17 November 2018

On today’s show, Preston and Stig talk about the current market conditions in the 3Q 2018.

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  • How Preston and Stig’s previous stock picks have performed.
  • How Preston and Stig are positioned given the current market conditions.
  • How often we experience corrections in the stock market.
  • The impact of rising federal funds rate on the stock market.
  • Ask The Investors: Should I add bonds to my portfolio?


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Preston Pysh  0:02  

On today’s show, Stig and I have a fun conversation about how we see the market in the third quarter of 2018. This has been an interesting year because the S&P 500 is only up 1% since the first of the year. In addition to that, we’re seeing a lot more volatility than we’ve seen in previous years. 

As we look to close out the year, many people are wondering whether the longest bull market in stock market history is reaching its final legs. 

On today’s show Stig and I provide our opinion on that idea and what the key factors are driving our theories. 

In the second half of the show, we talked about some of our previous picks from our MasterMind discussions and how those positions have performed when compared to the S&P 500. Without further delay, here’s our candid discussion about the current market conditions.

Intro  0:49  

You are listening to The Investor’s Podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.

Preston Pysh  1:10  

Alright, welcome to The Investor’s Podcast. I’m your host Preston Pysh. As always, I’m accompanied by my co-host, Stig Brodersen. 

Today, like we said in the introduction, we’re going to be talking about how we see the market today, because there’s so much happening and how we’re positioned. More importantly, we’re going to talk about some of the stock picks that we’ve made in the past, how they’ve performed, and how we think about them now today.

This should be just really a lot of fun for Stig and me just to have a candid conversation with each other. Stig, I’m curious to know how you see the market today.

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Stig Brodersen  1:41  

These are just very interesting times, especially with the earning seasons upon us. That always gives a little volatility. We just have the midterms. We are recording this ninth of November. 

Then we have this correction that we saw not too long ago. It’s very interesting, a lot of great volatility. I have to say, being a value investor at heart, that I don’t see volatility as something bad. I rather like it. 

I’m curious to hear how you see the current market right now.

Preston Pysh  2:08  

When I’m looking at where we’re at in the market cycle, from the big picture, I always try to see how I can compare it to other periods in time that were similar to where we’re at.

I think the thing that I find interesting is the Fed is still raising rates. They’re still raising rates on the federal funds rate. Then they’re also doing quantitative tightening, which has never been something that the market has experienced in the past, which might make things different than if you are using something as an analogy in the past. That’s where it might be a little harder to do that simply because of doing quantitative tightening. 

That impact is to make it simple for people to understand. It’s the exact opposite of quantitative easing. 

Quantitative easing, I think you’d have a really hard time making the case that quantitative easing did not help the market go up. You had a very profound impact. 

If we do buy into that narrative, that quantitative easing helped the market go way higher, we would have to have maybe the exact opposite opinion about quantitative tightening.

Stig Brodersen  3:09  

You said the thing about comparing it to where we’ve been in the past. One thing that really came to mind was when I read Tony Robbins’ book, “Unshakeable.” We talked to Tony here not too long ago and one of the most interesting chapters there, that is about how often we have market corrections. 

The way that he defines that is a 10% drop, which is basically what you saw here with the peak there in late September. Then you saw the market bottomed out at the end of October. You saw almost an 11% correction there.

We see that quite often. If you have a time period, going back to 1900. We experienced that once a year on average. 

The average correction is 13.5%. This is actually a small correction that we’ve seen in the past on average. It takes 54 days. Again, on average, to recoup that loss. 

I’m not saying that it’s nothing. If anything, I still feel that the market is overvalued, even if there was a correction here of 11% or what not. However, that doesn’t change the fact but I think it is also important to be adamant about… just because you see something like a correction, that does not mean that the market would crash. There’s still a chance it might crash. Again, we feel it is overvalued, but it’s two different things.

Preston Pysh  4:32  

I think it’s important for people to understand what the normal volatility is for anything that they’re in. 

If you’re in an individual stock pick, maybe the volatility is 20%. If you see a 20% downturn, a lot of people will get scared and sell that position. Though that’s normal volatility inside that equity. 

Then when you look at the market as a whole, that’s what Stig was describing there. So the S&P 500, I’m looking at a trade stops platform which tells you the volatility of any pick and that has a 9% volatility. You just got to be aware of that and know that that’s normal to see things operating within that range. 

Now, I would argue the most recent pull down that we’ve seen in the market here, and Stig told you the date, the ninth of November, when we’re recording this in 2018, that has exceeded that 9% pull down, which kind of starts to make your cue and say, “Hey, maybe there’s something a little bit more big going on or something that’s a little irregular going on, because it was such a large movement.”

It definitely has my concern, but going back to what I was saying earlier about where I kind of feel where we’re at compared to other points in time… 

When I go back, and I look at how the Fed was raising the federal funds rate in the last credit cycle, they were raising the federal funds rate until I’d say the end of the first quarter of 2006. Then they stopped raising rates. In fact, they held it steady for more than a year at that point. They continued to hold the federal funds rate for a year. 

If that scenario would then play out, and we’d see something similar, where the Fed is tightening, and then they get to a point where they hold and they stop raising the federal funds rate… The market continued to hold for a year in that scenario, because the market peaked at the beginning of 2007, during that last credit cycle.

You then almost had a year to nine months of the Federal Reserve holding at an interest rate in the market, still holding on before it really started to capitulate at that point.

I find that interesting, that doesn’t mean that that’s what’s going to happen here in the future because right now the Fed is still raising rates. The expectation is that they’re going to continue raising rates. They have not provided any type of forward guidance that they’re going to slow that train down. 

That kind of makes me feel like maybe the market is just going to kind of hang on a few more quarters, but it’s really hard to say.

However, my personal opinion is that we are seeing a topping process right now. Where we’re at in that topping process is really hard to say, but if we go back to just basic investing, and Stig, you correct me if you see this differently, but you go back to basic investing. It’s all about putting on asymmetrical positions. 

And so, when I ask myself, what does that position look like, I start with a really simple narrative: What’s my potential upside? What do I think my upside could be from here? 10%-20%? I think 20% would probably be a stretch. I think 10% would be in the realm of possibility. 

Then you’d have to say, “Okay, so what probability do you think that you’re going to have that 10% upside?” I think you’re around 50%. 

When I look at the downside, how far do I think that could go down? I don’t know. 30%, 40% or 50% downside. So we could just say 30-40, or something like that, that hit the average. 

Then what do I think the probability of that is? Well, it has to be the remainder of the other maybe 50%. 

When you start getting into that expected value of summing that up, my expected value, for me personally, as I’m looking at where I think the market could go, is to the downside. It’s a lot stronger to the downside than the upside. 

I’ve got a concern about the macro factors that are at play. In the past, I think you could have made the argument that the foreign markets are still easing in a major way. Look at what the European Union’s doing or look at what Japan is doing. They’re not really doing that anymore. They’re not easing like they were. 

I then think that further compounds in the narrative that Central Bankers are stalling this thing out. I just think that if you do have positions on, you’ve got to really kind of understand where your risks lie, because you can have a great company, but when they’re swimming against the current, even great companies are going to go down when the macro factors are against you. 

I kind of feel like that’s where we’re at today, but I’m not 100% confident in any of that stuff. I just see some analogies. 

I don’t know. Stig, I want to hear your thoughts on some of those comments.

Stig Brodersen  9:11  

I think it really reminds me of what Howard Marks was talking about how you can never figure out what’s going to happen in the future, but you need to know the odds, or at least approximation of the odds. That’s really what you’re getting into here where you’re saying, “Yeah, I can’t go higher, but probably it won’t go too much higher. Then there’s just a high probability of going down.”

If you ask me about my opinion, referring back to the statement I had before about what we’ve seen there in the past, we had the podcast here for four years. Since 2014, the market has been looking quite expensive. It’s looking more and more expensive. We’ve seen these corrections quite a few times just while we had this podcast and the market is still going up. 

Now, of course this is only a question of when it will stop. It can’t go on forever, whether or not it will go on a few more quarters a few more years. I don’t know, my guess is as good as yours. 

I’m very curious to hear how you position yourself now here, Preston, keeping that in mind that you see that the risk of a downside is perhaps greater than the upside right now. 

How have you positioned yourself?

Preston Pysh  10:20  

I agree with you. In the past, we’ve always felt like the markets were pretty overvalued. Though at the same time, that was before the Fed was even raising rates, then they started raising rates. Historically, when we’ve been in that setting, the market continues to run even though it’s overvalued.

Then we have conversations with Bill Miller and Bill Miller’s like, “Hey, if we could get to a PE ratio of 35 back in 2000, when interest rates were over 5%, what makes you think that we can’t get there when interest rates are less than 3%?”

People like that have really helped us understand that although it is overvalued, you can’t be too jumpy and scared of this thing, because the interest rate environment has allowed prices to go higher. I think that’s why we’re seeing how high this really went, which is extremely high, with the Fed now tightening and now doing quantitative tightening.

I think that that’s where we’re starting to see, the final leg of this is starting to mature. 

Back to what Stig was saying of how are you positioning yourself. he was talking about how, if you have this opinion, you can keep saying I’ve got that opinion, but you also have this thing called fallacy bias, which is just because something happened in the past, doesn’t mean it’s going to continue to happen in the future. You got to be very careful that you don’t get sucked into that trap. 

My positioning is I am looking for a big upside in commodities. I don’t think that we’re there yet. In fact, I think that in the short term or in the next quarter, commodities are going to continue to sputter around or whatever. I don’t expect them to have that big jump in the next quarter. 

However, I do expect them to have a big jump in 2019. I think they’re going to have a massive jump in 2019. 

What I think is going to drive it is when the Fed gets to the point where they are not able to continue to raise rates, and they start holding steady, that’s when I think you’re going to see commodities really take off. 

Going back to the 2006-2007 timeframe, what we saw during that period of time was as the Fed was raising rates, you actually saw commodities really kind of struggling. They were trying to go up, but it was just sputtering around. Then as soon as the Fed reversed course, and they said, “Hey, we’re not raising rates. We’re going to hold them steady,” you saw commodities just start going crazy, because it’s tied to the dollar and the dollar started to weaken at that point.

I’m expecting a very similar thing to play out in 2019. I think that there’s going to be money to be made. 

Then what I think is really interesting about that situation, if that situation would even happen, if all these commodity prices start going up, because the Fed has capitulated on their interest rate rising and their quantitative tightening, what you’re going to see if you’re going to see that inflation is really going to start taking hold. It’s really going to start taking off. 

If that situation plays out, then you’re going to see the bond market start selling off and you’re going to see bond rates start increasing as well, which is bad for equities.

Further Ray Dalio talks about these credit cycles and how they’re reinforcing, and I think that’s one of the main reasons why you see these credit cycles reinforced is because as those commodity prices start pushing higher, and you see inflation start to take hold, then you see the impact in the bond market, and then you see the impact in the equity market. 

That’s what I’m preparing myself for moving in 2019. Whether that actually plays out, who knows? But that’s how I’m thinking through the problem. 

I think the critical element that’s going to drive that narrative is if the Fed stops their federal funds rate increases, and if they pull back or hold steady on their quantitative tightening.

Stig Brodersen  13:57  

I would like to talk a bit about how I position myself here for the time to come. I will also give some of the framework of some of the picks I’m going to talk about here later.

One of the major things that I did, I actually bought rental property. That might look like a very defensive way of looking at the stock market. It definitely would be true. 

I don’t know how long this has been going on, but as we talked about before the stock market was expensive in 2014. It’s even more expensive now. 

If we look over the past 130 or 140 years, the stock market has only been more expensive once. Some people might say it’s a new normal. I don’t know. To me, it just looks like I don’t want to be fully invested in the stock market.

I’ve taken out some of the money I had and put it into rental property. I also started to invest outside of the US.

When we talk about the stock market, we always refer to the US, which I consider my home market. I’m still predominantly invested in the stock portfolio in the US for quite a few reasons. 

One of them is also capital gains tax, even though the stock market might look expensive. If you made these in profit, you have to pay tax on that. If you want to take the money out and invest it somewhere else, we will link to resources in the show notes where you can check different countries and different areas with their stock valuations.

Though right now, the US stock market is the third most expensive stock market in the world. That’s also one of the reasons why I’ve started to invest in other places. I’ve invested a little in India. I have also invested in Europe, and even a little in Africa, even though it’s very little. 

It might sound like a contrarian perspective. For me, it’s also a way of diversifying. In terms of currencies, I am still primarily in US dollars. I think the US dollar would do well, if we see a downturn. Aside from the US dollar, moreso in euros and then some of the smaller currencies. That’s how I’m positioned. 

In general, I like to hold a little cash. If something pops up, that’s very interesting. I think that’s very good. However, I’m also very aware of the danger of paying the opportunity cost of not being somewhat fully or partly invested. 

I don’t, in any way, recommend just a cash position, but perhaps you shouldn’t put all your money into the US stock market, if that’s what you’re thinking about right now. 

In terms of picking stocks, I would say that great companies with very little debt and fair valuations, you could probably say you should do that all the time. However, especially in times like this, buying these great companies fair valuations might be better than having these fair companies at great valuations.

As Preston was referring to before, if something really goes wrong, that’s where we can really see how good companies would perform during a crisis, even though that they will get slammed to some extent. They typically rebound a lot faster. I guess that’s what I’m looking at right now in terms of positioning myself.

Two examples of these great companies and whether you want to call it fair valuations… They are definitely not very cheap companies. The two biggest positions I hold today: Berkshire and Google.

Preston Pysh  17:11  

Okay, so what Stig and I wanted to do is just talk about random picks that we’ve made through past MasterMind groups or intrinsic value assessments that we have written and sent out to the community on our email list. 

The way that we’re going to talk through these different picks is we’ll briefly tell you the timeframe of when we recommended something, how it’s performed, and more importantly, how it’s performed compared to the S&P 500. Then maybe a little bit of tidbits about why we had originally selected it and kind of how we see it today. 

The first one that I want to talk about was a company called Footlocker. I think for anybody that hears Footlocker, just off the top of your head, you’d be thinking, “Oh, my God. Why in the world would anybody want to own that, with the day and age of online shopping and the mall traffic being so low?” 

We made this recommendation on September 23, 2017. Since that period of time, if you would have bought it on that date, until today, you would have gotten a 52% return on the pick. The S&P 500 has performed at 10%. So you’ve outperformed the market by 42% with that pick.

When we made the recommendation for this pick in our article, it was purely based off of the financials. Even though it was probably one of the scariest articles to write, because it just seems so wrong from a qualitative standpoint, the financial metrics were so strong in this company from the balance sheet to the cash flow. That’s why we had recommended it if you read the article back then.

So far, this one’s turned out pretty well. 

Now, my concern moving forward is I think that you’ve had a lot of mean reversion on the price. When I’m looking at the company today, my concern is more from a macro perspective and from a momentum perspective. 

You’ve got this huge jump in the price of this. The momentum is very flat, if not going kind of negative on the price. The fundamentals I think are still good, but not nearly as awesome as they were back when we made the recommendation purely because the price has gone up so much.  Now you’re going to get a lower yield with the price being higher compared to the fundamentals of the business. 

If you’ve got a really large capital gain on this, maybe you continue to hold on if you think that the competitive advantage of Footlocker is going to remain to be there. I’m a little suspect of that. I would personally turn this pick off at this point in time, but that’s me. I would probably take capital gains, pay the tax and just probably offload it because I think that if we are right… Huge “if”.

If we are right about where we think we’re at in the market cycle, I think that this would really have a real struggle moving forward in the next three years. I know I said earlier about searching on Forbes but what we’ll do is we’ll have a link In our show notes for every one of these picks.

[In the links], we wrote up to three or four page articles on how we’re looking at it at that point in time and how we came up with the valuation. Then you can compare the performance and all that fun stuff, but we’ll have a link in our show notes to our intrinsic value page, where we have all of these captured.

Stig Brodersen  20:19  

We can also send that directly to you in your inbox. If you just go to TIPemail.com, you can sign up to our email list. Every month we send out our newest intrinsic value assessments and a link to the page where you can see all our picks since we started the podcast. You can track their performance there. 

However, speaking of Footlocker in retail, I have three picks here from the MasterMind groups that I would like to talk about. The first one is Bed, Bath and Beyond. We had that on in the second quarter of 2017, back then it was trading at $35. 

Right now, it is less than $15. I would really like to talk about that because that pick really made me humble. At the time we talked about what would be the valuation if the company’s future cash flows were just flat, and then we had Jesse Felder on. 

Now, Jesse is super smart. He said, “I don’t think you will be flat. I think the cash flows would contract dramatically over the years to come.”

So far, he has been right. When I’m looking back at what the company has been doing, Bed, Bath and Beyond has been hiking dividends. In turn, they’re making less and less money, which to me seems a bit weird. 

If anything, it says something about the management. They’re not really been buying back any stock, or at least very, very little. It really looks like the dividend payment is a *inaudible* to build a floor below the stock price. 

They have been investing in the business… I think that they should probably focus more on that than paying out a close to 5% yield, especially for a stock they used to not pay a dividend. It was actually when things really started to go bad. It was very clear that it’s going bad when they started paying out dividends, which is kind of odd from a capital allocation perspective. 

For me, there’s quite a few teachings here. Though a lot of retail has been hurt and at the time, we talked about the influence of Amazon, e-commerce, the new age and how Bed, Bath and Beyond’s new e commerce initiatives might not be as effective as what Amazon is doing. It’s not so much what I took away.

Just one example is the Footlocker pick that Preston just talked about before. It’s not all retail. You have Nike, another company, you’ve been looking at, which is up more than 4%. You have a lot of retail that has done really, really well.

However, I think what I learned from the Bed, Bath and Beyond story here is that in times like this, buying stocks at fair prices, they are a wonderful, that’s definitely a lot better than wonderful prices, because at $35 at the time, Bed, Bath and Beyond was almost definitely a wonderful valuation, at least based on historical numbers.

Unfortunately, the business itself was just not good. Then using that historical data, like I did when I was pitching this stock to foresee the future, that really made me humble. 

I was almost ready to take a position in Bed, Bath and Beyond at the time. I thought a lot about what the group said, especially some of the items that Jesse Felder brought to the table. I ended up not taking a position in the stock and I should probably get Jesse something nice next time we get together because it saved me a lot of money. 

I also just want to say that even with this very, very low valuation that you see right now for the stock, this would definitely not be a stock recommendation for me.

Preston Pysh  23:55  

Just to give the audience because we always want to use the metric, at least I think the best metric is the S&P 500 to compare your performance to this particular pick when it was made back in February of 2017. It had gone down negative 65%. The market had gone up to 22% in the green. There is a significant margin on this one. 

Most of the loss kind of happened in the middle of 2017, where it just had this significant drop. Then it’s just kind of continued to have a pretty negative trend ever since. I would argue that that trend is still negative today. It definitely didn’t pan out the numbers back then. I think when we were having the conversation with Jesse, we’re all like, “You know the numbers look good, but something about this one just doesn’t feel right.”

Stig Brodersen  24:44  

I hope you didn’t take a position. 

Preston Pysh  24:46  

I didn’t like it back when you pitched it. You know what’s interesting about this one? It is when you look at this and then you look at Footlocker, I get the same qualitative feel about both of those picks and how they both just don’t really feel right, but at the same time, Footlocker, you had a huge return and Bed, Bath and Beyond, you didn’t. 

When you’re really thinking about how hard this stuff is, you have two picks that were suggested at the same time, but just had a drastically different performance.

Stig Brodersen  25:19  

One thing I’ll bring up and this is something that Toby mentioned on that podcast. He was saying that he had a really hard time. I don’t think he specifically mentioned Footlocker, but he had a really hard time figuring out if Bed, Bath and Beyond was a good pick or not. 

He said there were so many hated stocks in the retail industry so what he did was he just owned a basket of retail stocks where, across the board, you can just see on the fundamentals a *inaudible* probably too cheap. When you have that mean reversion, then you will see an overall gain.

Preston Pysh  25:54  

Something that’s changed about my investing approach and that has evolved through this show, is really always taking a look at the momentum trend of the pick, before I make the final selection. 

With Bed, Bath and Beyond, the one thing that I distinctly remember about that conversation is I did not like the momentum trend on the pick when it was suggested that it might be a buy. 

We talked about this a little bit earlier in the show where we were talking about understanding the volatility of the company and what kind of fits into that volatility trend. 

When you looked at Bed, Bath and Beyond back then, it was in a negative trend. When you look at the 200-day moving average, it was negative and it was going down. Where the volatility was at it was completely within its range of that downward trend. What it was doing was normal in a negative bear market. 

My opinion, when I mix that momentum investing with value investing is I see all the indicators that are telling me that this thing’s a buy. This is a very good price, but I have zero indication that the purging that’s currently happening is over.

What I’m then looking for in that momentum shift is to prove to me somehow that that bottom has happened through the price action exceeding that basic volatility that it continues to demonstrate through the years. For Bed, Bath and Beyond, that was not happening that’s why I was very hesitant to go along with the pick, even though I thought…

I agreed with Stig back then. The fundamentals looked good according to all the numbers and that it looked like a value. 

Just something to maybe help people keep themselves out of trouble is really kind of paying attention to the momentum trend, especially if it’s a long trend and looking for something that’s statistically showing them that they’re outside of that volatility range to the upside.

Stig Brodersen  27:51  

The next pick I want to talk about that would be Fiat Chrysler. We talked about this here in the early September 2017 in the MasterMind meeting. I already took a position at the time prior to that, but I really wanted the MasterMind’s views on that and as far as I remember, the group was not overly thrilled about it.

However, the reason why I wanted to talk about Fiat Chrysler, especially after talking about Bed, Bath and Beyond is I see something different from the management. I see a better management, which is why ultimately I also ended up investing in it. 

The management have these five year plans and they do as they say, which is more than what I can say about Bed, Bath and Beyond. It’s very cheap. It has consistently, over the past few years when I’ve been looking at my screener, been in the top five of the cheapest companies, based on an EBIT ratio. 

Basically, that means that you would get around a 20% return on your operating earnings if you bought the entire company. Since I pitched the stock, a few things have happened. They’ve sold Magneti Marelli, one of the divisions that develops and manufactures high tech components for the automotive industry. That will be a special dividend of $1.50. 

This is another stock *inaudible* not trading at a little less than $17. This is a significant special dividend. 

They also paid off all this debt just like they said in 2013. That’s something I liked. Back then, they took on a ton of debt. They’re doing as they said and now with the new plan going on to 2022, they will start to pay out 20% in dividend which right now is close to a 3% yield.

Preston Pysh  29:34  

I don’t remember exactly what I said when we were looking at Fiat Chrysler. I remember doing the intrinsic value on it not really coming up with that high of a yield, at least from the way I was viewing it when it was recommended.

 I wasn’t looking at this as a buy, but it has matched the market performance since the recommendation was made. It’s been the exact same as what the market has performed at which is like 10% or 12%-ish. 

My concern is owning it today. Moving forward, my expectation is that auto sales are going to be… that they’ve hit a top. I don’t expect auto sales to really perform very well moving into the coming three years. This is a company more importantly that I would not want to own today for many of those reasons of the macro factors.

Stig Brodersen  30:17  

I think you have some good points there. It’s definitely not a stock you would put, you know… Trying to present it in… I guess you can say that about most picks. There are definitely some concerns. 

One of the things I remember you brought up, which was a really good point today, but also at the time is that they really haven’t made any significant investments in the electric fleet. They actually recently did that, but it’s definitely not one of the first companies in that industry. 

When I think back on the latest pick I have here in the MasterMind group, that was Google. I was talking about how I found value in Google, with 20% plus multiples. I mean, that was what we’re talking about. Then you have something like Fiat Chrysler, the cheapest of the major stocks, trading an EBIT of 5. This is ridiculously cheap.

There are different states of the market cycle. I’m not talking about the overall cycle for the stock market, but for that specific industry and for that specific stock, if you like.

Google does gross 10% per year. Fiat Chrysler does not. The inventory levels of cars is somewhat high, Google is probably better positioned for the time ahead with the new era.

It’s just two very, very different stocks, but I think that Fiat Chrysler is very interesting. It’s very interesting to talk about as stock investors because it’s a company that’s good at unlocking shareholder value. They’re selling off the division that’s not a part of the overall strategy, paying it out is a special dividend, instead of perhaps buying back shares.

You might be thinking they should be buying back shares now that it’s cheap. For a cyclical stock, like a car stock, that tends to be either very cheap at the peak of the cycle, or very expensive, when they bottom out.

The truth is somewhere in between. It is not as cheap as it looks like but it’s very well managed. The trajectory that’s on, the unlocking of the shareholder value, not just for this division, but also what can be expected and the time to come, offsetting some of the other brands. It’s an interesting special situation for you as a stock investor to think about. Though it’s a very good case study in terms of understanding management and cyclical stocks.

Preston Pysh  32:30  

The pick that I’m going to talk about is back in September of 2016. One of the big news headlines was that Berkshire Hathaway was taking a position in Apple. When Stig and I went and looked at Apple at that period in time, because we saw Buffett was buying it, we’re thinking, “Okay, well, what is this worth?”

So we went and did an intrinsic value assessment on Apple. I felt like we did a very conservative estimate on what those cash flows might look like. And lo and behold, when we did this back in 2016, we found that the expected yield based on an IRR calculation was around 11% annually, which was extremely high relative to everything else that was being priced in the market. 

We felt like this was probably a very good decision by Buffett back in that period of time. We ended up writing some articles. I wrote one on Forbes and posted a bunch of charts. We showed how we went through that analysis to come up at the 11% price. 

We also posted this on our Intrinsic Value Page, which we have the link to. Since that period of time, this company has just crushed the market. It’s looking like at about an 83% return this company has performed at since we posted that article and when Buffett bought it.

The market has done around 30% so you have nearly a three times outperformance of the S&P 500, if you would have bought this position back when he put it on. 

Looking at it today, you’ve had a lot of and let me caveat that you would have actually been at 100% return on this pick if you would have gone back just 30 days ago because it’s had a very rough last 30 days, here in the fall of 2018. 

The point I want to make is moving forward, I think Apple is going to continue to hold its own, but it is such a large business. If we do subscribe to this macro concern or macro narrative, that could impact the performance of Apple moving forward.

As I look to Apple’s performance, I look at it being somewhat similar to what we’d see out of the S&P 500. I don’t see it really outperforming or underperforming in the coming couple years at this point. Most of that just has to do with the macro factors.

Stig Brodersen  34:49  

Very interesting to go through this intrinsic value in the next year that you mentioned. Some of the picks that had performed really well though the retail picks that began picks that has just looked so bad at the time. In terms of the markets, the markets really didn’t like them, but reprojected really good yields based on the fundamentals. There’s something like Target, Nike, and Footlocker that you mentioned. 

Now, we’re looking at 30% to 40% on those stock picks. I think that’s something that’s very interesting to consider that, yes, we are talking about specific picks. However, very often, that specific pick is just being carried away by the sentiment of that industry, whether in a positive or negative way.

Preston Pysh  35:36  

What I find interesting about this Apple pick, in particular the date of when Buffett and all this kind of came out, was in the September timeframe, you had a little bit of a bear market that happened in Apple, from call it the middle of 2015, to about the middle of 2016. 

You can see the volatility in that momentum kind of going down, but as soon as it had a breakout, and kind of proved that it was coming out of that volatility range of that down cycle, that’s when this position was put on. 

What’s interesting is you’ve just seen it go to a huge upside ever since that point in time so the momentum made sense when we were talking about it. I can’t say that in my article, I even addressed that, because that wasn’t something that I was personally looking at at that point in time when I was investing. I really wasn’t considering that very much back in 2016.

However, it almost seems like Berkshire understood that or something, or maybe they were just buying it because it was cheap. They’ve got to move a lot of money so they don’t necessarily have the same flexibility as a small investor. I just find that fascinating. 

All right, so this was obviously a lot of fun to talk about. There are some other ones that are really good and some that are really bad. However, there’s a good mix of learning lessons and things that we’ve kind of taken away. 

We have all these documented in that intrinsic value index so we highly encourage you to go in there and look through our thought process of why we were saying whatever at each point in time. 

At this point, let’s take a question from the audience. This question comes from Santos. This is what he’s got to say.

Sender  37:15  

Hi, Preston and Stig. My name is Santos. I’ve been following your podcast for the last three years and I have learned a lot. Thank you for that. 

My question for you both is, given the current market cycle, which probably is the longest bull market in recent history, under relatively higher interest rates, do you guys think it’s a good time to buy us more towards bonds instead of stocks for my portfolio? What is your general take on rebalancing stocks and bonds based on where we are in the market cycle? Thanks again for all the great work. Bye.

Preston Pysh  37:50  

I personally can’t stand bonds right now. Most of it just comes down to the fact that you’re getting almost no yield, after you account for the inflation, which completely impacts the bond, you’re really getting nothing. 

On top of all of that, you’re in a position where central banks, at least here in the US, are raising rates, which is not good for owning bonds. 

Now, if you’re owning a short duration bond, it’s not going to be impacted nearly as much. However, anything that’s long duration, I think you’re going to have not a good 2019 if you’re sitting in bonds.

Stig Brodersen  38:21  

The reason why you would say that Preston that it’s about duration. Basically what you’re talking about is if you have a one year bond, you might only get, say two semi-annual coupon payments, so it really doesn’t matter how the interest rate is doing. Though if you have your 30-Year long bond, then you have a lot of lower coupon payments compared to if you bought that. Though

However, Santos, I think it’s a good question that you bring up right now because if you look at the yield of the 10-Year Treasury right now, it is 3.2%. If you look at the Shiller PE key ratio that Preston and I have been looking at quite a few times here on the show, it will also give you 3.2%. 

You might be thinking, “Why would I not invest in bonds?”

I think that makes a lot of sense to bring up that question because would you rather have 3.2% that is safe, because it’s risk free? It’s issued by the government? Or would you rather have a 3.2% given everything we talked about here on the show, with the huge drawdown that we see the market could do here with the next period of time?

That being said, I’m still in the same camp as Preston. I don’t own any bonds at the moment either. I don’t find the yield attractive right now.

Of course, you can make an argument that if something really goes wrong in the central bank, just cut the rates and you would see your value of your bond go up. If that is your strategy, you have to be really good at timing, that’s for sure because we see rates climbing up right now. 

Just to give you an indication here at the start of the year, the 10-Year Treasury was selling at 2.46%. Before talking about rebalancing, which you also bring up, you should also keep in mind that the capital gains on bonds are typically different. You pay them every year because you get your coupon every year, compared to a stock you incur the *inaudible* and you sell it. 

Typically, you could be a bit more liberal with the stocks in terms of taxes. That really takes me to the other thing about rebalancing. I don’t think there’s anything wrong with rebalancing, but I would definitely consider the tax piece here, if that’s what you’re doing.

Going into a rebalancing strategy, depending on how *inaudible*, it can be very costly for you, if you’re buying and selling too frequently.

Preston Pysh  40:37  

At the same time, you also have to be aware of what inflation is doing, because the bond market is repricing things based on what their expectation for inflation is. 

Earlier in the show, I said that my expectation here in 2019 is that you’re going to see the central banks eventually get to the point where they’ve got to capitulate or or hold their rate rises, right? I don’t know when that will happen, but I would expect that to happen in 2019. 

If that would be true, that’s when I think you’re going to see the price of commodities go up, which means your inflation rates are going to go up, which is more pressure on the bond market, even though the central banks would then be holding there and not raising rates.

I guess that’s why I’m just so negative going into the coming year with the bond market. It is just because I think that even if the central banks don’t get you, I think that the inflation that we might see could potentially get you as well, but we’ll see how right that call is. We’ll keep track of it as we continue to progress in the show and we’ll continue to talk about these topics for sure. 

All right, Santos, thank you so much for asking your great question. We had so much fun talking about it here on the show. As a token of our appreciation, we’d like to give you a free subscription to our Intrinsic Value course which is on our TIP Academy website. 

If anyone wants to check out the course you can go to TIPintrinsicvalue.com. If you’d like to ask a question on our show, just go to asktheinvestors.com and you can record your question there. 

Stig Brodersen  42:04  

Alright, guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro 42:12  

Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.


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