Preston Pysh  01:18

There were a lot of unknowns because neither one of us had much technical skills when it comes to anything like this. But we figured it out, and yeah. It’s great to be here. We won’t drone on about some of those stories too much. We’ll hop into the episode, but pretty exciting for both of us to hit 300 episodes. If you would have told me that when we started that we would have done 300 shows like this, Oh my god.

All right. Let’s go ahead and cover this first topic that we have. We’re just doing a current market update. We’re just talking in general, the two of us here for Episode 300. Just Preston and Stig kind of episode, but the first topic that Stig wanted to cover was corporate debt and the Fed.

Stig Brodersen  02:01

Yeah, it’s not a current market condition episode without the Fed. I guess that’s what we’re seeing right now. Almost like how can we with everything that’s been going on, I took a chance to read up on the Fed here the other day. We always do that. We look at what they’re doing. We clearly follow the news.

I wanted to go back to the very root of the fiat to get the sense of the function of the Fed. There are actually three very specific goals that the Congress had mandated the Fed to do: maximize sustainable employment, stable prices, and moderate long-term interest rates. I felt that was interesting to mention because I know that we tend to bash the fiat. Perhaps, you will see a bit of that here in this episode.

02:52

I think it’s also important to say that the Fed is not created to become the best possible system for value. No one’s ever said that specifically about the fiat and stable prices. It’s designed to create inflation. You might say it’s the wrong objective to have. I also think it’s important that whenever you see all the things that the Fed is doing, and you’re thinking what it’s doing to your portfolio, what it does to whatever, it’s more or less doing what it’s been asked to do. I think that’s super important to understand because we might not agree with the fiat, but we need to navigate a world where the Fed plays such a big role. I wanted to kick the episode off by talking about the objectives of the Fed. And then, perhaps we can talk a bit more about what to then do as value investors based on that.

03:41

Now, so as Preston mentioned before, I wanted to talk about corporate debt. It’s such an exciting topic to talk about. The market itself is huge, $10 trillion, and it has ballooned recently. This is a day and age of new all-time-highs. Back in April alone, there was $300 billion of *inaudible corporate debt issued. Again, that might not be too surprising because so many companies have issues with financing, but it is very interesting to see the incentives that these companies have, perhaps, doing it right now.

I couldn’t help but notice what two billionaires whom Preston and I have been following had to say. Jeff Gundlach was out early in the game, and he’s talked about how we corporations are speculating on the Fed’s action. Warren Buffett talks about the Fed moves could have extreme consequences. I find that quote interesting too.

04:32

Now, to talk a bit more about what is specifically happening right now, the Fed has teamed up with BlackRock to buy back corporate debt. Like we covered last time, these are both investment grade, but also some high-yield bonds that they’re looking to purchase. Because I’m such a nerd, one of the things that I enjoy reading is whatever the Fed is making a statement on, and then it’s up to us to figure out what they mean by that. But they’re saying that the size of the purchases would vary based on market conditions, with a goal of reducing the deterioration of liquidity seen in March 2022 to levels that corresponds more closely to prevailing economic conditions. I felt that was a funny phrase because you can read into that however you want. To me, it seems like we are just getting started. Let me just put it like that.

05:29

What I really wanted to talk about, especially for us as value investors is it’s hard to know for sure what happens when this plays out. I think what I don’t like is how you’re messing up the capitalist system. It goes back to the objective of the fiat. Say maximizing sustainable employment. I think that there is a huge risk that you might be doing that in the short run, but not securing a good system in the long run.

Now, if we compare that to the situation with corporate debt, in a capitalist market, everyone can issue debt at any time. However, and this is the important thing, they can only issue debt at market prices. So, if you don’t have a sound business, you will either not have anyone who is willing to lend you money or you will be forced to borrow money at such a high interest rate that you might or will likely fall on it unless you’re very skilled. These are the bonds that activity referred to as junk bonds.

06:00

Let me come up with a simple example of what I mean by that. Capitalism is a fantastic system because it has a really strong feedback loop. If you take the example of an ice cream store, if you don’t sell good ice cream at fair prices, you won’t have any customers and you will just go out of business. That’s capitalism. That is what has made American companies so great and able to compete on the global scene. You have competition where the best survives.

But, if we go back to the example of an ice cream store, let’s imagine that you own that store. Every day you have a person walking into the store buying all your ice cream in huge quantities, and the buyer doesn’t care about the quality of the ice cream nor does he care about the price because he has free access to money. Now, what would happen? What would likely happen in a situation like that, with you being the owner of ice cream store, is that, as a result, you will start to lose the quality of the ice cream and you will stop having this positive feedback loop where the best one survives. You become completely dependent on that buyer because if that wealthy buyer is not there, you don’t have a business anymore.

I think that is what we’re seeing right now. We’re only seeing the very beginning of what could potentially erode some of the fundamentals behind a capitalist system. The Fed so far only deployed $100 billion, and they have pledged at least $2.6 trillion for this program. To me, that’s very concerning. If you look at the balance sheet, in general, we were less than $4 trillion before COVID-19, and we’re already up by more than $7 trillion. That my bleak way of kicking off this episode 300.

Preston Pysh  08:20

Stig, when we’re looking at the debt globally from a global level –because you were talking about the amount in the US, but I’m looking at it from a global scale as the US Fed is servicing dollars at a global scale. I think that when we look at all the social unrest that we’re seeing around the world, on a global scale, that’s why you’re seeing it so coordinated. I use the word “coordinated”, meaning when you look at all these different countries, they’re all having protests. They’re all having social unrest. So you have to ask yourself: What’s a common thread that would cause such a thing to occur? For me, it’s the money. For me, it’s the central banks that are controlling that supply of money.

To throw out a number on the corporate debt globally, back in 2009, the number was $34 trillion. Today, it’s at $51 trillion. That’s a 2019 number, so I’m assuming here, in 2020, it’s even way higher than that. Here’s the issue that I have. Right? When you talk about inflation, because what Stig was saying there first thing is to create a stable economy through a stable, small amount of inflation there. I’ve talked about this on the show. I talk about this on Twitter all the time. I’m going to try to get into more detail on this idea of what is inflation. If you’re measuring inflation in the CPI bucket, which is items A through Z, when you scope that and you say, “These are the things that I’m going to measure in order to say what inflation is or isn’t opposed to every single thing in the economy,” I think you get very skewed results.

10:01

From the Fed’s perspective, they’re saying we’re having all this money, but we’re not getting any inflation. Look at the CPI number. It’s abysmal, right? But go back to economic theories and ideas and you read about these people who wrote extensively about money supply in central banking and what causes the economies to fail. What you can find fascinating is this Yardeni organization publishes daily a report of the ever-growing total assets of major central banks. And so, if I was going to tell you what I think, the inflation of money, –and it’s very important that we talk about the inflation of money and not the inflation/deflation of price of particular items in the economy as those are two very, very, very different things, okay? I am talking about the inflation of the money supply. If we look at this pre-2008 crisis today, your number was slightly under a trillion dollars of assets sitting on the US Fed’s balance sheet. Today, we’re over $7 trillion. Okay? It was like $0.8 trillion or something like that, and now we’re at $7 trillion. So whenever I look at that, I say: What inflation rate is that if we’re looking at that being the inflation rate of the money supply? What does that come out to be as a percent if I annualize that, going from $0.8 trillion to $7 trillion? Well guess what? Over that period of time, that’s a 22.9% inflation rate. That’s massive. That’s insane.

11:49

The reason why I want to focus on that number is because that money is going somewhere. It’s not like it’s just disappearing. The money is going somewhere and guess where it’s going. The money is going into stocks, bonds, real estate, hard assets, and they’re getting bid higher and higher and higher in market capitalization. When I say market capitalization, what I’m saying is those companies kick off earnings. And then the market says, “Oh, well, if it made $10 this past year, it’s worth $100 because that gives me a 10% return if I buy it at $100 price.” That’s a market capitalization. So, when you’re stuffing money into the economy at the tune of 22.9% annually since the end of 2008, guess what? That’s going to inflate certain prices of certain things. Well, guess what? Stocks and bonds are not in your CPI bucket, folks. They’re just not. It’s that simple. It is that freakin’ simple.

These things are getting bid in the market, so then, the next question is: Why is it going to stocks and bonds and real estate and things like that? Follow the money if you started at the point of initiation of a new dollar of this inflationary 22.9% money supply. If you start at where that money is created and then inserted into the economy, the immediate insertion point for the last 10-12 years, right has been the bond market period. Period. They take the freshly printed money, step into the bond market, and buy whatever bonds are on that market, and they put that cash into the system. And then, that bidding of the bond market raises the price, drops the yield, and then if the owners of those bonds want to go and sell them on the market to then go buy stocks, they can go do that. The fact of the matter is that the money supply is growing at nearly 23% annually, based on just a simple look at the balance sheet of the US fed bank.

14:08

Now, if you go and look at some of the other central banks, they are also aggressively raising theirs, as well. I could go back and do the calculation for all these other banks. And guess what? They’re right there with the US Fed. So, when you look at that on a global scale, I would tell you that I think the inflation rate of the money supply over the last 10 years, globally, is in excess of 20%. You’re not going to see any college professor or economist talk about that number because they’re hyper-focused on– I don’t know why, but well, I guess I do know why. They have an incentive to not allow interest rates to go up because they fiscally can’t afford it, and pretty much any country around the world. That’s probably the incentive. I think that that’s the concern.

What’s fascinating about all of it is the central banks are… From the things that Stig read off, they’re trying to march towards in order to create stability. They have created stability over the last 80 years. They have done that. But the irony of all of it is, if you control something for so long for 80 years, maybe at the end of that, it actually creates the exact opposite of what they intended to do. It’s almost like a parent who’s trying to raise the perfect child. They create this stability in their life because they protect them from whatever, and they raise them for the first 18 years of their life. Then, after that, the child has to move on, and that stability that the parent created was actually instability to their ability to actually step out into the real world and live in a real environment. I think that that’s kind of what we have going on right now.

We’ve lived in this world where the central banks have stepped in, manipulated the market in order to protect and stabilize the market, only to create this world where businesses don’t have a rainy day fund. Like, the COVID hit, and people stopped showing up to the businesses. Mass amounts of businesses failed within the first two weeks. They didn’t have enough liquidity to even make it two weeks. I think if you went back into an environment that hadn’t been manipulated for that many decades before all this took place, you’d have businesses that could have lasted five months without another paycheck because they had a rainy day fund. They had a treasury of whatever on their balance sheet in order to withstand hardship. You’re seeing that on a personal level. People have spent and spent and spent because they’ve been incentivized to spend because the money loses its value so quickly. And when that has been incentivized, and people have no rainy day fund, well, they feel the pain immediately.

All right, so the next thing that I want to go through is investing in international markets. I know, Stig, you have some comments on this, so I’m going to throw it over to you.

Stig Brodersen  17:04

Last time, when we had one of those monthly market conditions discussions, I talked about how I was heavily exposed into US equities and how I wanted to diversify away from that, not just because of market manipulation, but just also that the US stock market, in general, was very expensive. I’ve gotten quite a few responses on that, not just from people in the US who wanted to invest internationally, but also international listeners were just interested because we all seem to have home bias one way or the other.

I found some interesting stats about a home bias. Typically, American retail portfolios would have between 70% and 90% of their portfolio in US equities. That is considering that the US market cap is just above half of the global stock market. That being said, if we’re using a global portfolio as a benchmark, the Americans do much better than the rest of the world. In a sense, Canadians and Australians have similar strength. They typically have around 60% of their portfolio in domestic stock, but their market cap investments are not more than 50%. It’s like 3% or 2% of the global market cap. So, we see a strong home bias that comes from us feeling that we are more familiar with stocks, more than necessary, because we’ve done a proper valuation of that. And so, if you’re looking at the S&P 500 right now, I think we’re 1% cheaper than it was before COVID-19, or at least just before the Momentum Tool turned red.

Yes, the stock market is not the economy and the economy is not the stock market. I know we keep saying that. We keep hearing that. But it is a reflection of corporate profits, what the stock market is supposed to yield. I’m thinking: We had COVID-19. We have all the social unrest that Preston talked about before. Knowing that the stock market was quite expensive before COVID-19 started, do we really feel that now we are *inaudible fail valuation? I would say no. What we see now is it’s an even more obscene validation when compared to the underlying fundamentals.

Preston Pysh  19:07

Stig, I just want to add something in there. When you’re talking about valuation, it’d be like trying to measure something on your table with a ruler that’s just constantly getting longer. I think in this situation, the ruler would be getting smaller, making you think that the size is getting bigger. So you’re going up and you’re looking at the piece of paper and you’re saying, oh, it’s 10 inches or 12 inches today; and then you come back tomorrow, the ruler got smaller, and you’re measuring that same piece of paper, and now it’s 16 inches today. That’s effectively what you have going on in the market. So when you’re thinking about valuations, people have to think in that lens of: the thing that I’m measuring this with keeps changing every single day in a major way.

Stig Brodersen  19:49

I agree with that. Basically, what you’re referring to here, just to clarify, if ever, is that you see this debasement of money, and you’re talking about the huge money flow coming in. So, you might say, the S&P 500 is trading at $3,000 today. It’s not necessarily as the S&P 500 trading at $3,000 at another point in time. It really comes back to, also, the earnings. And so, whenever I talk about the valuation here,  because your point is definitely completely valid whenever I talk about the earnings, I’m not just talking about if we keep on seeing that influx of money that will also be reflected in earnings, at least in the nominal numbers. I’m also thinking: What do I expect will happen to those nominal numbers even if we look away from that inflation coming in? What do we expect that to happen? I don’t necessarily think it looks fantastic in that sense. I don’t feel it justifies the valuation on the nominal numbers, the S&P 500 trading at $3,100 today.

20:41

But going into the discussion here about diversification, the point I really want to drive home here is to figure out what we want to invest in. We need to put it in comparison to something else, one way or the other. What most investors do is that they typically look at home audit first, as I mentioned before, because that is what they feel most comfortable with, or they look at historical returns from various stock markets. Then, they tend to extrapolate those results. The issue about that is that there are typically good reasons and good stories why you would do that. Just in the US, you would have NASDAQ that has outperformed the S&P 500. If you look at some of the reasons for that, just Google it or speak to people about it as people can give you really good explanations why that’s happening. “This is why Apple and Google and Amazon will outperform.” And it all sounds good and well, but my argument is that all of history will tell you that if something has gone well for a long period of time, it’s because there is an overstatement of the real underlying effects.

21:46

So, going into this episode, I looked at some of the major indexes over the past 10 years to prime the conversation. The S&P 500 has returned 11.7%. All international markets outside of the US, market weighted, has returned 3.2%; emerging markets have returned 1.3%; Europe has performed 3.6%; and Nikkei 5.8. So, I kind of felt those were some interesting stats to look at. I looked at the valuations of the different markets, and it was no surprise that the US was very expensive because they had a really good run for a long period of time.

I looked at some of the research that’s been conducted, and Lyn Alden did some very interesting research on this. We’ll interview her in a few weeks, but she had been conducting research specifically based on Shiller’s PE. She also looked into some of the research that *inaudible, who is another economist that Preston and I follow, have been conducting, too. We’ll make sure to link to these in the show notes. It’s a very interesting write up that she did of that. The evidence is very clear because not just in the US can we see that if we have a high Shiller PE ratio, it would lead to subpar returns in the following decade. But it’s evident throughout all international markets that you look into the only exceptions with Denmark and Sweden. That was for very, very different reasons, but we see that across the world. And so, that would be my word of caution if you’re thinking about diversifying. Don’t look too much at past performance.

23:22

I wanted to be a bit more hands-on with some of the different strategies you can apply if you want to diversify. The first strategy is very, very simple. You can go in and buy something like Vanguard ETF (VT). It’s a very cheap ETF, 0.08. In expense ratio, it’s very cheap. Now keep in mind that you are 57% invested in the US if you buy a global ETF. So, if you already have a bunch of individual stock picks, or you have the S&P 500 in your portfolio, you’re not diversifying in equities as much as it seems. If you are heavily exposed in the US, one thing you can do is to invest in all international markets. Vanguard thought of that, too. Again, the cost of that is a basis point of 0.08%. I just want to clarify, I don’t have any affiliation with Vanguard, but the only reason why I typically bring up those tickers is because they have a good track record of low-cost and they have good attractive indexes, as well. And so, that’s a way to do it. If you did that, you would be 4% in Europe, 23% in emerging markets, and almost 30% Pacific. So, that’s a way to go about it, which is not as specific. Of course, you don’t go in and target which market you think is the best, but it’s a way to diversify away from the US.

24:41

Alternatively, this is sort of like the theoretical the optimal way to do it, but it’s also a tricky method. You can make a valuation of each international market and then allocate your funds to the cheapest market. Generally, I do not recommend that you do individual stock picks, unless you know the market well, but rather that you buy an index. For instance, for India or Australia or whatever you find the most value. That approach has a lot of upside. I definitely also have some downsides I’d like to talk about, but it has clearly more upside in the sense that you don’t get the average. You can pick and choose.

If you really believe that evidence in terms of how we can historically see which countries perform better based on, say, a Shiller PE ratio, remember that a stock market in a specific country is nothing more than the aggregated valuations. So, just like whenever we know that, for individual stock picks, if they’re priced at an expensive ratio, they won’t perform as well. It will be the same for that specific stock market since it’s just an aggregate of that and you’ll see some inversion because of that. Also, I want to say that as you’re looking at some of those countries that looks like they’re trading at a very attractive level, keep in mind that the risks you take on are different than if you invest in Europe and US because there’s a global reserve currency. Now, that’s not the same as saying that you don’t have any issues in Europe and the US. We’re going to have a segment here later about Europe. We just talked about what’s happening in the US. There are major problems. But if you look at some of the list of the “most appealing international countries,” like Russia or Turkey, not only will you have a lot of political risk, but you will also have a currency risk. Those currencies just might go to zero. You would see crazy inflation, so that’s also one of the reasons why you see a premium whenever you’re looking broadly across all stocks.

Preston Pysh  26:40

I have a different way of looking at international investing. It’s specific to the last 10 years before everything changed in 2008. I would have done exactly the way Stig was describing it, but, more recently, my thesis is that central banks are manipulating everything and that they’re driving the price of securities up.

Let me give you an example. Back in 2015, you had the European Central Bank step in and conduct massive amounts of quantitative easing. They did this from the start of maybe the end of the first quarter of 2015 up until 2018. During that period of time, the same period of time when the ECB was aggressively expanding their balance sheet, they went from $2.5 trillion on their balance sheet to about $5.7 trillion or somewhere in those ballparks. It was practically a 100% expansion of their money supply over that duration of time from 2015 to 2018.

So, you have to think of it in relative terms to what all the other central banks in the world are doing. In the US, the balance sheet through that same period actually went down. If you pull up the chart and look at the expansion of the balance sheet on the Fed’s part from 2015 to this beginning of 2018, it went down. It didn’t go down by a lot, just by a little bit. It was pretty much flat through that whole period of time. If you were an equity investor during that time, where do you want to be? Well, I can tell you. I watched an interview with billionaire Stan Druckenmiller back in 2015. He said, “I just put on a massive position in Europe.” At the time, it didn’t make complete sense to me why he was doing that. Today, as I’m looking at it, in hindsight, it was brilliant positioning. He was doing that because he was looking at how the central banks are supplying the liquidity that’s causing the bid in all these assets. He was right. Did he outperform everything else relatively speaking in the equity market? Of course, he did.

Using that same logic, which I think is still valid today, because nothing has changed, when I look at where we would see similar performance due to just aggressive expansion of central bank’s balance sheet in those countries, relative to all the other countries in the world, in the US, it’s insane. Just in 2020, we’ve gone from $4 trillion to $7 trillion just this year. We’ve almost done a 100% expansion. When you look at the other central banks, they’re also expanding, but they’re not expanding nearly as aggressively, so they’re up not even close to those numbers, about 25% to 40% of the easing that you’re seeing here in the US. So, where do I think we’re going to see the performance in relative terms? If I’m comparing it to all these relative markets, I think you’re going to see it in the US. I think the US is going to be the location that has the highest amount of manipulation, and therefore the highest bidding relative to the other spots in the world. Now, this gets really complicated because we’re talking about something that is nearly impossible to predict where they’re going to ease the hardest next. This all comes down to policy. Which country is going to have to insert more liquidity and more fiat into their system?

30:13

From an investing standpoint, I think that one of the most powerful ways to defend your treasury of work is how I look at it. Your treasury of work that you have saved, how do you protect that? I think the best way to protect it is through a momentum investing approach, where you’re looking at the price, and you’re saying, “All right, there’s a statistical move based on previous volatility. Now, I should be an owner.” Or, “Now, there’s something that has broken the statistical volatility to the downside. I should sell it and protect my principal.” This approach has worked very well for Stig and I in 2020. I would argue we missed a significant portion of the drop based on our TIP Momentum Tool that provided that for the S&P 500 for any other ETF. Miraculously, the tool also recommended a buy shortly after the drop because it’s a statistical change in the volatility coming back to the upside. Would I have thought that that would have happened based on the fundamentals? No, there’s no way. But from a momentum standpoint, it’s saying: Be in the game.

31:27

I think that, moving forward, central banks are conducting aggressive quantitative easing. I think they’re going to continue to do aggressive quantitative easing. Not only are they going to be doing quantitative easing, but they’re going to be doing universal basic income and they’re going to be making payments to pretty much every American and also every other citizen. Central bank in the world is doing the same thing.

So, where does that take the market? I have no idea because, at the same time, my expectations for earnings are going to be atrocious relative to where they were before for a majority of the companies. The five companies that are driving the whole S&P 500, they’re probably not included in that description. But for every other company in the world, they’re losing business.

How do you navigate this? In my opinion, you navigate it through momentum investing. I don’t know any other way to do it because this is defense. Man, you are not on the offense here. You are playing defense.

32:24

One final thought I have. I believe that there is a gross misunderstanding for most market participants on something being up in nominal terms versus something being up in buying power terms. Let me explain what I mean by that. In the stock market, if you went and asked 100 people: Is the stock market up this year? I think you’d probably have 100 people tell you yes. You might find some crazy weird ball, like myself, that would tell you it’s down.

Let me explain what I mean by that. If I measure the value of the S&P 500 in gold since the start of this year, the S&P 500 is down nearly 16%. If I measure the S&P 500 in Bitcoin, the S&P 500 is down negative 35%. For this year, I think those trends are going to continue in the future. That’s my expectation. I know we’re talking about international stocks here, so let me just tell you. If I pull up any other ticker for this year, since the S&P 500 is outperformed, internationally, for 2020, those numbers for whatever country you want to pick is worse than -15%, and worse than -35% for whatever country you want to throw at me in gold or Bitcoin terms. That’s what I mean when I say that there’s a gross misunderstanding between something being up in nominal fiat terms versus something being up in buying power terms. I think very few people understand this. I think most people are extremely skeptical of the idea that I’m talking about, and that’s fine. I want people to be skeptical of that idea because that’s the only way. If you do buy into that idea, you better have some conviction, especially with the volatility on one of those two things.

34:22

The reason I’m bringing this up is because I want people to challenge the way they see the world. I want people to challenge their thinking and dig into this more. Dig into this idea of buying power. What do nominal prices mean versus buying power prices mean? I think it’s probably one of the most important topics of 2020 for people participating in financial markets.

Stig Brodersen  34:47

I’m very old school. As you know, I’m not too different than the way I look at valuations compared to when we started the podcast in 2014. I know that you are, in many ways, and I think it’s great that we have this discussion. It’s probably also a lot more interesting than if we always agreed because that would be boring for people to listen to. I feel that it still comes down to valuation. I do think a lot of valuations have become harder because of the manipulation. But whereas –I’m just throwing out some random numbers– say that, 10 years ago, if you could be trusting valuations explaining 80% of the future returns, it would now be less than that. I think you’re right in that *inaudible. It’s been distorted by that influx, a few occurrences, and all that that’s being printed.

35:42

Let’s just look away from currency risk here for a moment in the sense of exchange rate and who is printing more money, but let’s say that I should just look at the Canadian stock index in the US. Would I buy the one that has the most attractive valuation? What do I expect would have the best performance? Everything else equal, right now, that would be Canadian. And so, I’m not saying that you cannot or should not include all the other factors, which we also try to do here in the podcast. I think there are a lot of good things to be said about using momentum in the way that we hadn’t really been doing before, and a lot of people have been doing before because of that. But for me, it still comes down to valuation as the one most fundamental factor in terms of determining that.

You might have a part in the sense that oh, but Stig, the discussion is not about buying stock A or stock B or stock index A or stock at index B. It’s about deciding to buy another asset class. I think you have a part about that. To me, that’s a different discussion. It’s not a less valid discussion, but it’s a different discussion to have. When I’m looking at two stocks, I would be looking at the most attractive valuation.

36:50

To the other thing that you mentioned about central banks. Later, we’re going to talk about Europe. We’ll be talking about how many bonds are they going to buy back. The €750 billion that the ECB is buying back is not the same impact as the Fed. It’s two different markets, two different impacts. So, any thoughts on that, Preston?

Preston Pysh  37:12

I think it’s really important for me to say that, for all the people listening and have learned value investing through some of Stig and my conversations, maybe even the Buffett’s books and videos that I did years ago on YouTube, I believe in all of that stuff to my core. I would tell you my foundational roots are in that stuff. We’re in a very unique environment today in this environment, and I think the better way for me to describe it is that stuff works. I have complete and utter faith in how value investing works. There’s one key thing that value investing requires in order for it to work, and that’s a sound currency that is unshakable. If you have an unsound currency, you’re trying to do evaluations with a ruler that keeps moving around on you. I don’t know that. Especially if you’re just looking domestically and you’re not looking internationally, all the things that are playing out, I think it gets very difficult to do effectively.

If you’re talking about increasing your buying power, does it mean it’s obsolete? Of course not. When I look at TIP Finance, the first thing I go to is the valuation page. The first thing I go to is which company is giving me the most earnings for the price that I’d pay on the market. That’s the first thing I’m looking at. But I’m also looking at a lot of other factors, and I’m pulling them all together. I think that it’s just important for people, especially for young people that are in college right now, that are learning about valuations. They’re learning about discounted cash flow models or learning about IRR calculations and all those things. Those are very important things and there’s going to be a day when the person who’s really good at those things is going to be extremely lethal in the market.

38:58

In the last five years, they have not been extremely lethal, it’s maybe much more momentum-based in order to have been a person who’s really outperforming. But I think once we return to some type of sound money, and I have no idea the timeline of when something like that’s gonna play out, you better darn well believe that Preston Pysh is going to be the biggest value investor on the planet, buying up the picks that are kicking off the biggest cash flows based on the price that I’m paying. But I really think that you have to have a sound money in place in order for that to be such a slam dunk, shooting fish in a barrel approach, like it was for Warren Buffett for decades. I think you’re starting to see why it isn’t shooting fish in a barrel for Warren Buffett in the last 10 years.

39:44

At the end of the day, I think I’m just I’m kind of a chameleon in the way that I approach investing. I am trying to look at what works. I’m trying to look at all the external factors and I’m trying to adjust. If I were on a sailboat, I’m adjusting the sail and rudder in order to navigate where I want to go. I guess that’s all I’m trying to say. But anyway, Stig, let’s transition. Let’s talk about what’s next on our agenda here. We’ve got European markets, monetary and fiscal policies. Let’s do it.

Stig Brodersen  40:12

I’m going to come up with a very old school way of valuing Europe right now.

No, I’m just teasing Preston right now.

Whenever I’m looking at European markets, and we look at the major markets like Germany, UK and France, they haven’t seen the same rebounds in the stock market index as the S&P 500. When I saw that, it was like a signal to perhaps I should see if there’s still some value to be found in Europe, and then talking a bit more about what is happening over here.

40:49

So, let’s talk about some of the somewhat comparable things. The ECB are growing their balance sheet too, like Preston mentioned before. They’re saying that the program is vital to ensure that, especially Southern Europe, which has been hit the hardest by the pandemic, won’t see a surge in borrowing costs. We recorded this on the 3rd of June. There’s going to be a new meeting tomorrow, June 4, and the rumors are that they’re probably going to spend that program. That is what the market expects. You’ve seen that in European markets here lately. That’s what’s been trying to be factored in.

I think what’s interesting for American listeners to understand when they learn about Europe is that it’s comparable and it’s not, whenever you look at some of those numbers. One thing we talked about before is that the debt market in Europe is just not as deep as in the US. $1 or €1, for that matter, would just have a different impact. It’s also because of fiscal policies.

By fiscal policies, as opposed to monetary policies where you’re more controlling the monetary supply, in fiscal policies, there’s a different way to spending money, if you like. It might be government programs like unemployment programs. Fiscal policies can also be taxes. So, it’s much more directed at the consumers than the financial markets.

42:13

Now in Europe, we don’t have a central unit, as you guys do in the US, to determine the fiscal stimulus. We have that in the sense that we have a long-term EU budget. In the States, you also have something that is state-based and something that’s Fed-based. It’s structured very differently in Europe due to historical reasons because we are still very independent nations. The EU has been trying to do –not the eurozone, but the EU, just to clarify that as they’re two very different things. Mainly, the countries are the same, but definitely not all of them. What the EU has been trying to do is that the German Chancellor Merkel and the French President Marcon has proposed a €500 billion recovery package.

There were a few interesting things about that. The first one is that it’s not a lot of money. What do I mean by that? €500 billion, that should be a lot of money, but it’s not because fiscal policies are a lot more comparable between the US and Europe in the sense that it goes directly to the consumers. And so, the depth of the market are not different. Actually, Europe and the US has a similar-sized economy, so it’s a lot more comparable. €500 billion is not a lot when you compare it to what has been happening in the US and how much it’s been stimulated there. So, that’s one thing.

The individual member states can still print, but it’s a trickier situation because if you look at EU as such because we have the construction that we have, all 27 countries have to agree. I know that sounds ridiculous. You have something where the richer northern European countries are supposed to pay for some of the European countries. When 27 countries have to agree, you’re just bound to run into problems, which is also what you’re seeing now. So, right now the southern European countries are saying, “Hey, guys, you have to help us.” The Northern European countries who are typically wealthier are saying, “We’re not going to bail you out because this won’t be a loan. This would be made as a grant.” It would be money raised all over Europe, but distributed to the poor countries, which a lot of countries are against. Since you have to have 27 countries agree on this, it is very difficult. That just tells you something about the inefficiencies of the European markets.

44:37

Now, what are the implications then for us investors? How are we supposed to deal with those facts that are brought before? Well, despite all of this, I would still say that if you’re too exposed in the US, you might consider diversifying into Europe. It is everything else equal in trading with a much more attractive level. Southern Europe probably doesn’t seem like the place you want to put your money in, but some of that has already been priced in. But also, if you buy a European ETF, for instance, Vanguards Europe ETF (VGK) you will only be 9% exposed to Spain, Italy, and Portugal as those financial markets are not as developed. So if you feel bad about investing in Europe because of what you’re seeing there, typically, they won’t be too exposed to that. Now, I don’t expect a double-digit return for Europe going into this. If I do, it would be very nominal numbers because of what we’re seeing now.

I think the downside protection compared to all the equities, for instance, emerging markets, are much higher, giving Euro’s status as a currency. I think it’s also a nice way of diversifying into another currency. If you are very concerned about the future of the US dollar, it might make sense for you to diversify into some of the other major currency.

46:02

The other thing I want to say about Europe, not trying to sell investing in Europe too much here, but is that if you want to invest in Europe, you can clearly do that in many different ways. The easiest and most transparent way I would like to say would probably be to buy something like a VJK, a market-weighted index for Europe, which is trading at around a 6% expected return. The US is closer to 3% to 4%. Another way you can invest in Europe, which is something I don’t recommend, is that popular way that’s very often-suggested in the media, is the index called EURO STOXX 50, which is a collection of the 50 biggest and most liquid stocks. Just knowing that would make one think, “Oh, why wouldn’t just invest in the biggest better these days? Looking at the FAANG stocks, why wouldn’t I do that with Europe?” The index is still 4% down from the peak model 20 years ago, which is interesting in itself. I think it’s also important to understand some of the components of the legal framework here in Europe.

We are entering a world with more and more winner-takes-all technologies and industries, and Europe just doesn’t have the same whole fuel advantage as US companies. The reason I say that is that European regulators are much happier than the US or, for that matter, Asian counterparts to start anti-trust cases. That just implies that it’s much harder for European companies to compete with big tech in say, your Tencent, Alibaba, Google, and Apple; which is just one of their multiple reasons why the EURO STOXX 50 hasn’t been performing that well.

It is also very difficult to compete for European companies. Just one example. Last week I pitched Spotify. They’ve been suing Apple in Europe for discriminating them on the iOS platform. Apple’s using the monopoly power to do that. Now, the weird thing is that Android is actually much bigger than iOS here in Europe, so you would wonder why they’re specifically targeting Apple. That’s because they can. It’s much more difficult than in the US where, if they’re not Apple, they don’t have that monopoly power. So they’re doing it in Europe because they can, not because that is what they want to do the most. So, one thing is what the lack of anti-trust means for us as consumers. But for investors, US companies just have a leg up because if you have a legislation that allows you to have more monopoly power, that also allows you to have more profitability, which is essentially what you’re going after being an investor. So, those were some of the pros and cons of potentially diversifying away from the US into Europe.

Preston Pysh  48:49

Alright, so for this being our 300th episode, we want to do something special. We have a forum on our website. Anybody can participate on the forum if you want to ask questions about stocks picks, if you want to talk about whatever we’re on there, and we interact with the audience there. What we want to do is determine top 10 people on our forum, and this is measured by the number of engagements they’ve had on the platform. To those top 10 people, we’re going to give you a lifetime subscription to TIP Finance. You’re going to be able to use it into perpetuity. The TIP Finance has the momentum tool that we were talking about earlier on the show. It also does a stock filter where it looks at every single company on the US markets, and it prioritizes them based on Warren Buffett’s type of value filtering. We’re just excited to be able to give this to everybody completely for free for their entire lifetimes. If anyone else wants to check it out, go ahead and go to our website, or you can just go into Google and type “TIP Finance” and conduct a search. It’ll be the first thing that pops up. Thank you to everybody in our audience. Thank you. Thank you for listening to our show, for supporting us, for engaging with us online. We just feel so blessed. Stig and I just enjoy doing this. We would do this if no one was listening to us to be quite honest with you. We just enjoy these conversations.

Stig Brodersen  50:11

I mean, that’s the thing. If only people heard about what we rambled about financial markets before we hit that record button. And can I say, Preston, it’s especially fun here now that we starting to look a bit differently at it. We came in in 2014 very much treating Warren Buffett being the Oracle. I think we still think he’s the Oracle, but like, I wouldn’t say it was boring because we two had a lot of fun. But we were very much sounding like, yeah, we got this. We read the gospel. This is the truth.

Preston Pysh  50:40

It’s obvious that we’re learning right there with you. I think that’s probably the best way to put it as we’re learning all this stuff right there with you. It’s not that we have this knowledge or anything. I mean, when we interviewed the Jeff Booth to the world and when we read whatever book and we come on the show and we talk about it, we’re right there with you learning this stuff. I think the exciting part is, I feel like there’s still so much more to cover and so much more to learn on this topic, so I look forward to another 300.

I’m just going to put it out there. Stig, behind the scenes, is the guy really running this thing. He is the guy that manages the day-to-day with the whole team. He is one hell of a partner. That’s all I can say. Thank you, Stig.

Stig Brodersen  51:31

You’re definitely too kind. I’m desperately trying to come up with something other than “thank you for telling me to buy Bitcoin.” I really need to come up with something more heartfelt than that, Preston, because it shouldn’t just all be dollars and cents. But I think I want to put it like this. It’s fantastic to have a good job, but it’s much better to have a good job when you’re doing it with people you admire, respect, and love. So, let me round off the episode by saying that, and let’s just forget the whole Bitcoin comment.

Preston Pysh  52:03

Likewise.

Stig Brodersen  52:04

All right, guys. That was all that Preston and I had for Episode 300 of The Investor’s Podcast. We’ll be back with Episode 301 next week. Please stay safe.

Outro  52:17

Thank you for listening to TIP. To access our show notes, courses, or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication or rebroadcasting.