I was recently reading about the value investor Howard Marks. I came across an investing checklist he once created. He likes to say that before he buys anything, he asks five questions:
1. Why should a bargain exist despite the presence of thousands of investors who stand ready and willing to bid up the price of anything that’s too cheap?
2. If the return appears so generous in proportion to the risk, might you be overlooking some hidden risk?
3. Why would the seller of the asset be willing to part with it at a price from which it will give you an excessive return?
4. Do you really know more about the asset than the seller does?
5. If it’s such a great proposition, why hasn’t someone else snapped it up?
While everyone has their own strategy for investing or trading, whether it’s YOLO’ing their own account or talking with a financial advisor, a checklist for each decision, whether to buy or sell, is never a bad idea. Patience is often rewarded. So is thoughtful thinking. A checklist can help you do both of those things.
Charlie Munger will sometimes tell the story of his uncle, who was an architect. A Harvard educated architect. Meaning, he put in a lot of time and effort to be the best possible architect he could be. When the Great Depression hit, when it spread across the country, his uncle and, many member’s in the Munger family, lost everything.
What did they do? They cut the house in half. Downsized. Moved in outside family members, saved, and his uncle took a job way below his skill level doing drafting work. It was hard. Yet, Charlie says his uncle never complained.
He just worked, and he pushed onward. They eventually made it through.
Charlie says two lessons from that experience have always stuck with him, and ultimately, played a part in his life:
ONE: Never feel sorry for yourself.
TWO:Never have envy. It’s the only one of the deadly sins you won’t have any fun at.
I think that’s a fantastic story and one I wanted to share. Do with it what you will.
I was surprised to see that the Fed actually bought $300 million worth of ETFs. I knew they had planned to launch this buy program, the ultimate YOLO, but I actually did not think they were going to do it. As Hank Paulson once said at the depths of the Financial Crisis, “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”
Looks like the Fed really wants everyone to know:
In this post, I want to share my thoughts on why I think the Fed is buying ETFs, and at the end, I’ll tell you my thoughts on the situation.
This Isn’t Your Grandpappy’s Market Imagine how salty investors from 1929 would feel if they could see the Fed buying ETFs today. I don’t blame them. An investor in 1929 is no different than you and I except this time, the chairs at the Fed have a bullzooka and they’re launching rockets filled with cash. We entered a new paradigm of Central Bank intervention over the last 10 years and this is just the reality. At this point, we should expect nothing less.
It’s Not Worth Not Trying The thinking might simply be that this is an experiment worth taking. Maybe it’s the perfect time to try something this crazy, even if that only means learning through experimentation. Perhaps the perfect time to try something this bold is during a downturn that is arguably no one’s fault. I know I will be watching markets to see how they respond.
About Those Pension Funds The pension situation is not great. Some states have huge unfunded pensions and hefty promises to a lot of people. These pensions largely rely on public markets for an annual return to help cover the gaps. The Fed might feel that it’s necessary to do whatever it takes to support this corner of the system. A financial market crisis can turn into a pension crisis really fast in this enviroment.
Buy All The Bags Markets have never been more popular. I lean on the side of that being rather concerning. Davey Day Trader is swinging millions around like nothing matters. Markets are going viral like a Buzzfeed listicle about cats wearing top hats. With so many people invested at this moment, markets have become that much more systemic. Injecting some cash into a few ETFs might actually be a bailout for everyone who has chips on the table. If you lost money buying MoviePass or some other sketchy stock all these years, here’s your chance to get it back.
The Battle of Central Banks If every other Central Bank is going all out to save their economy, then not doing the same is potentially even more perilous. Letting your economy fall while everyone is doing whatever it takes is how you can fall behind especially fast. In a strange way, it’s choosing ideology over national security. I personally believe that most major Central Banks are in a war of attrition. They are all trying to wear each other down with various forms of easing and stimulus. The irony is that while they are all trying to wear each other down, they are all also cancelling out their desired intentions. If everyone is cutting interest rates, no one is cutting interest rates.
It’s An Election Year There’s an election coming up and the Federal Reserve probably has a ton of pressure to do whatever is necessary to get cash into the hands of markets. The goal probably being to have an election where things are relatively calm. In this era, calm markets mean calm politics. That’s what’s needed to have a clean election as important as this.
My Musings on the Bullzooka
When I was in college, I tried to buy the dip in Washington Mutual. I lost all of my burrito money after they went bankrupt. That sucked, but I learned from it and moved on. The Fed did not bail out my bad stock pick. I also don’t think they should have. There would have been no learning process, no growth, and no drive to push onward. If the Fed is buying public equities, and if we rebound massively, I personally believe it will drastically change the definition of risk. It’s almost impossible to lose.
I am believer in free enterprise and the democratic process. I don’t think the Fed buying ETFs helps either of those things. In my view, this is just more of the same since the Financial Crisis. It is preferential treatment to the investor class with very little explanation or analysis ever shown to the general public. Still, to this day, no one has ever shown me stats that these type of actions actually help anyone except a few small circles. Not only is the Fed redefining the meaning of risk, they are also giving benefits to one group of people far more than other groups. Each aggressive measure by the Fed, in my view, tilts the scale of the economy’s equilibrium. No one gets more socialistic support than financial markets.
As of this writing, the S&P 500 is down about 15% year-to-date. This is not out of the ordinary. Drawdowns like that happen a lot. The Nasdaq is actually GREEN on the year. That’s also not out of the ordinary. Why start buying ETFs now? Save it for when things get really bad.
I have no idea what’s next for markets and, as I wrote on my blog earlier in the month, I am not interested in trying. They could go up down or sideways, but right now it’s the last thing on my mind. I wrote this post to talk about the Fed and what I think. Including why they would do it and why I still disagree with it. So if you find yourself chatting about the Fed, its wild actions and its wild ride, I hope this post helps inspire a good debate.
Thanks for reading and leave some comments below if you’re interested in sharing your thoughts on all of this.
For the first time in a long time, I literally have no idea what to say about markets. Usually, I always have something to say, whether it’s the ultimate YOLO call option or a theory about the velocity of money. This time, however, I really do feel the market gods, the millennials day trading from their Robinhood accounts, the insane volatility of news and price, has created a vortex that I can’t put into ink.
It’s not even worth thinking about, quite frankly. I am not interested in trying.
My own portfolio has shifted some and I hope I don’t jinx it by telling you all. I am overweight small cap stocks and it’s been a while since I’ve done that. I mean, I am amazed at all the money sloshing around, the stimulus, and yet some small cap companies are out there, dealing mostly in Dollars, US based, mucho cash on the books, no debt, and trading at like 5 or 10 times free cash flow. For me, the play is, and it’s a gamble, that just maybe some of these companies can actually use their unique positions of not feeling any financial squeeze, and use it as an opportunity to ignite their business. When 20% of your market cap is cash, and sales are sticky, while everyone else around you is trying to meet lofty growth expectations, squeezing water from a rock, the opportunity to be cash rich and locally based seems fairly unique.
I don’t need to say it, but I will anyways… yes growth has trounced value for years. I do think it’s about to get interesting, though.
In the spirit of The Last Dance, the ESPN documentary many of my friends are watching, I think of Jordan when he came back to Chicago Bulls after playing a year of baseball, abruptly quitting, and then, in his first year back winning a championship out of nowhere. When all the chips were stacked against him, and all the doubt and media chatter was swirling. That’s how I’m feeling about value. Especially small cap value.
I see some tech companies trading at 60 times sales. I am flat out amazed.
60 times sales.
Let’s just think about that for a second. Apple trades at like 4 times sales. Same with Google. For a company trading at 60 times sales it would have to grow at 100% for several consecutive years in a contracting global economy under severe pressure from a virus we still don’t even understand that well just to get a multiple that is the same as Apple or Google. What has me really thinking, though, is the commoditization of tech. Programmers and engineers are getting so good, they are abundant now, that the edge is getting smaller and smaller. Everything is everything. I have 16 video apps on my phone, 19 different work apps, and 12 text message apps. It will only continue. It’s all the same.
That’s all for now. It’s been a while since my last post. Outside of my own little portfolio’s world, the bets that have been made, I have no clue what’s going on.
There is no right or wrong way to view the Federal Reserve. It is not based on any scientific truth or physical law. It is an entity based on the pseudo-science of economics. But, even with that being said, one thing is for sure: considering the sheer importance of the Fed, it is a national folly that so few people actually understand what they’re trying to do and why.
*prepare yourself, we’re about to dive deep into the history books like Samwell Tarly at the Citadel*
The Federal Reserve was founded to be the guardian of the United States Dollar. Their mission is to defend against inflation, deflation, and to support the Dollar when it is threatened by unemployment or financial panic. They are the lender of last resort.
Woodrow Wilson, back in 1913, was the first President to enact the Federal Reserve. And Wilson was one smart dude. While it is clear he supported the Fed’s creation, he was not ignorant to the financial system that was taking control of the country. In his published work called A New Freedom he wrote:
“The great monopoly in this country is the monopoly of big credits. So long as that exists, our old variety and freedom and individual energy of development are out of the question. A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men who, even if their action be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom.”
Political officials fought intensely over the creation of the Fed. If you watched wrestling as a kid, I want you to imagine it as Stone Cold Steve Austin vs. Mankind in a cage match. The political battle involved lobbying from Wall Street, opposition from progressives, and at one point, a giant wooden tombstone being carried through the halls of Congress meant to signify the death of capitalist money.
At first, people like Woodrow Wilson were critics of the Federal Reserve. He and others were worried about the people who would run this new Central Bank. A Senator named Nelson Aldrich, a man who wined and dined with the great Wall Street power houses, was suspiciously the one who spearheaded the first Federal Reserve bill. No one is entirely sure how Aldrich became the man responsible for the creation of the Federal Reserve, but to get a sense of who Aldrich was and his beliefs, you only have to look at how political cartoons were depicting him at the time.
In his original proposal to President Wilson, Aldrich suggested the Federal Reserve be controlled solely by the biggest Wall Street banks with no political interference. While everyone agreed that a Central Bank made sense, that they needed some form of backstop to the financial system, no one could entirely agree on who and how it should be run.
This is where the story of the Federal Reserve gets interesting. Because long before it was created, free market capitalists of the time hated it. Why would the booming capitalists ever want intervention, especially a central banking authority? They wanted to grow, compete, and win! What’s funny is that opinion quickly changed after the Panic of 1907 when they almost lost everything. It is the single event that set in motion America’s first Central Bank.
The Panic of 1907 was the first financial collapse in American banking history. Not many people are aware of the Panic of 1907, but it started when group of traders tried to corner the Copper market. They took out massive margin loans from banks, and bought gobs of copper. Their plan was to literally buy all the copper they could until they had monopolistic control over the price. The trade did not go as planned. I guess there is a lot of copper in the world, and when they failed to corner it, the price started to drop and their trade collapsed. The banks who lent those traders money quickly realized they were never going to see that cash money ever again. A chain reaction of panic followed. People started to pull their money from banks until there was none left. All of Wall Street was in shambles. As the gamers might say today:
After the panic, the banks realized the only way they could survive long-term, in this emerging society, was to have a Central Bank who could loan them money when all else failed. A passage between James Stillman, who was one of the great bankers of the time, and Paul Warburg, an academic working on the first draft of the Federal Reserve, shows how quickly the average banker’s opinion changed in the good times compared to the bad times after the panic of 1907:
“How is the great international financier?” he asked with friendly sarcasm. He then added, “Warburg, don’t you think the City Bank has done pretty well?”
I replied, “Yes Mr. Stillman, extraordinarily well.”
He then said (about founding a Federal Reserve), “Why not leave things alone?”
It was not without hesitation that I replied, “Your bank is so big and so powerful, Mr. Stillman, that when the next panic comes, you will wish your responsibilities were smaller.”
At this, Mr. Stillman told me that I was entirely wrong, that I had the mistaken notion that Europe’s banking methods were the most advanced, while, as a matter of fact, American methods represented an improvement upon, and an evolution of, the European system, America having already discarded its central bank. He had no doubt that progress would have to be sought, not by copying European methods, but by elaborating our own.
Four years later, in the midst of the panic of 1907, I found Mr. Stillman once more standing over my desk; and when I looked up, he asked, “Warburg, where is your paper about the Federal Reserve?”
The Fed was not exactly created for the goodwill of the average everyday American as much as it was to backstop the operators of the financial system. They witnessed 1907, and never wanted to do it again. The Fed today has evolved greatly to this day, and as you will come to read, I am impressed with their work, but it is still eery to consider the true intentions of its foundation.
I hope my post is not coming across as something nefarious. That’s not the point. What I’m trying to highlight is that the institution itself, its founding mandate, was literally designed to keep a certain class of people backstopped at all times. Bertie Charles Forbes, after the Panic of 1907, wrote about how the first draft of the Federal Reserve came to be. It started as a secret meeting between bankers in a far away location:
“Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily riding hundreds of miles South, embarking on a mysterious launch, sneaking onto an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned, lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance. I am not romancing; I am giving to the world, for the first time, the real story of how the famous Aldrich currency report, the foundation of our new currency system (the Federal Reserve) was written.”
Bertie Charles Forbes
The meeting Bertie Forbes writes about is called The Meeting at Jekyll Island. The history of that meeting is fascinating and the name of the meeting is hilarious on so many levels. So while my opinion on the Fed is generally positive, I do not ignore the way it was started. I don’t think it’s a coincidence that, of all the great American companies ever started, even going back to the 1800s, is that only a few are still around and thriving today. And they are almost ALL financial institutions. What I’m saying is, if you look around, the financial institutions from 100+ years ago, think JP Morgan, Wells Fargo, Goldman Sachs, are the only companies that are actually still thriving. Most other companies built in that time have either lost out to better technology, disappeared through mergers, or are hanging on by a thread today.
The thing is, whether the Fed realizes it or not, they are giving a specific industry a resource most others do not have. Today, a bank or a hedge fund in a perilous position can get instant liquidity or cash infusions from the Fed no matter what reckless behavior they have taken now or in the past. The same is not true for regular people, small businesses, or anything of the sort. If you were born randomly into a less fortunate area somewhere in middle America, and you messed up your credit score once, guess what, your liquidity is probably going to be frozen forever. The Fed is never there to bail out people like that. As I always say, the Fed never goes to the hood.
Wealth inequality is one of the great problems of our time. The destruction of middle America and small business is right behind that. And, as the Coronavirus wages ware on us all, I am sure we will emerge with both of those problems in even worse shape. Because while everyday people are failing, one group will never — those closest to the Fed. I recently read that the Fed is calling the Coronavirus outbreak a natural disaster and that it needs to be treated with aggressive actions. I got a chuckle from that, because during Katrina, also a natural disaster, the people impacted in New Orleans got nothing. Do you think any of them were given liquidity after that natural disaster? Not a chance. If anything, the majority of them them saw their credit wiped out. The only loans they could get from that day on were probably from loan sharks. It is not hard to see the asymmetry in the Federal Reserve’s support for different classes of people.
This is my criticism of the Federal Reserve. They continue to backstop and support the same class of people time and time again. It breads wealth inequality and worse, stagnation. There is no survival of the fittest in modern banking. That is why we stuck with the same banks doing the same thing. It’s also why I believe in the emerging fintech space today. I want to see Silicon Valley take this over. Crush old ways of thinking. Society does best when competition is thriving and we are a country built on the underdog and the redemption story not legacies and tradition.
This post was not meant to convey that I disagree with the Fed nor do I think we should ever get rid of them, but I am saying we need to push them to think more creatively. A liquidity line in a less fortunate area, or giving less fortunate people a second chance at credit in hard times, can do more good and long-term health for our country than any amount of money given to the same group of people over and over again.
There is only one thing going through my mind right now.
How can we get back to normal without a vaccine?
I don’t plan on doing much with my money until I have a better understanding of that.
I’m taking on some swing trades here and there. Or trying to lower my cost basis on some positions I am the most loyal bagholder of. For the most part, I am approaching everything like the kid who shows up with knee pads, elbow pads, and a helmet.
The Federal Reserve and the Government want you to think they have the biggest Bullzooka in town. And they just might. The coordinated stimulus of Jerome Powell slashing rates, launching QE, and pumping overnight liquidity while the White House passed a $2 trillion stimulus bill is, easily, the greatest coordinated stimulus package in history. It makes Cash for Clunkers look like a side order of soup while the guy next to you has the prix fix menu and the chef is personally walking out to shake his hand.
When Hank Paulson was trying to save the economy in 2008 he famously said, “If you’ve got a squirt gun in your pocket, you may have to take it out. If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” So far this administration has made it very clear that they want you to think they have a bullzooka.
But here’s the thing, while J Pow and the White House have shot their shot, I am not sure a bullzooka is the answer. This isn’t a financial crisis. We need a damn NUCLEAR BULLHEAD. Something that can wipe the Rona (Coronavirus!) out forever. Erase all doubt. That only comes in one way: a vaccine. I have no doubt we will get there, the question is who will lead us and when will they do it.
I saw a chart the other day that predicted how society will operate over the next 12 months. It looked like an oscillation between normalcy and outbreaks. We go 3 months without much worry, then it breaks out, then we quarantine, we go another 3 months, and then it breaks out again. Repeat. That does not sound like fun.
One thing I continue to write about is the Cares Act, and how we allocated $500 billion to “large corporations.” I just don’t get it. Most of these corporations are going to fail regardless, they offer nothing right now, they are mismanaged, and more importantly, I do not understand the return on investment compared to showering hospitals, local cities, biotech companies, and healthcare so we can search for a vaccine, prepare for future outbreaks. I would take that investment any day compared to giving bad management teams free loans so they can buyback more stock and ensure that their personal bank accounts have more cash in them than the companies they run.
*Schep gets up from his desk, pours a cup of coffee, thinks to himself, “man that was a good line. you let them hear it.”*
In terms of my own portfolio, while the vaccine is on my mind, I am also thinking about stagflation. Let’s add it up. We have an aggressive stimulus bill, an aggressive Fed, a shock to the supply chain, rising food prices, the need for rising oil prices to save energy companies, and a slow down in employment. I have studied a few things in my time and, when I look into Saruman’s orb at the top of Mordor, there is a cloudy haze forming that looks something like the monster called stagflation. Hopefully the tree elders save us before we get there. Only time will tell.
I’ll have an update when I can and I hope you enjoyed my thoughts on markets in this interesting moment.
My Great Uncle Jeek says “In the middle of difficulty lies opportunity.” He did not make the quote up, but I’ve never forgotten it. I think it may actually come from Albert Einstein.
Jeek is also pretty happy right now watching the show Gold Rush and cooking beans in a pot. The quarantine works for some people, I guess.
Over the last few days, I’ve been reading about some businesses who are still trying to build despite the Corona Crisis. I heard the Texas Roadhouse CEO is slashing his own pay. I’ve never had food at that restaurant, but I respect it. He’s trying a takeout-only menu that is as contactless as possible. I think of Amazon hiring 100,000 workers to fulfill the sudden surge in shipments or General Motors now making ventilators. I even heard the f’ing My Pillow guy switched his entire manufacturing plant into a place where 40,000 protective masks are made. I love that attitude. Don’t wait for someone to save you. In the middle of difficulty lies opportunity.
Back in 2008, when I was just getting started in the trading world, I was fascinated by all the moving parts and people. I took notes. I did not know if those notes would come in handy again, but today, they are. One thing has perplexed me, however: the same people who were there in 2008, say in media, politics or a position of corporate power, are largely here again today giving advice. Why would I listen to anyone who was bailed out? I’m looking for the new leaders. What companies and people can not only survive this, but actually adapt and get stronger without a weak bailout.
The world is really good at balancing itself over time. Even the moon pulls bodies of water from one side of the Earth to the next while maintaining perfect balance. I wonder if the great 2008 bailouts will ever come back and ask to be “balanced.” I think modern finance, for example, could actually benefit from a wave of creative destruction. There are so many old and terrible processes in finance, many of them carried on from 2008 in both corporate and retail.
The other month, when I was traveling, I was surprised by how many people and businesses had completely adopted digital payments. Not a single credit or debit card, besides my own, was seen in my travels. The US still needs to push this. Fintech companies, it would appear, have an opportunity right now with everyone so spread out. I think Venmo and Square could deliver government stimulus 100x faster, especially to an unbanked population, than any other solution. Intuit and GoFundMe recently created a system to let people support their local businesses online through donations and small investments. I love hearing stories like this. I respect the adaptation.
The opportunity goes far beyond business and banking. In DC, our politicians average age is over 61 years old. The three most important positions on either side, POTUS, Speaker, and Majority Leader average 77 years old. Yet the majority of the country is aged 25 to 50. Are we so sure our political leaders really understand the dynamics of the country? I think, in times of crisis, quite a few doors can suddenly swing wide open. The Corona Crisis, as bad as it’s been, just might need young people to step up in a big way. Those who have been waiting for their chance, will get it.
When the Black Death swept through Europe in 1346 they were still huddling near candle lights, wearing muddy rags, and struggling to even get a cup of porridge. Europe was never the same after that. Today, we are all inside connected, gaming, working, and binging TV shows. There is still plenty of opportunity and while this isn’t quite Europe in 1346, the changes and opportunities today will have a lasting impact on how we do things for years to come. There is no better time to strike than when a crisis rages on.
Thanks for reading. I’ve wrote a lot in the last week, so please read more if you find it interesting.