Daily Learning – July 19, 2017
Superinvestors Podcast with Jesse Felder of the Felder Report
Podcast #9: Mark Yusko on Gut Instinct (and Why He Says We’re Headed For A Crash)
Released Tuesday July 18, 2017
Approximate Length – 1 hour 4 minutes
Mark Yusko (You-Sko). Writes a quarterly newsletter that is fantastic.
Says we are headed for a doozy of a stock market crash.
Ran endowment portfolios at both Norte Dame and the University of North Carolina. Set up hedge fund of funds with Julian Robertson. Today he oversees $3 billion at his firm Morgan Creek Capital Management. He is a very astute student of value investing. He is a wealth of knowledge.
We all evolve as professionals based on our earlier experiences, relationships and mentors as well as what we were exposed to in those early years. Mark started early in his career in investments the month before the crash of October of 1987. He was on the bond side. He went to school to be an architect. That lasted a semester then switched to engineering which lasted a few semesters. Then wanted to be a doctor so spent his time at Notre Dame studying science and prerequisites for medical.
At the end of his senior year he went on directly to business school (which he wouldn’t recommend going straight back without experience). It worked for him as he needed that base in business to get going. In hindsight, that exposure to science training was excellent for him because science is about hypothesized processes and testing and data gathering, reformulation. He grew up in a series of happy accidents in his career.
He hired Dan Fuss before Dan became famous. He worked with a bunch of early deep seated value investors (pre PC’s). Did low price to book screening on early computers in the late 1980’s. He would have stayed there a long time but got “the call” from Notre Dame in the endowment business. He thought everything about investing was about picking stocks and bonds. Most of the success actually comes from asset allocation. Those big asset allocation decisions drives everything.
Then got the call to be the guy at UNC. The environment was completely busted and a mess. They had terrible performance. He had to build from the ground up to compete against Duke. You learn so much more when you are doing it by yourself. So I reached out in the business and asked for help and integrated those into a new process at UNC with a value bias. That’s how I became a deep rooted value guy with a margin of safety concept ingrained.
He writes overlong quarterly letters. He sits down over weekends and writes these. Eventually did on on Seth Klarmen and value investing. What he discovered is that value investing is either genetically within you or its not. You can either buy Tesla at ridiculous values or you can’t because it is so over-valued. If value or margin of safety matter to you, then you are constantly being ridiculed because you are either buying when nobody else is or you aren’t buying when everybody else is getting greedy at the top. So you are basically a terribly boring guy going against the grain. You are always on the outside looking into the party.
There are some guys who are both. They can buy value but also ride trends.
He stayed at UNC for 7 years about 1998 to 2004 and then formed Morgan Creek. He is celebrating 13 years at Morgan Creek.
When he was leaving North Carolina he met a lot of good people and knew Julian Robertson. He got a call from Julian when he left North Carolina for a meeting. Julian wanted to work together and put in some seed capital. Julian was a mentor to him. Julian is one of the greatest people at picking talent and also being a super investor. He had an uncanny ability to double up. He would cut his losses but when he was on a winning trend, he would double up and ride the lightning.
A lot of value investors get sucked into value traps and you need to avoid those.
Twitter is a great place to meet up and combine the great characteristics of trading with fundamental investing. Cut losses but ride trends. Was your analysis right, did you have a margin of safety? Did the world change? Did you get trapped? That is a fundamental difference between good and great investors. There are very few greats out there. It is trading plus value. When something goes against you, it’s best to get out and re-evaluate. You can always get back in.
Sometimes its best to come in on a Monday morning and say, “We have a brand new portfolio of 100% cash. So what are our best ideas?” This gets you out of the funk that we all slip into. When you are really smart, you think you are right. So you do all of this work but the market tells you that you are wrong. You can’t ride losers into the ground when the market is blasting you.
Peter Lynch used to say, “The best approach is to pick your weeds and water your flowers. But most investors do the opposite. They pick their flowers to lock in gains and then water their weeds because they are so sure they are right.”
One of the greatest challenges of being a value investor is balancing your own skills and confidence with analysis and understand that you are right when the markets are going the other way. You need to have humility to balance things out.
#edge used is humility. People that don’t have humility can’t be successful. You have to know you can be wrong. You know you are a legend in investing like Julian when you are recognized by a single name and you are only right 58% of the time. It’s not whether you are right or wrong. Drunkenmiller said, “It’s how much you make or lose when you are right and wrong.”
All of these things come into this discipline of being a value investor. The problem with people that fake it is that they justify in their mind why Amazon is a value play because it is trading at 168 times and it used to be 1000 times. It’s cheaper than it was but it’s not value.
That’s what people are saying about the market right now. They are saying, “It’s not as expensive as it was in 2000 so it’s ok.” It’s not cheap. It’s not value.
The discipline to buy things with a margin of safety and then sell at fair value is what it takes. You need that discipline. The risk reward equation is constantly changing.
Julian was a great investor in human talent. He developed and groomed great talent just like Mark Yusko. Mark is now going back to his roots of picking investments rather than picking talent to run money. He developed a process of testing (with people), he would train them, and then he would back them when they went out on their own. Part of it is the ability to identify talent. You don’t go for the highest talent (Harvard or Stanford). He recruited from smaller schools that didn’t go to top tier but did something exemplary in their life that made them competitive. Tennis players and golfers. Competition is what the game is about. It’s not about IQ. It’s about hard work and heart. That’s what separates the great from the good. Most of them tend to be competitive but not valedictorians. They have humility and a personal integrity about them. Never fudge or bs the numbers.
Hanging out with great investors is a great way to go. It’s mentorship. Mentorship doesn’t have to be one on one. You can have a mentor through a book. Pick up Market Wizards and read about these guys. That is a form of mentorship. Watch them and read them.
Favorite books are Market Wizards, and management letters (Hugh sloans), Jeremy Grantham, some paid services (Raoul Pol), Carrell Sokoloff at 13D Capital. He writes “what I learned this week every week.”
Most people won’t be great investors because they only use half their brain. (The right side which isn’t the creative side). Trust your gut. Gut instinct is real. Bennet research. Tao Jones Research. Trust your instinct which is a super computer that is working all of the time. You need to channel that. Live in Bend, Oregon or Chappel Hill. Get out of group think and what everybody else is doing.
Another great book is by Harry Dent the Great Boom Ahead in 1993 is uncanny. He predicted a lot of things that really turned out to be spot on. It is amazing at understanding S-curves and how demographics, debt and deflation are the 3D’s of success in investing. If you have those wrong, it’s tough to make money.
Jesse loves to play music to get unplugged and rework his brain. Great investors bring in a lot of disciplines and worldly wisdom. Mark Yusko likes things outside of finance like worldly wisdom. He loves fly fishing, the time on the water, the environment. Fishing is a great analogy for investing. If you think about the art of fishing, it’s so similar. Water temperature can change. Fish have patterns. You need to outwit the fish. You need a lot of disciplines. Balance equals edge. You need balance in your life to be successful in investing. You need family, health, time away from the office, time in the office. Sometimes the harder you work the less effective you become. You need solitude. I’m not saying move to Little Caymen like Raoul Pol with 140 people on the entire island but now back on Grand Caymen. This way you also aren’t totally immersed in things like Twitter.
It’s good to just unplug. Being off the grid is amazing. That replenishing is great. We have grown kids but then we also had an unexpected new baby. I had so many new ideas in that first year of the new baby then in the previous 10 and I look back and I would be home by 6:00pm and my wife would just hand me the baby. I felt like I wasn’t doing anything but my brain was working the entire time and I would have these aha moments.
You get shocked out of your routine. It helps with the creative process.
Jesse just finished Rainbow’s End the Crash of 1929 which is an awesome book. Mark was the keynote at the Mauldin Conference and gave a quote that went viral, “The U.S. is going to have a massive crash.” What are you thinking about at this time?
To get back in the proper context, Mark was paraphrasing Roger Babson from his last two letters. Roger who called the crash in 1929 in September of 1927. He said that there was going to be a crash and it would be terrific.
People didn’t believe Babson because he said it in 1927. Then he said it in 1928 and the market kept going up through 1929 and since it kept going up while he was screaming crash probabilities people said he was an idiot. Not only did it go down, but they went 86% down and they went way down past the levels in 1927 when Babson was giving big warnings.
So a year ago Mark said that we were do for a recesssion and correction. And now a year later, here we are with higher prices. I believe in Newton’s Laws which includes for every action there is an equal and opposite reaction. The reality is gravity rules. Ultimately there will be a reaction.
We are at the second highest valuations ever in history. Earnings are the same as 2012 yet we are up 100% because the multiple doubled. People are justifying that because interest rates are low. They are thinking that rates will stay low forever or multiples will stay high forever. But my biggest issue just like 1929, if you look at 1928 when Hoover was elected, he was the 2nd president elected with no experience. It sort of mirrors today. Markets went up with politics in disarray. Markets went through the roof while political issues are dysfunctional without policy improvements. A small slowdown recession turned into the Great Depression of the 1930’s that led to a trade war.
There is too many similarities to 1929. But demographically it is almost the same.
There is too many similarities to 1929. But demographically it is almost the same.
Neil Howe The Fourth Turning is a great book which gets into the demographics and numbers of people aging and the dearth of young people. So things are lining up pretty nicely.
There are fascinating parallels. You feel in your gut that we are heading to Hooverville type experience. In the Rainbows End they had more trusts than stocks in the markets. It’s just like ETF’s today. There are more ETF’s than stocks. On top of it they are levered (exactly as today) with personal debt with margin at all time high. Margin peaks at top of market. But also in 1929 corporations are borrowing at record levels. Last 5 years corporations borrowed at about the same levels as back in the late 1920’s inflation adjusted.
Margin debt to GDP is high once again. We are up to 3% in GDP for margin. Throw in buybacks is financial engineering to management teams. Borrow money, buy back shares, drive EPS up but there is no real financial strengthening of the companies themselves.
We are in a very tenuous spot. I’ve been old enough to live through some cycles. You are a product of you environment and 1987 was not a crash it was a sharp decline with a rebound. It wasn’t like 1929. We are like 1929.
Low vol ETF’s are an example of what’s questionable in the market. Once volatility goes up then those ETF’s have to sell. That leads to systemic risk. There are emerging market ETF’s that have lower vol than S&P.
Short volatility positions out there and volatility targeting (risk parity) has added layers to this situation. A lot of insurance companies are scaling equity exposure around volatility. There is just so much in this market structure that will add to risk that we have never seen before. This short VIX and having pension funds jump on. 97% of VXX is sold short.
It’s like the CAPE ratio. I can tell you in a few years we are going to look back and say how stupid we were at these levels but that doesn’t mean in 10 days or 10 months we will say it. These volatility structures will crack and they will crack in a hurry because risk happens fast. When this goes, and this reaction occurs, the volatility skew, ETF’s and passive, risk parity, smart beta, all these things are led to a misallocation of capital. They have added to complacency and a fooling of risk.
The absence of something leads to that something. (Minsky). The longer we go in this, the worse this will get. Ray Dalio has left his own house of cards. Risk parity should be called risk disparity.
There is a lot of risk out there. Risk parity is really the risk party and the party will lead to a hangover. There has to be a hangover after the party. You can’t get rid of risk or the business cycle. You can’t destroy it. You can’t take risk away. You can’t get rid of risk. The fed hasn’t abolished the business cycle. The debt has to be paid back at the corporate level.
We have all of this talk of how the central banks can just solve all of this but if it was just as simple as printing money to create wealth out of thin air, wouldn’t every country be doing that everyday (even if they appear to be trying).
The fed hasn’t abolished the business cycle they just pulled demand forward. When you pull demand forward secularly it doesn’t leave you with much down the road. Chris Cole has talked about this with volatility. You don’t make volatility disappear. You just push volatility down the road into the future. So once this breaks the volatility will be that much more.
It’s just math. It can’t “not be right.” My all time favorite line is when people say, “This time is different.” It’s never different. Nothing is new in this world. Humans do the same things over and over again and they expect different results.
It’s like physics and Newton. When you push in one direction it has to come back in another. Every action has an equal and opposite reaction. That is fact and law. It’s not a thought or idea. It’s a law.
Everybody believes that they are smarter and that they will get out first and will stay at the party just right before the cops come. What keeps you up at night? I sleep well at night because I don’t expose myself to those risks. My returns stream is sort of boring day to day, month to month but over the long term they compound better.
In 2011 it was a choppy year. Investor complained that results were too low. If you believe bad things never happen or don’t count, then value investing is not for you. Jeff Gundlach said when people say “never” it is just about to happen.
Follow Mark on Twitter. Morgan Creek Cap.com has downloads. Mark is out and about on TV. Otherwise feel free to reach out on Twitter (and not email). His letters are long but awesome.