The Compound and Friends - Burn It All Down (with Josh, Michael, and Ben Hunt)

Episode Date: November 16, 2019

Ben Hunt joins Michael Batnick and Downtown Josh Brown at The Compound to explain what he's so angry about - he sees wealth inequality as being driven by hijacked narratives about capitalism, stock buybacks, central banks and the managerial overclass orchestrating it all. Follow Ben on Twitter: https://twitter.com/EpsilonTheory Stay up to date on Ben's thoughts: https://www.epsilontheory.com 1-click play or subscribe on your favorite podcast app   Subscribe to the mini podcast on iTunes or Spotify    Enable our Alexa skill here - "Alexa, play the Compound show!"   Talk to us about your portfolio or financial plan here:  http://ritholtzwealth.com/   Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer: https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey, it's Josh Brown. I'm here with Michael Batnick. We are live from the compound with Ben Hunt, the founder and creative genius behind Epsilon Theory. Ben is very angry and we're going to find out. Well, sort of angry. We're going to find know we pulled you off the farm in what I call pastoral Connecticut. That's right. How often do you come into the city? You know, probably a couple of times a month. All right. A couple of times a month when I have to. Well, we appreciate you coming in. Thank you very much.

Anything for my godfather, Josh. Okay. So I'm going to get right into it. I'm worried about you. Should I be worried? No. I mean, I've always kind of been an angry guy and sometimes you know the the blood pressure but not in person you're angrier online than in real

life like everybody i think like everyone right yeah yeah yeah okay that's fair that's for sure okay so here's what i want you to do um and leave room for for later but like in a concise way why are you so fired up right now? I feel like the blog has gotten a lot of momentum. People are, even people that disagree with you, they're still talking about what you're saying. And I think that's powerful to a certain extent. But what's going on? The reason I'm angry, and I've always got this kind of simmering inside me, right, is that, and here I'll do one of my literary allusions here that I like to do. I like that.

But it's an old school literary allusion. So it's Cat on a Hot Tin Roof, which is a Tennessee Williams play, right? And Big Daddy and Cat on a Hot Tin Roof, he's always railing about what he calls mendacity, right? The mendacity of the world. Right. And that's what's got me angry too, because what I see are all of these, I'm going to use my terminology, are narratives, right? Whether it's around stock buybacks, which I know we'll want to talk about, right? Or, you know, anything to do with finance,

right? And what I find is that, yes, I believe in all of these narratives, right? I'm a capitalist, I'm a patriotic guy, I'm all of these things. I really am, right? What I find is the mendacity, the way that these narratives are being gamed by management, if we're talking about, you know, stock buybacks and the like, right? By the way, more broadly, I think that these narratives are being gamed by politicians. And by politicians, I include central bankers, right? The way that these narratives, I think, are being gamed by the rich. So is this about income inequality? Or is this about wealth inequality? So is this about income inequality or is this about wealth inequality? Because this is not a red versus blue thing.

It's absolutely not a red versus blue thing. Okay, I understand that. Yeah, and if you'll see in my writing, I mean, I'm at least as anti the Democrat mendacity as I am the Republican. Right. So the root of all of these posts you're doing, talking about, I think your latest post was the age of the high functioning sociopath. Yeah. Yeah. A lot of this is just coming from this idea that all of the disparities in society and all of the anger all around us, the root cause of it is a specific class of people who outsmarted everyone else and have figured out how to continuously engineer society and economics and politics so that they keep pulling more of the chips over to themselves. So it's getting worse.

It's the C-suite. It's central bankers and it's politicians. Yeah. I mean, those are examples, right? It is absolutely part of human nature, right? And I'm not saying that we're ever going to do away with fear and greed, these eternal things. What bugs me, you know, you asked what was making me angry though, And it's done under cover of rules and ideas and stories, narratives that I think are important. Give us an example of one of these narratives. Let's get right into stock buybacks.

Please. Because I think that's a really good one. Look, I'm a fan of stock buybacks. So I used to run a hedge fund. fan of stock buybacks, right? So I used to run a hedge fund. And I loved it when my companies, and we'd always recommend this to them, the management, why don't you buy back your stock with the cash you've got? I like that so much more than management that does some cockamamie acquisition, right, to spend the money or do something that's just nuts, right? I love it.

Say, no, no, buy back your own stock. Let's get the accretive power of the stock buyback, all the good things that come from a stock buyback. So what's changed? What's changed is that, well, even back, so I was running the hedge fund from, call it, you know, 05 till, you know, 2012, right? And what started to change even on the last years of that fund,

really started to change after the GFC, right? But it really accelerated over the last three to five years is management issuing themselves so many shares in restricted stock units, stock-based comp of some sort, right? So that the stock buyback, and again, this has always happened to a small extent. What's bothering me now is just the massiveness of it, right? So that the stock buyback is used to sterilize the issuance of shares. Okay. So that this story, oh, we're oh, we're returning capital to shareholders.

That capital never gets to the shareholders if it's used to buy back shares that have been issued. So rather than shrink the float, the amount of shares outstanding, what they're doing is they're issuing more stock for themselves and then buying back the offsetting amount. Correct. And you acknowledge that. Cisco was doing that 25 years ago.

Here's the difference. Yes, there were some companies, particularly tech companies that have always done this. And in a sense, I'll say, trained their investors to expect that. Right. And then even I'll call it more value oriented companies, right, would do some of this, right? Because the tax laws changed in terms of how much of cash compensation you could – was tax deductible. And so when that changed, people started saying, oh, well, we need to align our interests. What I'm talking about is the agency problem. And the agency problem is never going to go away. The agency problem has always been there.

But what bothers me is that these companies – I'll use – I don't know. GE is an example, right? So GE would issue stock-based comp to its executives and its employees. That's the other thing. I don't know how much of this stock-based comp is widely distributed. So I think that's really important because you write a lot as if it's just management. And I think it's much wider than that. Obviously, they're taking the biggest piece of the pie. So this is important. So shares outstanding only fell just over 1% a year from 2011 to 2018. So the net buyback, there was a lot of issuance and a lot

of buyback, net dilution, not so much. So your point is that this management, they're just taking it from our children, basically. My point is that in the past, when management would sterilize its stock issuance, a lot of companies did this, right? So they'd say, all right, yeah, we issued X hundred thousand shares to employees. We bought back that number of shares, right? But it was not described as giving cash back to shareholders. So your beef is with the narrative? My beef is with the narrative and the way that the narrative is being, again, gamed by management to dramatically increase the amount of compensation

they are paying themselves through stock issuance of one form or another. So what do you think is motivating people that work in finance who are not on the receiving end of billions in buybacks directly, but they're investing on behalf of their clients, and they do have some real points about, hey, you know what would be worse than buybacks? To your point, reckless M&A, reckless CapEx, and all of the various ways that money can just be wasted. So when I say banned buybacks, I am not at all comfortable with any of these flamethrower ideas. I'm really not. My problem, though, is that these are not mean reverting phenomena.

This is not something you can kind of tinker with at the edges or kind of say, hey, guys, would you mind not giving yourself, like Microsoft of their, however many, $15 billion buyback last year? 80% of that went to buyback shares they issued. So maybe are you more in favor of banned stock-based compensation? Well, see, but that's the other side of the coin, right? And I'm not really in favor of that either, right? But I don't know how to, I feel like you've got to attack one end or another of this problem, right? And I don't know which of those ends is more damaging to take a flamethrower to. I really don't. Microsoft is now a trillion-dollar company, and shareholders have done extraordinarily well. So who is being hurt by this? And I think your answer is it's not a financial answer. It's a societal answer.

That's exactly right. Okay. But let me make a financial answer first, right? Because I think you guys occasionally like to go to a casino, right? Not me personally. No, really? Yeah, Michael. Yeah, yeah, yeah.

Right, right. Me too. Me too, right? So if you go to the casino and you play poker, right, you're playing a zero-sum game with the other players around the table. Why not just buy the NASDAQ? Just buy the Qs. Why gamble?

All right, go on. Because it's entertaining and fun, right? But what does the house get out of it? They get the rake, right? They'll take a couple of dollars out of every pot. And if it's a really big pot, they might take $5 out. If it's a medium pot, they might take $3 out. But it's a small amount of that pot, right?

What I'm describing, what a lot of companies are doing today, it would be as if the house, right, was taking a quarter of the pot, or 50% of the pot. So that's my economic argument about why as shareholders, you should be upset. You're saying you could have made more. But it's hard to quantify. So but stock-based- Well, no, it's actually not hard to quantify because you can actually measure the number of shares, the money that the company took in, so the price for the dilution of those shares. But they're boosting earnings per share, though, by doing that.

So I was about to say, can we see- But you are diluting through the issuance more than you are accreting through the buyback on a dollar-per-dollar basis. Because you're selling the shares back to management at a much cheaper price than you're buying them back from the public. Have you looked at total stock-based compensation as a percentage of free cash flow or earnings? Yes. And has it grown dramatically? It absolutely varies by company. Some companies have always had a ton of, you know, SBC, right? But that's another issue with SBC. So stock-based comp, what you see on the income statement, right, that is based on what you have, the fair market value of what you've issued this year, right? It's not necessarily what's been vested

or granted or any of that. What I'm talking about, what I'm looking at, is when the rubber meets the road of actual stock issuance, of when management says, yes, give me that share of stock. And then what happens to the float? You were talking about it before in terms of how much is issued and how much is taken out. And to answer that question, I find that it is inextricably bound up with stock buybacks for a lot of companies, right? That in order to start giving so much more shares to themselves as management, you've got to find some way, if you haven't trained your shareholders to expect that, like Cisco did back in the day, and Salesforce.com does today, right? If you haven't trained your shareholders to say, oh, yeah, that's great,

then you've got to do bigger and bigger stock buybacks just to sterilize that, just to mask it. That's what I've got a problem. So let's get into the impact of all of this. It should come as no surprise if the populace is as angry as we think it is, or at least as angry as it sounds online. Like, is this one of the root causes for why we get Donald Trump followed by literal socialism on the ballot for 2020? Is the buyback thing and the wealth inequality that you're saying is engendered by that, is that one of the root causes for the political volatility? So I think we've got three things going on. This one that I'm talking about, right? And I think nobody really knows about it.

That's right. I think that's why it's created kind of a stir to the degree that I can create a stir is that people say, oh, yeah, we've known about this kind of sterilization for a long time. I had no idea it had grown to the levels that anyone who wants to go through a 10K can document. to the levels that, you know, you can, anyone who wants to go through a 10 K can document. So you have, so 99.99% of Americans are not downloading a 10 K and then calculating. Correct. It's not hard. I mean, it's not advanced math, right? But it's not easy to do on, on, on a screen. So what I'm not saying is that this is, you know,

something that people are up in arms about. I think they should be, but they're not. There are two other things, though, that they don't understand. I think that's right, Josh. They do understand that the CEO is making 225 times the lowest paid employee, and 20 years ago it was more like 50 times. You must have loved Jamie Dimon last night. Oh, my God.

On 60 Minutes, $30 million a year, and he said the board sets his pay. He's the chairman of the board. He didn't mention that. See, that's a big problem. So I do think there are things. I'm going to get to your question, Josh, about the other two big things that I think are driving what I like to call the widening gyre, this polarization of politics all around the world, right? Not just in this country. of politics all around the world, right?

Not just in this country. But to your point, I think there are some things that we can do to address this issue that I'm talking about. All right, solutions, what do we got? So one is that there shouldn't be CEOs who are also chairman of the board. That was also the problem at Boeing, right? Which is a company I wrote about recently.

That seems commonsensical. And yet it's not out there. So what else? In a perfect Ben Hunt world, what do we say? Two other things. Two other things. One, the board of directors, they should not be getting stock-based comp. Right?

The directors who are there to act on behalf of shareholders and approve these plans. Shouldn't they be shareholders? They should get cash comp. And if they want to buy stock, absolutely, go buy stock. What I'm saying is they shouldn't get options and restricted stock units. That's what I'm saying. They should be salaried. Correct.

The people that are on boards of directors, though, will not do this for cash comp. They don't need to pay more taxes. They don't need the money. They're CEOs of other companies. Which is a problem, right? And it is an old boys network, right? It's the fox in the henhouse. It's exactly that.

It's log rolling. There are two ex-CEOs on my board, so they'll scratch my back, and I'm on the board of these other two. I'll scratch their back. So what's the third solution? The third solution is that I believe directors, so long as they are on the board, should not be allowed to exercise options in restricted stock units.

They should have to wait until after their term. Until they're not in a position to actually legislate for the company the sterilization and the buying back of those shares. So those are the three things that I think are kind of, to me, they seem common sense. We can legislate that, potentially. Absolutely.

Not now we won't, but somebody might. Which is the issue where then you end up, I think, and I'm not comfortable with it, but I get it. You get to the flamethrower solutions of, well, just ban stock buybacks. But I do want to get back to the two, I think, things that most thinking human beings recognize as driving this wealth inequality, right? And I've been talking about the stock buyback and the enrichment of the managerial class, right? The Tim Cooks of the world, the Jamie Diamonds of the world, who are now freaking billionaires, right? Not because they started a company or, you know, they're great. They're good managers. They're managers, right? And now they're billionaires, right? But I think the thing that everyone sees,

two things, tax policy, the 2017 Tax Cuts and Jobs Act, right? I mean, what was that except a redistribution of, you know, borrowing to make up those tax revenues and giving it back to corporations. But these people actually spoke out against that. I don't think Jamie Dimon was in favor of that. I'm not saying that Jamie Dimon was particularly in favor of the tax, but I'm not sure he wasn't. We should check the tape on that, right?

We should really check the tape on that. The other thing, though, is monetary policy, right? And it's when the price of money is so cheap for corporations and the very rich, but it ain't so cheap in the real economy. And it's not having the impact in the real economy that the Fed and policymakers thought it would. This permanence of extraordinary monetary policy and low rates, it is absolutely exacerbating. Can I take the other side of that? Please, of course.

If you look at the housing market, that would be a big counterpoint to what you're saying. You can borrow, you can take a 30-year mortgage out with just decent credit, somewhere around 4%, at certain moments, slightly higher, slightly lower. But you've been able to do that for seven or eight years, which I think is important now, given how many people in their 30s have not yet bought their first home. And I think like the whole housing recovery that's now in its 11th year, would argue against the regular people not getting any benefit from monetary policy. So the financing of your home is certainly easier, right? Well, starter home sales this year have absolutely exploded. It's one of the hottest segments. I don't think that's for rich people. And yet, when you look at household formation and the like,

it's still way down in the dumps. We need it to get better. So you saw the, I'll call it the housing bubble. When you look at the share of household wealth in this country, going into the housing collapse, housing prices, your home, was the largest chunk of household wealth, by a large margin, much more so than financial markets. Yes. Right? That has changed, right, since the great crisis. You are right that the equity in your home, the value of your home, was then and remains today for most people. Yeah. That's their wealth, right? Yeah, they're not going to have stock market wealth. What I'm saying is that great wealth, right, becoming centimillionaire, merely a decamillionaire, right, much less the billionaires of the diamonds and the cooks and the managers.

So that can only be accomplished with the stock market. Correct. Okay, we agree. Correct. And this is what bugs me, right? I mean, everyone is better off from ultra-low interest rates and the like. It's this – and this is the rationale behind the tax cuts too. It's all part and parcel of the trickle-down theory of how money should be handled in our society.

It started with Ronald Reagan and it's still today. What bugs me again, the mendacity is that people don't seem to realize, but I think they're getting it, that monetary policy of keeping these rates really low for so long is a form of trickle down economics. Okay, let's say the Fed stopped managing rates at all, and they let it be a market rate. Where do you think it just where? So Fed funds rate, I think is one and a half percent now. Right? Where would it be? 1.75? I think the Fed funds rate. So where 1.5% now, right? Where would it be? 1.75, I think, of the Fed funds rate. So where would it be if they just said, you know what, let the market decide what people can borrow from the government at?

You think it would be materially higher? The market is deciding. Well, the market is just not the Fed funds rate, but farther out the curve, right? And it's not much higher then. But you're right because we've got close to an inverted yield curve and all like that. I think in large part because it's not just monetary policy as in setting what the overnight rate is, but it's also what you're doing with your balance sheet, right? Because that does affect farther out down the curve.

So you think there's like a debt for equity swap happening all over corporate America? Yeah. I mean, yes. Okay. Yes. Ben, we really appreciate you coming on. And when I say I'm worried about you, let me just wrap up by saying I think you're one of the best writers writing about finance right now. I read all your stuff.

Thank you, Josh. I see the font sizes starting to get bigger. And some of them 16-point font and then also bolded. And I just say, we need Ben to stick around. We need Ben around in this world. So that's the only reason why I say that. But I appreciate coming on. How can people read more of your stuff? Where do you want them to go to follow you?

Epsilontheory.com. Sign up for free emails. We'll have links to that. Fantastic. And on Twitter, you are? At Epsilon Theory. Amazing. You make it so easy for us.

Yes, that's right. Thank you so much for coming on. Thank you, Josh. It was a blast. Thanks, Michael. Thank you. Hey, if you liked what we said, go ahead and let us know. Make sure you give us a like.

Make sure you're subscribed to the channel. Follow Ben Hunt, and we will be back with you soon.