Chris Bloomstran - An Update on Public Markets - [Invest Like the Best, EP.171]
This episode is brought to you by coughing. I've become very interested in the best software tools in investing and when I asked twitter for the best Bloomberg Alternative. The overwhelming winner was an excellent new product called Coif and it's a web based platform that you analyze stocks. Etf's mutual funds and other asset classes in one place. I've been using everyday to track. What's going on in the market? And I think if you try you will to. Cohen has a ton of high quality data powerful functionality and clean interface. The best part is that it's free you can sign up at. Www DOT CO DOT com. That's K. O. Y. F. I N. DOT COM Hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets ideas methods stories and strategies. That will help you better invest. Both your time and your money. You can learn more and stay. Up-to-date AT INVESTOR FIELD GUIDE DOT COM. Patrick o'shaughnessy is the CEO of Shaughnessy Asset Management. All opinions expressed by Patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes. Only and should not be relied upon as basis for investment decisions clients of Shaughnessy Asset Management May maintain positions in the securities discussed. In this podcast. Award I guess today for a Flash Update is Chris Blue Strand the founder and CEO of Semper Augusta's in a popular pass guest on the show. We talk about his view on the state of the Public Equity Market. Why it will be hard for the market to deliver. Great returns for the next decade rolled in the last decade and where opportunities may lie. Please enjoy our conversation. Talk to me a little bit about how you are thinking about. Or actually making adjustments to your portfolio in light of what has to be the most bizarre and challenging macro backdrop that we've ever faced as investors in our collective careers well. There's no doubt nobody's saying anything like this. You can draw parallels to periods like the Great Depression or the World War Two period. But I don't say you've ever seen the enormity of entire broad swath global economy just stopping on a dime going into this and one of the themes of my letters in the last few years has been that we've really built up inordinate levels of debt in society at all levels household debt corporate debt government debt and for that we think that the debt stock relative to the size of the economy is unsustainable. I think given where we are trying to work out of over levered capital stock comes with deflation over time and because of the dangers of leverage. We've intentionally really timid the other way. In the last handful of years even prior to the crisis we've gone out of her way to ensure that we owned businesses that if they don't have net cash on the balance sheet to the extent they're using any material levels of debt that it was taken on purpose. Save for an acquisition. It makes sense but with an eye toward running the overall capital level leverage wise at a reasonable level overtime as evidence. But I tell you you get these kinds of periods where you get. Enormous downdraft on a daily basis and investors can do two things that we sat there at the market lows really and late fall of weight and into marge about nine looked at portfolio. And said you know we could flip out a number of these businesses that we own that we think are really well run rate balance sheets. Good Management's if we're right and we're at a market low we would make a whole lot more money liquidating big trump this buying more lever businesses. Because you're going to capture a lot more the upside when you flip into things that wind up surviving the worst part of the downdraft. Don't fail and come out and we refuse to do so and so the opposite way to approach that is you get a decline like this or at least like what we have up until a couple of weeks ago and we run around with a working list of businesses that we don't own but we'd like to own and I think the world has caught onto the notion that's durable returns on equity make a Lotta Sense. Owning businesses with pricing power makes a lot of sense. So there's generally very outstanding good businesses that just typically are very expensive and expensive enough to take a lot of the expected. Return out of the equation if you own a business that you've got a sense of reasonable organic growth just in terms of simple yards dixie. And if you think twenty-five earnings is a fair number we'll communities things trade thirty five to forty times and if you believe company trading at Forty Times. Which would be an example of a Costco talked about? I think at some point Costco Trades it twenty five times. The growth curve is not what it was when we bought stocks the first time in two thousand four. I think it was. They'll open stores rate of twenty five saved thirty per year. The net number of new stores per year is not as creative to the installed base of stores. They're still gonNA have terrific same store. Sales rose it. Still traffic franchise great business but I find a multiple close to forty times for the business to be pretty high. You can say well sure. But how much of. The depreciation of the fixed assets of the business are actually real. And that's and that's a fair point. Zero draw couple three points off by just two expense if these downdraft. And you're getting to the point. Where a lot of businesses that? We'd like to own. We're getting close enough to buy. And then we almost flipped the switch and launched into this recovery phase when the Treasury and the Federal Reserve Dot more active in the Capital Markets. And for that or just bewildered where we are today and we had done some of that. If you want me to talk about things related government the Fan Treasury. I can but we've been very active. We'll go entire years and do very little in the portfolio last year. For example we simply watched everything goes straight up. We added one new business to the portfolio. What Olin Corporation? We brought in small position. When was the price decline this year? We've really made it a material position for the firm. We've had the opportunity to liquidate some things in the portfolio that our businesses are there just to expense so dollar general which we talked about. I think last time we recorded late last summer dollar general. If you had to pick a business that was going to sail through this crisis. That's the what food supply chain is essential. The economy dollar general sells into largely rural America. Seventy percent of their stores all their stores are open with access to food and necessary household goods. There's rift and you have a sense that we're in a recession. I think we're in a very deep recession my senses. The recession lasts a lot longer than people would probably think coming up. The backside and dollar general happens to be a business that historically has done better recessions than they have during boom times. Some of that is that the margin on increased use of the Food Stamp Program but the stock has done to well. We had dollar general veteran the portfolio for more than three years. I think we're in it at high sixties per share. We couldn't avodon any better. We bought all the retailers. Were being chucked out because Amazon's GONNA take over the entire swaddled the retail economy which probably is the case for a lot but it certainly not the case company like dollar general or COSTCO TO RETAILERS. That we And the stock is up to the year. And it's just performed well in its trading at price where you look at opportunity cost. We had other names in the portfolio and other businesses that we kind of been hoping to buy for a long time that some of which rebound chance to buy in so taking dollar general down over a series of transactions from four percent of capital the one percent of capital has freed up apple to buy things that are very good businesses but at much much better price points that give us a much higher expected returns for the duration so not allied two thousand eight. We've been very active. And my sense is that with his run-up leaves a scratching our heads. You know we talk just a minute before we got on the line. I'm sure you look at your portfolio since well and Sam and if you had said to me Chris let me paint a scenario for you. Three months from now four months from now we're GONNA have the entire global economy stop. All the restaurants will be closed. All of the retail in this world will be closed the airlines will be running five percent of their fleets aircraft manufacturing will have stopped globally auto manufacturing. We'll have stop globally and you're down twelve percent for the year. It doesn't reconcile them. There's something wrong with this picture. I think was wrong with that. Picture is just an enormous amount of intervention on the assets government which we understand. I mean I get that. You don't WanNa penalize households and you don't WanNA penalize businesses for this stoppage in the economy for however long it lasts and so the folks in Washington are expending every resource times ten trying to inject liquidity into the settlements for that. I spent too much Easter Sunday. Rereading parts of the Federal Reserve Act trying to figure out whether what the Federal Reserve is doing is even legal. I'm not sure it is but you can't flaw. What's taking place right and doesn't matter as an investor you have to play the game. We HAVE TO PLAY THE GAME. And then you have to decide because we're playing the game a we like to think we play the game a little bit with our heads in the sand and we like to thank you can ignore the macro and just focus on business business business and price price price. And that's what we do and for that. I think we've got a collection of businesses that will farewell any economic or monetary environment. Now that's not to say that Disney is not on. Its back in the moment with big swath of the company not running not but we would look out the case like Disney to where they were in the nineteen. If you were on the back end of this occurs and we're going to put people back to work. At what point does Disney get back to full levels of capacity utilization or? What does that look like? Is there any permanent? Draw down to their use of their entire capital stock. And so we're doing a lot of that kind of work but I think you look at just what's happened with the economy and you've got projections all over the map. He's got a couple of Wall Street house in saying that. Gdp is going to be down. Forty percent annualized basis for the quarter. A for a six month period of time. We've got the FED president here in Saint. Louis James Bullard came up three or four weeks ago and said thirty plus down on GDP. So you kind of break down the components of GDP. There are several ways to look at it. But I mean there's no doubt. Consumption which is seventy percent of the economy is going to be doubt so if. I've got the numbers in my letter. I've got the table in the front kind of showed where we were at year. End Versus various secular peaks and troughs throughout time and our sense was introduced team that we were on almost any fundamental metric. You can use price. To sales cash flow yield prices were very high we overlay that was total credit market debt-to-gdp which has been three hundred fifty percent since two thousand seven again. I go back to this too much leverage but GDP is going to be down consumption if it's seventy percent of what was going to be a twenty trillion dollar economy. I mean it's not unreasonable. Thanks to GDP comes this year. Nominal GDP now not inflation adjusted comes in maybe ten percent below expectations. I don't think for the year it'll be near as bad as some of your pundits have suggested but if consumption is seventy percent of that number at fourteen trillion dollars is going to be wade out a look at our own household consumption. My Wife's lover. Yes she's professional shocker. She's not running around the stores but she's leaning heavily on Amazon. I think if you looked at our house from Google Earth to think the balloon strands are under now Amazon Distribution Center right there and say Ross. You mentioned already the surprise if you were to have been given the setup at the start of the year and to have had a broad portfolio only down twelve percent. I looked today. The Nasdaq is now up on the year. Which is just kind of remarkable. What has surprised you most given the setup that we've already discussed so said differently looking at the market what market action in sectors or industries or companies has been most odd to you so far in the Kovic market period. Well I think the five big tech companies that are wrote about in my letter this year. It was remarkable the degree to which they held up now. They're outstanding collectively outstanding businesses music about Amazon's business being up during a crisis that's happened. Microsoft's Cloud Business Asher being up during the crisis. So some of those were to be expected but going into the year when I was writing my letter this year and I don't know February. Eleven or twelve collectively. Those five businesses together were valued at twenty percent of the overall S. and P. Five hundred we ranchers fund mass and letter effectively. Said if you're expecting these stocks to compound for the next decade at the same twenty four percent that they ads last ten years if you're expecting the revenues to grow at nineteen and a half percent. You're delusional. You're just not GonNa get it and I would say for most of the last ten years the they stocks generally as a group and even individually were not very expensive. You take the cash out of Google really cheap at times. Microsoft. We own for a decade. I wrote about Microsoft in January. Two thousand predicted shoulders. Lose money for the next fifteen years which they did but we bought the stock in the low twenties in two thousand and six owned it for a decade trimmed it when it was expensive. Bought it when it was cheap and finally sold the whole thing without a doubt three or four years to I didn't get the clowns. Would it be as big of a deal for Microsoft but the stock traded at thirty eight times earnings in two thousand traded twenty one times earnings when we bought it into the duration of ownership most of our ownership for ten years and traded back into the thirties to earnings profit margins had fallen they were washed out in the low twenty s? Now they're back to thirty percent so that roope really I don't think is going to produce even near the same results not just in terms of share price but in terms of sales and the margin structures. They've enjoyed just real quick interrupt there so they're sort of prices if they will maybe especially given the backdrop here and the fact that many of them are at or near highs despite the macro environment. Just say a little bit more about what you discussed in the letter as to why you don't think those kind of nineteen percent revenue type. Compounding experiences are as likely over the next decade for those huge tech companies. It was the same logic. I use twenty one years ago now to Microsoft when the market is six hundred twenty billion in revenues were only twenty assembly. The price is too high. We took a ten year horizon in a twenty a horizon using market cap using sales and using that income and ran scenarios at compound growth rates of on the high end twenty five percent twenty percent fifteen percent ten percent and then four and we basically said yes when p. five-hundred if we assume for the next decade or two decades will grow at four percent a lot of people would say well that's crazy except if you look at the last ten years and consider that sales have only grown three and a half percent a year for the S. and P. Five hundred kinda matching nominal GDP. Ross most people wouldn't believe given the performance of the Stock Market for the last ten. But it's been three and a half percent and you've got profit margins that peaked in my opinion and probably won't return to those levels perhaps even in my lifetime in the third quarter of thousand eighteen we saw net profit margin of little over twelve point one percent on the S. and P. Five hundred most of that during two thousand eighteen was on the back of the big tax cut which took marginal rates from thirty five percents to twenty one percent through editor more accelerated depreciation. There were a lot of angles but a lot of benefit was exhausted. Over the course of the first three quarters so you had peak making the assumption that sales growth for the next decade at fifty basis points more than they had the last decade which. I don't believe you assume. Four percent of you assume no margin increase so you hold profit margins at year end two thousand nine hundred levels in the low elevens and you just extrapolate those out at four and you assume no more multiple expansion. So we went out with the S. and P. Five Hundred Trading at twenty three times trailing earnings on reported basis of the end of nineteen so at twenty three trailing. We'd make the case that you're not gonNA get any multiple expansion malicious whole multiples at twenty three. Let's hold margins at eleven eleven percent so I think it's reasonable to assume the S. and P. does four percent by those three yard sexual next ten years or twenty years starting at year end. Nineteen running the same and then running those various same. Three yardsticks for those five companies individually and collectively you simply get to mathematical impossibility by growing at twenty percents. You grow if you're starting a twenty percent base if these five components or twenty percent of the index and they grow at twenty percents the next decade or two decades. You start to get to where the five components are more than one hundred percent of the S. and P. Five hundred. She gets impossible figures in running those scenarios and kind of working backwards down the growth for all three again market cap and sales and net income. I kinda got to where I could buy. Revenues which were stocks were twenty percents. Revenues were eight percent of the S&P five hundred. Let's say a net income was fourteen percents. I could get revenues growing at ten percent a year for the next decade and becoming a larger multiple somewhere south of twenty percent but those five companies can't become in my opinion more than twenty percent of the sales of the entire SB. Five hundred decide the laws of large numbers diminishing returns and I wrote and I still believe I don't what stops it if it's simply a nurturer but regulation comes along the point where these five get so big and they're already having regulations Europe you to stumble into new competition. Who knows what it's GONNA wind up getting. Who are known that a company like Google was gonna come along and just a visceral the entire traditional advertising business. I've got a couple of friends in here in town in town here who ran. Southwestern Bell's Yellow Pages Directory Business and our Number One. Google is in its early days had just gone. Public is guy swore on a stack of bibles that that wasn't a threat because locally they had boots on the ground well it wasn't but two or three years before they were done the advertising agencies. They're all inside the big couple conglomerates. Now I'm the calm. They're all trying to cut cost just to stay alive and they're gone. I don't know what it will be. And that's not a conversation for this cova crisis but these are generally great businesses. They have very very good balance. She's balance-sheets collectively. They've got net cash Lavalle sheets. We simply found. The price is too high scales. The businesses in aggregate being too large but for the last ten years. If you're only own those five companies and maybe throw on a visa and Mastercard so seven businesses if you'd only own those seven that's all you need it and then you get to the first quarter here and all of the chaos if you just own those five you were down. Maybe nine percent quarter end when the S. and P. Five hundred was off. A what was it off. Nineteen percent twenty percent down thirty two or thirty three percents low. Those five businesses held up better than all you take the top twenty companies and the S. and P. Five hundred and collectively. They've held up better so I think good businesses tend to keep you out of trouble. It has a point. Where if you're thinking beyond what's happened during a crisis next ten or fifteen or twenty years he's not GonNa get the same returns but I think the problem is you probably not going to get very good returns out of the broad stock market either. Let's go to the literal opposite story which I think in this market has been the energy market so if the big five tech have navigated this with sort of amazing resilience I think on the other end of the spectrum just like no one could have predicted what we're facing economically. It would have been very hard to predict the action that we've seen in oil markets and therefore an energy equities love to your take on this space. Since I know it's one you're interested in and maybe even have a few investments in what you're taking what's happened in energy. And whether or not the relative carnage there versus the Big Five Tech has created any sort of opportunity for much better long-term returns than what you see in the S. and P. Five hundred we've owned oil and gas and various iterations over the entire history of our firm. And we've done well. We've made cyclical investments early on and in a couple of the deepwater drillers late nineties. Oil was under ten dollars. A barrel oil thought it was headed for. We spent a couple of weeks in Houston and talked all of the drillers and wound up owning transocean. Diamonds we wound up. Triple your money with way too little chapel. We did the same thing again with the same companies the next time. Oil traded down to those lowes. We've owned Exxon Mobil. Cyclically we I think have a good history buying it when we thought it was cheap sully. When it was deer the problem was oils is and the world. Learn this lesson in our hurry here. This quarter WIS oak pack really existing in perpetuity with a sword over the head of the industry few take us production of oil and gas. We were a bit player. Globally twenty years ago the United States was producing four to five million barrels. A day are net. Consumption is in the high teens for barrel. Today it's twenty million barrels a day before the crisis twenty million abruptly down for a very short period of time so we've gone from producing twenty five percent of our crude needs to producing twelve out of twenty barrels and so at the margin that incremental seven million barrels. A day over the last decade has really eaten indo-pak in it's really eaten into the international community. We stand up and say were energy of independent while we're not. We still important that eight million barrels a day but now restarted exports various products in your Saudi Arabia. And you see this and forever Saudi and most of these nations. The per state OPEC's are very dependent upon oil and gas to meet their federal budget. Their spending needs you know. There's very little middle class. A lot of these countries very wealthy in Saudi Arabia apprentices mistakes. And then you've got the poor. The poor the vast vast majority oscillation they need OPEC needs as high of a price as possible to run their affairs and generally they'll go in cycles for they will typically keep oil off the market place and never run full out will here in the United States. We've been running full out and it's kind of a nutty thing. We saw the lessons this year with the collapse in crude but if he followed cycles even Exxon Mobil which we think at least historically had been best of breed best cap alligators. We own Exxon today. And I think of the last ten years the businesses eroded considerably they used to zag when the industry would zag when their competitors were ramping up capex exploration and they sensed the we were going to get to a oversupply. Exxon had a great history of backing off their Tabak's when everybody else was spending money and then they go make investments when Uranium Cyclical downturns will in they bought x t O and. They couldn't under worse time really at the peak of the gas market and over the last ten years. They've been hitched his dividend policy. They've just increased dividends in perpetuity to the point. Where IN THE LAST COUPLE OF YEARS? They've modern the dividend if you're the CEO of a business that is hitched to a high dividend payout. It's absolute handcuffs owens in that same boat. My recommendation took folks that run all and has been during this crisis. Got A couple of evidence. Eighty cents a share there in the list of the dividend aristocrats. Which is one of the stupidest things you can have? Because you're obligated is a cyclical business to always pay the DON dividend. Well in Olen case. That's one twenty million dollars. They ought to be freeing up but they haven't read out and Exxon's case they've got a dividend that's going to be three dollars and forty eight cents a share this year. But they didn't even that year they didn't earn it the year before they didn't earn a year before that their history read. That's over one hundred percent of their capital was you're not earning on a free cash. Basis your dividend. You're borrowing money in so Exxon has obliterated their ballots. She they've gone from ten billion dollars in debt. Going into the air they had about forty seven. Maybe fifty billion in here in the crisis. They've done what everybody's doing drawn down revolvers and they're floating debt issuance. They've had to bond issues in the last month. Were they've collectively raised. I WANNA say eighteen billion dollars. Now they've got seventy billion dollars that got more cash proceeds of the issue but their burdens or capital to cut the CAP ex budget by thirty percent. A couple of weeks go but they haven't touched dumbed Emdin so we did a deep dive on a bunch of little independent love. Gas Companies last year because crisis didn't just start. These businesses in the service sector in particular has been incredibly weak. The small independent producers have been incredibly weeks from the last couple three years. He has really good. Investors really highly regarded. I WON'T MENTION COMPANIES LIKE INTEL RESOURCES BIG institutional ownership from high class investors in. These stocks are down. Were already down ninety five to ninety nine percent prior to what transpired the first quarter. So you get into the depths of the krona virus and the global economy flat on its back and we really had an assault from OPEC when they said they were GONNA pump out. Couldn't happen at a worse time. I think intentionally happened. It was couched as the conflict with Russia. Russia was going to produce Saudis. And we're going to produce and we're GONNA flood the world with too much crude. Well that just exacerbated the problem and so the entire oil and gas patch just got absolutely crushed. Exxon traded at thirty bucks a share having traded a hundred dollars a share a couple of years ago. They were numbers of businesses. That were down already like say ninety ninety five percent and during this died inordinate number of businesses and could not get comfortable with any of us what you've seen but I think the world's not miss is a massive amount of debt that finances this industry at the end of the day. This is not a business that generates sustainable freak. Ashcroft's they're cyclical profits. They don't generate returns on tap their actually net over long periods of time capital destroyers and so there were an enormous amount of debt. Coming due late twenty through two thousand twenty one. Two Thousand and twenty two. You're going to see an enormous number of bankruptcy so here we are with Exxon. Mobil has made it a bigger position. We look were. They produce around the globe and we think they've got pretty reasonable Brady Evans in various places. The refining operations are running at sixty five percent acidy but they have fields that break even at thirty dollars. Thirty five forty dollars a lot of production. So you're not back there on oil down on a current spot basis or fissures basis but back to say forty five to fifty dollars staying Exxon's in good shape when they calculate the reserves. They're overstated using a longer term higher oil price. But I think they're fine at today's prices you'll wind up making a lot of money but they are not businesses. You can own durably for thirty years is going to destroy. Apple is a shame for lotteries. Spot they're cheap and so as long as you get through the capital structure and you get through. The capital leads some sources of the quantity and demands for Apple. You find the ones that will survive and you'll wind up making lots of money be will come out of this thing and we're going to put people back to work and we will use more oil and gas. We're not going to be topping up our refiners. Which can't even take more crude. We're not could be layering on crude. On tanker ships will use it. It was a painful downturn. The industry auto learn you still live at the mercy of and only for their mercy of keeping crude off marketplace and four that these are really terrible businesses and yet we own a couple of them right right well obviously ultimately prices key variable in all this reason for I loved the expression from famous value investor that they made all their money going from very bad to bat in businesses because the price is just too low so yet another variable that one must consider in this strange market. I think that's very well put. That's kind of the nature of investing in circles. Is You can only own them. When they're very bad you can only buy them when they're very bad. You can't have an expectation of good. I think it's a perfect way of putting it. Everyone listening that knows your work will know your deep exploration of Berkshire Hathaway model. You've been a big investor there for very long time. Know the INS and outs of their balance sheet. Maybe like nobody else and so I think it's been a very curious thing to watch. Berkshire in the Corona Virus. Smart period sort of doing perhaps the opposite of what many would expect of them given buffets famous spy American. Im OP ED. In The New York Times in the two thousand eight crisis when he was aggressively bidding and setting up interesting structures with places like Goldman Sachs and Wells Fargo to sort of act as a backstop and get paid very well for doing that whereas in this period he's really. The only notable activity seems to be sales of banks and airlines no major landmark purchases at least announced and a huge cash pile by absolute standards if not by relative standards. I'd love you to talk to your reaction to berkshires activity or lack thereof so far in the coveted period. Well there's very little activity to observe yet because to your point. They've been extremely quiet. Thank the all-white crisis evolved over a longer. Duration and so when companies like Goldman and GE needed capital. You didn't have the massive federal intervention immediately. Like you've had this crisis and was going to say you know screaming. Berkshire doesn't own airlines and money center banks. While they do their meaningful positions you saw them take their southwest airlines Delta positions below ten percent. Just last week they shrunk their banking the your position to ten percent which was really regulatory driven in that case. So it's hard to know what's going on inside the business. I think you've not seen the deals. Like they did during the crisis yet because of the nobility of this federal money. That's coming to the party. You've got the airlines with their hands out to the government trying to come to terms over whether and how much equity ownership via warrants that the government's GonNa wind up taking raw. Berkshire can't get in front of that. The same way to get in front of outside of the Krona virus of bidding war for outright ownership or companies when private equity has so much capital on the sidelines. Waiting to deploy. I'm not sure they were at the point where they were able to get capital on terms made sense to Berkshire when there's so much more free money coming from the federal government. But it's interesting. It's hard to know what's going to happen. I think the airlines are going to get diluted. We own a couple of suppliers of parts to airlines. They're good businesses and we're struggling with what the back end curve. Looks like replace the parts? We're looking struggling with what the build profile looks like for construction of wide body. Jets the seventy seven and the Airbus a three fifty for example in the case of exile which supplies Inter modulus carbon-fiber But tarnaud at Berkshire has done. It's GonNa be really interesting to see my expectation would be of the hundred and twenty five billion dollars in cash that they would have bought back a whole bunch of shares. They spend on the order of seven or eight billion dollars last year. Binstock back average of two hundred two hundred three dollars on the b-shares stock traded as low as one hundred sixty and I think there have been days and bullets where I can spot. Berkshires buys on the opening on the clothes. I'm probably I could be wrong. But I presume they've spent a fair amount of Catholic interesting on the Equity Franc's to see what they've done. The airlines we held off in a big way owning these things. It was obvious coming out of the late nine when the all restructured. It was a different business. Got a lot more religion in terms of cost structure the got control of their gates the work till each other on price but all these actions were gone outside of recession. I think the carriers figured out how to sell first class seats for price that people would actually pay instead of getting those seats away to their frequent-flier Platinum stands customer. I for free because nobody was buying the seat instead of selling a first-class aid for three thousand dollars. They would sell it for twelve hundred dollars or nine hundred dollars so there was a lot of good down where we started sidelines. It's near and to see how this industry fares when you get the next recession. Who BLINKS FIRST IS? You've got a history of blogging and taking fares down to levels below brave so load factor. Start to get below eighty five percent. You start to get into trouble and obviously nobody could seamless thing coming. Rea- really shutdown global airline traffic to agree we have you've got federal money county in on one hand. I wouldn't be surprised to see Berkshire having sold out. Or Materially. Sold down the airlines structure knowing that this will not be the same business going forward knowing that demand will not return to a hundred percent of two thousand and nineteen levels. I don't know it's adding to the portfolio. I don't know if they've sold down banks. The bank seemed to be in more trouble than the world thought they had to be. Graham Dodd Standards and they apparently were better capitalized. But outside of the banking structure in shadow banking the fact that you've got all these credit funds that looked like long term capital management's leveraging up at Obscene Multiples Equity Capital. Twenty five to one fifty to one hundred one. I wrote about two years ago the degree as debt in levered loans and the COO marketplace. We went around talking to them. University endowments and their. Cio's pension. Ceos. I bet you that nobody runs cash fixed income by simply owning individual credits so Berkshire goes into one hundred twenty five billion in cash. Or what's their cash invest you? They've t-bills. Nobody does that. It's a crazy time for such an interesting company. I can't wait to see the buyback. Titi looking back now. Once we get the data but it has been somewhat surprising perhaps their method for capturing value created by. Cova is simply in their own stock. I'm curious you mentioned energy on one. End The top end of the tech ecosystem on the other end as contrasting examples other other areas that you see as sort of wildly cheap or what seems to be wildly expensive in this market today on April fourteenth. Two Thousand Twenty the places where you still have enormous upsides if you believe the durability of Federal Reserve and treasury intervention in the marketplace or businesses that were destined to fail lousy retailers. That were already going out. Macy's is just in a slowly they were GONNA go from nine hundred stores. Eight hundred stores coming out of this downturn if they don't follow chapter eleven very quickly which may not be the case. Now that you've got access to capital for the time being I think they'll still accelerates number of stores. They'll close the mall retailers even Mr Buffet is invested in at least he wasn't vested than Sarah. Taj Her Simon property all of the big malls just long-term businesses. That are probably going to zero in a lot of cases are still cheap. Even though they're fifty percents one hundred percent off their lows. They're still down sixty seventy percent off high. So if you're willing to swim in that off and go find the most over leveraged businesses even though you've had an enormous recovery. There's a whole bunch of them that are still down seventy eighty ninety percent. We're not doing that the things that we own today. There are a lot of businesses that are really cheap and still down maturely for the year not as cheap as two weeks ago but I would contend that coming out the back side of this. The we'll have deflation for an inordinately long period of time. I think a better way to think about what to do with capital today. It's like about how apple's work for the next ten or twenty years certainly in the next ten years and if you bake in short-term interest rates which are already at the zero bound if you bake in a Federal Reserve that will be determined to try to compress long-term Treasury rates as close to zero bound as possible and you go back to the Fed's treasury accord that existed during the latter part of World War. Two the end of the period obediently after the war that allow them to run enormous federal deficits increase the household savings rate the point where we actually managed to finance the deficit from hustled savings. We rationed a lot of was consumed at the household level. Coming out the back side of this you can bake deflation. And if corporate credit levels were at all time highs in government debt levels on balance sheet debt levels which were already at the point where you get diminishing returns out of the next incremental dollar of death taken on this all smacks of deflation in so ren period where none of these things are going to fail. I mean if you figure this out and realize they're not going to let businesses fail. We're going to probably violate Federal Reserve. Act AND BY secondary corporate bonds both investment grade and now high yield as of last Thursday's announced. We're going to buy each by high yield. Ats which is way beyond the Fed. Charter put a stake in the ground and said we're going to get enough liquidity into this extra and we've got the fire. Pardon or yes. They fired hard to do it. But it's GONNA take a four plus trillion dollar deficit this year which is going to add an enormous amount of debt to the Fed balance sheet. We're GONNA take total credit card debt from seventy six trillion dollars to somewhere north of eighty trillion dollars debt to GDP which has been three hundred fifty percent is going to be at least four hundred percent of GDP. The only way to deal with these kinds of debt levels is deflation which comes austerity which comes with things like lower wages versus higher wages for. We're not mentally stuck to that. We haven't seen this the nineteen thirties. And so if I'm right and we have deflation for the next ten years. Let's say then finding businesses they have pricing power. Because see. We're going to have it. That also has rock. Solid balance sheets is the way to survive and make decent returns for the next ten years. If you survive this Cova crisis because you happen to have access to capital because the Treasury has allowed the Fed lever up its balance sheet at ten to one for grade corporates. And for the scariest that they're allowed to own treasuries and agencies may be Muniz but not high-yield ninety s not CEELO's not commercial mortgage backed securities. This is all crazy. Thraw GONNA live. But YOU'RE GONNA come out of this thing with even more leverage than you had. Even good businesses Disney is gonNA come out with more debt on the Balance Sheet. And they already had that on the balance sheet vs the Fox Dina last year. We're introducing more leverage into the capital structure of business then existed prior to two thousand nineteen. And if we have deflation then these companies are going to bleed badly. I think you've got a decade of restructurings. You have to be vigilant. And so yeah. I think. The companies that we own are the right businesses and today extent. We've been able to ask those. It's been the right thing to do. Can you say a bit more about this? Deflation versus inflation concept. I think your viewpoint on deflation is a bit against the grain. Where maybe the simple would be with as much money being pumped into the system the expansion of M. Two of the money supply of everything. The Fed has don to introduce liquidity. That the naive expectation would be inflation. Not Deflation and that the way to get rid of that day would be inflate your way out of it. So can you just maybe draw a little bit more detail around why you expect deflation versus inflation? Yeah the problem is the same problems that the Japanese had. The last thirty years for. Peaking nights eighty. And that's you can run up the money supply but an increase in the money supply if you WANNA call m-2 money M Two's really your monetary base times little land. Which is the money multiplier? But em to let's just say am two's right number will if your GPA was gonna be. Let's say twenty two trillion dollars going into the year. Probably Twenty by year end. Ma'am to at last week. Sprint was sixteen and a half maybe sixteen seven trillion dollars off thought my head which means the velocity of money which is what nobody thinks about isn't working so none of this federal money none of the two trillion dollars endings. None of the leverage that's incorporated from these special purpose vehicles will occur show paper deal the various credit funds the various term asset backed facilities. None of these are stimulus. And I think it's been proven academically that at higher and higher levels of on balance sheet federal debt the incremental use of debt starts to produce diminishing returns where it's not effective and so that's deflationary so the answer then becomes and. I think you're right the end game. The end game is inflation. The end game is probably hyperinflation given where we are is here on broad. There's so much dog. She debt but we will go through various iterations. With the Japanese dot we did the first generation of quantities enduring the financial crisis. And we had to do that. It'd be as we were going to. Nineteen thirty style down to Berlin. We had the thracians of quantitative easing one. Two and three and I didn't push up GDP. I talked about earlier. That sales for the S. and P. Five hundred of grown at three and a half percent nominal. Gdp is barely grown. If you go back with beginning of my career and my investing career total credit market debt. Gdp was about two hundred percent up from one hundred fifty eight percent. During the middle of Reagan's first ministration will interest rates. Were Sky High. It took a thirty years coming out of World War. Two forty years to utilize capital stock. There was overbuilt the nineteen thirties. And we have this glorious gross in real GDP per capita an enormous love well in the subsequent twenty years in two thousand when the tech bubble peaked in the nifty fifty. Fifty big caps peaked at forty to sixty times earnings. The Nasdaq traded two hundred. Forty times we had taken out on an enormous amount of debt to that point and that was two hundred and fifty percent of the economy and we were stunned to that number. It was just crazy. Gdp was ten. Trillion in debt was twenty five trillion dollars. So we had the downturn the stock market broach. Snp dropped fifty percent. Nasdaq dropped eighty plus percents. We had many recession in two thousand and two and then recovered and we really put credit works in things like the mortgage stocks we household finance and Covenant Light No covenant loans and. It was a stunning seven years from two thousand seven in the GDP grew from ten trillion dollars fourteen trillion dollars but the debt stock total credit market debt doubled from twenty five to fifty trillion dollars. We took an incremental twenty five dollars debt to grow the economy by or think about that so we have the great financial crisis. We've been taking the Fed's balance sheet from eight hundred fifty billion dollars. The first thing they did was took up that first bailout with various SPD's various cities they had the conduits and we added a trillion a trillion dollars to the Fed balance sheet. That had to be done to avoid going to a nineteen thirties. I'm not sure needed to qe's but in the subsequent years when taking the Fed balance sheet for what was eight hundred fifty billion dollars it got up to four and a half trillion dollars a couple of years ago and then we tried quantitative tightening. We're GONNA run down. I remember the president of the Fed in San Francisco. Saying we'RE WE'RE GONNA get this balance sheet about halfway to where it was so you would have said two and a half trillion dollars what they cruised was. You can't do it. Yeah we had nine increases in the Fed funds rate and you started to really weaken the economy we in the global economy. We got into a trade war. We'll China was already weak in the last five years even though profits for the S&P five hundred rose profits more broadly under Nipah. National income accounts have been in decline and last year we had the SNP up thirty one and a half percent. Prophets were flat and it looked for most of the year like prophets. Were GONNA be down year over year so tax cut benefit was gone? So here we are. We came out of. Oh Seven Oh eight. Oh nine at three hundred fifty percent de GDP. Now we're sitting here three hundred and fifty percent against over the last ten years we've taken on three dollars and fifty cents in debt to grow. Gdp by dollar so for most seven GP's grown from fourteen to twenty one trillion dollars we've added sub but now he's seventy six trillion dollars in debt. There's an inefficacy of the ability to get money into the economy and have organ that gets back to this philosophy of money so velocity. I remember when I twenty years ago when we started. I was hounded my head that M. Two Times Las Vegas. Gdp was always about half of the size of the economy so back when we had a ten trillion dollar economy 'em to had been five trillion dollars. The velocity of money was to run out of LAS MONEY. Down to about one point three hundred client. There's no way to get this money working because we've already got an overbuilt apple. Stock that applies whether capital is harvey equipment. Or whether it serves we simply have too much stuff. We have too much retail square footage. We have too much restaurant. Square footage re too much manufacturing capacity globally and syringe big decline. And you can't simply introduced bore debt on top of debt and call that solution so yes I see her. That hyperinflation is the end game. But we're not there yet. I think everybody thinks that all these. Qe's is absolutely crazy inflation and it's not only when the Fed really turns liability side of the balance sheet into notes currency instead of going through the treasury when the Fed directly monetize the debt buys treasuries that are not issued first by the Treasury Department to finance deficit spending. Then you probably get but tell that it's just deflation deflation and so we'll do numerous ongoing to try to get inflation in order to try to get inflation up to that said target or two percent. I don't see it. We fast forwarded by a decade over the matter of three months in terms of how much debt the system could really bear now. It's beyond kind of that. Tipping point where there's no ability to take new debt and grow the and I think that's problematic and so my bet would be deflation deflation deflation and hopefully we. Don't get hyperinflation in my lifetime. I'd always hoped we can get it through my kids lifetimes my grandkids. All bets are off. You can't control that much from the grades so it's coming at us yet. I'd love to review the characteristic profile. You mentioned one or two already. Which is this notion of pricing power maybe capital efficiency in contrast to the very capitol inefficient growth. Which is how I would characterize the increasing debt load to produce the same amount of few DP as sort of capital on efficiency. What other characteristics do you think are most important to look for businesses to own perspectively over the next ten years alongside pricing power? Well I think you'd better sell things that are essential that households need if you go back to the Great Depression when GDP fell by half nominal GDP got cut in half. The consumption was similar to where we are today was seventy percent of the economy when GP was one hundred and three billion dollars. Nineteen twenty nine. We cut the economy and half consumption grew to ninety percent so everybody now knows unemployment went from three percent or four percent up to twenty four point nine as long as the headline numbers. We still have to eat drink so businesses that sell things that you need food food products drink. Consumer goods companies should be in terrific shape unless they've just layered on too much debt. Because was GONNA wind up happening is if the price level starts falling by two percent. A YEAR IS PROBLEMATIC. Reverent portfolio companies like dollar general. Which I think is perfectly weathered for a deflationary environment except that if the overall cost level cost goods sold declined by two percent. You'RE GOING TO BE PUSHING BACK ON WAGES BY CHEAPER SENATOR. Try to maintain margins but if you're levered business if he's got an enormous amount of debt capital structure even nominal declines in. Your top line can have profoundly bad impacts on the backside so I would make sure you own company. I regret now having owned and sold Pepsico a few years ago because a company like that. It's perfectly situated there beverage franchise but also they're salty. Snacks PepsiCo stills business that has pricing power. Now they may ask you. Adjust the price level to the overall inflation level. But they're in a command position in terms of distribution in great shape companies like that businesses. That are GONNA have a permanent a long tail fall off into Ma'am I go back to these things that I struggle with the supply chain to the airline industry might experience had always been when you had a deep recession. That the backlogs at Boeing and the backlogs at Airbus would disappear and that was the case. Go Vivid memories over the last thirty years during recessions where we would park airplanes in the desert but the thing that happened during those downturns was even though the backlog disappeared production never really stocks because there was still enough order. Slow WELL IF WE'RE GONNA wind up eighty five percent of capacity utilization tourist three years from now all of these new aircraft that have been built is a game changer so that really impacts companies that sell into the supply chain that you'll that sell into the parts. Business for replacement very disruptive. I think this three month period is being incredibly disruptive for the economy any closing thoughts. Chris you look forward things that you are most heated on rates of change that you're paying close attention to whether it's in your businesses or in the economy things that you would leave with to consider. I've watched the economy for the thirty years that I've managed. Money moved production to the lowest cost of production so nike moved production to Vietnam and then as Vietnam grew they moved production China. I think our relationship with China is irreparably harmed from this episode and so we all know that the Chinese held the supply chain for our pharmaceutical industry. Kind of over our heads at the most inopportune moment. But I think about if I'm running manufacturing company and I need to grow passivity and my decision now is am I gonNA locate a plant in Dothan Alabama's are in on who bay products. I'm going to Alabama the southeast cadaver research as we bring manufacturing back home. I think about companies like starbucks. We we've always said we would never directly own a Chinese this so lockin couple of weeks ago. Had A lot of people laugh at unless you're on the company. The we own starbucks starbucks top fivefold and the premise on the growth curve at starbucks is very heavily dependent upon opening new stores in places like China and if we really have generally irreparably gone the other direction and you've seen Japan now introduce federal money to try to help industry take supply and manufacture out of China. If we go down that asked which we very well may and perhaps even should. Then you get to wear. We've seen governments around the globe. Commandeer assets we'll starbucks as a whole bunch stores already on the ground in China. They ended their east China joint venture which was done on a license. Basis a franchise basis announced company owns those stores. I on the table. My biggest concern prior to this crisis had been that at some point the Chinese commandeer starbucks stores and kick him out in the country something that gets very much on the table. And if that's the case then starbucks is not worth mid twenties to earnings if they have sixteen thousand. Let's say company owned stores. Another sixteen thousand franchise license we. The the number of stores will grow high single digits over the next ten years but they have to grow in China. And so yeah I everybody's going to do. A lot of thinking about what the whole landscape looks like on the backside. If were more insular economy if globe becomes more insular that absolutely has a bearing on world trade. We have seen in the last three years getting back into that. Gp discussion this year will probably be accretive because probably the total number of exports imports are both declining precipitously. Just like the thousand eight during most recessions. The aggregate numbers don't declined to whether they're both going to be negative this year. But think about the equation. Exports MINUS IMPORTS EXPORTS ARE probably declining less abruptly than imports so that differential will be creative GDP but the absolute number is going to be down thirty percents where it was the absolute level of trade. So if you go back to nineteen thirties the absolute levels trade was only exports network's rolling three or four percent of GDP then will be read net exporters so if we were one hundred and three billion we were exporting four billion and importing three kinda rounding up on it. I don't know exactly what they were. Well now those numbers were like thirteen and eighteen percent of GDP and we're in global trade and global supply. Chains are much more fabric the global economy and I wouldn't be surprised to see a retrenching both here and abroad and that has very profound implications for a whole lot of businesses. So you really didn't understand your cost structure but you really. I think I think we win this because we were ahead of the curve. I kind of feel like the patio poker game because the last two weeks we've lost because everything else that has too much leverage. Things getting bailed out by all this federal action. But if I'm right we have the flation then yet has to be a lot more careful with debt and balance sheets. I think the world has grown accustomed to over the last thirty years I love. It's such a fascinating place to close. So many interesting topics covered here today. What a crazy time and it's always fun talking to you about what's happening in markets. Chris I appreciate your time yet again. Well Patrick by look forward to maybe a month out two months out and seeing you in New York City. We're all definitely declared travel and we'll have a cocktail and look back on. What hopefully is the covert or three or four or three or four but hopefully this things in the rear view mirror before long? Chris have a great day. Thanks better everyone patrick. You again to find more episodes of invest like the best go to investor field guide dot com slash. Podcast if your lover you can also sign up for my book. Club AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you up to receive a full investor curriculum. Right away and then three to four suggestions of new books every month. You can also follow me on twitter at Patrick. Underscore Osieck S. H. G. If you enjoy the show please leave a quick review for us on I tunes which will help. More people discover invest like the best. Thanks so much for listening.