool. So, Cole, thanks a lot for being part of our community.

Stig Brodersen  56:45
All right, guys. Preston and I really hope you enjoyed this episode of The Investor’s Podcast. We will see each other again next week!

Outro 56:52
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