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🔑 Key Takeaways

  1. Billionaire Jeremy Grantham accurately predicted the bearish market and inflation of 2022. The NASDAQ and S&P 500 peaked before a drastic reversal. The Fed raised rates, leading to speculation of stagflation caused by oil crises.
  2. Focus on a company's fundamentals and earning the right to use evaluation multiples, but stay cautious as stocks, housing, bonds, and commodities are all in a bubble. A recession may not be all bad but be aware of potential consequences such as increased mortgage rates and pressure on housing prices.
  3. For a company to create value, its returns on capital must be higher than the cost of capital while growth is important. However, young companies face challenges in determining returns, and understanding valuation methods such as P/E multiples and enterprise value to EBITDAs is crucial.
  4. To earn the right of multiple, understand accounting, cash flows, and return on capital. Measure inflation with a personal metric considering spending. Energy drives transportation, food and beverage. Lack of energy investment caused oil price hike. Profitable drilling needs high oil prices and highly economic activities.
  5. Despite a shortage of skilled workers and necessary equipment, the oil industry needs to increase investments in drilling and completing wells to bring a multi-year boom market on the horizon.
  6. Buffett's investments in Chevron and Occidental Petroleum show his market timing expertise, but it's important not to blindly follow his approach as it may differ for smaller amounts of money. The US's temporary use of petroleum reserves may result in higher oil prices in the future.
  7. Investing in microcap companies, with a high turnover rate, can offer exposure to potential success and benefits in the oil industry, without copying big oil companies like Chevron or Oxy exactly. Consider adding microcap companies to your portfolio.
  8. Warren Buffet's success began in the micro cap market, but he quickly grew out of that ecosystem and transitioned to larger market cap classes. Investing in small companies can be a strategy, but it has its risks and rewards.
  9. Focus on companies with strong cash flow from customers and investors to ensure long-term success, while being mindful of potential risks and debt concerns. Illiquid microcaps have historically performed well, but supply and demand ultimately determine economic success.
  10. Tightening monetary policy in the west may cause a volatile shift of capital flow, leaving other countries deprived of capital. The Fed is raising interest rates globally to fund money printing, creating bonds for the rest of the world to buy for real yield.
  11. Raising interest rates can attract investments and curb inflation, but sustained high rates may have negative political and economic effects. The US's current policy may pressure the rest of the world, exacerbating economic problems. Watch for high yield spread as an indicator of default risk.
  12. Monitoring high yield spreads can provide insight into the potential for a financial crisis. When spreads rise, the economy may contract and investments may be scaled back. Reacting accordingly can mitigate risk for investors.
  13. Tight high yield spreads indicate an inflationary environment, while wide spreads suggest deflation. The put call ratio signifies the consensus of traders with a high ratio being bearish and a low ratio being bullish. Bet against the consensus but be right to make money.
  14. Put-call ratio is a contrarian indicator that predicts bearish market sentiment. The reverse repo market can be affected by macroeconomic factors like inflation and government borrowing, but concerns of a collapse due to bad collateral were unfounded.
  15. The Federal Reserve stepped in during the cash crunch in the repo market, created cash and lend it to banks, preventing collapse. Later, with excess capital, opening of reverse repo facility offered risk-free return but it potentially leaves the facility and could be a government funding boost.
  16. The Fed may reduce its payment of risk-free rates into the reverse repo facility, which could lead to $2 trillion funding for the government and lower borrowing costs. If necessary, the Fed may also become the lender of last resort by buying up government bonds to prevent panic in the bond market.
  17. Investors should avoid the mistake of going in and out of the market based on events like pandemics, as staying invested in the long run pays off. Listening and learning from financial podcasts can make one a better investor and person.
  18. Don't forget the purpose of your money and take time to enjoy it. Market losses are temporary, but losing sight of your purpose can be permanent. Be a successful investor by keeping the purpose of your money in mind while also enjoying it.

📝 Podcast Summary

Market Turmoil and the Threat of Stagflation in 2022

The year 2022 was marked by a bearish market, worsened by inflation. Billionaire Jeremy Grantham accurately predicted the peak of the market in November 2021. Termites of bull markets ate away at high-flying tech stocks of the NASDAQ before it peaked on November 19. The S&P 500 lagged but eventually peaked on New Year's Eve before a drastic reversal on New Year's Day. The Fed raised rates to combat inflation, fueling speculation of stagflation, but unemployment remained low. The oil crises in the seventies lowered the growth rate, pushed up prices, and increased stagflation, which can be caused by an oil price increase.

The current market environment is unpredictable, with debates on recession, inflation, and deflation. Despite this, it is important to focus on a company's fundamentals and earning the right to use evaluation multiples, as the return on invested capital and growth are the biggest drivers for doing so. However, the market is playing with fire as stocks, housing, bonds, and commodities are all in a bubble. The invasion of Ukraine caused spikes in food, fertilizer, and natural gas prices in Europe. A recession is not necessarily bad news as it can lead to lower interest rates and help stock prices. However, the brutal increase in mortgage rates and pressure on housing prices could lead to disastrous consequences.

Understanding the Relationship between Returns on Capital and Growth for a Company

In order to create value, a company's returns on capital must be higher than its cost of capital, and growth is good. The impact of growth is contingent on the return on invested capital. Young companies find it difficult to determine returns as they have a range of outcomes, and often have to spend money on pre-production costs without knowing the exact economics. Understanding the drivers of the multiple is crucial, as eventually, everything becomes a commodity, and companies have to migrate toward the cost of capital. The two most popular ways to value businesses are through the P/E multiple and the enterprise value to EBITDAs, which may have different ratios for different companies.

Understanding the Drivers of Businesses and Measuring Inflation

Understanding the underlying drivers of businesses, accounting workings, cash flows, and return on capital characteristics is the key to earning the right of multiple. Having a personal way of measuring inflation while considering the items or services one spends money on is crucial. The consumer price index is a popular metric for measuring inflation, and energy affects transportation, food, and beverage. Lack of investment in the energy sector caused a gap between supply capacity and future demand that led to the oil price hike. It takes a long time to bring oil to production, and high oil prices are needed for the economic activity of many companies. Companies should develop highly economic activities for their drilling to be profitable.

Challenges and Opportunities in the Oil Industry

Oil services and short cycle rigs require higher prices to bring on new equipment and rigs. The oil industry is facing a problem where a talented workforce is scarce along with capable additional rigs and other equipment. Underrated investment and logistical problems are keeping the industry from expanding and raising wages enough to attract workers. A multi-year boom market might be on the horizon incentivizing a lot of investment but it would take years to build the necessary equipment. There has been an underinvestment and many wells have not been fracked yet. In order to complete more wells, the oil industry needs to increase drilling and completing wells while raising their capital budgets because they are doing too many step twos.

Warren Buffett's Expertise in Market Timing in the Oil and Gas Industry.

The US has used its special petroleum reserve to lower oil prices and ease inflation on citizens but this is only temporary and may result in higher oil prices in the future. Warren Buffett has made some huge bets on oil producers, highlighting his expertise in market timing in the oil and gas industry. He has a track record of getting in and out of the industry at the right time. Berkshire Hathaway's investments in Chevron and Occidental Petroleum are based on their superior cash flow torque to higher oil prices and their trading liquidity. One can learn a lot from Buffett's investing strategies, but it is important to note that he advises against blindly following his investments as his approach would differ if he was managing a smaller amount of money.

Microcap Companies vs Big Oil Companies

Josh Young believes that there are benefits and diseconomies of scale in big oil companies like Chevron and Oxy and prefers positions in microcap companies like Sandridge and Journey instead. Ian Cassel, a microcap expert, highlighted that investors like Buffett and Peter Lynch actually got their start by investing in microcap companies, and had high turnover, meaning these weren't buy and hold forever type positions. It's possible to learn from what Berkshire is doing without copying it exactly, and to have exposure where there are companies that can do well from the things that would make big oil companies do well, but potentially even better. Investors can consider adding microcap companies to their portfolio.

Warren Buffet's Journey from Micro to Macro Cap Investing

Warren Buffet's partnership, which started with $100,000 in capital in 1957, grew to a capital of around $100 million by 1968, making it an incredible journey. Buffet's micro cap experience lasted only a few years as he was quick to grow out of that ecosystem and succeed in other market cap classes. Buffet's performance sustained at different levels, and he was able to continue his success and compounded those great rates as he went upstream and up market cap. Concentration in small, micro and small cap companies combined with acquiring private small companies can be a possible investment strategy for Buffet today, but it could be a dual-edged sword. Some big names that successfully transitioned from micro to macro include Walmart when it went public in 1971 as an IPO.

Exploring Small Market Cap Companies for Investment Opportunities

Investors can find opportunities in relatively small market cap companies, including illiquid microcaps, which have historically performed the best since 1971. The DX Y Index recently peaked at 114 on September 27th, 2022, which may be concerning for some investors, but ultimately, the key to economic success lies in supply and demand, particularly cash flow. Government stimulus has kicked the can down the road and prolonged debt concerns, but debt will eventually matter. Investors should consider the potential risks and focus on companies that attract cash flow from customers and investors to ensure long-term success.

The Impact of Monetary Policy Divergence on Global Debt and Capital Flows

The lack of coordination and liquidity coupled with monetary policy divergence within and between the west and east sides of the world could cause debt to matter. With the US being the global reserve currency and primary funding currency of most countries, raising rates or tightening monetary policy would affect the whole world, resulting in volatile situations. Flow of cash may leave certain places and move to the west, which could deprive the rest of the world of capital. Thus, the Fed is thinking more globally and increasing interest rates to create more bonds to fund money printing, which ideally should be bought by the rest of the world to provide real yield.

The Benefits and Drawbacks of Raising Interest Rates

Raising interest rates has multiple benefits, such as making investments more attractive, creating room for future cuts, and curbing inflation. While financial repression may seem like a viable solution, sustained high inflation rates can have adverse political and economic effects. The US is currently raising interest rates and tightening its monetary policy, which strengthens the dollar and puts pressure on the rest of the world. This global squeeze perpetuates a vicious cycle that worsens economic problems. Inflation is one of the primary causes of the national debt, and an indicator to keep an eye on for banks and fixed income investors is the high yield spread, which measures default risk for high-risk borrowers.

Why Watching High Yield Spreads is Crucial for Investors

Watching the high yield spread is crucial because it gives a clear picture of where people worry about downside risk and how small shocks turn into big crises through the financial accelerator. When small shocks happen, people in the financial markets reprice risks, and this feedback loop affects people in the economy who may scale back plans and not invest. The financial accelerator may lead to the constricting of the US economy when high yield spreads rise and may eventually blow out if the spreads go above 600. During this unique environment, external financings are shut off from the economy, and the financial accelerator is in full swing, leading to a dire situation. Being aware of these signs will help investors react appropriately.

Understanding High Yield Spreads and the Put Call Ratio

The direction of the high yield spread is more important than the nominal number. Tight spreads suggest an inflationary environment, while wide spreads indicate a deflationary one. Paying attention to both the level and direction is important in determining if the economy is healthy or at risk of a crisis. Spreads tightening suggest a growing GDP and stimulative debt, while rising spreads are contractionary. The put call ratio, which signifies the consensus of professional and retail traders, is another market indicator to consider. A high put call ratio is bearish, while a low ratio is bullish. To make money investing, it's important to bet against the consensus but also be right.

Understanding Put-Call Ratio and Reverse Repo Market

The put call ratio is a sentiment indicator that measures the number of puts and calls being traded. A higher ratio indicates more puts being traded, which means bearish sentiment among retail investors. This is a contrarian indicator as by the time the ratio peaks high, the bad news is already priced in. This, along with other macroeconomic factors such as inflation numbers, money supply, and Federal Reserve actions, suggests that the bottom may already be in with the stock market. The reverse repo market is a market where banks lend money to each other using collateral. In 2019, the spike in overnight cash rates caused concerns of a collapse due to bad collateral, but it was later found to be a shortage of cash in the system caused by high government borrowing.

The Federal Reserve's Role in the Cash Crunch and Potential Pivot

During a cash crunch in the repo market, the Federal Reserve stepped in to create cash and lend it to banks, preventing a collapse. Later, due to the influx of cash from the government, banks had an overabundance of cash deposits that had to be offset by collateral. To prevent interest rates from going negative, the Fed opened up the reverse repo facility and paid banks an interest rate to park their cash and access collateral directly from the Fed, creating a risk-free return. However, this soaked up around $2 trillion of excess capital from the system, which could potentially leave the reverse repo facility and be a boost in funding for the government. This has been termed as a potential Fed pivot.

Fed's Reverse Repo Facility and Potential Impacts on Government Funding and Borrowing Costs

The Fed may stop paying risk-free rates into the reverse repo facility, leading to $2 trillion of funding for the government. This will lower borrowing costs for the government and be the first phase of the pivot. As interest rates go up, the Fed's reverse repo facility may dwindle down. If something breaks in the current path, the Fed's response may be similar to the Bank of England, becoming the lender of last resort by buying up government bonds to prevent bond yields from moving higher and stopping the panic in the bond market.

Central banks can control bond yields with mere willingness to buy bonds. Staying invested in the market pays off, even during downturns.

Central banks do not need to spend as much money as they claim to control the bond yields. The announcement of their willingness and resources to buy bonds in the required amount is sufficient for calming the markets. This was evident from the Bank of England and the Bank of Japan's experience in controlling government bonds' yield. People tend to make the mistake of going in and out of the market, depending on incidents like pandemics, elections, or wars. But staying invested in the market pays off in the long run, even during market downturns, as history has shown. Peter Mallouk, an expert in financial planning, advises investors to avoid making this mistake. The ultimate goal of listening and learning from podcasts like Trey Lockerbie's is to become better investors and better people.

The Importance of Enjoying Your Money While Investing

The biggest mistake investors make is not enjoying their money. Instead of piling up money for no reason, investors must focus on the purpose of the money they wanted in the first place, i.e. to enjoy life, help their kids, or go on vacations. Losing focus on the purpose of their money is the most tragic mistake investors make. Investors must remember that loss in the market is temporary, while loss caused by exiting the market is usually permanent. The market can turn quickly, and active trading can have friction. So, to become great investors, people must enjoy their money, but also remember the purpose behind it.