Episode #426: The Best of 1H22 – Zeihan, Grantham, Zelman, Bloomstran, Ilmanen, Arnold, Baker, Grice, Valiante & Ariely
Run-Time: 46:25
Guests: John Arnold, Whitney Baker, Jeremy Grantham, Ivy Zelman, Gio Valiante, Dylan Grice, Antti Ilmanen, Chris Bloomstran, Peter Zeihan, & Dan Ariely
Summary: Today we’re looking back at some of our most popular episode in the first half of 2022 covering a range of topics with some amazing guests. I know it’s hard to listen to every episode, so we picked some clips from our most downloaded episodes for you.
If you enjoy this episode, do me a favor and be sure to subscribe to the show. And if you’re already subscribed, send this episode to a friend so they can learn about the show.
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Transcript of Episode 426:
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Meb: Welcome listeners. Today’s a very special episode. We’re looking back at some of our most popular episodes in the first half of 2022, covering a range of topics with some amazing guests. I know it’s hard to listen to every episode, so we picked some clips from our most downloaded episodes for you.
If you enjoy this episode, do me a favor, and be sure to subscribe to the show. If you’ve already subscribed, send this episode to a friend so they can learn all about the “Meb Faber Show.”
To kick things off, we’re going to start with legendary natural gas trader and billionaire philanthropist, John Arnold. When John left Enron and started his own hedge fund, he found himself on the other side of a fund manager who was overexposed. I asked him about that experience, and later why he decided to wind down his fund to become one of the most prolific philanthropist in the world today.
John: Yeah, I’d seen a lot, 17 years of trading. One of the things I’d frequently see is that a trader would come in, have some success, and just start trading too big. And after a couple of years of success, he gets significant risk capital from his company or his fund, and just ended up in positions that were too big. And almost, without doubt, that person would end up blowing up.
So this happened with Brian Hunter, who in 2004, 2005 had very good years. He was at a hedge fund that was really a hedge fund, doing a lot of convertible bond ARB and some of the more traditional hedge funds, strategies, arbitrage strategies. They weren’t known for understanding and managing energy risk. And I think management started to see the numbers that he was putting up and gave him more rope without really understanding the risk he was taking.
And so he ended up very, very deep in a position that dependent upon having a hurricane, this exogenous event of a hurricane coming and really, significantly impacting Gulf of Mexico production. And the whole market was kind of against him on this. He had built it up to such size. And then as the summer starts to tick through, and it’s a slow hurricane season, the … started to decay.
And at some point, his management came in and said, “No more. In fact, you got to decrease position.” Turns out, he wasn’t decreasing the position. He may have even been adding to it. And then they get to a point where they’re clearing firms steps in and says, “Position is too big. You got to get out of it.”
And so he calls me up one weekend when I’m in New York, getting engaged, get the call and says, “Do you want to buy my book?” And I had a notion about what the size of it was. I had been a counterparty to him on many of the trades often as a market maker. I had some of the other side of the position but the whole market had the other side of the position. He just kind of told his folklore that it was centaurs versus emirate. It really wasn’t. It was Emirates versus everybody. I had a piece of it. Everybody had a piece of it.
And that weekend, he has to show me the position because I’m bidding on it. And I was flabbergasted by the size of it and that his management would let him get into a position with a position size like that. And I gave him a price that ended up being I think the right price given where things traded that Monday whenever the market opened up, and it had been shocked. His clearing firms ended up taking over the position and liquidating it. And then the market really just evaporated. That became the natural gas story that led to a lot of regulatory oversight and a lot of headaches for me in the long term.
Meb: So your interest started to shift from this sort of phase of your life with the fund and everything you’ve done up to this time. I mean, there’s an overlap, it sounds like, too. You started being interested in some other areas before the fund shut down but it seemed like a glide path. What was sort of like the crystallizing decision that the Arnold Ventures kind of like path would become this really the next chapter in your life? Or was there one was it sort of like one month at a time, one year at a time, this is kind of where you’ve arrived, where at the time was like, “You know what. This is what we’re going to do?” You sat down with your wife and said, “Let’s chat about this.”
John: I had always been interested in philanthropy in the nonprofit sector. I had started writing checks, maybe when I was 25 or so, getting involved in the charter schools in Houston, got on the board of one of KIPP Houston. And so I just kind of started going to some of the education reform conferences and thinking about this from a systems-level thinking. And I was interested in this. We started a foundation, very passive and just put a bunch of money into a foundation, had one or two employees, and we’d write some checks pretty passively. My wife at the time, we had met in 2006, got married in 2007, she worked a couple of more years, decided to retire from her career as an M&A lawyer, and then helped start a EMP Company in Houston. She decided to go full-time on the foundation.
And I would go over there to the foundation’s office after working at Centaurus and go spend an hour or two they’re in the afternoon. I think a couple of things became clear, one was that, if you’re not 100% focused on the markets, it’s hard to be profitable on it. It’s incredibly competitive space. And so, once my mind started to drift, and I wasn’t 100% in there, I wasn’t dreaming about it at night, I wasn’t thinking about it in the shower in the morning, I wasn’t not talking about it with friends at night, then it became harder to be successful.
The second was that I became more intellectually interested in the nonprofit space than I was in trading energy. So by 2012, it was time for me to close up Centaurus. I was just drained. And I had this thing, I had this foundation. I wanted to go spend some time with it and try to figure things out. And one thing led to another I was like, “Okay, I have this thing I can go do.” And that was important. I’ve seen a lot of people in the industry who got tired, got exhausted, quit, and then they searched for what next. And they could never find something that was intellectually stimulating to them. And that became very frustrating. But I had this.
And so, with my wife, we put our full-time efforts into, at the time, the Laura and John Arnold Foundation, which has become our ventures in trying to build this really impactful foundation. We work on issues of public policy viewing policy as a more sustainable, more structural, more scalable solutions, work on some of the most endemic problems that society faces, work in areas like criminal justice, health care, public finance, education, research integrity, and trying to figure out what works, what doesn’t with social programs. And that’s how I’ve spent every day since 2012.
Meb: Next up is Whitney Baker. Whitney is the founder of Totem Macro, an emerging markets macro consultancy in hedge fund advisory boutique, and previously worked at fame shops like Bridgewater and Soros. When we spoke in early January, she said, “We’re starting to experience a secular and cyclical regime change that people weren’t adjusting to,” and why she believed the U.S. was in a once-in-a-generation bubble. Let’s listen in to see what she had to say.
Whitney” Not every cycle is a bubble. Obviously, sometimes you just end up with a credit cycle that then influx when they tighten and you get a normal sort of garden variety recession. The U.S. ones have been bubble. U.S. exceptionalism was a bubble in the 20s a bubble in the 90s and a bubble today. And what’s interesting is they always follow the same kind of even like internal breads, indicators and things like that. Like, what happened in 1928 was the Fed was hiking aggressively, commodities collapsed because they sort of sniffed out that global growth and inflation would be impacted by this. And then basically second half ’28 through beginning of ’29, it was only the thing of the day effectively, radio and stuff like that, that was getting any flows and doing anything.
They were the only… it was like, again, five stocks doing everything. It’s almost like the last vestige of the bubble mentality because you’re like, “Oh, man, I really feel like I should buy the dip but I’m not sure I want to have something that’s going to be negative free cash flow till 2048. So maybe I’ll just buy Amazon or whatever.” Same kind of thing goes on. And then ultimately, it’s the whole sort of range of those bubble assets and those flows that unwind.
My big concern here, when I think about secularly, the outlook and I’m not necessarily talking about EM here, but we have had an insane increase in metrics of U.S. wealth, as a ratio of GDP, as a ratio of disposable household income, anything like that. It’s like six to seven times. It’s never been anywhere remotely close to this. And it’s gone up by about one and a half terms of GDP in the last couple of years. Now, assets are just things that are tied to future cash flows. Cash flows are tied to the economy and earnings or spending of some kind. And so what you have here is this huge disconnect between asset valuations and the cash flows that can support them.
And when you think about a stock, let’s say it’s trading on 30 times earnings, whether earnings grow 10%, next year, like they grew 10% last year or whatever, when you’re just trading at such an expensive multiple, the earnings themselves are not really the thing that becomes attribution-only what drives the stock volatility. It’s changes in that multiple that drive much more of what’s going on. So, anyway, ultimately, you get this on wind. And when the bubbles pop, I think this time around, my main concern here is there’s going to be a lot of wealth destruction.
When I think about how they’re going to slow this inflation problem down, normally, like, let’s go back to 2006, 2007, what they did was raised rates. There’s a big credit boom ongoing globally, but especially in the developed world. And they raised rates and then value start to fall. So house prices start to fall credit rolls over and this whole borrowing cycle ends. And that’s how normally hiking brings about the end of the cycle and disinflation. This time around, this isn’t a credit-driven thing. This is like lots of money being printed, lots of checks being mailed to people, $2.7 trillion of which are sitting there on spent in the excess savings that everybody talks about in the U.S.
And so there’s a lot of dry powder to go. This hasn’t been driven by credit. This hasn’t been driven by money and fiscal. Fiscal is going to be higher through the cycle than we’ve been used to. And it’s very difficult given the polarization for any kind of fiscal retrenchment. And so it’s hard for me to see how through the normal channels of like moderate rate hikes, we actually get a meaningful slowdown here, other than through wealth destruction, and that recoupling of huge asset values with the economy, and, therefore, things like the market cap to GDP, or household wealth to GDP, these sorts of crude reads, sort of go back to something more normal.
And it’s through that channel that you actually get a reduction in spending, and so on and so forth. Because if anything, credit is accelerating. and I think that’s natural because you’re getting such a massive investment boom. So, there’s a response that’s going on now to the first round of inflationary problems, which is perpetuating the inflation, which is obviously the labor market, and wage gains, and the CapEx boom that’s going on. All of that just more demand for goods and labor right now, more spending power for labor. And it only actually gets disinflationary later on. So that’s really starting to come in now, and it’s offsetting any fiscal drag people are talking about, plus you’ve got this dry powder issue.
So anyway, from you globally as investors and also just as society, how we navigate the challenges of dealing with the shifting inflation and interest rate paradigm secular change there, huge debt levels, assets that are extremely expensive and probably not offering you decent forward returns in the U.S., in particular, how does that whole thing play out in a benign way? It’s very hard to see.
Meb: Soon after Russia invaded Ukraine, we spoke with legendary investor and co-founder of GMO, Jeremy Grantham. Jeremy touched on rising food prices, the relationship between inflation and PEs, and even shared some unfiltered thoughts on the Fed.
Jeremy: The UN Food Index is back to those highs of 2011. And Ukraine is not a bystander. Ukraine is part of the great breadbasket of Europe. It’s where wheat comes from into the export market. So if you’re an Egyptian, half your imported wheat comes from the Ukraine. This is entirely relevant. And you add together the change in the weather. At least in the Arab Spring, people weren’t obsessing about floods, droughts, and higher temperatures, but that has become painfully more obvious in the last 10 years. And it’s making agriculture very difficult.
Meb: What do you think this analogue as we look back, is this a slight early ’70s vibe? Is there another period that feels similar to you, whether it’s in the U.S. or globally or anywhere that’s a similar market setup that we have today?
Jeremy: Every system is so complicated, they’re always different. But I think the last 20 years has been completely different. Indeed, I wrote a quarterly letter in 2017 saying I couldn’t find anything that wasn’t different. The four most dangerous words in investing were not, “This time is different.” But really, the five most dangerous words were, “this time is never different.” Because from time to time, things absolutely change. And they changed in the early 21st century. And we went to a regime of corporate paradise where PEs were not just higher than the previous 60 years. They averaged 60% higher. Profit margins were not just higher, but they average close to 40% higher.
So, profits as a percentage of GDP went up several points, and wages as a percentage of GDP fell a few points. So these are profound differences. And they were accompanied by the lowest interest rates in the history of man, which declined… Well, they declined for 50 years, but they declined the entire 21st century. And the supply of debt rose more rapidly than probably any other 20-year period outside of major war. So everything had changed. I think what is going to happen is that it is changing back. We’re going back in many ways, to the 20th century. Inflation has been a non-issue in this Goldilocks area for 22 years. I am proud to say I wrote 20 years of quarterly letters, and I never featured inflation. It was completely boring and out of my interest zone.
And in the 20th century in the 70s, ’80s, and ’90s, as investment managers, of course, you could not ignore inflation, I think inflation is always going to be part of the discussion once again. It’s not always going to be 7% or 17%. It’s going to ebb and flow. But it will always be thought about. Again, the last 20 years, we forgot about them. And PEs depend on two things profit margins, and inflation. Profit margins are high, inflation is low, you have a very high PE. You go back to the ’70s, you have high inflation, low-profit margins, you sell at seven times depressed earnings. And then in 2000, you sell it 35 times peak earnings.
This is double counting of the worst variety. And we have been selling at peak PE of peak profit margins recently. That is not a point that you want to jump off if you had the choice. You want to start a portfolio in 1974. PE is seven times, profit margins are about as low as they get. Paradise, how can you lose money? You do not want to start at the opposite where we were a year ago.
Meb: I posted on that topic this past year. And it’s probably the number one angriest responses I got on Twitter. And I said, “Look, this isn’t even my work. I mean, you can look at Robert Nah, you can look at GMO, a million other people have talked about this. It’s very easy to see in the data.” But you guys have a beautiful chart. I think it even goes back to that 100 years or so but overlaying a predicted PE based on the inputs you discussed. And there’s really high correlation. But there’s two periods that really stick out, you know, now and 2000.
Jeremy: I’m sure that you say 100 years, but, of course, 1925 year is suddenly, almost 100 years. But it tracked 1929 beautifully, and the ’30s with local years, and the 50’s recovering. And the only thing I got materially wrong, as you say, is 2000. In 2000, profit margins and inflation predicted the highest PE in history. And we had the highest PE in history. Only it wasn’t 25, it was 35. But it went 40% higher. And for two years, that was possibly the only really crazy psychology ever, because it took perfect conditions, and then inflated those, if you would, by 40%. And now, starting just after we spoke a year ago, the thing diverged again. It was beautifully on target when we spoke, and then a month or two later inflation started to rise rapidly. And the PEs instead of going down went up. And I can say with a clear conscience, nothing like that has ever happened since 1925.
When PE goes from zero to 1, 2, 3, 4, 5, 6, 7, the market crashes. You can explain the PE of December 31st. You’re going to explain it by saying, not that it’s 7% inflation, but that it’s perfect inflation, it’s 1.9 unstable. Not 7% and unstable. That has always been a bane on PEs, but not this time. This time the world 100% believed that the Fed was right when it said it was temporary, which is remarkable given the Feds record of getting nothing right. I find it bewildering that the world would believe them. But they do.
Meb: As the housing market starts look shaky and mortgage rates have shot up, it’s fun to go back and listen to Ivy Zelman, one of, if not, the expert on the housing market. She explained why she thought the housing market had gone completely bonkers at the time.
Ivy: Well, I think that the demographics are really the foundation of our cycle call. And so, we lean heavily on that. And Dennis McGill is our in-house demographer. And that’s a quite sobering outlook right now, just based on what’s happening with the overall trajectory for both not only household growth, but population growth, which has been on a downward trajectory. And we had household growth in this prior decade hit the lowest ever on record, and population growth second-lowest on record behind the 1930s. And the outlook is even bleaker for this decade it had. And then when you look at what the drivers are for growth right now, the housing market is euphoric. And you have insatiable demand. And you also have significant governor’s on getting starts in the ground and getting homes completed with supply chain bottleneck.
So, it has allowed for substantial home price inflation. And I think people are either giddy or scared shitless. You’ve got a lot of dynamics that make it incredibly complex, but what we’re seeing is that local primary buyers really spiked during COVID. So the pandemic took a market that had been on an upward trajectory, especially the entry-level because builders got a memo that finally they were listening, like, if you build it, they will come. If you go out to the French, the secondary, whatever you want to call it tertiary markets, but they weren’t willing to because there was really a tight mortgage market. So we analyze the mortgage market and recognizing every aspect, every silo of it, the builders were reluctant to build further out, rightfully so after they got so burned.
And they were being very cautious on how much land exposure they wanted. So, in 2015, D.R. Horton, leading homebuilder in the U.S., they create a product called Express Homes, and they went out to the exurbs. And they started providing homes that were in the 100 plus, and their industry followed suit. And so really 2016 was the trough in the homeownership rate. And that’s something we’re obviously watching. And that homeownership rate has continued to proceed on an upward trajectory and now, hovering at about 65% and probably moving higher. But the primary buyer because of the level of investors that are in the market, has peaked out at the end of 2020. 2021’s first quarter peeking out after a substantial spike, as COVID created a significant flight from urban to suburban to exurb with people desiring safety and more space, and they were taking advantage of really free money, thanks to the Fed.
We also saw tremendous stimulus that gave people incremental savings that otherwise they wouldn’t have also. They were not spending money in the initial shutdown. So the housing markets gone bonkers, just completely bonkers.
Meb: Later in the conversation, she talked about the risk of rising mortgage rates, which we’ve seen shoot higher since the episode.
Ivy: In the housing, specifically, because the primary buyer, when you look at not so much absolute re-mortgage rates, how much is the monthly payment for an entry-level buyer buying a median-priced home? How much would it cost them today versus a year ago? And it’s up over 30%. And that’s now incorporating the increase in mortgage rates that we’ve seen. So when the Fed is pulling back on MBS purchases, they’re also tightening. And as a result of that, mortgage rates are rising. And one of the backlash is that the Fed, their policy will be felt is if you’re not moving from California to a lower-cost state, you’re probably locked in. Seventy percent of homeowners in the United States are locked in, not at four below four. And more than half are locked in below 3.75.
And you start to look at what would be the bread and butter in the United States and you say, okay, well, these people aren’t giving up that low rate, because conventional mortgage jumbo mores are not transferable. So I think that might start to dampen the, again, primary activity, but can the investor activity offset that? And that’s what we’re seeing right now.
Meb: If you’re a fan of the show, “Billions,” you’ll love this episode, Wendy Rhodes character was based on our guest, Gio Valiante, who was a performance coach for Point72 and Steve Cohen, and is now the performance coach for the Buffalo Bills, and some of the top golfers on the PGA Tour. Listen to Gio share the greatest single statistic he’s ever heard of in sports and the commonalities between Steve Cohen and Tiger Woods.
Gio: I have a statistic I pulled up for you that this really matters to anyone who wants to be good at something, From 2002 till 2005, Tiger Woods had 1,540 putts from three feet in. He missed three of them. So when you really think about this, 1,540 times, over the course of three years, Tiger had a putt inside of three feet. Now, this is in wind, in rain, in perfect greens, left to right, right to left, uphill to downhill, 1,500 times, he only missed three of them. Can you imagine the type of discipline, rigor, commitment to process required? Like, that is the greatest single statistic I’ve ever read in sport. People have no idea how hard it is. There’s nothing that Tiger did that was… That is the tell how good he is.
You want to hear how good Steve Cohen is? Here’s how good Steve Cohen is. I asked his wife, I said, “I have a quick question, how many days off does your husband take?” And I hadn’t known Steve for that long but she said four days off from the time that she’d known him. So if you go 40 years, 250 trading days called 10,000 days just average, 10,000 days Steve Cohen took off four. You know why? He was in the hospital. And as soon as he woke up from surgery, he had them set up monitors as the story goes. In other words, Tiger Woods shows up every day for his craft. Steve Cohen shows up every day for his craft. The everydayness, showing up and being present in the moment for what you’re doing really matters.
And so when you tell me about this, buy-side sell-side, and having a process and a commitment to a process, you want to see, well, who lives at the tail end of the curve? People keep showing up. Tiger Woods, 1,540 putts from three feet, missed three of them. That is an insanely hard thing to do. 10,000 trading days for a guy who doesn’t need the money missed four of them because he was in the hospital. That’s an unbelievable… I admire that kind of commitment so much. And I can give you example, example, and guess who these people are? They all occupy the tail end of the curve in a talent. It’s not IQ points. It is those things but it’s also the everydayness of showing up for the job.
Meb: So far in 2022, we’ve seen a brutal year for the 60/40 portfolio. Back in April, we spoke with Dylan Grice, co-founder of Calderwood Capital and the author of the “Popular Delusions” newsletter, and he touched on the need for investors to be truly diversified beyond just stocks and bonds.
Dylan: To have a stable portfolio return requires a very, very well-diversified portfolio. And I think that the thing that people maybe don’t usually understand about diversification is that it’s hard. It’s really hard to build a diversified portfolio. It’s not a trivial thing to do. Because if you’re really looking to diversification, if you’re really looking for diversified return streams, what you’re actually seeing is you want your return streams to be fundamentally different from one another, which means that you’re doing things which are fundamentally different from the main one, which is equities, which means that, well, if you’re fundamentally different, you’re fundamentally contrarian. So if you want to build a fundamental diversified portfolio, you have to be contrarian.
We’ve talked already about the problems with 60/40, the problems with the death of duration with interest rates being zero, with expected returns being very low. Everyone’s aware of that. There are lots of articles you read about how people are dealing with it. What are people using instead of 40? What are people using instead of bonds? And it seems as though what they’re doing is they’re doing private equity, or they’re doing more real estate, all right, or they’re doing more venture.
Meb: As you just described like half the pension funds in the U.S. over the past four years where you see this, and they’re just like, “You know what? Interest rates are lower, or we’re trying to figure out how to continue to get these 8% return. So, we’re just upping the dial on private equity and VC, which God bless them if that’s what they’re going to do but that creates a whole host of challenges in my mind.”
Dylan: I agree. I think two very, very obvious ones. The first is that it was certainly a smart thing to be doing that 40 years ago, or 30 years ago. It’s not obvious that it’s such a smart thing to be doing it today, when all the big private equity founders are multibillionaires, and they’re all selling out. The second thing is, again, diversification, what kind of diversification are you actually getting? And if you put private equity into a public equity portfolio, you’re not diversified. There’s lots of good reasons for you to invest in private equity. Maybe that’s your skill set. Maybe that’s the area that you understand. Maybe you have some expertise there. There’s nothing wrong with investing in private equity. But don’t kid yourself into thinking that you’re building a diversified portfolio.
And again, maybe you don’t want a diversity. You just want pure equity, you want leveraged equity. Again, that’s fine. But if you genuinely want diversification, if you want some protection against the very real possibility that the party of the last 40 years is over the next 40 years are going to look different, you’re going to have to basically let go of all of that stuff that worked so well over the last 40 years and embrace things which are far less conventional. This is our hunting ground. These highly unconventional, highly unfamiliar asset classes are, I think, where you’re looking at very, very attractive return profiles. And more importantly, very, very diverse return streams like cryptocurrency arbitrage, reinsurance litigation, trade, finance, synthetic credit and correlation, mortgage derivatives, none of these things really correlate with broader financial conditions. And so, even in this kind of crazy inflated world, you can still absolutely build a diversified portfolio with good stable returns, that’s going to be robust. And I think it’s going to be the cockroach.
Meb: And one of my favorite all-time episodes, I talk with AQR’s Antti Ilmanen about the challenge investors face as decades of tailwinds are turning into headwinds. He talked about the importance of humility, and the need to avoid return chasing.
Antti: You’ve got to think, what can you forecast and what’s just a random outcome. That’s another way I’m thinking of the Serenity Prayer, having the wisdom to know the difference. So, if exposed, you get a big valuation increase for already expensive assets. Sorry, shit happens. And you just got to accept that forecasting is difficult. We are not saying that these things are useful for one-year market timing or something like that but they are still about the best we have for thinking of 10 years ahead, expected returns. And when you get this occasional dictate who has breached, things get even richer, you will get the bad outcome. If people after that think, let’s just ignore that type of advice, that’s something that has worked historically, very badly. That’s an X 10 year returns are negatively related.
So you are getting the sign of at least with what we are talking about, on average, you tend to get it right with these valuations. You get lots of forecast errors, but on average, you tend to get it right. So we’ve got that history on our side. But still, humility is very important here. This last forecast was from… And it’s not easy to reuse these things, but it’s the best we have.
Meb: Yeah, I mean, you actually… I have that highlighted in the book. You’re talking about humility, and I was saying that’s so important. There’s a quote that I just love this past year I can’t get out of my head is about talking, like, “You don’t want to make your idea your identity.” And so, you know, you’re over here, you and I, or someone else buying hold stocks, or even if it’s… Stocks are expensive. Like, the reality of probability and stats is like these things can go either way, and you learn to embrace and accept the market. So you almost got to be a comedian. I say you got to be part historian, part comedian to really get it. But you said like investing with serenity is not only about calmly accepting low returns. It’s about investing thoughtfully, figuring out the best way to reach your goals. We need to make the most when markets offer the least.
While on this journey, investors should focus more on the process than the outcome. That’s interesting, because it’s easy to say but hard to do. Most investors, even the ones that say they focus on process, and not outcomes, I feel like they do that on the buy decision, and they almost never do it on the sell decision. And I don’t know if you’ve experienced that. A good example I always give, as I say, people that go through this process, say, “All right, here’s my process, focusing on the outcomes. Do you underperform after a year or two, you’re fired?” Or if it’s not an active manager, if it’s an asset class, whatever, ETF, on the flip side, people say, “All right, you underperform more than my expectations, you’re fired.” But no one in history, and you can tell me if it’s happened to you has ever said to you, “You know what, Meb? You know what, Antti? You guys did way better than expected, I have to fire you. I’m sorry.” Have you ever heard that? Because I’ve never heard that.
Antti: Yeah, there’s extremely rare cases but there is some situations where people sort of go with it. But it’s one percentile thing where that happens. And, yeah, I think it’s understandable. But at the same time, the same people know that there is a tendency for, if anything, like three to five-year mean reverse on the salary, and still people are doing it. Like you said, I think discretionary decisions will tend to have this return chasing/capitulation tendency. Cliff has got this lovely quote, “People act like momentum investors at reversal horizons.” And that’s just so unhealthy for your wealth. But we all do it if we don’t systematize things. Yeah.
Meb: One of the challenges… Like, there have been plenty of times in history where say stocks are expensive, and dollar great. There’s been times when bonds may not look great. This seems to be, and you guys have touched on this before, a rare moment when both U.S. stocks and U.S. bonds look pretty stinky. And I’m just talking about generally last couple years, pretty stinky together at the same time. And then you talk about, like, how does this resolve because, like, most people the way they solve this problem historically is you diversify. You go to stocks and bonds, 60/40. But rarely is it kind of, like, have we seen this many times in history where they both just look kind of gross?
Antti: No. So, again, both of them have been first or second percentile. So just at the tail end of their richness in recent years. And by the way, again, if anything, then drifting to even reach a level of CIO, which meant that this contrarian forecasts were just getting things wrong in recent years. As U.S.A., it’s rare for that to happen together. And that makes me feel even more confident that gravity is going to hit us. I say, “I don’t know how it’s going to materialize.” I use this terminology, slow pain or fasting.
Slow pain is that things stay expensive. And we don’t have any more of those tailwinds behind us. And then we are clipping non-existent coupons and dividends. And that ain’t fun. And then the other possibility is that you get the fast paying things cheap. And I think we might be getting both of, you know, now we’re getting some of the fast pay this year. But I don’t think we are going to get that much faster, and that is going to solve the problem. I don’t think we are going from this tiny levels to historical averages. If we get halfway there, I’m already surprised. That requires a very big bear market to happen. So I think we’ll get some fast pain but still end up with that slow pain problem with us.
Meb: Now, this guest is someone you don’t want to audit your investment letters and research reports if you aren’t on your A-game. Chris Bloomstran is a fundamental value investor and CIO of Semper Augustus Investments. I talked with Chris about some of the shenanigans and charlatans we’re seeing lately and why it’s important to him to call those things out to protect retail investors everywhere.
Chris: I regret at some level being on Twitter, but the place is where I’ve knocked heads with folks or 100% exclusively, where I think the retail investor is just getting shellacked and abused. If Goldman Sachs wants to go fleece a hedge fund, everybody in that world are big boys and big girls and know what you’re getting and know what you’re buying. You’re professionals and you’re trained to ferret out the good, the bad and the evil. But when you’re fleecing the retail platforms like Robin Hood at the time of their IPO, I would never have commented on Kathy had she not put up a Tesla report a year ago with a $3,000 stock price target, which was riddled with inconsistencies and impossibilities about some of the business lines they’d be. And I happen to know a little bit about insurance and auto insurance, in particular, to suggest that they were going to be the number two or number three underwriter in Otto within a five-year period of time was insane.
And then to now come out in the last fall, and then more recently, a couple of weeks ago to suggest you’re going to make 40% a year and then what’s now 50% a year, may, to use legal terms, may or could be criminally negligent. You’re just promoting. And I find the behavior appalling. We saw a lot of examples like that in the late ’90s. We haven’t seen it until this latest iteration. And so, I’ve simply tried to raise awareness and a lot of people will like me for it, but it is what it is.
Meb: And one of our most downloaded episodes ever already, geopolitical expert, Peter Zeihan talks about the implications of rising food prices around the globe.
Peter: The Chinese stopped phosphate exports late last year, and they were the world’s largest exporter. The Russians largely stopped potash exports in the first month of the war, because most of their export points go through the Black Sea, which is a warzone. And the ships are having trouble getting insurance indemnification. So the ships just won’t go there. Or if they do go there, they have to get a sovereign indemnification from another country. The third type of fertilizer is nitrogen-based, the Russians were the biggest exporter of the components for that. And the Europeans have stopped producing nitrogen fertilizer, because natural gas prices in Europe are now seven times what they are in the United States. And it’s not economically viable.
So even if all of this magically went away today, we already have had too many months of interruptions to the supply system. And it’s already too late for the planting and harvest years of 2022. So we know already from what has been planted or not, and what has been fertilized or not that we are going to have a global food shortage that’s going to begin in the fourth quarter of this year. We only, for example, have two months, roughly, of global wheat storage. Half of that is in China. And the Chinese storage system sucks and it’s probably all rotted just like it has been every time they’ve tried to build a grain reserve before. So, we’re going to chew through our backup very quickly when it becomes apparent that the harvest season this year just isn’t going to be that great.
Replacing or augmenting fertilizer production is not something you do in a season. Phosphate and nitrogen infrastructure for the processing the creation takes a minimum of two years. Three years is probably more realistic. And for a potash mine to be brought online, you’re talking a decade. It’s just not something that we’re capable of fixing anytime soon. And this is just disruption from one part of the world. One of the really dark things about agriculture is that the supply chain system is so integrated with everything else that if you have a failure at any point in the process, you immediately get an agricultural crisis. If you have a financial shortage, farmers aren’t able to finance their seed and their inputs. If you have a manufacturing crisis, they lose access to equipment. If you have given energy crisis, they can’t fuel the equipment, they can’t make things like pesticides. If you have an industrial commodities shortage, fertilizer is removed from the equation.
It doesn’t matter where it happens, it doesn’t matter what the scale is, you pull that thread out, and it pulls a lot else out with it. And that means some farmers in some parts of the world simply can’t produce what we expect. We have exceeded the carrying capacity of the world if it delocalizes. There is no way in the best-case scenario that we get out of this without losing a billion people.
Meb: Later in the episode, he shared his thoughts on how the Russia/Ukraine war may just play out.
Peter: The Russians always had to try this. The Russian state in its current form is indefensible. But if they can expand out through Ukraine to places like Poland and Romania, they can concentrate their forces in the geographic access points to the Russian space. Their ideas, if they can forward position like that, then the Russian state can exist longer. And I think, overall, that is a broadly accurate assessment on the Russians’ part. So it’s not that they’re not going to stop until they have all of Ukraine, it’s that they’re not going to stop when they have all of Ukraine.
Ukraine is just like step four of a seven-part process that involves a general expansion. Here’s the problem for this year. We know from the way that the Russians have failed tactically in the war, that in a direct confrontation between American and Russian forces, the Russian forces would be obliterated, and would leave them with only one option, escalation to involve nuclear weapons. And so we have to prevent that from happening. That’s the primary reason why the Biden administration, and specific, and all the NATO countries in general, are shipping so many weapons systems into Ukraine for the Ukrainians to use. We just have to prevent anything that would make American forces face off against Russian forces.
And since the Russians ultimately are coming for NATO countries, that means we have to try to kill the Russian military completely in Ukraine. And that is now official policy. That’s basically what Secretary Austin said a couple of weeks ago. Now, the problem we’re facing is that the United States military has not had to use a supply chain for general warfare since the ’70s, since Vietnam. We’ve had short intense conflicts where we’ve gone against non-pure pat wars. And the sort of war of attrition that we now find ourselves backing in Ukraine requires a different sort of equipment sourcing. I think the best example are the Javelin missiles, which the Ukrainians love, which had been very effective.
We have already given the Ukrainians a quarter of our total store of that weapons system. And if we operate the existing supply chain system to max out production, we do not have enough to replace that system for over two years. The stingers are even worse. We’ve already given the Ukrainians a third of our stinger stockpile. We don’t even have a manufacturing supply chain for those anymore because our army doesn’t use it because we have an actual Air Force. We provide stingers to third countries that are fighting a different sort of conflict from the kind that we design, just establishing a new supply chain for a weapon that’s basically been decommissioned from the U.S. Army’s point of view, that’s going to take a year just to get going.
So we are looking at the primary weapons systems that we are providing that the cupboard is going to be bare sometime before the end of the summer, maybe into the fall. And if the Ukrainians have not managed to break the Russian military in that timeframe, then this war of attrition, the Russians have more guns, they have more tanks, they have more people, and they will roll over Ukraine. So at some point, in probably let’s call it September, October, the math of this war is going to change dramatically. Either the U.S. is going to have to up its game in terms of involvement and risks that direct conflict, or it turns into a partisan war, where the Ukrainians have fallen, and they’re fighting from behind enemy lines now trying to savage the Russian deployments from within. Either way, the level of risk goes up substantially.
Meb: In one of the more recent episodes, I talked with behavioral economist, Dan Ariely, about the pain of paying and why the ease of how we pay for things today with Apple Pay and online ordering encourages people to spend more.
Dan: On day-to-day talk about the psychology of money, I bring pizza and I charge the students 25 cents per bite, and what do you think happens?
Meb: They just take one enormous bite and stuff it in their mouth.
Dan: Very, very large bites, and they don’t enjoy it, and they don’t learn from experience because you sit there after the first unbelievably large bite you didn’t enjoy and you’re so tempted to push a little bit more inside. And the pain of paying is this really interesting thing that gets us to enjoy things more or less depending on the timing of payment and the way we pay. So if you think about the Apple Pay and Google Pay, less salient, we don’t pay as much. We don’t think about it as much. There’s a study showing that when people pay the electricity bill with a check, they spend less on energy. And when they move to automatic deduction, they start spending more on energy. What happens, this one minute when you write the check, you’re pissed off, you pay attention to the number of the money, you write the check, you tell your kids close the lights, do all these things, look at how much money you’re wasting.
If it’s coming from your checking card, you don’t pay attention. You don’t know what it is. So this saliency of payment to the society, we’re going away from saliency. Everything’s automatic in the background, subscriptions and so on. It’s not necessarily great for us. There are some things where it’s great, but not always. Sometimes it’s terrible. And we need to think about it differently. By the way, once I tried to get… I teach at Duke University in a very big hospital. I was trying to convince them to have the running bill on one of the television stations in patients’ rooms. Every time you get lunch, it updates. Every time you take Tylenol, it goes up and so on. And I wanted to see whether people wouldn’t get released out of hospital sooner when they see that. By the way, they wouldn’t let me run that study.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at feedback@themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
