Motley Fool Hidden Gems Investing - Tom Gardner and Morgan Housel on Inflation, Tesla, and Starbucks

Episode Date: January 8, 2023

Everything feels unprecedented if you don’t study history, and 2022 wasn’t unique for the stock market. Morgan Housel is the best-selling author of “The Psychology of Money”. He joined Motley Fool co-founder and CEO Tom Gardner for a conversation about: - Why cash is a better hedge against inflation than many believe - Parallels between the 2022 stock market and the dot-com bust of the early 2000s - What Tesla investors can learn from Starbucks’ past decline Companies discussed: BRK.A, BRK.B, TSLA, SBUX Host: Tom Gardner Guest: Morgan Housel Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. everyone thinks when there's high inflation you don't want to own cash your cash in their savings account your checking account is losing value to inflation you want to get rid of that you want real assets real you know gold whatnot but whenever inflation pops up and it's unexpected everything gets demolished crypto gets demolished bonds get demolished stocks get demolished gold gets demolished every single time so it happened in 2022 happened in the 1980s happened in the 1970s, short-term, everything gets wiped out. The smallest declines, so to speak, come from cash. I'm Chris Hill, and that's bestselling author Morgan Housel. He joined Motley Fool co-founder

and CEO Tom Gardner a few days ago at our member event, and we're bringing you part of that conversation. Tom and Morgan discuss how investors can hedge against inflation for the short-term and the long-term, and some unexpected parallels between Tesla and Starbucks. It's been such a painful time for growth investors, but the long-term prospects still remain very bright, in my opinion, for so many of these companies, certainly not all of them. So we'll be talking about that, but we want to start at kind of the macro level and talk about the primary worries that investors face. So Morgan, why don't you start us off? I think one big worry that virtually everyone has right now that is not, I'm not saying it's wrong, but I think there's a pretty easy pushback to it. And I think people are taking this worry to extremes that they shouldn't, which is the idea that what has happened in the last 12 months or so is somehow abnormal or somehow indicates that the market is broken or that there's a big fundamental flaw or that you as an investor necessarily made a mistake, so to speak.

In some cases, that might be the case. There might be things that people regretted. But I think if you look historically, in my view, there is virtually nothing that has happened in the last 12 months that I would consider abnormal or unprecedented or something that even I would not say is guaranteed to happen over the course of your life as an investor. There's a great quote that I love from a writer named Kelly McGonigal who says, everything feels unprecedented when you haven't engaged with history.

Such a good, good quote. And I think this is times like these in the last 12 months is when being a kind of amateur market historian is the most advantageous. And everything from the NASDAQ going down 30 some odd percent to plenty of companies going down 60, 70% or more to companies like FTX being exposed as a fraud, if we can use that word now, I don't want to discount the pain and the anxiety and the uncertainty that that can cause, but none of that is unprecedented. And all of that is a guaranteed feature of being a long-term investor.

I do think there is a point to make here that if you were to look at the last five years and say, and ask the question, what is the anomaly of the last five years? It's not the decline that we've had over the last 12 months. I think the anomaly over the last five years is the boom that occurred in 2021 during the biggest economic upheaval of the last hundred years, which is not an exaggeration, coming out of COVID and on the stimulus packages, that we got to a level of valuations that for not all companies and not as a market as a whole, but for plenty of individual names didn't make a ton of sense given where they were as companies, at least for that moment of time. If I were to look at the

last five years, I think that's the enum. It's not the last 12 months. That's what it is. But I think if you were to look historically at the last 100 years as an investor, or even the last 30 years as an investor. The common feature, we talk about this so much and drive this home so often because it's so important. The common feature of all market history is volatility. And when people think about volatility, it's not 5% or 10%. It's 20%, 30%, 40%, 50% volatility. That tends to be more common than people think. These are the kind of things that happen once in a lifetime. The 30% pullback in the NASDAQ or 20% in the S&P, that's the kind of thing that will happen every 5 to 10 years as an investor. So if you are an investor like Tom and I, who want to be investing for the

next 30, 40, 50 years, that's the kind of thing that it's not a possibility. I know with almost certainty that this thing is going to happen to me as an investor, I hope five or 10 more times during my lifetime as an investor. None of that should diminish the uncertainty or the pain of watching your net worth kind of shrivel over the last 12 months as virtually everyone has, no matter how you invest, everyone has some degree of that. But I think when you view these things as an inevitability and not a signal that something is broken or a signal that you made a mistake per se is important. What's equally important is that if you are the kind of investor for whom a 30, 40, 50% or more decline was unpalatable, you just couldn't accept it.

And it costs you a level of sleep that in hindsight, looking back at the 12 months was not worth it. That's an important realization as well. I think the mistake that people make when there is an error and where there is a scar that people will regret, it's going through a decline like this, realizing that it's too much risk than you want it to take, selling, but then coming back three years later and doing it all over again and making that same mistake over and over again. So I think if you are the investor, not everybody is, but if you are the investor for whom the takeaway over the last 12 months was, that was too much risk for me.

I think that's totally fine and okay. And my plea to you would just be to embrace that mentality with both hands and think of an asset allocation that is more appropriate for your ability to sleep at night and your risk appetite going forward. I like that so much. Thank you for all of those thoughts.

They remind me of some of Peter Lynch's writings about how each time it seemed like all of the factors were new, But when you looked at them collectively over time, there were always problems and always times of confusion and always periods of market volatility. And Peter Lynch, I remember sharing his personal story that it seemed like every time he launched a new fund or got a new job, right as he allocated all the capital, the S&P fell 15% or 20%. And all of a sudden, it was a devastating beginning for him. And that's really who this market decline is most painful, most damaging for the newcomers to the markets over the last few years, right?

And of course, that included a number of people because we were at home and with more time to look into the digital screens and find opportunities to invest. And that made the markets more exciting, more volatile. And there were new asset classes were launched, cryptocurrency arrived. And a whole new group of investors came into the marketplace because of the condition brought on by COVID. Unfortunately, that group is the most burned. For those of us who have invested for 10 years, 15 years, 20 years, 25 years, 30, 35 years, it doesn't mean it's not painful. I've always liked my brother David's statement that he never feels happy when the market's – he's never – like, be fearful when others are greedy and greedy.

He's like, I never feel better when the market's down. It's not a good time. It's not a fun time as an investor. It's much more fun to see your companies being rewarded for the risks they're taking and to see your investments rise. But for those of us who've been through various cycles, we can look back and see some of the echo or hear some of the echo of the past. So I would say for this market environment, I think it's obviously most similar to 2001,

2002, where there was an incredible boom in enthusiasm for new technologies and for things that are actually have traction in a real remote work. As much as any company wants to think or any leader or any politician or whoever wants to think that you can mandate a return to the workplace, it's not going to happen because that's a daily habit formed around commutes, around taking children to school at a particular time. And that daily habit doesn't come back together for everyone in an organization. There are some organizations that are very local

in their orientation and they have a local office and they just weren't in it and now they can all go back. But for any company that is more national or global that has multiple offices, it's kind of can't really put everything back together the way it was before COVID. And so these things are real, these changes are real And they are creating the need for new digital solutions, collaborative work, communication.

If we think we have Slack and Zoom and there's still so many things that need to be discovered to help organizations, families, friends, to help people connect. And those things will be digital and they will be cloud native and they will have a lot of machine learning and there will be greater and greater efficiency that will come from it. But of course, when we were all at home looking at the markets, that was a time of great enthusiasm. Valuations ran very high historically. And so is it unprecedented? Well, no. I mean, the patterns are there from 20 years ago. And then it can be useful to look at what happened after 2002, 2003, because everyone felt pretty shipwrecked at that point in time. I'd say

probably Berkshire Hathaway didn't. And I don't think Berkshire Hathaway investors feel shipwrecked now. And S&P index fund investors don't feel as shipwrecked. It's not such an outlier that the S&P is down 15% to 20%. It's painful. It depends who you are as an investor. But if you've been around a long time, you're more shipwrecked as an NASDAQ investor. But remembering in 2000 and 2001, NASDAQ was down more than 70%. So here we are. We've been down 35%, I think 40% maybe at the max, 35% the max. But let's look at the pattern of what happened after. And what happened after is that it turned out that the internet was for real. Pets.com notwithstanding, and a bunch of IPOs that should never have come public, and a bunch of SPACs today, and a bunch of cryptocurrencies,

a bunch of things that will vanish if they haven't already, and probably a few more frauds that will emerge, um, um, and become more evident, uh, than, um, but, but then you will see taking hold the real R and D spend that did matter. And what those factors were, because those companies are all being tossed to the side as well right now, pretty much indiscriminately, uh, most growth companies are, I mean, you can have a portfolio of Amazon and Netflix at the core and you could feel unbelievable for the last 15 years and you feel absolutely awful for the last 12 months right and so it depends when you got in but you still i mean everyone takes this experience on in different ways it comes in different time different amount of capital different expectations

um and and so now i think i really um just want to affirm your basic point morgan that uh this this isn't that unique uh we can and and and i say that as painful as it has been for all of us as investors um what we can see in the past are some of the little signals that um the evidence the clues as to what could come next and there are no guarantees in the marketplace but we do the market does go through cycles and i would have to say that i think there are some wonderful, uh, uh, technology cloud native companies that have some really great growth prospects over the next 10 years. I mentioned snowflake as an example, and, uh, this would be a terrible and unfortunate time to be selling the best of these companies. Uh, it's painful to have

the worst of them because they, um, it's, it's hard to avoid them, um, for growth investors, but I think the really high quality growth stories are very well positioned right now for, pleasing returns over the next decade. What about inflation, Morgan? How worried are you about inflation? Zero. Zero. I mean, let me put it this way. Personally, zero. For the broader economy, maybe like a four or five out of 10. Are you worried about deflation long-term? Long-term? No, definitely not long-term because the Fed has all the tools to prevent deflation and is not scared to use them. They pull out the bazookas, the howitzers, and they print trillions of dollars. Deflation, I think, will virtually never be a risk during our lifetime,

provided we don't have a complete nut running the Fed. Putting that aside. Inflation is really interesting. In my view, I think that was the biggest economic story of 2022. It wasn't the market. It was inflation, which is, of course, at a 40-year high. When we finished the year, 8% or 9% annual inflation. It was something like that. Inflation from an investing perspective is really interesting. Everyone wants to answer the question, hey, we have inflation. How should I invest? What should I put my money in to maintain my purchasing power? It's like a very widespread question right now, a very good question. And the answers I think are pretty counterintuitive. I'll give you the punchline of how I think broadly people should invest in

inflation. This is not advice because everyone's different, but here's what I think tends to work in an inflationary environment. And let's separate short-term inflation, which is like the inflation over the next 12 or 24 months with long-term inflation of like, how do you protect your capital for the next 10 or 20 years? The biggest, the most effective anecdote against short-term inflation over the next 12 or 24 months is the exact opposite of what everyone thinks. What works in the short term is cash. That's what works. Everyone thinks when there's high inflation, you don't want to own cash. Your cash in their savings account, your checking account is losing value to inflation. You want to get rid of that. You want real assets, real

gold and whatnot. But whenever inflation pops up and it's unexpected, everything gets demolished. Crypto gets demolished. Bonds get demolished. Stocks get demolished. Gold gets demolished every single time. So it happened in 2022, happened in the 1980s, happened in the 1970s. Short term, everything gets wiped out. The smallest declines, so to speak, come from cash. So look at 2022. We had 9% inflation and maybe your savings account yields 3%. So you lost 6% to inflation in your cash. Negative 6% real returns is what we call that. If you look across all different assets, losing 6% in 2022 was great. That's the best as you could have possibly done. Better than crypto, better than gold, not by a little, but by an order of

magnitude. Cash tends to be how you preserve your wealth in short-term inflation. Longer-term inflation, if we're talking about more than a year or two, there the verdict is pretty clear as well historically. There's basically two ways to protect your assets from inflation over the long-term. One is let's put stocks and real estate into the same bucket because that's just owning equity in real assets. And what that tends to do is not only in the long-term, not only keep up with inflation, but tends to exceed it. And you see this in the long-term inflation rate historically in the United States over the long-term over the last hundred years on average is two and a half to 3%. Stocks after inflation have returned about six and a half percent. So not only are you

maintaining it, you're exceeding it over the long term. That includes the 1970s, the 1980s, includes the last year, et cetera. Gold over the long term tends to keep up with inflation, but nothing else. And in the short term, it is a very poor inflation hedge. There's plenty of periods, even 10, 20 year periods when inflation was moderate to high and gold declined. That's what happened from the mid 1980s through about the early 2000s. So in the short or even medium term, gold tends to be a pretty poor inflation hedge. And even in the long term, it's an inflation hedge, but you're not going to exceed it. You're going to maybe keep up with inflation. So as I view this from my own money, and I think this is a good basic framework,

how do you protect yourself from inflation? Cash and stocks. The cash part is so counterintuitive to people. And it's almost like heretical to say that, that you want cash to fight inflation. But in the short term, I think that's the best you're going to do. It's not that you are going to beat inflation. It's just that it's going to decline the least relative to other assets, particularly something like gold or crypto that you think is going to be the best. And in the long term, it's just stocks. It's companies that can raise their prices in conjunction with inflation. So when airline ticket prices go up by 50%, Delta's revenue just went up by 50%, which will eventually transfer to the nominal dollar amount

of their profits over time, which is what drives stock prices over time. So that's how I think about inflation in general. I would say this, I have not changed anything about my asset allocation or how I invest in years. When inflation was low in 2020, and when it was very high in 2022, I didn't make a single change to my portfolio. Just because A, I just don't think it's a very wise way to be fiddling with the knobs in your portfolio based off of what inflation was last month. But B, it's just, I accept that there's going to be periods of high inflation. My portfolio is not always going to keep up with it in the short term, but over the long run, I have enough cash for the short term. And I have stocks that I plan on owning for the next 30,

40, 50 years that I'm very confident will not only keep up with, but exceed inflation during that period. I really just wanted to think a little bit about what companies end up succeeding through periods like this, but not just periods like this, just succeeding. So if we look at Starbucks and go all the way back to their IPO in 1992, you see the opening price or the closed price in their early days. They were somewhere around $0.34. There it is, I think, something like $0.34. So here we are, and it's $100 a share. So we can look down here since the IPO and see It's up about 300 times the value, which is a very pleasing return to get over a 30-year period, which is what it's been here for Starbucks. So 300-bagger in 30 years.

Now, a couple things to think about. All the way through, Starbucks has been steadily raising prices. I don't know what a Starbucks venti latte cost back in the early 1990s, but I can tell you it's a lot less than it does now. And they just kept inching their prices up over time, uh, because they have a, a brand and a unique offering in the marketplace, uh, because in large part, because they're such a familiar name, uh, they're, they're ubiquitous. The old joke on Starbucks was that Starbucks was thinking about opening up a Starbucks inside the men's room of existing Starbucks, uh, locations.

Um, so now some other things to remember about Starbucks, which is that it's high before the meltdown was something like $18.70 there you see in october 2006 and the low 2006 two years later was around four dollars four dollars and 30 cents so a drop from 1870 to four from 19 to four that's about an 80 drop 75 to 80 drop in the value of starbucks over those years remember this is a period before this where howard schultz was kind of i mean i think it was a mutual decision but kind of stepped aside from starbucks because the feeling was that howard had too many other interests he wanted to do he wanted to acquire and create online communities he wanted to make movies akilah the bee and and the marketplace was saying stick to the coffee stick to the coffee

it's a coffee business so that was part of the story there's a lot more uh dynamics that i know nothing about Starbucks during that period. But Howard's gone, the stock falls 80%. Howard comes back and builds the business up. And I'm actually going to mention a controversial company in stock right now that I think could go through a similar journey, actually, and that is Tesla. I think that the marketplace is getting just really disappointed in the founder of Tesla. And I wouldn't say that uniformly across all people because obviously there are strong feelings about tesla and about elon musk um and it's kind of a lightning rod these companies like starbucks apple you can look back in history they all had their lightning rod periods where everyone was talking about them

and everyone's saying this is this is a tear this is going to fail and you know what sometimes the general marketplace was right and they did fail so i don't mean to say that oh this is a this is a pattern and it's it's obvious and it's automatic but to me tesla has a unique offering and they have a founder CEO who is showing a lot of interest in other things. And for me, actually, I don't mind his interest in other business, but it's when it just starts getting so all over the place that it's just, it's just, it's too much. It's becoming a distraction. And I wouldn't be surprised if some sort of change in leadership came or some statement or clarification on what's happening there. This is a little bit of period that I think Tesla is going through where there

are a lot of questions about leadership and the stock is down from $400 a share to $100 a share. So 75% decline. Now that's actually sadly not that unique out there on the NASDAQ among a lot of growth companies, but for such a large company, it is a dramatic decline. But I believe that Tesla like Starbucks, there are very few similarities between those two business models, But powerful consumer brands with unique offerings that I believe over the long term have pressing power, that when these companies see their stocks decline so dramatically, and it happens to every great growth company, we all wish that we could own, name the great company, Amazon, Apple, Microsoft, Tesla, we all, Starbucks, we wish we could own them without going through a 50% decline. but that's why Warren Buffett has said, if you can't handle a 50% decline in the value of one of your investments, you should not invest in it because the probabilities are it will go through that period. The hard thing is that all of these companies are going through that period together.

That is the hard thing. The thing that's a little bit easier about it is when they all go through it together, you know, there are some environmental issues that are affecting all of them, that there's not a lot of discrete individual evaluation of companies and saying, this one has fallen way behind all of the other businesses out there. So I do think the inflationary period we're going through, rising interest rates and the attempt to return to a 2% to 3% rate of inflation annually is a big disruption in the marketplace, hurts a lot of growth-oriented companies, companies looking to reinvest in their business. And that has hurt the NASDAQ quite a bit. So that part of inflation, I can't say is underrated. But I do agree with you that I think

in a long-term way, I'm much more concerned about the potential spilling over of the conflict in Ukraine than I am about inflation. These things are all linked together. So to pull one out, but I think that that's a much more concerning challenge than the challenge of bringing inflation back in line. Morgan, we're going to close with one piece of investment advice that you offer to the world, knowing that there are so many different people in so many different situations that will hear this advice.

And for some, it will be so spot on. And for others, it will be just off the bullseye. But what's the piece of advice that you can give that is likely to get close to the bullseye for as many people as possible? I would say if you're interested in investing and economics and where things might be going next, spend less of your time reading economic forecasts

and spend more of your time reading history. That advice probably applies to a lot more than economics. Spend more time reading history and less time reading forecasts. I think you'll have a better view and a better grasp of the future, ironically, if you do that. I love that.

For me, I'll say Shelby Davis Sr. was an investor for really the second half of his life. I think he really began investing in his early 40s and I believe he died in his mid 80s. So he had about a 40 year period. Now, he did have low interest margin access at his brokerage firm, and he did use that. So I don't want to suggest, for those of you who already know where I'm going, I don't want to suggest that this is an achievable return by everyone.

He was working the levers. But here is a little bit about Shelby Davis Sr.'s journey. He started investing in his 40s. He had $50,000. And his philosophy was to always be buying companies that you believe in for the long term obviously to accept some of his companies went down all the way down to zero i believe he had a company worth a couple million dollars in his portfolio that went to zero started with fifty thousand dollars a couple million think of we're talking you know sort of 1940s to 1980s

is the time period the 40-year time period so starting fifty thousand makes his way forward and one of his principles is i'm never going to sell i'll take the dividend some companies are acquired, I'll get cash that way, but I'm not going to sell. And that's going to cause me to work hard to try and decide what to buy. So I'm pretty much not going to sell. The best time to invest is right now. And the best time to sell is never. That's kind of Shelby Davis barbell principles there to his investment style. In the 1970s, inflationary period by the stock market, the Dow Jones industrials fell 45%. 1973, 74. Shelby Davis senior's portfolio it was down 75%. Market was down 45%. He was down 75%. All told, from the first investment

he made in the 1940s to the end of his life, he turned $50,000 into $900 million through the power of compounding. You're always investing. Now, again, utilized margin, low interest margin. We really don't do that at the Motley Fool. And most people don't have access to like 1% margin costs. So what if you, if you, I haven't done the work. So, but if you were to remove all of the use of margin, it started at $50,000. I'll say he at least had 75 million. Let's just say that. And so, and who needs, anybody need more than 75 million? So the key for all of us, no matter our situation is to stretch out our time horizon and to think about creating multi-generational wealth where your children and their children, even if they're

not interested in investing, they don't have to be passionate about it. If you are, we all know that I've always loved the Warren Buffett, uh, thought about succession and who should be the next, uh, CEO. I think he said something like, you know, should John Elway's son be the next quarterback of the Denver Broncos? Like, I don't think that's a smart way to do succession planning. um so so um but all of us can learn to use index funds save put money away and let it compound over a long period of time and allow for the really difficult years and i don't mean to minimize what's happened last year and certainly my portfolios that i managed at the molly pool my personal portfolio are down significantly certainly down 40 to some the ipo portfolio

i managed down 60 most of the portfolios i managed are somewhere down between 35 and 30 to 50 percent um even though we're deploying cash and even though like still looking at some of these companies just seeing them it's a painful painful thing to go through but um we started with morgan asserting that it's not unprecedented and i guess i'll close with my agreement that it's not unprecedented as painful as it is and if it's not unprecedented there must be patterns and there must be information that we can find to help us make smart decisions and stay in the game of investing for the rest of our lives. Morgan, thank you so much for spending this time with us and look forward to more of these conversations together in 2023.

Thanks, Tom. It's been fun. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. for listening. We'll see you tomorrow.